The construction sector in Poland

March 2014 | EXPERT BRIEFING | SECTOR ANALYSIS

financierworldwide.com

A few years ago, when Poland started one of the largest construction projects in Europe involving billions of euros of contracts, every civil engineering firm involved in such projects expected to benefit. The country’s stable political situation, funds granted by the European Union helping to finance such infrastructure projects and the country’s decrepit highway network following decades of communism seemed to offer great opportunities for Polish and European companies.

However, the drop in net profits of Polish construction companies in 2012 and 2013, along with bankruptcy statistics, paint a completely different picture than was generally expected.

According to a Deloitte report, the earnings of the 15 biggest Polish companies decreased in 2012 by 17 percent compared to 2011. 2013 did not bring any improvement in this respect. Moreover, many large Polish construction companies are either in bankruptcy or struggling financially.

Statistics collated by Euler Hermes Collections based on the information announced in the Business and Economic Journal show that 273 construction firms went bankrupt in 2012, with 253 bankruptcies in 2013.

At the end of December 2013, the General Directorate of National Roads and Motorways (GDDKiA),the central Polish government body responsible for national roads,terminated the contract with one of the largest Polish construction companies, Polimex-Mostostal S.A., for the construction of the S-69 express road. In January 2014, the GDDKiA terminated the contract with Polimex-Mostostal S.A. for the construction of the A1 Rzeszow-Jaroslaw section and the A4 Strykow-Tuszyn section.

As recently as 2012, Polimex-Mostostal S.A., which is viewed by the Polish government as ‘too big to fail’, was rescued by the Industrial Development Agency (ARP). ARP purchased the newly issued shares in Polimex-Mostostal S.A. for roughly €35m (150m zloty) and two of Polimex-Mostostal S.A.’s subsidiaries and the company’s real estate for €38m (162m zloty). Barely any time passed before Polimex-Mostostal S.A. was in trouble again.

Polimex-Mostostal S.A. is not the only large Polish construction firm experiencing serious trouble after entering a contract with the GDDKiA for infrastructure projects. Other firms, such as Dolnośląskie Surowce Skalne S.A., Poldim S.A., Hydrobudowa Polska S.A., Aprivia S.A. and PGB S.A., filed for bankruptcy in 2012. The bankruptcies of the big companies had a domino effect on smaller ones usually acting locally as subcontractors. Thousands of people lost their jobs in the construction sector.

But Polish companies are not the only ones in trouble after dealing with the Polish government in road construction projects. Several foreign civil engineering companies – such as the Austrian company, Alpine Bau, Czech company, Boegle a Krysl, and Irish company, SIAC Construction Limited – are also in financial difficulties after the GDDKiA rescinded or terminated its contracts with them and exercised the given performance bonds.

Also, Chinese company China Overseas Engineering Group Co. (Covec), a subsidiary of China Railway Group, one of Asia’s largest construction and engineering companies, lost a construction deal in Poland when the GDDKiA cancelled that contract after payment disputes.

Currently, several contractors are in legal battles with the GDDKiA trying to recover millions of euros they claim that GDDKiA owns them due to groundless termination of contracts and illegal exercise of performance bonds. The situation in the construction sector in Poland was even brought to the European Commission’s attention, which investigated the way the European funds were handed out by the Polish government.

So what went wrong? Most importantly, who is to blame for the difficulties the Polish construction sector is experiencing? The general constructors and GDDKiA are pointing fingers at each other. But the problem is more complex than one may expect.

The contractors argue that the GDDKiA did not do its job properly when preparing the planning and construction documentation for specific projects. Moreover, the GDDKiA often failed to prepare the site in a timely manner and handed over the latter to the contractors with significant delays. In many cases, the contractors could not start the work because neither the required construction nor environmental permits were issued by the administration.

Another factor that the construction companies are highlighting is the exorbitant rise in prices of construction materials in Poland, caused mostly by enormous demand from the accumulation of a large number of construction works in the region. The contractors indicate that the road construction contracts were signed at a low margin, so after the unexpected rise in construction material costs (in some cases ten-fold), such contracts were no longer profitable. Most of the companies tried to renegotiate the contracts based on the unexpected increase in prices in raw materials. But GDDKiA in most cases rejected such attempts, insisting that the works be completed at the prices agreed in the contracts.

Here comes the real problem. Poland does not incorporate into its contracts theprovisions set out by the International Federation of Consulting Engineers(FIDIC), which divides the risk equally between the parties. The general terms of a contract revealed by the GDDKiA at the time of bidding are not negotiable and the companies have no choice but to accept them or walk away. So, the bidders accept the general terms hoping that they will be able to renegotiate them when they negotiate the proper contract. However, the contracts imposed by the GDDKiA lacked MAC clauses, often offloading the risk on the constructors, making them assume the risk of possible project changes, supplementing documents and land repossession.

Polish law and procurement methods also come in for widespread criticism. The contracts are awarded on the lower price criterion. As there is intense competition in the market, many companies bid below the real construction costs or with a low profit margin in order to win the tender. Covec’s offer to build the two sections of the A2 Motorway was lower by almost 50 percent than the GDDKiA had estimated.

Unprofitable contracts for the contractors and the GDDKiA’s inflexibility in renegotiating them usually result in the rescission or termination of the contract by one or both parties. Subsequently, the GDDKiA exercise the bank or insurance guarantees issued for the benefit of the constructors while the contractors take legal action to block such actions. It is estimated that the total value of contractor claims against the GDDKiA exceeds €2bn.

Many market analysts believe that the worst years are behind for the Polish road construction sector. Despite its bad international reputation, the GDDKiA is not concerned about the lack of interest in tenders organised for different infrastructure projects. Surprisingly enough, more than 20 companies usually line up to participate in the procurement procedures organised by the GDDKiA. According to the National Road Construction Program for 2013-15, approximately €10bn will be allocated for road construction in Poland and 50 tenders are on the table. But this leaves us with the question of whether large European construction companies will still be interested in becoming involved in Polish infrastructure projects.

Joanna Gasowski is an associate at K&L Gates Warsaw. She can be contacted on +48 22 653 4200 or by email: joanna.gasowski@klgates.com.

Joanna Gasowski

K&L Gates Warsaw