Home / Publications / JunHe Legal Updates / details of junhe law review

Annual Review on Construction Dispute Resolution in China (Series 2)—Analysis of Major Cases

2019.08.13 ZHOU, Xianfeng (Elvis)ZHENG, Yanli (Leanne)、WANG, Shuning、LIU, Zhe、YANG, Tianbolun

CASE STUDIES


1.1 Major Cases in Domestic Construction


Case 1  Identification of “Black and White Contracts” and the Validity of “Time Bar” Clause1


Facts


The applicant in the arbitration is a contractor (hereinafter referred to as the “Applicant”) who won the project via a legal tendering procedure, and the respondent is the company owning the project (hereinafter referred to as the “Respondent”). The project is a controlled tunnel as part of a national large-scale livelihood project (hereinafter referred to as the “Project”). The Respondent stipulated in the bidding documents that the construction period was from December 2010 to September 2011. The price of the bidding contract is RMB 20 million. After receiving the bid acceptance letter, the Applicant failed to sign the bidding contract with the Respondent within the statutory time. 


On 24 January 2011, after the Applicant had entered the site and conducted preliminary work such as “Four Supplies and One Leveling”,2 the Respondent notified the Applicant to change the section design of the tunnel, by changing the design section area from 3.0 m * 3.0 m specified in the original bidding documents to 3.4 m * 3.4 m. On 28 September 2011, both parties confirmed the adjusted contract price and construction period and signed the Contract for Construction of XX Tunnel Project (hereinafter referred to as the “Contract”). In comparison with the bidding documents, except for the adjustment of the design section area, the scope of the work has no material change, while the total contract price was adjusted to RMB 30 million, and the construction period was adjusted from 30 August 2011 to 30 June 2012. In addition, the documents of the Contract, claims procedures and principles for handling wall rock changes had also been changed. 


On 1 February 2013, the Applicant stopped construction of the Project with 44% of the agreed works completed. On 22 February 2013, the Respondent notified the Applicant of the termination of the Contract. After the termination of the Contract by both parties, the Respondent directly contracted the remaining part of the Project to a third party without a bidding procedure. 


Article 23 of the general conditions in the Contract provides that “after the occurrence of any situations that may result in a claim by either party, the claim shall be made to the other party in accordance with the time limit prescribed below and other relevant provisions of the Contract; 23.1 the claiming party shall send a written notice of the claim within 14 days after the occurrence of the situation that may result in the claim. The claiming party shall present a claim report within twenty-eight (28) days from the date of sending the notice of claim… 23.2 the claiming party shall be deemed as having automatically waived its right to the claim if it fails to give a valid written claim against the other Party in accordance with time limit and requirements”.


Issues


First, whether the change of construction period or price after winning the bid constituted substantive changes.


Second, whether the claim was valid in violation of the claiming procedure stipulated in the Contract.


Third, whether the Applicant shall bear the loss caused by replacement of the contractor. 


Judgment


First, with regard to whether the changed construction period and price are substantive changes, the Applicant claimed that as per Article 46.1 of the Bidding Law that the bid inviter and the successful bidder shall conclude a written contract in conformity with the terms of the bid and the successful bid within 30 days from the issue of bid acceptance letter; the bid inviter and the successful bidder shall not conclude any other agreement that is contrary to the substantive contents of the contract, the Contract therefore shall be invalid due to the failure to call for the bidding procedure after the design change of the tunnel. In this regard, the tribunal held that the contract price and construction period arrangement were inconsistent with those specified in the bidding documents due to the change of tunnel section, which cannot be simply and dogmatically equivalent to the substantive contents specified in Article 46 of the Bidding Law. The price change in the Contract caused by such substantive change may still be determined by the unit price generated from bidding competition and the pricing principle specified in the bidding documents, which can still fully reflect the competitive effect of the bidding. On the premise that the Applicant failed to prove the legal basis of re-bidding for the Project, the tribunal held that the Project did not need a re-bidding, and confirmed the validity of the Contract. 


