Croatian legislation in the field of construction mostly encompasses the following laws:
The Special Construction Customs (Posebne uzance o građenju) is also an important source of rights in relation to construction contracts. These rights are applicable between parties who are entrepreneurs unless they explicitly exclude their application in the contract. New Special Construction Customs were adopted in late 2021 and have been in force since then.
All these regulations are available in Croatian on the website of the Official Gazette of the Republic of Croatia, while some versions of the above-mentioned laws are also available in English.
In principle, standard contracts are used in the Republic of Croatia, but non-standardised contracts still prevail. The scope and complexity of such non-standardised contracts depend primarily on who the parties are, the type of project, the value of the contract and other circumstances. Here it is also important to note that the Civil Obligations Act prescribes certain mandatory provisions regarding construction contracts, among them that construction contracts have to be in written form.
As regards standard construction contracts, this primarily implies the use of the International Federation of Consulting Engineers' (FIDIC) contracts, which has recently increased in the Republic of Croatia. This is especially the case with large-scale and complex projects, with projects where the employers are international entities and projects which are financed by international financial organisations. The most commonly used FIDIC standard construction contracts are:
FIDIC standard construction contracts are primarily used to regulate the employer–contractor relationship and the employer–designer relationship.
Given all the above, there is obviously no general obligation to use certain standard contracts in Croatia. Thus, the parties have the right to freely regulate their contractual relationship, although they cannot regulate it contrary to the mandatory provisions of the Constitution of the Republic of Croatia or Croatian laws and morals.
The COVID-19 pandemic, which hit Croatia in March 2020, affected the Croatian construction sector in several ways. There have been issues with the supply of construction materials, the closure of factories producing building materials, delays in the importation of goods, as well as the departure/arrival of workers (at one point migration from city to city, and thus to construction sites, was not possible). All of these factors led to short-term closures of some construction sites.
Also, many investors (especially in the tourist sector) have given up or put projects on hold, given the general climate of uncertainty brought about by the pandemic. In addition, the current events in Ukraine have caused delays in the transportation and supply of goods, which has increased construction costs (especially in relation to the increase in the price of steel) and made it difficult to supply materials and thus to develop projects.
However, despite the pandemic, the Croatian government measures, aimed initially at reducing the consequences of the pandemic (anti-pandemic measures), as well as enabling the necessary reconstruction after the earthquakes that hit several Croatian counties in March and December 2020 ((re)construction measures), resulted in an increased demand for construction services. Additional new measures have recently been introduced, to reduce the consequences of the armed conflict in Ukraine, given that all the above-mentioned extraordinary events have led to an increase in the price of construction services and materials. The effects of the measures taken by the Croatian government, as well as by European and world institutions, on the construction market are expected to be seen in the coming months.
Naturally, both individuals and legal persons can act as employers in construction projects. As regards legal persons, private companies and state-owned companies, as well as local self-government entities (municipalities, counties, etc) all act as employers, depending on the type of construction project. Public companies and entities primarily appear as employers for public works (strategic construction projects, eg, communal, public energy, transport and health infrastructures, etc), while private companies appear as employers for a whole range of construction projects (eg, residential construction, tourist projects, energy infrastructure, industrial infrastructure, etc).
Employer’s rights primarily refer to the employer’s right to:
As far as the employer’s obligations are concerned, its most important obligation is to pay the contractor the agreed price for the work done.
Apart from the employer–contractor relationship, which is the prevalent relationship during construction, the employer establishes relationships with other construction participants, inter alia, designers, supervisory engineers, subcontractors and financiers.
Generally, subcontractors are not in a direct business relationship with the employer, only with the contractor.
It is a mandatory rule that the employer has to appoint a supervisory engineer(s) whose role is to monitor the works in order to confirm that they are performed in line with the issued permits, design and mandatory requirements prescribed by applicable regulations. It is often the case when FIDIC contracts are used that the supervisory engineer role is somehow “mixed” with the role of “engineer” envisaged by FIDIC contracts, ie, that the supervisory engineer’s scope of work is expanded to include the FIDIC “engineer’s” scope of work.
Financiers are usually involved in construction through monitoring mechanisms and requests for implementation of mechanisms for securing the financial feasibility of the project (eg, imposing milestones for payments under construction contracts, requesting the bankability of guarantees, etc).
Most contractors are private companies. Crafts (craftsmen – individual entrepreneurs) also participate in construction but as small-scale contractors or subcontractors, rather than large-scale contractors. Out of the total number of employees in the construction sector, approximately 80% were employed in legal entities, with approximately 20% employed by craftsmen. Roughly 5% of all employees in construction are working with the top five construction companies.
Foreign companies that meet the prescribed criteria may also appear as contractors. Often, in such cases, Croatian (domestic) companies are used as subcontractors.
Construction companies participating in tenders (private or public) often team up in consortiums to work together on large-scale construction projects that are too big for just one contractor.
As for the rights and obligations of the contractors, these normally include the contractor’s obligation to provide sufficient personnel with adequate skills and expertise to perform the construction works within the agreed terms and to fix determined defects, all of this in accordance with the designs (technical specifications and agreed deadlines), permits, applicable laws and standards. The contractor’s main right is to be paid for the work performed in accordance with agreed price and payment dynamics.
As for the contractor's relationship with other participants in the construction process, the contractor must obey mandatory instructions given by the supervisory engineer for the purpose of aligning the works with the permits and applicable laws.
Subcontractors are mostly small or medium-sized private companies or craftsmen. Although, when some specific works require specific know-how or skills, large private companies that specialise in certain types of works can also work as subcontractors.
