On 4 January 2019 the Supreme Court of China promulgated the Legal Interpretation (II) of Issues Concerning the Application of Laws Relating to Construction Work Contract Disputes (“Interpretation II”).

The promulgation of the Interpretation II marks the first time in the past fourteen years that the supreme court gives a detailed explanation of laws relating to construction work contracts since the Legal Interpretation (I) of Issues Concerning the Application of Laws Relating to Construction Work Contract Disputes (“Interpretation I”) was carried out on 1 January 2005.

Based on the Interpretation I, the Interpretation II consisting of 26 clauses is intended to: (a) gather common opinions of different courts and practical experience in dealing with legal cases in different regions; (b) give further explanation of laws and create rules; (c) use a single set of applicable laws to enable works on construction projects to be done successfully, regulate the building market and protect interests of all parties; and (d) address urgent problems while considering future development of the building industry.

This article summarizes and comments on major parts of the Interpretation II based on the principles of the Interpretation II, values in accord with it, and its effect on the building industry.

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III Further Action to Establish a Single Set of Standards for Adjudicating Cases

1. How to adjudicate on a commencement date dispute

[Clauses]

Article Four In case of a disagreement between the parties involved over the commencement date of the construction works, the court should find that the construction works should be deemed to have started from (i) the commencement date specified in the commencement notice from the outsourcer or supervisor, and if not all the conditions are met for commencement of the construction works, from the date when all such conditions are met, and if the beginning of the construction works is delayed for a reason attributable to the contractor, from the commencement date specified in the commencement notice; and (ii) if the contractor has started to work on the construction site with the outsourcer’s approval, from the date when the contractor starts to work on the construction site; and (iii) if there is no commencement notice from the outsourcer or supervisor and no proof of the commencement date, the commencement date should be decided by considering relevant dates specified in the commencement report, contract, permit, completion and inspection report, filing of completion and inspection information, etc. and if conditions for commencement of the construction works are met.     

[Comments]

This clause contains a set of rules used for deciding on commencement date disputes between contractors and outsourcers of construction projects. This set of rules were already used by legal authorities for deciding relevant cases in the past years and were separately included in guidelines for courts at all levels. This clause is intended to prevent contractors from using a delay in collecting the permit for construction works as a valid reason for delaying the construction works when a commencement notice is issued and conditions for the commencement of the construction works are met or the construction works have begun.  

2. How to deal with cases involving several invalid contracts

[Clauses]

Article Eleven If all construction contracts for a construction project are invalid when the construction works are completed with the quality of the work being of an accepted standard, if one of the parties involved claims that the amount due for the construction works performed should be paid according to the contract performed, the court should approve the claim.

If it is impossible to decide which contract was performed and one of the parties involved claims that the amount due for the construction works performed should be paid according to the final contract, the court should approve the claim.  

[Comments]  

According to Article 2 of the Interpretation I, if the construction contract is invalid and the construction works thereunder are completed with the result of reaching an accepted standard, if the contractor claims that the project price agreed in the contract should be paid, the court should approve the claim. However, the supreme court dealt with calculation of amounts agreed in invalid contracts without explaining how to decide calculation methods for the price of a project for which several construction contracts are invalid, resulting in a lack of a single set of standards for deciding calculation methods for a project in this case.

In Article 11 of the Interpretation II, the supreme court clearly explains how to decide calculation methods for the price of a project for which “several construction contracts made by the parties involved are invalid”.

3. What adjudicators are obligated to do in the assessment process

[Clauses]

Article Fourteen In case of a dispute connected with a specific issue such as the project price, specifications and restoration cost between the parties involved, the court should explain to the person who has the obligation to provide evidence if the court considers it necessary to make an assessment. The person who does not apply for the assessment after being given the explanation, applies for the assessment without paying the assessment fee or refuses to provide relevant materials should be responsible for legal consequences of failing to provide evidence.

