The chain of general contractor and subcontractors behind large-scale construction and the occasional failure of certain subcontractors to obtain proper payment gave birth to the institution of construction payment agent, a form of collateral management. It was typical in the construction industry that subcontractors were exposed to circle debt. The construction payment agent is a unique statutory solution to eliminate such debts.
Introduction of Payment Agent
The concept of the construction payment agent was introduced in 2009 with the amendment of Act 1997: LXXVIII on the formation and protection of the built environment (the “BE Act”). Apart from the BE Act, the main rules pertaining to this agency – such as liabilities of the parties involved in the construction or the mandatory elements of the contract constituting the trusteeship – were detailed in Government Decree 191/2009 (IX.15.) on construction activities (or the “Construction Codex”). The aim of the payment agent is to ensure the purposeful use of the funds of construction projects and to ensure that the performance of the construction contract is concluded. The use of a payment agent is mandatory, and the strict consequences if one is not used may involve fines or the suspension of the construction project by the construction supervisory authority.
Payment via the Agent
The payment agent manages the amount held in an escrow account and informs the developer and the general contractor about changes in the amount of collateral placed at his disposal under the payment agent contract. However, the most important function of the agent is that he manages the payments made to the general contractor(s) and the registered subcontractor(s). Registering in the subcontractors’ register, which is part of the main contractor’s construction e-log, is done electronically. The agent, on the basis of the invoice issued with respect to the performance certificate, pays the agreed-upon consideration for the given work phase to the general contractor and the subcontractors. Payments made to the subcontractors are not direct. The agent withholds the amount due to the subcontractor from the amount the general contractor is entitled to and only transfers it if the subcontractor certifies that the payment has been made to him by the general contractor.
When Is It Obligatory? Still Somewhat Unclear
The payment agent is obligatory only if the overall value of the construction work reaches or exceeds the community threshold published by the European Committee. At the moment, that threshold is EUR 5.35 million.
The construction’s overall value must be determined based on the rules of Hungary’s Government Decree 245/2006 (XII.5.) on construction fines, if applicable. The first theoretical question, then, is when is the Penalty Decree applicable, especially when no fine will be imposed. Unfortunately, the Penalty Decree is somewhat unclear as to how exactly the value should be calculated. If the Penalty Decree applies, then usually low amounts are calculated (much lower than the contracted price).
Given the uncertainty in the Penalty Decree, and fearing the consequences, developers tend to choose the net value of the contracted price when determining the need for a payment agent.
In this regard, developers should analyze the costs of technology because that should not be part of the contracted price for purposes of the payment agent requirement. It is not always easy.
Who Can Be a Payment Agent?
The selection should not cause any particular headaches for developers, as commercial banks usually provide this type of service, as does the Hungarian State Treasury, allowing them to choose the best offer.
We think that the concept of the construction payment agent is a good answer to certain problems, but it would be useful to clarify the rules pertaining to the value of the construction work. We recommend that investors and developers thoroughly examine the requirements of the payment agent because, if mandatory, the absence of an agent could lead to the suspension of work and fines, potentially adding significant costs to a construction project.
By Peter Berethalmi, Partner, and Andras Juhasz, Associate, Nagy & Trocsanyi
This Article was originally published in Issue 8.2 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.