Subcontractors have the same obligations as contractors, but only with respect to the parts of the works they have been engaged to do. They are directly responsible to the contractor for the work performed and only indirectly to the employer. They are, of course, entitled to compensation agreed with the contractor for the work performed. It is standard that contractors ask subcontractors to provide appropriate performance and liability guarantees proportional to their scope of works.
Contractors generally appoint their subcontractors, but there are cases where they are appointed or approved by the employer. Where they are selected by the employer, a mark-up fee is usually charged and the contractor’s responsibility for such subcontractors is limited.
The contractors enter into separate subcontracting agreements with the subcontractors. These are independent of the contractor–employer construction contracts, but are usually entered into on the basis of a back-to-back model with the main contract concluded between the employer and the contractor.
In projects that are not financed by employer’s equity, the financiers are mostly commercial banks, international financial institutions (eg, EBRD, EIB, IFC, etc) or various (mostly EU) funds, depending on the type of project.
In principle, financiers do not appear as parties to construction contracts, but they impose certain conditions for which they require to be integrated into the contracts (eg, bankable guarantees and securities, an appropriate financial plan, and the bank’s mechanism for reviewing interim payment certificates before payment, etc).
In construction contracts, the scope of the works is generally described as the entirety of the works required to construct the fully functional target building/construction, with all its characteristics and requirements specified in the main design and pertaining construction permit, detailed designs and, sometimes, in specific employer’s requirements.
Depending on the type of works, they will be described in more detail through schedules to the contract (designs, specifications, the bill of quantities, etc) and references to requirements in documentation, which forms a constituent part of the main design, and the construction permit.
Scope variations are quite common in construction contracts and are due to some objective circumstances which impose variations, or to the employer's wish for variations.
Variations of scope requested by the contractor mostly refer to unforeseen works and/or surplus works. The contractor’s right to request variations depends on the type of contract, ie, whether it is a turnkey contract or the price has been determined based on costs and unit prices from the bill of quantities. Under turnkey contracts with a fixed price, the contractor’s right to variations is, with certain exceptions, quite limited, ie, unforeseen works and/or surplus works are included in the price.
In the event of variations, the contractor typically submits to the employer a request for variations with specifications of the variations and a proposal for the price and time adjustments required for such variations.
The contractor is not entitled to proceed with variations without the explicit (written) consent of the employer. Exceptionally, in the case of variations that occur due to extraordinary and unexpected events, and which need to be urgently carried out to protect certain essential interests (eg, to ensure the stability of the building or to prevent risk to the life and health of people or to the environment, etc), the contractor may perform the works without the consent of the employer.
In variations requested by the employer, they must specify the changes and invite the contractor to provide a corresponding bill of quantities and offer for price and time adjustment, for the employer’s approval. It is usual for parties to agree on a limitation of variations which can be requested by the employer for variations which assume non-performance of certain works. Such a limitation is introduced either by stipulating the maximum percentage of the works that the employer can leave out or some specific type or part of the works that the employer cannot exclude without adequate compensation to the contractor.
Unless otherwise agreed under the contract, the contractor is entitled to ask for a price adjustment if:
It is mandatory that even where a clause on “fixed” prices was agreed, the contractor is entitled to a price adjustment, under the above-listed preconditions, if the cost of elements has increased to the extent that the overall price of the works should be higher by at least 10%. Recent increased application of this legal concept has led to different interpretations on whether the aforementioned “overall price” of works relates to the price of entire agreed works or it can relate to the price of a group or even one item of works. This is subject to interpretation; however, relevant courts have still not reached a position on this through case law.
Under the new 2021 Special Construction Customs, the price adjustment is now envisaged if the price increases by more than 3% instead of the earlier 10%.
If a contractor is in breach of the deadline set for completion, it is not entitled to price adjustments.
Generally, the employer is entitled to ask for price adjustments if:
In cases where the contractor is not up to date with the agreed timeline, the employer would be entitled to a price decrease proportional to the percentage by which the prices of elements have decreased.
In the design process, the responsibilities are basically “divided” as follows.
Under the Construction Act, it is the employer’s obligation to entrust the design work to person(s) who fulfil the conditions for carrying out these activities according to a special law.
The basic designer’s liability implies that:
In terms of types of designs, the designer is responsible for the conceptual design (idejni projekt) which must be completed in accordance with the zoning rules (spatial plans). The designer is also responsible for the main project design (glavni projekt) as a set of mutually harmonised designs which provide a technical solution for the building and provide compliance with the basic requirements for the building and other prescribed and specified requirements and conditions. Finally, the designer may also be responsible for execution designs (izvedbeni projekti), if they are entrusted with preparing these (execution designs can be done by the designer or contractor). Where execution designs are done by the contractor, they are usually submitted to the designer for their opinion.
For a design audit, the auditor (revident) is responsible for these designs, or those parts of the designs on which it conducted the audit and gave a positive report that the designs met the requirements of special laws and regulations, technical specifications and professional competence requirements.
The contractor’s obligations are to perform the works in line with issued permits and pertaining designs.
In the construction process, each of the participants is responsible for those works for which it is engaged, ie, the responsibilities of each party are determined in relation to their statutory and agreed roles.
Thus, the basic responsibility for construction lies with the contractor and the employer bears all other risks that are not covered by the contractor's risk. Furthermore, the contractor is also liable for any delay, unless the delay is caused by some reason attributable to the employer or a force majeure.
The employer and the contractor are jointly and severally liable to a third party for the damage that occurs as a result of the performance of construction works.
The supervisory engineer is responsible for all construction defects arising from their supervision of the work. The supervisory engineer is also responsible for all construction deficiencies arising from deficiencies in the implementation of supervision.