Second, with respect to whether the claim was valid in violation of the claim procedures, the tribunal ruled that the delay of the Project included the delayed commencement, the design change, the failure of the Respondent to timely fulfil the land taking obligation and the political activities including the “18th National People’s Congress” (hereinafter referred to as the “18th NPC”), which shall not be attributed to the Applicant. The extension of the construction period shall be subject to the claiming procedures stipulated in the Contract. However, the existing evidence of the Applicant can only prove that it had obtained the extension of the construction period for 70 days due to the change about the wall rock level. The existing evidence submitted by the Applicant to the tribunal was insufficient to prove that it has obtained the extension of the construction period agreed by Respondent due to land taking, other design changes and the 18th NPC. Nevertheless, in the event of certain delay on the Contractor’s side as agreed in the Contract, the Respondent shall warn the Applicant and make adjustments to the quantities. Due to the failure of the Respondent to take the above actions, the tribunal held that both parties were responsible for the delay of the construction period. 


Third, regarding the loss of price difference caused by the separate contracting after the termination of the Contract, the Respondent claimed that after the termination, the loss amounting to RMB 16 million incurred by the Respondent due to the change of constructor shall be borne by the Applicant. The Applicant claimed that the Contract, based on which the settlement report was produced to prove the Respondent’s loss, for the remaining works was not tendered in accordance with the Bidding Law, so the contract shall be deemed invalid. The tribunal held that the Project fell within the scope of projects required to call bids and the remaining part of the Project fell within the same scope after the Contract was terminated. As a result, the construction contractor for the remaining Project should be selected under the bidding procedure. However, the Respondent had signed the corresponding construction contract with a third party by direct contracting, and the contract price had not been squeezed through the competition mechanism of bidding. Therefore, the tribunal cannot determine from the analysis of the existing evidence submitted by the Respondent that if the subsequent contractor was selected through the bidding, whether the actual price of the remaining part of the Project will be higher than the price of the remaining Project determined based on the Contract. The Respondent shall bear the consequences of failure to prove, and the Applicant therefore did not need to bear the additional losses caused to the Respondent. 


Comments


First, with the development of construction dispute resolution practice, the judicial practice of dealing with “black and white contracts” gradually becomes profound and scientific. The characteristics of the construction work determines that the construction contract needs to be changed and refined during the performance of the contract. Even the construction contract concluded through bidding shall not be strictly or mechanically identified as the change of “substantial contents”. In this case, the tribunal upheld that the construction period and price arising from major design changes do not deviate from the substantive contents of the awarded contract, and the core consideration is that the parties still adopt the pricing principle established by the bidding, and the result can correctly draw the line between the reasonable changes and the “black and white contract”. 


Second, the claiming procedure, working as procedural right and obligation in the construction contract, shall be strictly observed by both parties and the adverse consequences arising therefrom shall also be borne by both parties. In this case, the tribunal recognised that the right would be entitled to request for extension of the construction period if a claim is made within the time limit of the claiming. On the other hand, it also strictly interpreted the application of the “Time Bar” clause based on the Respondent’s mitigation obligations when applying the said clause, thereby strictly restricting the employer’ right to terminate the Contract. 


Third, for projects requiring call bids, even if the employer has the right to terminate the contract on the grounds of breach by the contractor, whether the loss in price difference on a separate contracting for the remainder of the project is claimable, and whether the remainder of the project takes the form of the bidding are important factors in the judgment.


Case 2  Impact of Environmental Policies and Public Events on the Performance of Construction Contracts3


Facts


On 20 November 2006, Albert Company and the general contractor, the Central Southern Electric Power Design Institute (hereinafter referred to as the “CSEPDI”), signed a general construction contract for Tenglong Aromatic Thermal Power Plant (3 × 480 t/h + 2 × 100MW) (hereinafter referred to as the “General Construction Contract”). According to the General Construction Contract, in the event of early termination of all or part of the services under the Contract, the general contractor shall be entitled to the following payments: (1) all costs which are necessary and unavoidable for the general contractor to perform his services as required by the Contract at the time of early termination as audited and certified by an independent and certified public accountant firm and which have not been paid, and (2) all costs actually incurred by the general contractor for the purchase of the equipment, materials, equipment or other necessary items forming part of the Project which have not been actually paid by the Owner. In addition, the Contract specifies that the force majeure refers to any event or circumstance that is unforeseeable, unavoidable and insurmountable when the contract is signed by either party, with the specific scope being provided in the Special Conditions of the Contract. The Contract also provides clauses on the allocation of risks and expenses caused by force majeure event. 


