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Annual Review on Construction Dispute Resolution in China (Series 3) —Analysis of Hot Legal Topics

2019.08.15 ZHOU, Xianfeng (Elvis)ZHENG, Yanli (Leanne)、WANG, Shuning、LIU, Zhe、YANG, Tianbolun

1. PRACTICAL AND ACADEMIC FOCUS


1.1 Black and White Contracts


Article 21 of the Judicial Interpretation I on Construction Contracts sets out the basic principle for dealing with “black and white contracts”. With the development of judicial practice, this Article has been unable to adapt to the complicated and volatile “black and white contracts” related dispute resolution. Therefore, the Judicial Interpretation II on Construction Contracts has refined and adjusted the principles of “black and white contracts” in the four articles, as shown in the following table:


Article

Content

Article 1

Where the substantive contents such as scope of project, construction period, project quality, construction project price etc. agreed in the construction contract entered into separately between the tender inviting party and the successful bidder are inconsistent with the awarded contract, if a party concerned petitions for determination of rights and obligations in accordance with the awarded contract, the People's Court shall support.

Where the tender inviting party and the successful bidder enters into a separate contract in addition to the awarded contract, which provides for purchase of the constructed building at a price evidently higher than market price, construction of complementary facilities free of charge, surrendering profits, donation of monies and goods to the builder etc. so as to reduce the project price covertly, if a party concerned asserts that such contract deviates from the substantive contents of the awarded contract and petitions for a declaration that such contract is invalid, the People’s Court shall support.

Article 9

After the contract awarding party has invited tender for a construction contract which is not required by law to invite tender, where the construction contract entered into with the contractor separately deviates from the substantive contents of the awarded contract, if a party concerned claims that the settlement of construction project price be based on the awarded contract, the People's Court shall support, except where the contract awarding party and the contractor have entered into a construction contract separately due to occurrence of changes unforeseen at the time of invitation to tender and bidding which are attributable to objective reasons.

Article 10

Where the construction contract entered into between the parties differs in the scope of project, construction period, project quality or project price stated in the tender documents, bid documents or the notice of award, if a party concerned claims that the settlement of project price be based on the tender documents, bid documents or the notice of award, the People's Court shall support.

Article 11

Where several construction contracts entered into between the parties concerned for the same construction contract are all invalid, but the construction quality complies with the standards, if a party concerned petitions for settlement of construction project price with reference to the actually-performed contracts, the People’s Court shall support. 


1.1.1 With Respect to the “Awarded Contract”


According to Article 21 of the Judicial Interpretation I on Construction Contracts, the “awarded contract filed for record” shall be used to represent the “white contract”. However, on the one hand, considering that the record-filing system for construction contracts mainly exists in the area of housing construction and municipal infrastructure engineering, and does not actually exist in other industries; on the other hand, the record-filing system for construction contracts has been cancelled by the MOHURD on 28 September 2018, therefore, Article 1 and Article 9 of the Judicial Interpretation II on Construction Contracts now use the definition of “awarded contract” to represent “white contract”, which obviously will be more accurate than “awarded contract filed for record”. However, based on the overall understanding of Article 1, Article 9, Article 10 and Article 11 of the Judicial Interpretation II on Construction Contracts, we tend to hold the opinion that the “awarded contract” is not necessarily equivalent to the “white contract”. In practice, the following points should be noted for the understanding and the application of the “awarded contract”:


First, the “awarded contract” shall be signed in accordance with the bidding documents, the tender documents and the notice of award. According to Article 10 of the Judicial Interpretation II on Construction Contracts, if the content of the “awarded contract” is inconsistent with the bidding documents, the tender documents and the notice of award in terms of the scope of the project, the construction period, the project quality and the project price, the “awarded contract” will then be actually considered as a “black contract” and cannot be used as a valid basis for settlement by the parties. 


Second, the case where the parties do not sign the “awarded contract” based on the bidding documents, the tender documents and the notice of award is likely to continue to exist and will not disappear due to the cancellation of the record-filing system for construction contracts. The reason is that although the MOHURD has now abolished the “record-filing system for construction contracts” as stipulated in paragraph 1, Article 47 of the Measures for the Administration of Bidding of the Construction of the House Building and Municipal Infrastructure Projects (Ministry of Construction, Order No.89), it has not cancelled the “filing system of the tender documents” as specified in Article 19 thereof. We anticipate that the cancellation of the “record-filing system for construction contracts” and the existence of the “filing system of the tender documents” will not substantially reduce or eliminate the phenomenon of the “black and white contracts” in practice but may increase the inconsistency between the “awarded contract” and the substantive contents of the bidding documents, the tender documents and the notice of award. That is, the possibility of the “awarded contract” constitutes a “black contract” will increase. 