In general, the employer as the owner of a construction site is responsible for the status of the site (eg, geotechnical condition, underground obstacles, archaeological finds, etc) when it comes to the competent public authorities. Employers mitigate this responsibility by negotiating with other participants in the construction (contractor, designer, etc) to share that responsibility by making certain concessions regarding the timeline and prices, etc. The employer is responsible to the contractor to secure uninterrupted rights over the construction site, including the right of access to public roads and access to the communal infrastructure necessary for the performance of the agreed works.
The contractor is responsible for maintaining the construction site in a clean and tidy condition, and for cleaning and removing (disposing of) all construction materials and waste that accumulate as the works progress. The contractor is typically responsible for the implementation of both work safety measures and other measures for the protection of human life and health, as well as measures to reduce air, soil and groundwater pollution and keep noise to a minimum.
As for the contractor’s liability for defects in the status of the soil, see 7.5 Risk Sharing.
Before starting the construction works, it is necessary to obtain a construction (building) permit, and in some cases, before obtaining a construction permit it is necessary to obtain a location permit. These permits are issued by the competent authorities under the Construction Act and the Physical Planning Act. The main party responsible, ie, authorised to obtain these permits under the regulatory law, is the employer. After the construction process has been carried out, and for the building to be used, it is necessary to obtain a use permit, which is issued at the request of the employer following the technical inspection of the building.
Here, it is worth noting a specificity when contracting a design-and-build contract. Namely, in this case the employer usually gives the contractor power of attorney so that they can obtain the above-mentioned permits on behalf of the employer. Nevertheless, all permits will always be addressed to the employer and they remain the employer's responsibility.
Responsibility for the maintenance of the works after the handover process is carried out, lies with the owner of the building.
Maintenance of the works entails performing construction and other works on an existing building/works with pertaining equipment, for the purpose of preserving the statutory essential building requirements and for securing continued compliance with the rules related to the energy performance of buildings and other rules.
If maintenance works are not carried out by the owner of the building, those works are entrusted to service providers who fulfil the conditions for carrying out those duties under a special law, through a separate (maintenance) contract.
In the construction process, the employer does not usually impose other roles on the contractor apart from the obligation to perform the construction works.
The contractor is generally obliged to submit to the employer a detailed plan for the organisation of the construction works, which includes organisation of quality assurance, including a list of tests. Also, for the purpose of reviewing the manner of performance of the construction works in line with the designs and applicable laws, before the technical inspection performed by the relevant authorities, the contractor usually submits all test results to the employer and/or supervisory engineer.
Apart from the above-described standard testing performed for the purpose of the technical inspection and to obtain a usage permit, for some more sophisticated constructions (eg, energy and industrial facilities) it is prescribed by law and/or envisaged by the main design that trial work should be performed before issuance of the usage permit. It is the investor’s obligation to entrust such tasks to persons authorised to perform them under a special law and to report commencement of such trial work to the relevant authorities by submitting the appropriate form with the required plans, programmes and other documentation.
Upon completion of the works, the contractor informs the employer that the works have been completed and invites the employer to inspect and take over the works. The purpose of such employer’s inspection is to check whether the performed works meet all the requirements specified in the permits, design documentation and the construction contract. Depending on the type of agreed works, the employer’s inspection is usually performed prior to the technical inspection of the works performed by the relevant authorities.
The final handover (especially in “turnkey” projects) typically takes place once the building has been completely built, without deficiencies, and after issuance of a usage permit based on a successfully completed technical inspection of the building.
Within the handover process, the contractor also submits to the employer all documentation on the performed work and the handover protocol is signed.
If the employer has any claims against the contractor in terms of (visible defects in) the quality of the performed works and/or any penalties; in order to preserve such rights, the employer must submit such a claim, or make an appropriate note in the handover protocol, before the handover is completed.
Generally, contractors can be held liable for defects for different spans of time, depending on the type of defects (ie, defects in essential building requirements, visible defects, hidden defects, defects covered by contractual warranties, etc).
Defects in Essential Building Requirements
The contractor's liability for defects relating to the statutory essential building requirements of construction works during a ten-year period from handover date is mandatory (cannot be limited or excluded). This liability can be invoked by any subsequent owner during the period, not just the employer. Essential building requirements are defined by the Construction Act and include seven basic sets of requirements for any building, such as mechanical resistance and stability, fire protection, hygiene, health and environment, and others.
Notice of such defects in essential building requirements has to be made within six months from noticing the defect, otherwise the employer/owner is precluded from invoking it. The rights of the employer/owner towards the contractor expire one year from the defect notice. During the respective one-year period, the employer/owner has to sue the contractor if no amicable solution or remedy has been made.
The employer has the obligation and the right to inform the contractor without delay of any visible defects at handover. After handover, as a rule, the contractor is no longer liable for visible defects which should have been noticed at handover. As an exception, the contractor will still be liable for such visible defects if he was aware of such defects but did not report them to the employer.
Defects which are not visible at handover are referred to as “hidden” defects in Croatian law, if these do not fall into the category of defects in essential building requirements. In this case, the employer has to notify the contractor about the hidden defects as soon as possible, and no later than within one month of their discovery. After the expiration of two years from the takeover of the construction works, the employer can no longer invoke hidden defects.
As with the essential building requirements, the liability of the contractor for visible or hidden defects (with some additional modifications) may not be limited or excluded in consumer contracts.