On 30 May 2007, the Xiamen Municipal People’s Government announced that the construction of the PX project was postponed because Xiamen residents boycotted the supporting xylene (PX) project. On 15 January 2008, the Albert Company sent a letter to the CSEPDI, indicating that due to force majeure, the General Construction Contract was suspended. 


Since the parties failed to reach an agreement on the completed project cost, relocation and variation cost, the Albert Company issued a letter on 10 August 2009 claiming that CSEPDI had violated the General Conditions and Special Conditions of the Contract signed by both parties and changed the total contract price, which constitutes a material breach. It requested the cancellation of the General Contract for Construction signed by both parties, and at the same time, make the relevant claims based on the Contract. 


The CSEPDI filed a lawsuit for termination of the Contract due to Albert Company’s breach and requested to order the Albert Company to continue to perform the General Construction Contract and pay the additional costs arising from the change of project location; later, the CSEPDI changed the claim for the Albert Company to compensate RMB 67,724,509 (including the on-site construction cost RMB 2,217,183; the cost incurred by the general contractor from the commencement of the project to the shutdown of the Project was RMB 544,373; the cost incurred by the subcontractor before the commencement to the shutdown of the project was RMB 1,595,380; the cost of suspension of the project was RMB 20,536,002; the statutory profit was RMB 17,855,57; and the compensation to the subcontractor of construction was RMB 20,076,000). The Albert Company requested for judgment on the termination of the General Construction Contract on the grounds of breach of contract by the CSEPDI.


Issues


First, the cause of termination of the General Construction Contract and whether both parties have breached the General Construction Contract.


Second, the distribution of liabilities to the costs and expenses arising from the performance of the contract before the termination of the General Construction Contract. 


Third, whether the CSEPDI’s claims for compensation for the loss of profits should be supported. 


Judgment


First, in relation to the reason for the termination of the General Construction Contract and whether the parties have breached the Contract, the court held that, on 20 December 2006, the Albert Company and the CSEPDI signed the General Construction Contract. The Project faced resistance from Xiamen residents during the performance of the contract and was postponed by the Xiamen Government on 30 May 2007. Later, relevant ministries approved the Project’s relocation plan. This was a major change, which was not caused by force majeure at the time of signing the contract and does not belong to commercial risk. The reason for the project relocation is a change of circumstances, not force majeure. After a major change in circumstances, the parties negotiated over the follow-up work after relocation, cost adjustment and schedule, but could not reach an agreement on terms such as the contract price. The General Construction Contract shall be rescinded in consideration of the fact that the Project has been constructed and completed by the third party and the General Construction Contract cannot be performed de facto. 


Second, with respect to the issue of how the costs and expenses incurred due to the performance of the contract before the termination of the General Contract for Construction, the court held that since the General Contract for Construction could not be performed due to the change of circumstances, both the employer and the contractor have no fault subjectively. In accordance with the principle of fairness and the terms of contract, the employer shall compensate the contractor for the costs incurred or must be paid by the contractor in performing the contract prior to the termination of the contract, but the employer shall not be liable for breach of contract. 


Third, in relation to the claim of the CSEPDI for compensation of the loss of profit, the court held that the construction of the project was completed by the third party due to change of circumstance, and the CSEPDI’s claim for the loss of profit was not supported by the contract or the law. 


Comments


In recent years, with the large number of laws and regulations on environmental protection coming into force, environmental law enforcement has become more and more rigorous. Environmental protection has gradually become a hot topic in the field of construction and attracted greater attention. In this case, the project was delayed and relocated due to environmental protection reasons and the contract was finally terminated due to change of circumstances. Neither party constituted a breach of contract, and neither party was liable to the other for breach of contract. 


In this case, the settlement after the termination of the General Construction Contract is also a key issue. The settlement amount finally verified by the court through judicial cost appraisal was RMB 3,791,741.39 (for the cost of the project during the suspension period) and RMB 7,970,000 (cost paid to the subcontractor for termination of the Contract). In fact, how to settle the construction works contract (especially the total price contract) after its termination is a sticking point in construction dispute resolution practice. Especially in recent years, because of the macroeconomic backdrop, environmental protection policies, real estate regulatory policies, financing policies and other factors resulting in a large number of projects under construction unsuccessfully completed. These result in long-term suspension or even termination of the Contract, which lead to disputes over settlement. A topic of interest in practice and research.