Third, if the tendering, bidding or winning of the bid is invalid due to the illegal activities of the parties, then, the bidding documents, the tender documents and the notice of award that form the basis of the “white contract” will also be invalid. Likewise, the construction contract concluded afterwards will also be invalid. All of these agreements will constitute a “black contract”. In such case, the construction project price shall be settled with reference to the “black contract” that was actually performed in accordance with Article 11 of the Judicial Interpretation II on Construction Contracts. 


1.1.2 With Respect to the “Non-mandatory Bidding Projects”


Before the promulgation of Article 9 of the Judicial Interpretation II on Construction Contracts, with regard to whether the non-mandatory bidding projects shall apply the principle of handling the “black and white contracts” case as stipulated in paragraph 1, Article 46 the Bidding Law and Article 21 of the Judicial Interpretation I on Construction Contracts, not only are the jurisdictional standards of local courts not uniform, even in the same court, the standards of practice are different at different times. Take Jiangsu Province as an example, in response to construction project contract disputes, the Opinions1 and Guidelines2 issued by the Higher People’s Court of Jiangsu Province in 2008 and 2010 respectively stipulates that for non-mandatory bidding projects that adopt the bidding method, the awarded contract shall be used as the basis for its settlement. However, in the latest Answer3 released in 2018, the basis for settlement has been changed to the “contract actually executed by the parties”. 


In fact, the application scope of paragraph 1, Article 46 of the Bidding Law shall not be limited to the projects that are required by the law to invite tender, but also include construction projects that are not required by the law to invite tender, here the company owning the project can choose whether to adopt a bidding method. Therefore, Article 9 of the Judicial Interpretation II on Construction Contracts, which provides that the “black and white contracts” disputes arising from a bidding process for projects that are not required by law to invite tender shall still be settled on the basis of the “white contracts”, is actually the specific application of paragraph 1, Article 46 of the Bidding Law, which is of great significance for unifying the relevant judicial standards in the country. 


Although Article 9 of the Judicial Interpretation II on Construction Contracts is consistent with paragraph 1, Article 46 of the Bidding Law and the correctness of the content of the law shall not be questioned, in practice, it shall be noted that for companies owning a majority of non-mandatory bidding projects, “actively” using the bidding method would often be based on inertia or mindset. Their original intention may not be “voluntarily” applying the Bidding Law. However, in accordance with the applicable rules established in Article 2 of the Bidding Law, as long as the “tendering and bidding activities” are carried out within the territory of the People’s Republic of China, the Bidding Law shall apply, including a series of compulsory provisions such as Article 43 and paragraph 1, Article 46 of the Bidding Law. As a result, the mandatory application of Article 9 of the Bidding Law and the Judicial Interpretation II on Construction Contracts for non-mandatory bidding projects will cause a serious deviation from the reasonable autonomy of the parties. In view of this, especially in the context of a large reduction in the scope of projects that must be tendered, for the employers owning a majority of non-mandatory bidding projects, a more rational approach is to avoid “active” bidding.


1.2 Compensation for the Losses Caused by Invalid Construction Contract


1.2.1 With Respect to the Determination Rules of Compensation for Damages


Article 58 of the Contract Law provides that: “After a contract has been declared invalid or revoked, all property obtained by reason of the said contract shall be returned; where the property cannot be returned or there is no need to return it, compensation shall be paid on the basis of the depreciated value of the property. A party that is at fault is liable to compensate the other party for its resulting losses, and where both parties are at fault, then each party shall bear the relevant liability respectively.” 

In the case of invalid construction contracts, Article 2 of the Judicial Interpretation I on Construction Contracts establishes the basic rules on how to conduct “discount compensation”, which provides that “where a construction project contract is invalid but the construction project passes the acceptance inspection upon completion of construction, the contractor may request for payment of project fee with reference to contract provisions”. However, the Judicial Interpretation I on Construction Contracts does not specify how to deal with the losses caused by the invalidity of the construction contracts. Therefore, Article 3 of the Judicial Interpretation II on Construction Contracts sets forth the following rules:


“Where a construction contract is invalid and the party concerned wish to claim damages from the other party, the party concerned shall bear the burden of proving the fault of both parties, the extent of damages, and the cause and effect of the fault and damages.


Where it is impossible to determine the extent of damage, a party concerned shall submit petitions for determination of the extent of damage with reference to the quality standards, construction period, payment date for project price etc. agreed in the contract, the People's Court may take into account the factors such as degree of fault of both parties, the cause and effect of fault and damages etc. to make a ruling.”