Contractual Warranty Periods
Contractors mostly provide contractual warranty periods for the quality of the performed works. These are almost always agreed; however, these are mostly agreed with the same scope and deadlines as the aforementioned statutory defects liability for hidden defects. Sometimes, defect notification periods are negotiated differently within contractual warranty periods, eg, 15 days as of takeover for both visible and hidden defects, or similar. Warranty periods for installed equipment are agreed back to back with provided manufacturer’s warranties.
The employer has the following remedies in case of defects in the construction works or in the design:
In general, the contract price can be determined as follows:
It is important to note here that this is not an exhaustive list of methods to establish the contract price. The method of establishing the contract price is subject to the agreement of the parties and it is permissible to contract the price in any other way that would make it definite or determinable. In addition, it should be noted that when negotiating the price of the construction contract, it is possible to apply safeguard clauses such as an index clause and sliding scale.
In many construction contracts, the contracted price does not actually represent the final price (contract price), given the additional and unforeseen works affecting the final amount. The exception is the turnkey contract, where the contract price includes all unforeseen work and surplus work but excludes the lack of work, as mentioned in 3.2 Variations.
In conclusion, in construction contracts, provisions can be found which contract the milestone payments according to the milestone payment schedules.
Late or Non-payment
In case of late and non-payment, the contractor is entitled to statutory default interest on the unpaid amount during the delay period. Furthermore, the final consequence of late or non-payment might be the right of the contractor to suspend the works, or even to terminate the construction contract.
To mitigate risks of late or non-payment, contractors are trying to negotiate that employers provide certain-payment security (typically in the form of a bank guarantee or promissory notes) to contractors as collateral for potential contractor’s claims on late and non-payment.
In addition, contractors regularly ask for advance payments. The amount of the advance payment varies from case to case, and usually ranges from 5% to 30% of the total contract price. Agreeing advance payment, especially in turnkey contracts and contracts based on a lump-sum agreed price, recently became standard and a crucial element on the contractor’s side. The reasoning behind this trend is that advance payment is usually used to purchase construction resources at the price that applied at the time of the contract, as opposed to paying resource prices that have risen in the meantime. The price of some materials recently increased significantly and some even enormously (eg, steel, concrete and in some areas, wood), leading to addendums and disputes.
It is noteworthy that when advance payment is agreed, employers often request from the contractor an advance payment guarantee (in the form of a bank guarantee or promissory note), which serves as collateral for repayment of the advance payment, should the contractor fail to perform the contracted works.
Invoicing of performed construction works depends on how the contract price is determined and what invoicing dynamic and methods have been agreed between the parties. Typically, invoicing is carried out by virtue of interim and final payment certificates (privremene i okončane situacije) which are considered as invoices.
In cases where unit prices are agreed, interim payment certificates are typically issued on a monthly basis, and they are based on the contractor’s calculations of installed materials and performed works (at the prices agreed under the bill of quantities) approved by the employer and supervisory engineer. In cases where the price is agreed as a lump sum or in a turnkey model, interim payment certificates are issued in accordance with agreed milestones, or monthly on the basis of the percentage of the works performed.
Before signing the construction contract, the contractor usually prepares a plan and programme for the performance of the works in accordance with the main design and submits it to the employer for review and approval. In some cases, a programme is prepared by the employer and the contractor reviews it and gives its comments. After the programme is adjusted and agreed, it forms an integral part of the construction contract as an appendix.
As far as safeguarding the planning is concerned, this is mostly agreed by linking fulfilment of the programme (execution of the works) with the payments schedule, with penalties in case of breach of the agreed programme and through mechanisms for changing the programme.
In a construction contract, the parties can agree on the rules and procedures in the event of delays, in particular on damages and measures to accelerate performance. Normally, the parties agree on mandatory notification of any possible delays and related claims.
Where delays are justified or arise due to extraordinary circumstances, then an extension of deadlines is normally agreed. However, in the event of the fault of one of the parties, the other party, depending on the circumstances of the case, might be entitled to some compensation, time extension, termination of the contract, etc.
It is noteworthy that if an employer has any claims against a contractor on delay penalties, in order to preserve their rights, the employer has to submit such claims before taking over the works.
In the event of the contractor’s delay, depending on the circumstances of the case and agreed mechanisms, the employer might be entitled to some of the following rights:
The typical way for a contractor to request extension of the deadlines is to submit a written request to the employer as soon as the contractor becomes aware of the need for a time extension.
The most common reasons justifying a request for an extension of time would be force majeure, unforeseen circumstances or non-fulfilment of the employer’s obligations which prevented the contractor from performing the work. The deadlines are extended for the duration of the respective disturbance and for the time necessary to re-start the works.
In Croatian law, there is no clear and explicit definition of force majeure, therefore to define force majeure, it is necessary to summarise several clauses of the Civil Obligations Act relevant to this matter. Generally, force majeure exists if, after signing of a contract and before completion deadline, one party is unable to fulfil its obligations due to the occurrence of circumstances for which neither of the parties is responsible and which could not have been prevented or avoided, and which could not have been envisaged when the contract was concluded.
If the debtor’s inability to fulfil the contractual obligation is proved to be a consequence of force majeure, then this can be a reason for a debtor to be released of its obligations and liability for damages (a debtor can, in this case, be either the employer or the contractor).
The law does not prescribe any examples of force majeure; however, in court practice and legal literature there are examples of natural events (eg, earthquakes, floods, fires, pandemics, etc) and human actions (eg, import bans, orders, war, revolutions, etc) that were under certain circumstances considered as force majeure.
Although parties usually define and regulate force majeure in contracts, including setting specific limitations and exclusions, the legality and scope of such limitations will be assessed by the court on a case-by-case basis, while the burden of proof is on the party invoking force majeure.
