Tales from the National Appeal Chamber: Requiring additional evidence is an unreasonable barrier to fee indexation
The last two years in the public procurement market have been stormy. The Covid-19 pandemic and the war in Ukraine have caused a steady and dynamic increase in the prices of materials and services, and disrupted supply chains, translating into record inflation rates and unprecedented fee increases. With this tough economic situation directly affecting the market, contractors have faced the difficult task of indexing their fees in public contracts. The National Appeal Chamber, which hears challenges in public procurement matters in Poland, gave essential guidance on this issue in its ruling of 28 November 2023 (case no. KIO 3389/23).
Unlawful contractual provisions
The National Appeal Chamber’s ruling in case no. KIO 3389/23 arose in a fascinating project—construction of the new building of the Polish Antarctic Station. In the dispute, one of the prospective contractors challenged several provisions of the proposed contract, alleging that they were inconsistent with the Public Procurement Law or improperly worded:
- For the annual indexation rate, the contract indicated the “price index of consumer goods and services” announced by Statistics Poland, but the appellant argued that under Art. 439 of the Public Procurement Law, indexation may occur no more frequently than once every six months.
- The contracting authority reserved the right to demand additional evidence from the contractor to prove that the indexation is justified, but the appellant asserted that imposing additional requirements was an unreasonable barrier to indexation.
- The contract stated that the fee change would take effect from the month in which the request for indexation is filed, but no earlier than the month following announcement of the underlying rate by the president of Statistics Poland—however, the rate is published once a year, and a request for indexation can be submitted every six months.
- The contracting authority limited the maximum level of fee indexation to 5%.
Pursuant to Art. 439(1) of the Public Procurement Law, relied on by the appellant, any contract for construction works, supplies or services concluded for a period exceeding six months must include rules for modifying the contractor’s fee in the event of a change in the prices of materials or costs of performance. The appellant argued that the purpose of this provision is to ensure adequate compensation when there is a change in prices or costs, and its application is mandatory. This means that the provision cannot be modified in the contract, and the contract cannot be worded in a way that would circumvent this provision.
The purpose of indexation clauses
In its deliberations, the National Appeal Chamber pointed out that the essence of Art. 439 was to oblige contracting authorities to adopt realistic indexation of contractors’ fees. Citing previous rulings, the chamber asserted that the aim of indexation clauses is to maintain an effective and fair economic balance between the contractor and the contracting authority. This means setting the rules for increasing the fee so that when contract performance is stretched out over time, the contractor is compensated as much as possible for the decreasing value of money as a result of receiving deferred payments.
The chamber also stressed the conditions under which public procurement has been carried out in recent times. It is no secret that Poland has suffered from a steady, rapid rise in prices of materials, services, and wages over the last couple of years. These increases make it vital to examine how contracting authorities provide for indexing of contract fees, and whether they can guarantee to compensate contractors for the increase in costs they must incur in connection with performance of the contract. As indicated in the National Bank of Poland’s inflation reports, high inflation has a big impact on the costs incurred by contractors. In turn, using indexation clauses in a public contract which do not realistically reflect cost increases may discourage potential contractors from bidding for the contract. Thus, the contracting authority’s unilateral insistence on provisions shifting this risk solely to the contractor may result in failure to perform the contract. According to the chamber, the current geopolitical and economic situation, including Russia’s aggression against Ukraine, further increases economic uncertainty, reinforcing the need for effective indexation mechanisms that will not upset the balance between the contracting parties.
Clauses should maintain the economic balance of the parties
The National Appeal Chamber upheld all the allegations raised by the appellant in this case. First, the chamber shared the appellant’s reservations about the 5% limit on indexation specified in the contract. The chamber found that such a limit violates public policy and is contrary to the nature of the legal relationship. Given the high inflation rate, which is likely to last for the period of performance of the contract in that case (until 2027), it was considered reasonable to raise this threshold to 15%. This is intended to ensure the economic balance of the parties to the contract—not to shift the balance to the contractors’ disadvantage, but also to ensure that an excessive increase in the fee does not cause negative consequences for the contracting authority. The contracting authority failed to show that the indexation limit was dictated by problems in obtaining financing, and this further supported raising the limit.
If a rate is published once a year, adjustment every six months is barred
The chamber also observed that the existing construction of the indexation clause in the contract prevented the contractor from effectively requesting indexation every six months. The contract stipulated that the fee change would take effect from the month in which a request for indexation is filed, but no earlier than the next month after the CPI announcement by Statistics Poland, and that is published once a year. The chamber correctly noted that a clause based on a rate published once a year will effectively render the contractor’s right to request indexation every six months illusory.
In view of the dynamics of price changes, the chamber found that it was advisable to introduce a semiannual rate, that would allow a more adequate response to cost changes.
What is an effective indexation clause?
The National Appeal Chamber shared the appellant’s objections to the provision that made indexation of the fee contingent on the contractor’s submission of evidence confirming an actual increase of the contract performance costs. The chamber found that this construction posed a barrier to indexation of the fee, upsetting the balance between the parties and constituting an abuse of law by the contracting authority. Indexation clauses should contain clear and effective provisions allowing legitimate indexation in response to changing market conditions. Contractual indexation can be an effective mechanism only if the contract includes rules for modifying the contractor’s fee in the event of changes in the prices of materials or costs related to contract performance. It is necessary to state precisely the level of change in prices or costs entitling the parties to demand a change of the fee and, above all, the method of determining the change in fee.
The National Appeal Chamber mentioned as examples of effective indexation formulas those based on the rate method (linked to various possible indicators published by Statistics Poland), the basket method (based on indicators for selected elements that mostly drive costs), and the comparative method. Either way, the formula must be carefully considered, precise and verified, first of all from the cost estimate point of view, so that later it will be feasible and actually bring the expected result for the contractor.
Conclusion
The reasoning for this ruling by the National Appeal Chamber points to the need for more effective and fair indexation clauses in public contracts. The key is to provide mechanisms that actually compensate contractors for cost increases, which is especially important in the current economic conditions. Such changes will maintain the economic balance between the parties to the contract and ensure fair conditions for performance of public contracts.
Gabriela Kobyłecka, Infrastructure, Transport, Public Procurement & PPP practice, Wardyński & Partners