According to the opinions in the Detailed Analysis of the Judicial Interpretation II on Construction Contracts issued by the SPC Judges Wang Yuying and Chen Ya,4 if the construction contract is invalid, the parties cannot directly invoke the liability clause for breach of contract to claim damages. If the employer or the contractor claims compensation for the losses due to the quality of the project, delay in construction, shut down, work slowdown or other reasons, it is difficult to determine not only the degree of the loss, but also whether there is a problem with the quality of the project, whether there is a delay in construction, and whether there is a shut down or work slowdown. In consideration of the above, paragraph 2 of this Article follows the practice specified in Article 2 of the Judicial Interpretation I on Construction Contracts, allowing the parties to refer to the agreed quality standards, construction period, the payment time of the project price, etc. to prove the existence of defect in the project quality, delay in construction, delay in payment, etc., and to determine the actual loss based on this. 


1.2.2 With Respect to the “Fault”


In accordance with the rules provided in Article 3 of the Judicial Interpretation II on Construction Contracts, the “degree of the fault of the parties” and the “causal relationship between the fault and the loss” are important factors in determining the extent of the loss. For the understanding of the “fault” in the Article, according to opinions issued in the Understanding and Application of the Judicial Interpretation II on Construction Contracts by the SPC (hereinafter referred to as the “Understanding and Application of Judicial Interpretation II”), the “fault” should refer to the fault5 that caused the contract to be invalid, that is, the contracting fault. For example, in the dispute over a construction project contract Jiangsu First Construction and Installation Group Co., Ltd. (“Jiangsu Yijian Company”) v. Tangshan Changlong Real Estate Development Co., Ltd. (“Changlong Company”),6 the SPC held that:


“Where it is impossible to determine a valid contract actually performed by both parties, each party shall bear the corresponding losses resulting from voiding of the contract based on the extent of fault pursuant to the provisions of Article 58 of the Contract Law, taking into account the factors such as the contracting fault, the quality of completed project, the balance of the interests, etc. The court of first instance found that the difference between the two valid contracts that the parties performed was the loss suffered in this case. In view of the fact that Changlong Company is the employer that organised the bidding according to law, and Jiangsu Yijian Company is a professional construction company with special qualifications and knowledge of relevant laws and regulations such as the Bidding Law. With the fact that the project is completed and accepted, it is not inappropriate for Changlong Company and Jiangsu Yijian Company to share the loss in a ratio of 6:4.” 


1.3 With Respect to the Issues Relating to the Claims for Construction Period


Litigation and arbitration over disputes and claims over the delays of the construction period have been increasing annually over the past few years. Disputes related to the construction period have also become baffling raising difficult practical questions in many cases. 


At present, due to the lack of analysis, identification methods and guidelines for project delays in China, the dispute resolution methods for domestic construction project delays mainly rely on the subjective experience of the experts. However, the experience of the experts varies greatly depending on their own experiences. It would be easy to cause inaccuracies or errors when judging the construction period due to the lack of analysis and identification methods. Reducing the influence of subjective factors on the identification and quantification of construction delays by following relevant processes, methods and selecting applicable criteria has become an urgent issue to be solved in disputes and claims. 


For the purpose of providing reference for the construction delay related disputes and claims, appraisal, improving the processing level, and regulating the behaviours triggered by disputes during the construction period, the BAC/BIAC funded the “Research on Construction Delays and Claims” in 2017, and compiled the Guideline on Claims (Appraisals) for Construction Period as well as Relevant Arbitrations and Disputes in August 2018. The purpose of this Guideline is to provide reference methods or instructions for disputes over project delays and to resolve claims. The Guideline can also provide a reference for contract drafting and project schedule management. The Guideline is divided into nine chapters, mainly include the general rules, the terminology, the basic regulations, the evidence of construction period disputes, the appraisal and related standards for construction period disputes, the procedures for analysis of construction delays, claims related to construction delays, the arbitration procedure applicable to the appraisal and the arbitration for disputes over project delays. The Guideline mainly draws on the research findings of the main construction delay analysis methods in China and other countries and combines relevant practical experiences in the analysis and appraisal of the construction delays in China. 


Compared with the examination of construction period related claims by professional arbitration institutions represented by the BAC/BIAC, the practice of courts at all levels in China lags behind other countries. However, in the Judicial Interpretation II on Construction Contracts, some practical value summaries have also been carried out.


1.3.1 With Respect to the Determination of the “Commencement Date”


Article 14 of the Judicial Interpretation I on Construction Contracts clearly stipulates the way to determine the completion date, which has achieved excellent results in practice. However, there are no specific provisions on how to determine the “commencement date”. In this regard, Article 5 of the Judicial Interpretation II on Construction Contracts provides that:


“Where the parties’ concerned dispute over the construction contract commencement date, the People’s Court shall ascertain in accordance with the following circumstances:


(1) The commencement shall be the commencement date stated on the notice of commencement issued by the contract awarding party or the supervisor; upon issuance of the notice of commencement, if the commencement criteria are not satisfied, the commencement date shall be the date on which the commencement criteria are satisfied; where commencement is delayed on the part of the contractor, the commencement date shall be the date stated on the notice of commencement. 