In practice, unforeseen circumstances (rebus sic stantibus) are seemingly very similar to force majeure (see 5.5 Force Majeure) and it can be challenging to clearly define distinctions between them based on the provisions of the Civil Obligations Act. Generally, unforeseen circumstances imply extraordinary events, which occurred after conclusion of the contract and could not have been foreseen at the time of conclusion of the contract, as a result of which, the fulfilment of obligations by one of the parties becomes excessively onerous or would lead to one of the parties suffering an excessive loss.
If unforeseen circumstances occur, the impacted party can request amendments or, under certain circumstances, even termination of the contract. Unlike in the case of force majeure, the impacted party generally has to prove that fulfilment of its obligations became excessively onerous (not impossible like with force majeure); however, the other party has the right to fair compensation if the contract is terminated.
Generally, liability of any party for gross negligence or wilful misconduct in any agreement cannot be contractually excluded or limited in advance.
It is also noteworthy that in construction contracts, parties cannot contractually exclude the liability of the contractor for construction defects which concern the fulfilment of certain essential building requirements determined by law, if these deficiencies show within ten years from handover of the works.
Croatian law acknowledges the concepts of wilful misconduct and gross negligence in the Civil Obligations Act. However, the concepts are not explicitly defined there. Instead, jurisprudence and case law clarify and apply these concepts, considering gross negligence (culpa lata) to be the conduct of an injurer who did not employ the attention that an average person would use in its conduct – applying the applicable standard of care (eg, of an average expert, businessman, etc). As opposed to (common) negligence, where an injurer did not employ the attention that a prudent/sound person/businessman/expert would use. In such interpretation, gross negligence will often be very unreasonable behaviour, from the perspective of the applicable standard of care. Gross negligence is thus treated equally as wilful misconduct.
As regards wilful misconduct (dolus), it exists when the injurer acted knowingly and wilfully, wanting both the action and its consequence (damage).
In the event of a dispute, the competent court shall determine gross negligence or wilful misconduct taking into account all the circumstances of a particular case, and assessing the conduct of the party according to the already mentioned criteria. As noted in 6.1 Exclusion of Liability, liability for gross negligence and wilful misconduct may not be excluded or limited.
Parties may contractually limit their liability, with exceptions as mentioned in 6.1 Exclusion of Liability.
The liability of the parties for common negligence may be limited unless that limitation has resulted from the debtor's monopoly position or from an unequal relationship between the parties.
Parties may also contractually exclude or limit the liability of contractors for defects in the construction/works, other than the mandatory ten-year automatically transferable liability for defects relating to essential building requirements. The Civil Obligations Act provides a statutory framework of rights, and deadlines for using those rights, which applies if nothing different was agreed.
Parties generally tend to limit liability for defects and for damages by agreeing on caps for liability (usually in the amount of the contract price or in some relation to the contract price). Liability for gross negligence and wilful misconduct may not be capped. In addition to caps, parties use limited defects liability periods (where allowed, as compared to statutory) or limited defects notification periods, or exclusions of liability for certain types of damages (eg, loss of profit, non-pecuniary damages, consequential damages).
In the Croatian jurisdiction, indemnities are normally used to limit risk. However, in the Croatian jurisdiction, indemnities arise from different legal concepts:
Such indemnities include the duty of the breaching party to remedy the breach in a procedure which can be agreed in more or less detail (including, for example, replacement works by a third party), rights to compensation of damages and costs, price adjustment (reduction), and ultimately, the right to terminate the agreement.
In construction contracts, it is common for contractors to provide various types of guarantees to the employer as security for the performance of contractual obligations in different stages. Depending on the scale of the contract and works, contractors usually deliver some or all of the following guarantees:
Nowadays, the employer is also expected to provide a Payment Guarantee, as security that the employer will pay the contractor for the performed work.
The aforementioned guarantees are usually agreed in the form of one of the following collaterals:
Contractors generally take out the following insurance policies:
It is mandatory for construction contractors (companies and individual entrepreneurs) to insure themselves against professional liability. As stated earlier, architects and engineers are also obliged to insure themselves against professional liability, appropriate to the type and degree of danger, for the damage caused by the performance of the work or activities, to the employer or other persons for the duration of the works or activities, where the amount of the insurance cannot be less than HRK1 million.
As the parties to a construction contract are free to regulate their relationship, it quite often happens that the parties define the consequences of insolvency of one of the parties. As a rule, in the case of insolvency of either party (or other similar statuses preceding the actual opening of bankruptcy proceedings), the parties agree the right of the other party to terminate the contract for future unfulfilled obligations, etc.
Where the parties have not agreed on termination rights and other consequences of insolvency, one party could invoke the fundamentally changed circumstances clause of the Civil Obligations Act and request an amendment, or even termination, of the contract.
Finally, the Bankruptcy Act stipulates that the bankruptcy practitioner may in that case decide to fulfil the contract and demand fulfilment from the other party. However, if the bankruptcy practitioner refuses to fulfil the contract, the other party can raise its claim for non-fulfilment of contractual obligations only as a bankruptcy creditor, in bankruptcy proceedings. If such a claim is disputed by the bankruptcy practitioner, the bankruptcy creditor (solvent party) can bring an action before a court of law.
In construction contracts in Croatia, risk sharing is common between certain stakeholders in the construction process.
In particular, there is a statutory level of risk sharing, eg, where there are defects in the status of the soil or at the employer’s instructions. Generally, under the Civil Obligations Act, the contractor is liable for soil defects in the same way as for essential building requirements (ten-year liability not subject to limitations), unless a geotechnical survey or other document finds the soil fit for construction and during construction there were no circumstances that implied differently to the survey. In the case of such a survey, the employer assumes this liability with the right to recourse from the engineer who made the survey.