Case 3  The Validity of EPC Contract and the Scope of Priority in Compensation4


Facts


In September 2014, without bidding, Chifeng Guangda Photovoltaic Agricultural Development Co., Ltd. (hereinafter referred to as the “Guangda”) signed with Shandong Electric Power Construction Third Engineering Co., Ltd. (hereinafter referred to as the “SEPCO III”) the EPC Contract for Phase I of the 10 MWP Agricultural Photovoltaic Power Generation Demonstration Project (hereinafter referred to as the “EPC Contract for Photovoltaic Power Generation”), under which Guangda is the general contractor for Phase I of 10 MWP Agricultural Photovoltaic Power Generation Project (hereinafter referred to as the “10 MWP Photovoltaic Power Generation Project”). The scope of general contracting includes engineering design, equipment procurement, construction, placement, commissioning, etc. The Contract stipulated that the completion check and takeover shall be conducted after the Project start-up, commissioning and production completion test. The project completion test and acceptance committee shall be composed of the relevant administrative departments in charge of the electric power industry, auditing, environmental protection, fire prevention, quality supervision, etc., and relevant experts. 


On 10 November 2014, without bidding, Guangda and SEPCO III signed the General EPC Contract for 66KV Line Project of Guangda (hereinafter referred to as the “EPC Contract for Line Project”), under which SEPCO III was responsible for the engineering design, procurement, construction, commissioning, trial production and performance assurance within the scope of 66KV line project of Guangda; and Guangda is responsible for coordination works during construction. 


On 24 June 2016, 66KV Qingxin Line and 66KV Qingquanshan Substation were installed, commissioned and tested, and passed the acceptance, which were ready for commissioning. On 30 June 2016, SEPCO III submitted the application form for completion acceptance to Guangda, indicating it has completed the 10MWP Photovoltaic Grid Interconnection Power Generation Project in accordance with the Contract requirements. The Project has passed the Class III self-inspection by the company and is hereby required to be completed for acceptance test. Attached was the completion acceptance certificate, which was sealed by Guangda. 


On 1 September 2016, Guangda obtained a power business license, and on 26 September, Guangda signed the Power Purchase Agreement for Qingquanshan Photovoltaic Power Station of Guangda. On 28 October 2008, Guangda signed the Dispatching Agreement on Interconnection of 10MWP Qingquanshan Photovoltaic Power Plant with Chifeng Power Grid. Since then, the 10 MWP Photovoltaic Power Generation Project has been formally put into operation. 


Due to disputes over the settlement of the project price under the two EPC Contracts, SEPCO III filed a lawsuit against Guangda, requesting the court to confirm the invalidity of the EPC Contract for Photovoltaic Power Generation and the EPC Contract for Line Project; and that Guangda should pay RMB 106,087,757.64 with interest; and SEPCO III shall have the priority of compensation to the Project.


Issues


First, the effectiveness of the two EPC contracts.

Second, whether the Project has been completed.

Third, whether SEPCO III has the priority in compensation to the Project.


Judgment


First, the court held that the Project is an infrastructure project relating to public interests and public security, so it is a project that must be subject to bidding. Under the relevant judicial interpretations, if the construction projects involved must be subject to bid invitation but failed to do so or the bid is invalid, such contracts shall be deemed as invalid in line with Item 5, Article 52 of the Contract Law. Before signing the two EPC contracts with Guangda, no bidding was conducted for the Project. So, the EPC contract for Photovoltaic Power Generation and the EPC contract for Line Project signed by both parties are both invalid. 


Second, the court held that, where the owner uses the Project without authorisation and without completion acceptance of the Project, the date of completion shall be the date when the Project is taken-over de facto. Although the Project had not undergone the comprehensive acceptance inspection by the competent electric power department, audit department, environmental protection department, fire prevention department, quality supervision department and other administrative departments as agreed under the Contract, Guangda had taken over the project on 30 June 2016 and put it into actual use. The Project shall be deemed to be completed. On this basis, the terms of payment agreed in the Contract shall have been met. 


Third, the court upheld that SEPCO III, as the contractor of the Project, is entitled to the right of priority for compensation under Article 286 of the Contract Law. 