(2) Where the contractor has entered the site and carried out construction upon consent of the contract awarding party, the commencement date shall be the date on which the contractor enters the site to carry out construction. 


(3) Where the contract awarding party or the supervisor does not issue a notice of commencement, and there is no relevant evidence to prove the actual commencement date, the commencement date shall be ascertained by taking into account the date stated on the commencement report, contract, construction permit, completion acceptance report or filing form for completion acceptance etc. as well as the fact of whether the commencement criteria are satisfied”. 


First of all, according to item 1 of this Article, whether the “commencement criteria” are met or not is very important in determining the commencement date. Does the “commencement criteria” specified herein refer only to the conditions of commencement of the contracts, or does it include the conditions for commencement of work (such as the construction permits)? In view of the logic of the items (1), (2) and (3) of this Article, the “commencement criteria” here shall mainly refer to the conditions for commencement of work as stipulated in the contracts, that is, the construction permit is not a necessary condition for “commencement criteria”. In this regard, the SPC held in the Understanding and Application of Judicial Interpretation II that: “Article 64 of the Construction Law with respect to construction permits fall within the scope of the administrative management of the competent construction authorities, and in the event of failure to obtain the construction permit for the project under construction, the competent authorities shall order a correction …. However, this does not necessarily have a substantial impact on the judgment of the date of commencement.” If the employer has actually entered the construction site for construction and defended the delay by claiming that there is no construction permit or the issuance of the construction permit is delayed, the employer shall further prove its failure to commence the construction work due to the lack of the construction permit, or the employer was notified by the competent construction authority to suspend the construction work”.


Second, in accordance with item (2) of this Article, the “actual date on which the contractor enters the site to carry out construction” shall also be significant in determining the commencement date. In practice, it is common that the parties would agree the “actual date when entering the site to carry out construction” as the commencement date when there is no agreement or no statutory conditions for the commencement of construction. In view of this, how to coordinate this situation with item (1) of this Article will be prone to controversy in practice. For example, the contractors often claim that the site does not meet the construction conditions, and their entering was only for preliminary construction or auxiliary construction. On this, the SPC, in the Understanding and Application of Judicial Interpretation II, held that: “Whether this circumstance can be considered as that the contractor actually entered the construction site shall be determined based on whether the construction conditions are met. If the contractor has obtained the consent of the employer to enter the site, but the site does not meet the construction conditions, the actual entry time cannot be calculated as the commencement date.”7


1.3.2 With Respect to the “Time Bar” Clause 


In practice, it is increasingly common that the construction contract will stipulate that if the contractors fail to file a claim of the construction period and/or expenses within the agreed time limit, the contractors shall lose their corresponding rights. Such “Time Bar” clause has even been included in the contract template issued by the State Administrative Department. Taking the Construction Contract for Construction Projects (Model Text) (GF-2017-0201) as an example, Article 19.1 of its general contract terms and conditions stipulates the following:


“According to the contract, if the contractors consider that they are entitled to any additional payment and/or extension of the construction period, they shall claim against the employer according to the following procedures:


(1) The contractor shall submit a notice of intent to claim the project supervisor within 28 days after it knows or should have known the occurrence of the claimed event, stating the causes of the claimed event. If the contractor fails to send the notice of intent to claim within the above 28 days, the contractor shall lose the rights of requiring additional payment and/or extension of the construction period;


(2) The contractor shall, after sending the notice of intent, formally submit a claim report to the project supervisor within 28 days; the claim report shall specify the reasons for the claim and the required additional payment and/or the extended construction period. Necessary records and certificates shall also be attached to the claim report;


(3) If the claimed event has a continuing impact, the contractor shall continue to submit an extension notice of claim at a reasonable interval, indicating the actual situations and records of such continuous impact, and list out the accumulative amount of the additional payment and/or the extension days of the construction period; and


(4) The contractor shall, after the end of the impact of the claimed event, submit a final claim report to the project supervisor within 28 days, specifying the final additional payment and/or the required extended contract period, and provide the necessary records and certificates. 


There are many disputes in the judicial practice regarding the validity of such “Time Bar” clause. Previously, only the Higher People’s Courts of Zhejiang province and Guangdong province covered this issue in relevant answering documents, and both courts recognised the validity of the “Time Bar” clause, that is, according to the principle of “following the contract”.8 Paragraph 2, Article 6 of the Judicial Interpretation II on Construction Contracts provides that:


“Where the parties concerned agree that the construction period shall be deemed not postponed if the contractor failed to apply for postponement of construction period within the agreed period, the matter shall be dealt with pursuant to the agreement, except where the contract awarding party consents to postponement of construction period after the agreed period or where the contractor has a reasonable defence.”