Similarly, employers are increasingly requesting that contractors – especially in turnkey contracts – assume liability for the project design documentation prepared by third parties (architects and designers) who were originally engaged by the employer. The idea being, of course, that the contractor may not invoke not being liable for defects caused by faulty design.
Similarly, under the law, the contractor is not released from responsibility just due to acting according to the employer’s instructions. However, if the contractor warned the employer about the risks of harmful consequences (damage) before complying with the employer’s instruction, the contractor’s liability will be decreased (ie, shared between the employer and the contractor), or even excluded, depending on the circumstances of each case at hand. This model is widely accepted and further elaborated in agreements. Of course, where the contractor, the designer and the supervisory engineer are liable for damage, the liability of each of them will be shared in proportion to their contribution.
It is also important to note the specificity of sharing risks and liabilities in turnkey contracts with a consortium of contractors. Unlike with subcontractors, where the main contractor is liable to the employer, the responsibility of consortium members towards the employer is joint and several. This means that a consortium member who performed a minority of the works is liable for the entire works, with recourse to other consortium members if such member suffered more liability than actually attributable to them.
Other forms of risk sharing are listed below.
Commonly used contractual provisions regarding personnel provide that employees participating in the performance of works under the construction contract must have adequate qualifications and experience in accordance with the applicable rules.
Furthermore, the contractor mostly undertakes to apply all the prescribed protective measures in terms of occupational safety, fire protection, property insurance and safe access to the construction site in accordance with current rules and regulations. In that sense, any specificities of the personnel’s access to the construction site are addressed.
It is also often agreed that the contractor has to provide a sufficient number of employees in order for the works to be carried out in accordance with the provisions of the construction contract, in particular, in accordance with the dynamic plan approved by the employer.
Provisions determining the conditions for the outsourcing of parts of works to third parties (subcontractors) may be incorporated in construction contracts. If not, statutory provisions are applied instead, which basically regulate only the permissibility of subcontracting and the liability of the main contractor for work performed by subcontractors.
Employers therefore commonly require one of the following limitations to subcontracting:
Normally, however, the employer does not have the right to unreasonably reject a subcontractor proposed by the contractor. Such refusal will normally have to be substantiated by some criteria, such as disputes between the employer/third parties and the nominated subcontractor, and/or unfulfilled/non-orderly fulfilment of contractual obligations on the subcontractor's side vis-à-vis the employer, or the employer's prior bad experiences with the same subcontractor.
Approval of the subcontractor does not normally limit the liability of the main contractor to the employer for the subcontractor’s work (the quality and timeliness of the performance of the work). Such limitation is sometimes agreed, however, when subcontractors are imposed on contractors by employers.
Construction contracts in Croatia normally contain provisions on intellectual property rights, regardless of complexity and value/type of agreement. In view of the above, designs and project documents are normally prepared by third-party designers (architects, engineers, etc). Those parties transfer the rights to use those documents to the employer under separate contracts. Therefore, in construction contracts, it is normally agreed that the contractor accepts from the employer the transfer of the right to use, limited to all agreed purposes, all written and digital main and execution designs, construction documents, tables, drawings, pictures, samples, patents, performance documentation and other content encompassed by permits for the execution of the works.
The employer normally undertakes to indemnify and keep the contractor safe from any breaches of IP rights which could arise from the contractor’s use of such designs.
Alternatively, in design and build contracts (where the contractor(s) procured the designs and permits), the IP rights to designs are transferred to the employer.
Furthermore, it is mostly agreed that the price paid by the employer to the contractor under the construction contract will also include full and fair compensation for the right to use the copyright.
In the event of a breach of the construction contract by one party, the other party will have the following rights (remedies):
Specifically, the employer may be entitled to a penalty and price reduction, and the contractor may be entitled to default interest.
Some remedies may not be limited or excluded, where provided by rules of mandatory law (eg, the right to terminate the agreement in case of material or repeated breach).
The procedure is often laid down for remedy of certain breaches, stating the order and priority of remedies, eg, a third party may be engaged only if the contractor personally fails to remedy the breach.
Liability for common negligence damages can also be limited and excluded.
In view of the above, it should be stated that the parties have the right to agree – and thus to limit the reasons for which one party would have the right to terminate the contract – what the amount of damages or penalties will be, whether a party will be entitled to compensation, etc.
Sole remedy clauses are not commonly used in construction contracts concluded under Croatian law. On the contrary, while in other jurisdictions delay damages are usually contracted as a sole remedy for delay in completion of the works, in Croatia, the employer may always request damages on top of the delay damages.
Typically, but not always, the loss of profit (and non-pecuniary damages) is excluded from construction contracts as a form of damages. The influence of English law led to the introduction of occasional exclusions of consequential damages, as this is not a concept formally and entirely recognised by Croatian law.
Retention and suspension rights are not often used explicitly in construction contracts. However, since the parties do not as a rule exclude the application of the Special Construction Customs, the following rules of the Special Construction Customs often apply:
It should be noted that in Croatia there are no special courts that only deal with resolving disputes arising from construction contracts. In view of this, according to the Croatian Litigation Procedure Act, such disputes must be resolved before commercial or municipal civil courts, depending on the parties involved in the proceedings. Namely, if there is a dispute between legal entities, ie, between legal entities and craftsmen concerning their business activities, then the commercial court will have jurisdiction, and if one of the parties is a natural person, the municipal court will have jurisdiction.
