Apartment owners in NOP 38 projects tend to mistakenly believe the guarantees issued to them by developers provide full safety nets, guaranteeing their rights in any case, even if the developer encounters financial difficulties before it fulfills its contractual obligations. In practice, the legal reality is far more complex. Not every guarantee is intended to cover all types of damage. In fact, in many instances, this is merely a performance guarantee, designed to ensure completion of the project’s construction works but not to cover compensation for associated deficiencies (inspections, compensation, or damages due to the prolonged duration of the construction works).
This distinction, which may at times appear purely technical, becomes extremely important if the developer enters insolvency proceedings and the apartment owners have no other source of repayment apart from the guarantees issued to them.
What Is a Performance Guarantee?
A performance guarantee is generally issued by an external financing entity (usually the lending bank), at the developer’s request, in favor of the existing apartment owners. Its purpose is to guarantee the project works are completed in compliance with the NOP agreement. If the developer discontinues the work midway, the guarantee can be exercised to finance an alternative contractor to complete construction. However, as soon as construction is completed and Form 4 is received, the performance guarantee has no further purpose. At this stage, the performance guarantee is supposed to be replaced by an inspection guarantee, which is intended to guarantee the repair of any defects discovered after delivery during the inspection period.
In practice, many apartment owners do not distinguish between the two types of guarantees. They believe that if a guarantee exists, it can also be used to cover damages discovered after completion of construction, especially when the agreement with the developer explicitly stipulates such an undertaking. However, the law and case law provide otherwise.
Examples from Case Law: A Performance Guarantee Is Not an Autonomous Guarantee
In the Savyoney Weizmann case, apartment owners claimed entitlement to confiscated guarantee funds for various damages they suffered during the project. Conversely, the receiver argued that the purpose of the guarantee was solely to guarantee completion of the construction works and that now, since construction is still underway, the funds should be returned to the project’s coffers. The Tel Aviv District Court accepted the receiver’s position and ruled that the guarantee’s sole purpose is to ensure continuation of construction and not to indemnify apartment owners for associated damages. The court emphasized that the wording of the guarantee itself clearly specifies that this is a performance guarantee, whose function is to ensure completion of the construction works and not to compensate for other associated damages. This ruling clarified that, when dealing with a guarantee, apartment owners should scrutinize its wording and purpose, and not assume this is an autonomous guarantee exercisable in any situation.
A similar issue recently arose in the 67-69 Arlozorov St. project in Bat Yam, which adjudicated a dispute between the trustee appointed to the developer that had entered insolvency proceedings (Adv. Idan Miller, head of our firm’s insolvency practice) and the apartment owners. The dispute concerned the status of a guarantee totaling about ILS 1.3 million and the trustee’s claim that, upon completion of construction and receipt of Form 4, the apartment owners should have returned the performance guarantee and replaced it with an inspection guarantee. The apartment owners refused to return the guarantee, claiming they suffered damages. In the end, they were forced to compromise and waive half the sum of the guarantee, in light of its wording, which stipulated that it is solely a performance guarantee, even though the developer undertook in the agreement between the parties to issue an unconditional autonomous guarantee.
The implications of this distinction are particularly far-reaching in instances of developer insolvency. If the developer collapses and there is no other source of repayment, the apartment owners may find themselves in a hopeless situation, since the guarantees in their possession do not cover the damages, they actually incurred. On the other hand, developers also have a clear interest in precisely defining the purposes of their guarantees. Performance guarantees at extremely high sums may unduly burden the project’s cash flow, while imprecise guarantees may expose developers to superfluous claims from apartment owners.
Recommendations for Avoiding Disputes
- Scrutinize the wording of the guarantee in advance: Before signing an NOP agreement, make sure the wording of the guarantee reflects the parties’ intention. If the apartment owners also seek protection against associated damages within the framework of the guarantees (such as in the event of prolongation of the construction works and delays in delivery), make sure the wording of the guarantee explicitly addresses this.
- Differentiate between a performance guarantee and an inspection guarantee: It is important to distinguish between the guarantee for completion of the construction works and the guarantee covering repairs of defects after delivery.
- Seek professional legal assistance: We recommend engaging a lawyer who specializes in urban renewal and insolvency law, who will examine the wording of the agreements and guarantees and ensure apartment owners’ interests are protected.deve
Conclusion: Guarantees in NOP 38 projects are not silver bullets
Guarantees in NOP 38 projects are an important tool for protecting apartment owners, but they are not silver bullets. Not every guarantee covers every type of damage, and not every guarantee is exercising in every situation.
The Savyoney Weizmann case and the dispute in the 67-69 Arlozorov case clearly illustrate the importance of carefully reading the wording of the guarantee and understanding its purpose. They also clarify the financial repercussions for apartment owners in cases such as these.
When a developer enters insolvency proceedings, the difference between a performance guarantee and an autonomous guarantee may be the difference between receiving compensation and a complete loss of financial rights. Therefore, it is essential to verify with the developer whether the guarantee provides protection against various situations and, if necessary, consult a lawyer before signing the agreement.
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Adv. Idan Miller is a partner and head of our firm’s insolvency practice.
Barnea Jaffa Lande’s insolvency practice represents clients in insolvency proceedings, corporate recovery proceedings, and debt arrangements, as well as counsels corporations facing financial distress, both in and out of court. The team also advises officers and directors on their fiduciary duties and legal exposure before the company’s economic crisis deteriorates to the point of insolvency or bankruptcy.