According to this Article, the expiration of the claim period may result in the elimination of the right to claim for the extension. However, Judicial Interpretation II on Construction Contracts here clearly stipulates that “except where the contract awarding party consents to the postponement of construction period after the agreed period or where the contractor has a reasonable defence”. Considering that the contractor’s “reasonable defence” may leave a large interpretation space in judicial practice, this may result in a significant weakening of the actual effectiveness of the “Time Bar” clause. 


1.4 With Respect to the Preemptive Rights for the Payment of the Construction Price


A total of seven articles in the Judicial Interpretation II on Construction Contracts regulated the preemptive rights for the payment of the construction price. The details are shown in the table below.


Article

Content

Article 17

Where the contractor who has concluded a construction contract with the contract awarding party petitions, pursuant to the provisions of Article 286 of the Contract Law, that its construction project price be given payment priority from the proceeds from transfer of project or auction, the People’s Court shall support.

Article 18

Where the contractor for a renovation project petitions that its renovation project price be given payment priority from the proceeds from transfer of renovation project or auction, the People's Court shall support, except where the contract awarding party for the renovation project is not the owner of the building.

Article 19

Where the construction quality complies with the standards, if the contractor petitions that its construction project price be given payment priority from the proceeds from transfer of project or auction, the People’s Court shall support.

Article 20

Where the construction quality of an uncompleted project complies with the standards, if the contractor petitions that its construction project price be given payment priority from the proceeds from transfer of project or auction, the People’s Court shall support.

Article 21

The scope of priority payment of construction project price to a contractor shall be determined pursuant to the provisions of the relevant State Council department(s) on the scope of construction project price.

Where a contractor claims for priority payment of interest, default penalty, damage compensations etc. of the late payment of construction project price, the People’s Court shall not support.

Article 22

The period for a contractor to exercise the right for priority payment of construction project price shall be six months, commencing from the date on which the construction project price becomes payable by the contract awarding party.

Article 23

Where the contract awarding party and the contractor agree on forfeiting or restricting the right to priority payment of construction project price, thus compromising the interests of construction workers, if the contract awarding party asserts that the contractor is not entitled to priority payment of construction project price on the ground of such agreement, the People’s Court shall not support.


1.4.1 The Subject of the Preemptive Rights


According to Article 17 of the Judicial Interpretation II on Construction Contracts, the contractor that concludes the construction contract with the employer shall have the preemptive rights for payment, which restricts the scope of the contractors who is entitled to the right of priority as specified in Article 286 of the Contract Law. However, according to the opinions in the Understanding and Application of Judicial Interpretation II:9


First, the surveyor or designer who concludes the project survey or design contracts with the employer shall not be the subject of the preemptive rights of the payment of construction prices, but for the part of the design fee and even the survey fee agreed in the general contract of the project, which belongs to the scope of the payment of the project, the general contractor may claim the preemptive right. However, matters such as the purchase fees of the equipment and the service fees for the trial operation are not explicitly covered in the rules. It is worth noting that in the aforesaid [Case 3], the SPC upheld the claim that the EPC contractor shall have the preemptive right to be repaid with the total EPC project price. 


Second, since the actual construction undertaker has no direct contractual relationship with the employer, the actual construction undertaker shall not have preemptive right. This is consistent with Article 29 of the Minutes of the 2011 National Conference on Civil Trial, which provides that “if the construction contract is invalid due to illegal subcontracting or contract transfer, the court shall not support the preemptive rights requested by the actual construction undertaker in accordance with the Article 286 of the Contract Law.” However, it is worth noting that in judicial practice, there are still precedents that the SPC supports the actual construction undertaker’s claims for the preemptive rights.10


Third, the subcontractor who only concludes the contract with the general contractor shall not be entitled to the right to the preemptive rights. The reason is that, in this case, according to the principle of contract relativity, there is no direct relationship between the employer and the subcontractor, that is, the employer has no obligation to pay the subcontractor. However, on the one hand, if the employer, the general contractor and the subcontractor enter into a contract jointly, the general contractor and the subcontractor shall have the preemptive rights accordingly; on the other hand, for the designated subcontractor, if the designated subcontractor completely replaces the general contractor in fulfilling the contractual obligations of the specific project, the general contractor in this regard will only undertake the obligation to cooperate with the stamping or other procedures, that is, the factual contractual relationship is formed between the designated subcontractor and the employer, then, the designated subcontractor shall also enjoy the preemptive right. 


1.4.2 The Applicable Conditions of the Preemptive Rights


According to Article 19 and Article 20 of the Judicial Interpretation II on Construction Contracts, the qualified quality of the construction works shall be a prerequisite for the contractor to exercise the preemptive right; under such condition, even if the construction works are not fully completed, the preemptive right of payment for the contractor shall not be affected. On this basis, the SPC further issued the following viewpoints in the Understanding and Application of Judicial Interpretation II:11


First, whether a contractor is entitled to the preemptive rights for payment shall be determined on the basis of the statutory standards for the qualified quality of construction projects, rather than on the basis of the standards higher or lower than the statutory standards as agreed upon between the parties concerned. 