Comments


This case has practical guiding significance for signing EPC contracts in the current construction industry, especially on the issue of whether the contractor of the EPC contract has the right of priority, which is embodied in the following aspects:

First, the right of priority is not subject to the validity of the contract. In this case, although the construction contract involved in the case was determined to be invalid due to the failure to conduct the bidding in accordance with the statutory procedures, the court still upheld that the contractor is entitled to the right of priority in payment with respect to the proceeds from the sale or auction of the Project. 


Second, with regard to the scope of the right of priority, Article 17 of the Judicial Interpretation II on Construction Contracts provides that the contractor that has concluded a construction contract with the employer shall be entitled to the preemptive rights, but does not specify whether the survey or design fees under the construction project survey or design contract shall be subject to the preemptive rights. In this regard, the guiding opinions on trial of some local courts expressly provide that no project surveyor or designer may claim the priority of compensation for the fees for project survey or design.5


Due to the general contractor’s combined responsibility for design, procurement and construction under the EPC contract, the price composition of the EPC contract is more complicated, including design cost, equipment procurement cost, construction and installation cost, etc. In view of this, there is certain vagueness in whether the full price of the EPC contract is applicable to the right of priority. In this case, the SPC not only recognised the application of the right of priority to repayment to the EPC contract, but also did not deduct the design fees and consulting fees from the scope of priority to be repaid. Therefore, the case has positive reference value for determining the scope of application of the right of priority under EPC contract.


Case 4  Identification of Independent Guarantee Fraud Exceptions, Limited Review Principles and Exceptions of Independent Guarantee Fraud Exceptions6


Facts


On 16 January 2010, the Oriental Real Estate Co., Ltd. (hereinafter referred to as “Oriental”), as the developer, signed a construction contract with Anhui Foreign Economic Construction (Group) Co., Ltd. (hereinafter referred to as the “AFECC”), as the contractor, and Anhui Foreign Economic Construction Central America Co., Ltd. (hereinafter referred to as the “Central America”), as the constructor. 


On 26 May 2010, the AFECC made an application to Anhui Branch of China Construction Bank, (hereinafter referred to as the “Anhui CCB”) for issuing a performance guarantee with Bank of Costa Rica as the reissuing bank and the Oriental as the beneficiary. 


On 28 May 2010, Bank of Costa Rica issued No. G051225 demand guarantee. The call of this guarantee shall require the beneficiary to submit in duplicate to the Department of Foreign Trade of the Central Office of Bank of Costa Rica a certificate specifying the reasons for the call of this guarantee, and a notarised statement issued by the beneficiary specifying the date of the request, arising from which Central America breached the contract, accompanied by the original certificate and any amendments issued. 


The Anhui CCB also issued No.34147020000289 demand counter-guarantee to Bank of Costa Rica and agreed to abide by the Uniform Rules for Demand Guarantees, ICC Publication No. 758. 


During the performance of the construction contract, on 23 January 2012, the project supervisors, Jose Brenes and Mauricio Mora, issued the Project Engineering Inspection Report (hereinafter referred to as the “Report”). The Report indicated that the construction project was under the circumstances of “bad engineering” or “low quality” and needed to be modified or repaired. On 7 February 2012, Central America filed a claim for overdue payment to the Dispute Resolution Center of Costa Rica Association of Architects & Engineers (hereinafter referred to as the “Association”). On 8 February, Oriental demanded payment from Bank of Costa Rica, requiring the presentation of the guarantee. On 10 February, Bank of Costa Rica sent an electronic message to Anhui CCB, claiming that Oriental demanded a payment for the amount of US$ 2,008,000 under the No. G051225 guarantee, and then required the Anhui CCB to make the said payment by 16 February 2012. On 12 February, at the request of Central America, the second court of the administrative court of the Republic of Costa Rica issued an injunction against interim protective measures, ordering Bank of Costa Rica to suspend the payment of the No. G051225 guarantee. 


On 23 February, AFECC filed a lawsuit of guarantee fraud. The court of first instance ruled to suspend the payment under guarantee and informed Bank of Costa Rica of the decision via Anhui CCB. On 6 March, the second court of the administrative court of the Republic of Costa Rica lifted the injunction against provisional protection measures after Central America lost the case by applying for preventive measures. On 20 March, at the request of Bank of Costa Rica, Anhui CCB extended the term of validity of Guarantee No. 34147020000289. On 21 March, Bank of Costa Rica paid the Oriental under the No. G051225 guarantee. 