Also, it is important to note that in disputes arising from construction contracts, experts from this sector are often consulted on technical questions, given that the court has no technical knowledge to resolve such disputes. The outcome of the proceedings in these cases often depends on such expert opinions.
Arbitration clauses are often agreed in the contracts of construction projects. This is more often the case as the value of the project increases, when the project is funded by the EU or other international organisation or where there is a cross-border element. Typically, arbitration proceedings are conducted before arbitral tribunals, such as ICC tribunals (eg, the Permanent Arbitration Court at the Croatian Chamber of Commerce), or before the Vienna International Arbitral Centre. When it comes to FIDIC's form of construction contract, arbitration is often used as a method of alternative dispute resolution, usually after an attempt to resolve the dispute before the Dispute Adjudication Board in accordance with the FIDIC provisions.
Furthermore, parties may also agree to resolve their disputes before a mediator, ie, in a mediation centre. In certain cases, mediation as a form of ADR can be a much more efficient means of dispute resolution, in terms of cost and time. Although disputes have been resolved in an increasing number of cases according to the mediation procedure under the Croatian Mediation Act, it appears that mediation is still only agreed in the minority of cases.
Extraordinary Times Call for Extraordinary Solutions
From the COVID-19 pandemic, through several powerful earthquakes, to the impact of the war in Ukraine, the Croatian construction sector has faced several significant challenges in just two years.
The market disturbances began in early 2020 with the pandemic. Numerous anti-pandemic measures were introduced in Croatia, and globally, which resulted in difficulties in the regular performance of construction work. Although construction works are mostly conducted outdoors and so were not directly affected by the measures, indirectly the measures have caused problems with production, transport and availability of almost all construction materials and equipment. Also, there have been problems with workforce migration within the country, especially between countries due to imposed migration restrictions.
These negative effects, together with the general uncertainty, resulted in the cancellation or putting on hold of the vast majority of construction projects, or enormous delays in the execution of such work.
While the COVID-19 restrictions have eased somewhat over time, the consequences of the pandemic and the imposed measures continue to be strongly felt throughout the construction market; there are still disruptions in the supply chains and availability of construction materials. Consequently, a significant and unexpected increase in the price of construction materials and equipment has occurred.
As if the situation were not challenging enough, recently the construction sector suffered another significant and radical blow which had, and still has, a severe negative impact on the development of construction projects and the realisation of construction contracts: the armed conflict in Ukraine. The consequences of actions and sanctions that occurred or have been taken by the warring parties and by other states and institutions have severely affected the Croatian construction industry.
This extraordinary and unpredictable situation has not been limited to security aspects only, but has already permeated the entire global economy, especially the European market. Already, limited availability of construction materials, fuel, energy and equipment has further deteriorated. In addition, prices have gone through extreme, sometimes multiple, increases due to the above described reasons and inflation. Even at the time of writing, three months since the armed conflict began, it is hard to estimate the scope and range of further (negative) consequences that will affect the already shaken markets.
According to the Croatian Bureau of Statistics, producer prices of construction materials on the Croatian market in April 2022 were 8.9% higher than in April 2021 and 15.2% higher than average in 2015. More specifically, according to the Croatian Employers' Association and the Croatian Chamber of Commerce, copper went up by 60%, iron by 50%, wood by 180%, concrete by 40%, PVC pipes by 60% and reinforcing mesh by 130%.
Such prices of construction materials, along with increased prices of other resources and a reduced labour force, create an extremely challenging environment for the European construction market and even more for the Croatian market, given that in addition to these factors, in 2020 Croatia was hit by two very strong earthquakes.
These unfortunate and extraordinary events have certainly added additional burdens to the construction resources in Croatia as demand for new public and private buildings or their reconstruction in earthquake-struck areas has resulted in highly increased construction activity.
Extreme Changes in the Market and the Use of Legal Institutes
In the Croatian legal system, the legal effects of extraordinary circumstances have generally been regulated through the legal institutes of unforeseen circumstances (rebus sic stantibus) and force majeure. These legal institutes are prescribed by the Croatian Civil Obligations Act and they provide for rules, some of them being mandatory, applicable in cases where fulfilment of obligations become extremely difficult or impossible for one party to the contract.
Although both institutes envisage a termination of the contract as a potential way out for the parties, in recent practice, the institute of unforeseen circumstances has been mostly used. The reason for this lies primarily in the fact that the legal institute of unforeseen circumstances, apart from the option of termination, envisages the amendment of the contract as one of the possibilities.
Recently, parties have been using it extensively as a legal basis for requesting amendments to construction contracts, usually in terms of extending deadlines and adjusting the contract price.
Furthermore, if the prescribed conditions are met, Croatian law provides for mandatory rules which allow price adjustments, even if the price is contracted as a fixed price. Contracting a fixed price was, in both the private and public sector, the predominant model of price determination, as this model enables control of construction costs and easier budgeting.
Extraordinary circumstances such as those which have cumulatively occurred in the construction market in the past year or two are quite unusual, and until now, the above-mentioned legal institutes have rarely been used as corrective mechanisms for such situations, making it under-regulated with no extensive case law.
With the recent frequent use of these legal institutes, a number of challenges and questions have arisen that need to be addressed by stakeholders involved in construction processes (eg, architects, builders, legal advisers, economists).
Main Challenges in Applying a Mandatory Mechanism of Price Adjustments of a "Fixed" Contract Price
Seemingly simple and clear provisions on price adjustments have proved to be not so clear and simple when it comes to their application to various situations in practice, and they are now subject to different interpretations.
The provisions of the Croatian Civil Obligations Act stipulate that even though fixed prices are agreed, the contractor may request a price adjustment if the price of the elements based on which the price is calculated has increased to such an extent that the price of the works would be higher by more than 10%.