Second, the validity of the contract shall not be a condition precedent to the contractor’s preemptive rights for payment. For the contract that is invalid, the reasons for the invalidity shall be further identified. If the contract is invalid due to the contractor’s qualification or violation of tendering procedures, the contractor may be entitled to the preemptive rights for payment within a certain limited scope; however, for the invalidity of the contract caused by other reasons, for example, if the employer fails to obtain a construction project planning permit, even if the quality of the project meets the requirements, since the procedures such as the depreciation or auction of the project cannot be realised, the contractor shall not be entitled to the preemptive rights for payment of the project costs. 


1.4.3 The Scope of the Preemptive Rights


Regarding the scope of the preemptive rights, according to Article 3 of the Approvals on Issues of Preemptive Rights for Payments of Construction Projects (Fa Shi [2002] No.16) issued by the SPC, the scope of the preemptive rights only covers the actual expenses paid by the contractor for staff remuneration, the materials fees and other expenses. Article 21 of the Judicial Interpretation II on Construction Contracts provides that the scope of the preemptive rights shall be determined “pursuant to the provisions of the relevant State Council department(s) on the scope of construction project price”. However, pursuant to the Composition of the Costs of Construction and Installation Projects (Jian Biao [2013] No.44) issued by the MOHURD and the Ministry of Finance, the construction and installation costs shall include not only labour and materials expenses, but also the expenses of construction equipment, enterprise management, profits, compliance fees and taxes. Accordingly, the scope of preemptive rights has been dramatically expanded. Further, if the Composition of the General Contracting Cost of Construction Projects (Draft for Comment) promulgated by the MOHURD on 4 September 2017 has been formally implemented, then, it would be worth noting whether equipment purchase fees, general contracting fees, etc. can also be included in the scope of the preemptive rights in addition to the cost of construction and installation.


In addition, there are different judicial practices on whether the interest shall belong to the scope of the preemptive rights for payment. Article 21 of the Judicial Interpretation II on Construction Contracts clearly stipulates that the interest incurred from the overdue payment of project costs shall not be included in the scope of the preemptive rights. 


1.4.4 The Exercise Period of the Preemptive Rights


With respect to the starting time of the period of the preemptive rights, according to the Approvals on Issues of Preemptive Rights for Payments of Construction Projects issued by the SPC, the preemptive rights shall be six months from the date of the agreed or actual completion date of the project. The Minutes of the 2011 National Conference on Civil Trial further detailed the situation of failure to complete the work on time and the situation of contract termination. According to the Minutes of the 2011 National Conference on Civil Trial “the date on which the contract was terminated or the performance is terminated” shall be the starting point for calculating the preemptive rights. Nevertheless, in judicial practice, the SPC and the local courts have diversified understanding of the starting point of the six-month period.

In Article 22 of the Judicial Interpretation II on Construction Contracts, the starting point for calculation of the preemptive rights is revised to “the date on which the construction price becomes payable by the employer”. Article 18 of the Judicial Interpretation I on Construction Contracts stipulates the specific way to determine the “date on which the construction price becomes payable by the employer”. 


However, considering that time for the progress payment, the settlement payment and money of warranty is different, shall we calculate the period of the preemptive rights separately? If there is a situation of arrears in a project and arrears in settlement, which time shall be used as the time for calculating the period of the preemptive rights, or is it feasible to calculate the time separately? In this regard, the SPC held in the Understanding and Application of Judicial Interpretation II that “the time for paying the total final price of the project shall be taken as the starting time for the period of the preemptive rights”.12 


1.4.5 The Effect of Waiver of the Preemptive Rights


As for the validity of the waiver of preemptive rights for payment by the contractor, Article 23 of the Judicial Interpretation II on Construction Contracts makes different treatments depending on whether such behaviour of the contractor will harm the interests of construction workers. The system of the preemptive rights is established mainly to protect the interests of the third parties (i.e. the construction workers), and the waiver of the contractor shall not prejudice the interests of the construction workers. 


1.5 With Respect to the Protection of the Rights of Actual Construction Undertakers


Paragraph 2, Article 26 of the Judicial Interpretation I on Construction Contracts provides that: “Where an actual construction undertaker institutes an action against the employer, the people’s court may add the assignee(s) or illegal subcontractor(s) as parties in the case. The employer shall be liable to the actual construction undertaker within the scope of outstanding project price.”