On 9 July 9 2013, the Association rendered an arbitration award, confirming that Oriental had seriously breached the contract during the performance and ruled to terminate the construction contract, under which Oriental shall pay to Central America a total of US$ 800,058.45 and interest for the progress payment of unit No.1 to No.18; the request for payment for unit No. 19 was not upheld due to the failure of the developer to accept the corresponding part; as the payment under the No. G051225 guarantee had been made, the request for return of the guarantee by Central America was rejected. 


The court of first instance and the court of second instance both held that Oriental constituted independent guarantee fraud. However, the SPC revoked the judgments of second instance and first instance and dismissed the AFECC's claims. 


Issues


First, whether Oriental, as the beneficiary, had prima facie evidence under the underlying contract to prove its claim having a factual basis.


Second, whether the default occasions of the beneficiary under the underlying contract necessarily constituted a fraudulent demand under the independent guarantee.


Third, independent counter-guarantee issues related to the independent guarantee. 


Judgment


First, the SPC held that when AFECC claimed that the acts of Oriental constituted fraud under the independent guarantee, it shall submit evidence to prove that Oriental had any of the following acts at the time of presenting the independent guarantee: (1) it submitted false or forged documents for making the demand; and (2) it had no factual basis and reliable basis for the call. In this case, the bond was to guarantee the construction quality and other breaches of contract. Therefore, the beneficiary may, by submitting prima facie evidence of the existence of a construction quality problem, satisfy the requirement of submitting supporting documents of giving reasons for making the demand. During the performance of the underlying contract in this case, the Report issued by the project supervisors of Oriental identified the existence of “bad engineering” or “low quality” and that the project needed to be revised or repaired, which constituted the prima facie evidence to prove the existence of construction quality problem. The parties to this case did not expressly agree in the construction contract and in the guarantee to submit the Report to Bank of Costa Rica. Therefore, Oriental had the right to choose the type of the documentary evidence of “reasons for making the demand” to Bank of Costa Rica, and whether to submit such report to Bank of Costa Rica shall not affect the realisation of the rights under the guarantee. As AFECC failed to provide other evidence to prove that Oriental had no factual basis for the presentation of the guarantee or provided false or forged documents, Oriental applied to Bank of Costa Rica for making the demand, which did not constitute guarantee fraud. 


Second, with regard to whether breaches of the contract by Oriental inevitably constituted an independent guarantee fraud, the SPC held that the independent guarantee is independent of the underlying transaction between the applicant and the beneficiary, and the bank issuing the independent guarantee only takes charge of reviewing whether the documents submitted by the beneficiary are in line with the provisions of the guarantee and has the right to decide whether to make payment at its sole discretion. The payment obligation of the guarantee bank shall not be affected by the right of defence under the primary transaction between the applicant and the beneficiary. Oriental, as the beneficiary, whether or not initiated any dispute resolution procedure, or if the underlying Contract enters into dispute resolution procedure without determining payment or compensation liability yet, even if it constitutes a default under the underlying contract, the payment made to the beneficiary under the guarantee shall not be affected by the foregoing circumstances. Although the Association made an arbitration award at the request of AFECC that Oriental shall be deemed as having breached the Contract during the performance, it was not deemed as an exemption from payment or liability for damages by AFECC due to the breach of contract by the other party. Therefore, it shall not be deemed based on the contents of the aforesaid arbitral award that Oriental had constituted guarantee fraud stipulated in Article 12.3 of the Provisions of the Supreme People’s Court on Several Issues Concerning the Trial of Independent Guarantee Dispute Cases(Fa-Shi [2016] No.24) (hereinafter referred to as the “Judicial Interpretation of Independent Guarantee”). In addition, the facts of the dispute between the parties regarding the quality of the project and the statements on the quality issues made by the arbitration award issued by the Association can substantiate that the obligations of Central America under the construction contract have not been fully performed, and there was no circumstance in this case where Oriental confirmed that the underlying transaction debt had been fully performed or the payment had not been due. The existing evidence cannot prove that Oriental clearly knew that it was not entitled to demand a payment and abused its right. Oriental’s acts of breaching of the contract in the performance of the underlying contract, confirmed by the arbitration award, did not exempt AFECC from payment or compensation liabilities. To sum up, even if the Judicial Interpretation of Independent Guarantee was applicable as claimed by AFECC, this case did not constitute an independent guarantee fraud. 