If the person responsible for providing evidence who does not apply for the assessment, applies for the assessment without paying the assessment fee or refuses to provide relevant materials in the first phase of the proceedings applies for the assessment in the second phase of the proceedings that the court considers as necessary, the court should deal with the case according to Article 170.1.3 of the Civil Litigation Law.

Article Fifteen After approving the assessment application, the court should decide the subject, scope, date, etc. of the assessment according to the application and the facts confirmed and arrange for a debate on the assessment materials in question between the parties involved.

Article Sixteen The court should arrange for a debate on the assessment results between the parties involved. If the assessor makes the assessment based on the materials in question on which no debate is held between the parties involved, the court should arrange for a debate on these materials. If the result of the debate shows that the assessment cannot be made on the basis of these materials, no case facts could be confirmed on the basis of the assessment results made on the basis of these materials.  

[Comments]

The Interpretation II further improves and specifies duties of courts dealing with legal assessments in construction contract courts.

According to Article 14, based on the legal assessment of a construction project beyond the court’s authority to gather evidence and therefore subject to the application filed by one of the parties involved, not the court’s authority, the court is obligated to explain the responsibility for the burden of proof with the assessment application and the assessment results are evidence “on basic facts of the case”. Therefore, if one of the parties involved has a delayed application for the assessment in the second phase of the proceedings due to an intentional act or a gross negligence, the case should be reheard or reinvestigated and redecided if the court considers it necessary.

According to Article 15, the subject and the scope of the legal assessment should be decided on the basis of the third party’s application and “as needed for finding the case facts” and the court should arrange for a debate on the assessment materials in dispute.

Article 16 restates that the assessment results should be debated and further states that the court should arrange for a debate on the assessment materials in dispute on which no debate has been held and that if the result of the debate shows that the assessment materials are inadmissible, the assessment results are “not adequately proved” and no case facts could be confirmed on the basis of such results.

4. The person responsible for performing the construction works has the obligation of confirmation

[Clauses]

Article Twenty Four If the person responsible for performing the construction works claims against the outsourcer as defendant, the court should add the subcontractor or the illegal contractor to the list of third parties to the case and hold the outsourcer liable to the person responsible for performing the construction works to the extent of the amount of the construction project price owed by the outsourcer after confirming the amount of the construction project price owed by the outsourcer to the subcontractor or the illegal contractor.

[Comments]

According to Article 26.2 of the Interpretation I, if the person responsible for performing the construction work against the outsourcer as defendant, the court can add the subcontractor or the illegal contractor to the list of third parties to the case, the outsourcer is liable to the person responsible for performing the construction work only to the extent of the amount due but unpaid for the construction project.

The Interpretation II further improves the above principles. According to Article 22 thereof, (i) in such case the court “should” (not “can”) add the subcontractor or the illegal contractor to the list of third parties to the case; (ii) the court should hold the outsourcer liable to the person responsible for performing the construction work to the extent of the amount due but unpaid for the construction project after confirming the construction project price that the outsourcer has not paid to the subcontractor or the illegal contractor.

IV Further Action to Protect Interests of the Building Industry

1. Protection of the contractor’s right to extend the period of the construction works

[Clauses]

Article Six Any extension of the agreed period of the construction works should be subject to the outsourcer’s or supervisor’s confirmation in the form of signed approval, etc. If the contractor has requested with a cause for an extension of the period of the construction works under the construction contract with the outsourcer or supervisor within the agreed period, and before receiving a confirmation of such extension, claims that the extension should be approved, the court should approve the claim.

If the parties involved agree that the period of the construction works should be deemed as non-extendable if the contractor does not request for an extension of the period of the construction works within the agreed period, this agreement should apply in such case unless the outsourcer agrees to extend the construction work period after the agreed period or the contractor has a good reason for release.