Although this provision plays a positive role in solving the problem of migrant workers' wage arrears in a specific period, it also brings a lot of confusion in judicial practice due to contradiction with the doctrine of privity of contract. In this context, Article 24 of the Judicial Interpretation II on Construction Contracts (Draft for Comments) attempts to adjust and regulate this issue. In particular, the first opinion completely returned to the relative nature of the contract and did not support the actual construction undertaker’s claim, as the employer has no contractual relationship with the actual construction undertaker; the second opinion is to limit item 2, Article 26 of the Judicial Interpretation I on Construction Contracts to the following conditions: “the actual construction undertaker shall have evidence to prove that the employer with whom he has a contractual relationship has lost the ability to perform or has an unknown whereabouts, therefore the claims of the labour subcontracting project cannot be realized."


However, neither of the above two opinions has been adopted in the Judicial Interpretation II on Construction Contracts. The Judicial Interpretation II on Construction Contracts continues the idea of the Judicial Interpretation I on Construction Contracts, and regulated as follows:


Article 24: “Where the actual construction undertaker claims its rights against the contract awarding party, the People’s Court shall add the contract transferor or illegal subcontractor as a third party in the action, and upon ascertaining the construction project price owed by the contract awarding party to the contract transferor or the illegal subcontractor, rule that the contract awarding party shall bear liability towards the actual builder within the scope of overdue construction project price.”


Compared with the Judicial Interpretation I on Construction Contracts, first, the court should (note that this is no longer “may”) add the illegal subcontractors or the subjects who transfer the contract as third parties; second, the precondition for the judgment of the employer is to ascertain the amount of the construction price that the employer owes the subcontractor or the subjects who transfer the contract — in other words, if it is found that the employer does not have any outstanding debts, the employer shall not be held liable. 


In practice, since the employer and the subcontractor may not necessarily complete the final settlement when the actual construction undertaker sues, it is very likely that the employer’s progress payment has been paid but the settlement amount has not been determined. Under this circumstance, the employer does not necessarily have the payment due to the subcontractor; or the parties may not be able to confirm the amount of the payment due to the lack of evidence.13 According to the opinions in the Detailed Analysis of the Judicial Interpretation II on Construction Contracts issued by the SPC Judges Wang Yuying and Chen Ya, if it is really impossible to ascertain the specific amount of the project payment owed by the employer based on the current evidence, the actual construction undertaker shall bear the unfavourable consequences of the proof. However, according to the 2018 Answers of Jiangsu Higher People’s Court, it is expressly required that the employer shall bear the burden of proof for the amount of the project price already paid to the general contractor. 


2. CONCLUSION AND PREVIEW


The two major actions of the DIO Reform in 2018, namely, significantly reducing the scope of projects subject to bidding and cancelling the record-filing system for construction contracts, will significantly reduce the excessive intervention of administrative supervision on construction related transactions, and then reduce the series of complicated contract validity issues and related disputes arising from violation of the relevant mandatory legal provisions in bidding from the source. It will have a profound impact on the development of dispute resolution in China’s construction projects.


Meanwhile, the promulgation and implementation of the Judicial Interpretation II on Construction Contracts will also have an important impact on the practical development of the resolution of disputes over the construction projects in China. While resolving a series of existing problems, new problems will also emerge and new challenges will be presented. 


With respect to the field of general contracting, if the three draft regulations issued by the MOHURD in 2017 and 2018 can be officially implemented in 2019, it will not only help to further promote the development of China’s general contracting market, but also provide a practical basis for EPC general contracting related dispute resolution.


With dispute resolution of overseas project, except for typical issues such as the effectiveness of overseas project contracts, the identification of foreign laws, extraterritorial evidence collection, the mechanism for the general contractor to pass on the risk, liability and loss under the general contracting contract to the subcontractor through the pay when the paid clause will become one of the new focus issues. Further research and practice on the effectiveness of the pay when the paid clause will, to a greater extent, link the dispute resolution of construction projects in China to the international construction projects. Here, we sincerely hope that the judgment focus will gradually develop from the controversial areas with Chinese characteristics such as the issues of “black and white contracts”, affiliation and illegal subcontract, validity of contract, and actual construction undertakers to be in line with international dispute resolution standards so as to promote China’s construction dispute resolution to a higher level. 



1 Paragraph 2, Article 11 of the Opinions of the Higher People’s Court of Jiangsu Province on Several Issues Concerning the Trial of Construction Project Construction Contract Disputes (issued on 21 December 2008): “For construction projects that are not required by law or the administrative regulations to be subject to bidding and tendering, the contract actually executed by the parties shall be used as the settlement basis for the project price; after the tendering and bidding of the construction project, if the construction contract actually executed by the parties is inconsistent with the substantive content of the awarded contract, the awarded contract shall be used as the settlement basis for the project price.”