Third, in connection to the independent counter-guarantee related to the independent guarantee, the SPC held that even if the beneficiary made a fraudulent demand under the independent guarantee, it could not be assumed that the guarantee bank has constituted fraud under the independent counter-guarantee. A guarantee bank shall be deemed to constitute fraud under the independent counter-guarantee only when it knows that the beneficiary has made a fraudulent demand, violates the principle of good faith and calls the amount under the independent counter-guarantee against the counter-guarantee bank. In this case, AFECC sued on the ground of the guarantee fraud and it shall provide evidence to prove that Bank of Costa Rica still paid in violation of the principle of good faith even though it knew Oriental was engaged in a fraudulent demand, and then demanded a payment under the independent counter-guarantee as the beneficiary and constituted a guarantee fraud under the counter-guarantee. Not only can AFECC not prove that there was a guarantee fraud in the payment under the independent guarantee made by Bank of Costa Rica to Oriental, but also cannot provide evidence of any fraudulent demand by Bank of Costa Rica under the independent counter-guarantee. Therefore, there was no factual basis for AFECC’s claim to stop the payment under the independent counter-guarantee. 


Comments


As the No. 109 SPC Guiding Case, on the basis of the Judicial Interpretation of Independent Guarantee, the case has further established the following principles for adjudicating independent guarantee fraud disputes:


First, when it is identified that an underlying transaction has constituted an independent guarantee fraud and a review of the underlying transaction is required, the limited and necessary principle shall be adhered to. The scope of review shall be limited to whether the beneficiary is aware that the counterparty of the underlying contract has not defaulted under the underlying contract, and whether the beneficiary is aware that it does not have the right to demand a payment. 


Second, the default of the beneficiary under the underlying contract shall not affect the right of the beneficiary to submit documents and demand a payment in accordance with the provisions of the independent guarantee. 


Third, when deciding whether there is fraud under the independent counter-guarantee if the payment under the independent guarantee has been made in good faith even if there is an independent guarantee fraud, the people's court shall not rule to cease the payment under the independent counter-guarantee. 


The judicial standards established in this case in respect of the standards for identifying independent guarantee fraud exceptions, the limited review principle for independent guarantee fraud disputes, the exception of independent guarantee fraud exceptions and other issues provide guidance for the trial of independent guarantee fraud disputes, which therefore are of strong demonstration and significant guidance. 


Statement:The report is part of the research outputs of the “Annual Review on Construction Disputes in China (2019)”. All the research outputs will be included in the Annual Review on Commercial Disputes Resolution in China (2019) compiled by the Beijing Arbitration Commission. The Chinese-English bilingual report will be published separately by China Legal Publishing House and Wolters Kluwer Hong Kong Limited in the near future. Welcome attention.



1. According to the confidentiality principle in arbitration, this report has redacted the facts of this case.

2. Translator’s Note: The site provides access to road, water, electricity, communication and land leveling.

3. Disputes Over Construction Contracts between Central Southern China Electric Power Design Institute Co., Ltd. of China Power Engineering Consulting Group and Albert (Xiamen) Equipment Engineering Co., Ltd., (2018) SPC Min Zhong No. 105 (4 June 2018).

4. Disputes Over Construction Contracts between Chifeng Guangda Photovoltaic Agricultural Development Co., Ltd. and Shandong Electric Power Construction Third Engineering Co., Ltd., (2018) SPC Min Shen No. 5547.

5. The Notice of the Executive Board of the Higher People's Court of Zhejiang Province on the Answers to the Issues Concerning Dealing with the Priority of Compensation for Construction Projects, Zhegao Law Executive (2012) No. 2, 10 January 2012.

6. Case No. 109 in the 21th batch of Guiding Cases published by the SPC in February 2019.

JunHe is the only Chinese law firm to be admitted as a member of Lex Mundi and Multilaw, two international networks of independent law firms. JunHe and selected top law firms in major European and Asian jurisdictions are “best friends.” Through these connections, we provide high quality legal services to clients doing business throughout the world.