[Comments]

If it is agreed in a construction contract that “any delay of the construction work should be subject to the outsourcer’s or supervisor’s confirmation in the form of signed approval”, the contractor could be unable to meet the condition of following the procedures under the construction contract for delaying the construction work due to the outsourcer’s maliciously not or delay of giving its confirmation, causing the contractor to take responsibility for a breach of the contract arising from its extension of the period of the construction works.

According to Article 6 of the Interpretation II, to respect mutual agreement between the contractor as stated in Article 6.2 thereof and protect the contractor’s interests, if the contractor claims that it can extend the period of the construction works “without receipt of the confirmation of the extension” and with adequate proof of having filed a request for the extension with a cause specified in the construction contract within the limited period of time agreed therein, the court should approve the claim.

The supreme court laid down this clause with the aim to prevent the outsourcer from using the procedures unfairly to negate the contractor’s material right.

2. Protection of the right to claim the quality guarantee deposit

[Clauses]

Article Eight If the contractor claims that the outsourcer should repay the quality guarantee deposit for the construction project under one of the following circumstances, the court should approve the claim. (1) The deadline for repayment of the deposit agreed by the parties involved expires. (2) If there is no deadline for repayment of the quality guarantee deposit for the construction project agreed by the parties involved, the deadline should be two years since the construction works finished successfully. (3) If the construction works do not finish successfully within the agreed period of time for a reason attributable to the outsourcer, the deadline for repayment of the quality guarantee deposit for the construction project agreed by the parties involved should not expire until ninety days after the contractor submits the report of successful completion of the construction works; if there is no deadline for repayment of the quality guarantee deposit for the construction project agreed by the parties involved, the deadline should be two years from the ninetieth anniversary of the contractor’s submission of the report of successful completion of the construction works. The outsourcer’s repayment of the quality guarantee deposit for the construction project will not affect the contractor’s performance of its guarantee obligations under the applicable contract or law.  

[Comments]

Actually, contractors and outsourcers usually agree that the quality guarantee deposit should be refunded upon expiration of the warranty period. If no warranty period is agreed in a construction contract or it is agreed in the construction contract that the warranty period should be decided according to applicable law,  the contractor usually refuses to refund the quality guarantee deposit within the legal guarantee period stated in Article 40 of the Quality Management Regulations regarding the shortest warranty period - “with respect to a project of infrastructure or the foundations or main structure of a building, means the term of reasonable use of the project specified in its design documents”; “with respect to a project of waterproof house walls, a toilet with waterproof functions or a room or outer walls with no leakage, means five years”.

This clause is intended to remind the contractor of including the deadline for refunding the quality guarantee deposit in the construction contract and give a legal period of time to refund the quality guarantee deposit and rules on deciding the start date of this period of time in order to avoid leaving the contractor in an unpleasant situation, in which the contractor cannot realize its right to claim the project price in full on the ground of the legal warranty period.

3. Protection of the right to exercise the right of first refusal to receive compensation

[Clauses]

Article Seventeen If the contractor that has made a construction contract with the outsourcer claims the right of first refusal to receive compensation for the construction project price on the basis of a reduced price of the project or the price at which the project is sold in an auction, the court should approve the claim.

Article Eighteen In a decoration and renovation project, unless the outsourcer has no ownership of the building, the contractor has the right of first refusal to receive compensation on the basis of a reduced price of the project or the price at which the project is sold in an auction.

Article Twenty With respect to a construction project on which the work is not completed but of an accepted standard, if the contractor claims the right of first refusal to receive compensation for the project price at a reduced price of the part of the project the contractor works on or the price at which such part is sold in an auction, the court should approve the claim.

Article Twenty One The compensation that the contractor has the right of first refusal to receive is subject to provisions of a relevant administrative authority of the State Council regarding the construction project price.

If the contractor claims the right of first refusal to receive other compensation such as interests, default penalty and liquidated damages arising from a delayed payment for the construction project price, the court would not approve the claim.