2 Guidelines of the Higher People’s Courts of Jiangsu Province with Respect to the Examination of Construction Contracts (issued on 31 January 2010): “One opinion is that if the parties voluntarily bid for the project, if the parties sign a contract that does not violate the prohibition of the law in addition to the contract for filing, there is no “black and white contracts” issues. The court should reflect and recognize the true intent of the parties according to the contract. Another opinion is that although the project is not mandatory for bidding, the parties shall be bound by the Bidding Law, so “black and white contracts” may also exist. We agree with this opinion because the Bidding Law protects not only the interests of the parties themselves, but also the norms of the bidding markets. This concerns the protection of the interests of unspecified bidders and the maintenance of market competition order. Therefore, the tendering and bidding carried out according to the Bidding Law shall be subject to rules of the Bidding Law, and the parties shall not sign any ‘black contract’ outside of this.”

3 Paragraph 3, Article 7 of the Answers of Jiangsu Higher People's Court on Several Issues Concerning the Trial of Construction Contract Disputes (promulgated on 28 June 2018) (hereinafter referred to as the “2018 Answers of Jiangsu Higher People’s Court”): “For construction projects that are not mandatory for bidding, if the bidding or filing is carried out, and the content of the construction contract signed by the parties in addition to the bidding or the filing is inconsistent with the substantive content of filed contract, the contract actually executed by the parties shall be used as the basis for the settlement of the project price.”

4 This article was posted on the WeChat official account of “Fa Zhan” on 3 January 2019, 

https://mp.weixin.qq.com/s?src=11&timestamp=1553041375&ver=1495&signature=mOElNlVlQsZq*EB3BdeFEtyqZXtQumNvktvSUj5GC9WYCfzLYroalHiqgwlBR6P22YCaGl2u1aqeSXemnx1ow*0F3C48vcxBehR9Ipa9Ze2oND8VxGpAvbRNw4o16Omp&new=1.

5 No.1 Civil Court of the SPC: The Understanding and Application of the Judicial Interpretation II on Construction Contracts by the SPC, published by the Press of People’s Court, first edition, January 2019, p. 77.

6 SPC Gazette, 6th edition (2018). See the Supreme People’s Court Civil Judgment (2017) Zui-Gao-Fa-Min-Zhong No.175.

7 The Understanding and Application of Judicial Interpretation II, p. 129.

8 The Answers to Several Difficult Problems in the Trial of the First Civil Trial Court of the Higher People’s Court of Zhejiang Province on the Trial of Construction Contract Disputes issued on 5 April 2012: Item 6. Regarding the question of “How to determine the extension of the construction period?” If the employer only claims that the construction period cannot be extended because the contractor fails to file the application for extension within the specified time, such claim cannot be supported by the court. However, if the contract expressly stipulates that the application for extension of the construction period shall not be postponed within the specified time, the contract shall prevail.

The Answers to the Difficulties of the Higher People’s Court of Guangdong Province on the Trial of Construction Contracts issued on 19 July 2017: Item 20. In response to the question that “If the contractor fails to submit an application for extension of the construction period, can it be regarded as abandoning such right?”, if the employer only claims that the construction period cannot be extended because the contractor fails to file the application for extension within the specified time, such claim cannot be supported by the court. However, if the contract expressly stipulates that “the contractor’s failure to submit the application for extension of the construction period shall be deemed to be a waiver of the right”, the contract shall prevail.

9 The Understanding and Application of Judicial Interpretation II, pp. 364-370.

10 For example, in the construction contract dispute case of Qingdao Yude Construction Group Co., Ltd. (“Yude Company”) v. Yang Yongding. See the Supreme People’s Court Civil Judgment (2017) Zui-Gao-Fa-Min-Shen No. 4000. The SPC held that: “Item (4) With respect to the question of the subject and scope of the preemptive rights. First, according to the facts as determined by the courts of first instance and second instance, Yude Company has subcontracted the project to Yang Yongding for construction, both parties have thus constituted the de facto labor contractual relationship. Yang Yongding actually carried out the construction of the project. The claim of the corresponding project price and the preemptive rights does not violate the provisions of Article 286 of the Contract Law and Article 26 of the Judicial Interpretation I on Construction Contracts. Moreover, the Tailong Company, as the employer and the recipient of this project, did not raise any objection. Therefore, Yude Company, as the illegal subcontractor, who claimed that Yang Yongding shall not enjoy the priority right of the construction price, cannot be supported.”

11 The Understanding and Application of Judicial Interpretation II, pp. 407-408.

12 The Understanding and Application of Judicial Interpretation II, p. 462.

13 Zhou Yueping, Zhou Lanping: Collection Report on the Judicial Interpretation II on Construction Contracts, posted on the WeChat official account of “Lawyer Zhou Yueping” on 1 February 2019, 

https://mp.weixin.qq.com/s?src=11&timestamp=1553061838&ver=1495&signature=i493NgudqhtjgDeG*yaddAOZ-s01WqxHsvONDN-l3CiLl*8iJWv78ev7dC5W7*h12mgnoU7NQpsDFz27wWTqpj9tdt3rdyDRN76qKtKifaEgr956ceh-WJwEoc3s6bv3&new=1. Last accessed 10 February 2019.

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