Such an increase in the price of elements has to occur after the signing of the construction contract and without any influence of the contractor claiming the price increase. But even then, the contractor can only demand a difference in price exceeding 10%. The contractor is not entitled to request price adjustment if the increase in the price of elements occurred after the contractor’s delay with the execution of works.
Most of the different interpretations and discussions of this provision in practice relate particularly to defining what the "price of works" means; ie, whether it refers to the overall price of all contracted works, or to the price of a group of works, or even one item of the contracted works (one item from the bill of quantities).
The interpretation of the term "elements" in these provisions is also imprecise as it could be interpreted as an element of the overall agreed works (eg, one of the items from a bill of quantities) or as one type of material (eg, steel, concrete, wood, workforce), regardless of whether such material represents an individual item within the bill of quantities.
One argument defends the stance that a price adjustment is applicable only if the prices of elements (individual items from the bill of quantities) have increased to the extent that the overall price for all contracted works, now calculated based on such new increased prices of elements, is more than 10% higher.
There is a view that a price adjustment is applicable even in cases where the increase in the prices of elements (regardless of whether such elements represent separate items of the bill of quantities or are just a part of the items) results in an increase in the price of one item of the bill of quantities, regardless of the extent of the increase in the overall price for all contracted works.
The first interpretation is, somehow, closer to the current wording of the provisions in question and is more in line with the purpose and initial intentions of the legislator (ratio legis). However, if such provisions are applied directly and with no adjustments to the current dramatically and extremely changed construction market, it will result in almost all contractors themselves bearing the costs of the increase of the overall price up to 10%.
Most contractors are not in a position to survive such a financial impact on their businesses. On the other hand, it is the general impression that the latter interpretation is closer to the current (economic) market set-up and that it is driven by efforts to minimise the negative implications of the uncritical application of the rules to the current state of the construction market. However, it appears that this interpretation is not fully aligned with the purpose of the current provisions.
Therefore, perhaps a third, middle path is the right one. The solution might be to change the current provisions of the law in order to make them more suited to construction market trends and developments, rather than arguing for extensive and strained interpretations of the provisions.
The implementation of new mechanisms regarding price adjustments is even more challenging in the case of construction contracts concluded in the public procurement procedure as additional limitations to amending such contracts are prescribed by provisions of the Public Procurement Act.
Official Strategies to Overcome the Price Adjustment Challenges
Under the pressure of contractors, especially those who are parties to contracts with state/public investors, and in order to try to minimise the negative economic impact of the current situation on the construction market, in September 2021 the Croatian Government issued the Conclusion on Actions to Mitigate the Effects of Distortion of Prices of Construction Materials and Products.
By the respective Government document the Government has invited state/public investors to identify, analyse and prepare adequate calculations (together with their contractors), regarding those items for which the price has increased by more than 10% and accordingly to amend construction contracts to the extent justified to mitigate the negative consequences of the current situation.
In addition, in the case of ongoing public procurement procedures, or those yet to be initiated, state/public investors were invited to introduce contractual price adjustment mechanisms and set up adequate terms and conditions of such price adjustments.
It should be noted that the respective Government document does not provide for detailed rules or instructions for the implementation of proposed actions, nor does it represent a strict source of law with prescribed fines and consequences in the event of its breach. In future, the Croatian Government should adopt the methodology for calculating the price adjustment in construction contracts with state/public investors.
The Croatian Chamber of Commerce has issued guidelines that aim to help state/public investors with the implementation of price adjustments prescribed by mandatory provisions in contracts concluded based on the Public Procurement Act. To that end, the Croatian Chamber of Commerce is also working on listing the index prices for key construction materials since the Croatian Bureau of Statistics publishes only the aggregate price index of (all) construction materials.
Furthermore, recent events have led to the actualisation of another topic that has been suppressed for some time: the modernisation of Special Construction Customs issued back in 1978. The new Special Construction Customs were finally adopted in December 2021. Although some parts and legal institutes were amended to meet market developments, it is the general impression that Special Construction Customs are drafted in favour of contractors as in some parts the crucial rights of investors are unreasonably limited (eg, limitations of investors in use of performance bonds).
With such an imbalance in rights and obligations between contractual parties, investors are reluctant to have contracts governed by the Special Construction Customs and, therefore, in most cases they explicitly exclude them. Unfortunately, a great opportunity was missed to adopt balanced, updated, and practical Special Construction Customs acceptable to all stakeholders in construction. Due to the same reasons, it might prove that the application of new provisions of the Special Construction Customs regarding the adjustment of fixed price will also be limited (it can be adjusted if there are changed circumstances, overall price increases or decreases by more than 3%).
It appears that investors still did not accept the above documents and activities and we are not aware that state/public investors have concluded many amendments to construction contracts based on the above guidelines and conclusions.
Perhaps the legislator is waiting to see how private investors will overcome this issue and then whether such a model will be adequately reflected on contracts with state public investors. Or maybe not?
The extraordinary events that have affected global construction markets, with some specific negative impacts (earthquakes) in Croatia, have definitely brought about a series of negative consequences which have resulted in increased prices, an interruption in supply chains, and uncertainty both in the construction sector and other related sectors. On the other hand, the situation has also increased demand for construction activities and the construction workforce, and has led to discussion on new regulations for certain segments of Croatian construction law. As can be seen from this overview of recent trends and developments affecting the construction sector in Croatia, there is hope that in the end, despite these disturbances, the construction sector will recover and be a leader in boosting the economy and contribute greatly to the economic development of Croatia.