Article Twenty Two The contractor can exercise its right of first refusal to receive compensation for the construction project price within six months from the date when the outsourcer should pay for the project price.

Article Twenty Three If the outsourcer claims that the contractor has no right of first refusal to receive compensation for the construction project price according to an agreement made between them to waive or limit such right of first refusal, which harms interests of construction workers, the court would not approve the claim.    

[Comments]

The Contract Law of China grants contractors the right of first refusal to receive compensation for the construction project price. Based on the Approval of the Supreme People’s Court for the Right of First Refusal to Receive Compensation for the Price of a Construction Project (“Approval”) that specifies conditions for the exercise of this right, the Interpretation II further clarifies the right of first refusal with the intention to protect the contractor’s right to claim. Relevant clauses are cited below.

According to Article 17, people who have the right of first refusal to receive compensation are “contractors that have made a construction contract with an outsourcer”, but having a valid construction contract is not a condition that must be met for an exercise of this right.

According to Article 18, in a decoration and renovation project, unless the outsourcer has no ownership of the building, the contractor has the right of first refusal to receive compensation on the basis of a reduced price of the project or the price at which the project is sold in an auction.  

According to Article 20, if the project is not completed but the work on it is of an accepted standard, the contractor has the right to claim the right of first refusal to receive compensation for the project price on the basis of a reduced price of the part of the project the contractor works on or the price at which the part of the project the contractor works on is sold in an auction.

Article 21 lifts the restriction in the Approval that limits the scope of a claim to actual expenses spent on construction works, and includes profits that should be given to the contractor in the scope of the contractor’s right first refusal to receive compensation on the basis of “the construction project price provisions of the relevant administrative department of the State Council”.

According to Article 22, with respect to Article 4 of the Approval regarding the period of time in which this right exists for “six months from the completion date of the construction project or the completion date agreed in the construction project”, the start date of this period of time is changed to the payment date of the amount due for the project in order to avoid leaving the contractor in a difficult situation in which the contractor cannot exercise its right of first refusal because the project is not completed or the completion date is not agreed or clear.

According to Article 23, with respect to restrictions on disposing of the right of first refusal, no waiver or limitation of the right of first refusal may harm interests of construction workers. This clause is intended to prevent the outsourcer from forcing the contractor to agree to exclude the right of first refusal by using its advantageous in concluding the contract in order to protect legal rights of construction workers.

V Further Action to Ensure Quality of Construction Projects

[Clauses]

Article Nineteen If the contractor claims the right of first refusal to receive compensation for the construction project price on the basis of a reduced price of the project or the price at which the project is sold in an auction and the work on the construction project is of an accepted quality, the court should approve the claim.

Article Twenty If the contractor claims the right of first refusal to receive compensation for the construction project price on the basis of a reduced price of the part of the project the contractor works on or the price at which the part of the project the contractor works on is sold in an auction, before the project is completed, if the work on the project is of an accepted quality, the court should approve the claim.

[Comments]

The first thing that the supreme court considers when making a legal interpretation or policy regarding construction works is to ensure quality standards for construction works are implemented to protect personal and property safety of people. It can be seen in all parts of the Interpretation I and the Interpretation II. Standards for the building industry regarding bidding procedures, qualifications required for people doing construction works and the permit for making a building plan and clauses regarding extension of the period of the construction works and payment request by the contractor included in the Interpretation II are ultimately intended to achieve the aim to ensure quality standards for construction works are met as stated by the supreme court in the interpretation.     

Based on Articles 2, 3 and 4 of the Interpretation I that the contractor can claim the amount payable for the construction project on the condition that the work on the project is “of an accepted standard” even if the construction contract is canceled or invalid, Articles 19 and 20 of the Interpretation II by the supreme court state that the right of first refusal to receive compensation for the amount payable for a construction project is exercisable only if the work on the project is of an accepted standard, even if the project is not completed. (End)