Hello, this is Attorney Park Jong-han from Cheongchul Law Firm.

In construction contracts, the amount that is deposited or secured for the purpose of repairing defects that may arise for a certain period after the completion of the construction is called a defect repair guarantee deposit. The State Contract Act stipulates that in principle, a defect repair guarantee deposit must be paid in a construction contract.

The issue is that whether this defect repair guarantee deposit is a penalty or a pre-determined compensation for damages affects the possibility of reduction and the ability to offset negligence. Therefore, it is necessary to examine the legal nature and specificity of the defect repair guarantee deposit.

[Question]

The legal nature of the defect repair guarantee deposit (penalty or pre-determined damages)

[Answer]

Article 18, Paragraph 1 of the "Act on Contracts to which the State is a Party" (hereinafter referred to as the "State Contract Act") states that "The head of each central government agency or the public official in charge of contracts shall have the contractor deposit a defect repair guarantee deposit to guarantee the repair of defects in the construction contract. However, in cases prescribed by Presidential Decree, the payment of all or part of the defect repair guarantee deposit may be exempted." This establishes that the defect repair guarantee deposit is generally mandatory in construction contracts.

Regarding the legal nature of this defect repair guarantee deposit, the Supreme Court has stated, "In the case where the conditions for general construction contracts include that if the contractor fails to perform the defect repair obligations, the defect repair guarantee deposit shall belong to the client, it is only stated as such, and there are no separate provisions that the client must compensate for the damages incurred. Moreover, if the costs actually incurred by the client for defect repair exceed the defect repair guarantee deposit deposited by the contractor, the contractor cannot be held liable beyond that amount. Therefore, the provision regarding the return of the defect repair guarantee deposit implies that if the contractor fails to fulfill the defect repair obligations, the confiscation of the deposit serves as compensation for damages, which means that the defect repair guarantee deposit possesses the nature of pre-determined damages" (Supreme Court decision 2001. 9. 28, 2001Da14689).

Pre-determined damages mean that the parties to the contract specify the scale of damages in advance in case of breach of contract and, upon breach of contract, claim damages based on the specified amount regardless of the actual amount of damages. However, if that amount is deemed excessive, the court can reduce it, and even if the actual damages exceed the predetermined amount, the excess cannot be claimed separately (refer to Supreme Court ruling 2010. 7. 15, 2010Da10382, etc.).

However, while the Supreme Court views the nature of the defect repair guarantee deposit as pre-determined damages, it also states that, "In the case where the construction contract or the terms incorporated into that contract include a provision that states if the contractor fails to respond to a defect repair request from the client during the defect liability period, the defect repair guarantee deposit shall belong to the client, this defect repair guarantee deposit shall generally be regarded as a pre-determined amount for damages unless there are special circumstances. However, due to the nature of the defect repair guarantee deposit, even if there is no explicit provision stating that damages in excess of the defect repair guarantee deposit can be claimed, it is reasonable to view that the client can prove the actual damages and receive damages for that excess amount from the contractor due to the contractor's failure to fulfill the defect repair obligations, thus being seen as a special pre-determined damage amount." (Supreme Court ruling 2002. 7. 12, 2000Da17810), thus indicating that it is possible to claim actual damages that exceed the predetermined amount, which should be noted.

In this way, we have briefly examined the legal nature of the defect repair guarantee deposit. In disputes related to state contracts and public procurement, the relevant laws are very complex and subject to frequent amendments, thus requiring familiarity and experience in this area. One must be well-informed not only about the court rulings but also about the administrative agency's interpretations and cases of disposition. Therefore, it is recommended to seek the assistance of attorney Park Jong-han, who has expertise in state contract laws and experience in resolving various state contract and procurement disputes.

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