Contractual relations are typically associated with construction. However, contracts are also common in design and repair work.
Each participant in the construction process sees the project and their role in it differently. The designer creates the project, the contractor brings it to life, and the client is responsible for inspecting, accepting, and paying for the work. This creates a web of legal relationships.
In this article, we have selected what we believe to be the five most interesting Supreme Court rulings on contractual relations over the past few years.
1. Budget Overruns and Legal Consequences
In Supreme Court decision no. 3-2-1-89-12, the issue of budget overruns was discussed.
In practice, two types of budgets are used: fixed and floating. This may raise a reasonable question: who is responsible if the budget is exceeded, and how should this be addressed?
The Supreme Court concluded that it is unacceptable for a contractor to carry out additional work without negotiating or informing the client about the price changes, as this places the client in an unfair position where they are unilaterally asked to pay.
The Supreme Court ruled that, by default, the budget is assumed to be fixed. In cases of significant overruns of a floating budget, the contractor has the right to demand additional payment only if the budget overrun was unforeseeable. In this case, the contractor must immediately notify the client about the significant overrun. If the contractor fails to notify the client, they are entitled to claim payment beyond the budget only up to the amount of the client’s unjust enrichment.
In an earlier decision, no. 3-2-1-79-08, the Supreme Court also addressed budget regulation and concluded that in cases of budget overruns, the parties are not bound by the agreed rates, and market rates will be applied instead.
Determining market rates is usually done based on similar price offers or through an expert evaluation. In dispute situations, the client typically tries to lower the cost of the exceeded budget, while the contractor aims to increase it, which can eventually lead to litigation.
Summary:
- It is important to agree on whether the budget is fixed or floating. If this is not clearly agreed upon, the budget will be considered fixed.
- If the contractor sees that the floating budget is being exceeded, they must immediately inform the client.
- If the contractor fails to notify the client promptly about the budget overrun, market rates will be applied rather than the rates agreed upon in the contract.
2. The Use of Good Practices
In Supreme Court decision no. 3-2-1-59-13, the issue of the significance of good practices in determining contract terms was considered. In this case, the parties entered into a contract and agreed that issues not regulated by the contract would be resolved based on the General Conditions for Construction Contracts (ETÜ).
The court ruled that the ETÜ serves as a recommended standard, used in the field of construction contracts as a good practice. However, it is not material law that the court would apply independently of the parties’ claims.
In practice, other construction good practices, such as the Finnish RYL standards, are also used. These standards set general quality requirements for construction work. In Estonian contract law, the RYL standards are often applied.
The parties may specify the quality of work in the contract, but this is often not necessary, as it can make the contract overly detailed. Detailed contracts are drawn up when it is critically important for the client that the work meets a specific quality standard, and lower quality would be unacceptable (for example, if the client requires that wall leveling must have a maximum deviation of 5 mm, and any deviation from this standard would be considered substandard work).
To define the quality of work, a reference to commonly accepted standards is often sufficient. This becomes an integral part of the contract, and in case of a dispute, the quality of the work can be determined based on the referenced standard.
If no quality standard is specified by the parties, the court will determine the standard based on law. The law states that the quality of work must be at least average (Law of Obligations Act, § 77, subsection 1). The law only defines quality abstractly, while the final determination of the work’s quality will be made during a specific dispute.
Summary:
- To avoid disputes about work quality, good construction practices can be used, or the expected quality of work can be specified in the contract.
- If the parties do not specify the quality of the work, the law applies, which sets a general rule that the quality must be at least average.
3. Preparatory Work and Liability
In Supreme Court decision no. 3-2-1-32-12, the court considered the contractor’s liability when performing work after the preparatory work was carried out by a third party.
According to § 641, subsection 1 of the Law of Obligations Act, the contractor is not liable for non-compliance with the contract if the issue was caused by the client’s instructions, defects in materials purchased by the client, or preparatory work performed by a third party, provided the contractor exercised sufficient control over the instructions, materials, or preparatory work. In other words, after completing their own work, the contractor will not be responsible for the work of third parties if they ensured that the preparatory work allowed for the proper execution of their subsequent tasks.
The Supreme Court emphasized that the contractor must check whether the preparatory work is suitable for proper performance or if there are defects that jeopardize the compliance of the contractor’s work with the contract. The contractor must inform the client of any deficiencies in the preparatory work.
The nature of this issue is that in construction, each specialist has a specific role. Usually, many companies and specialists work on the same site, each handling their own area. Therefore, it is important to assess the technical feasibility of performing the next stage of work before proceeding.
Summary:
- The contractor is not liable to the client if they have ensured that the preparatory work is suitable for continuing the project.
- If the contractor finds that the defects in the preparatory work prevent the proper completion of their tasks, they must inform the client. If they fail to do so in time, the contractor becomes liable.
4. Partial Acceptance of Work
In Supreme Court decision no. 3-2-1-126-13, the court explained that refusing to accept the entire work may contradict the principle of good faith if the work can be divided into parts and the acceptance of part of the work, without significant defects, does not harm the client’s rights. If the work is defective and the client cannot cancel the contract, they can claim compensation from the contractor.
This ruling is useful when part of the work has been completed with defects, but another part is acceptable. To resolve the issue of whether the work can be divided into parts, a technical expert’s opinion is usually required.
Partial acceptance of work is primarily in the contractor’s interest. This allows them to reduce their liability, despite defects in the work. The client’s main interest is to receive the completed work. The Supreme Court points out that in such situations, the principle of good faith can be applied to balance the interests of both parties.
Summary:
- The acceptance of contractual work can be partial. It is important to evaluate whether the work can be divided into parts and if the client can accept part of the work.
- A technical expert’s opinion is usually required to assess the possibility of dividing the work into parts.
5. Contractor Liability and Limitation of Liability
In Supreme Court decision no. 3-2-1-177-11, the court addressed several aspects of contractor liability.
First, the Supreme Court found that the contractor’s liability can be limited in the contract in a way that differs from what is stipulated by law.
The law allows the parties to agree otherwise than provided by law. The limitation is that the contract terms must not conflict with good practices or mandatory legal norms.
Second, the contractor cannot avoid liability by referring to the client’s instructions if following those instructions led to a violation of construction regulations.
Third, the contractor cannot justify substandard work by citing the client’s insufficient supervision.
Summary:
- The contractor’s liability can be limited by contract, providing more opportunities for liability exemption. However, the contract terms must comply with the law.
- The contractor’s liability arises even if the other party acts improperly: if the client gives incorrect instructions and following them violates construction regulations, or if the client’s supervision is inadequate.
Author: Attorney-at-law Ilya Zuev
The article was published in Delovye Vedomosti, dv.ee.
