China: A Revised Construction Law For China

On August 27, 2004, the People’s Republic of China ("PRC" or "China") Ministry of Construction ("MOC") issued a letter soliciting comments on a draft of a revised Construction Law. The MOC has been reviewing the Construction Law for some time, and this document is the result of the review.

The existing Construction Law was promulgated by the National People’s Congress of the PRC on November 1, 1997 and came into effect on March 1, 1998. It was the first general national legislation covering construction activities in China. Prior to the enactment of the Construction Law in 1997, the State Council, the MOC, and many local and regional governments had enacted a substantial body of regulations covering a wide range of matters in the construction industry. The Construction Law codified the basic principles of these pre-existing construction regulations and also introduced a number of new principles, such as allowing consortiums to bid for construction projects.

Over the six years since the introduction of the Construction Law, the MOC identified a number of areas where problems with the implementation of the Construction Law had arisen. Accordingly, in order to help resolve these problems, the MOC announced on November 20, 2003 a number of directions to deal with issues such as:

• Owners reducing the contract price and contract period

• Illegal sub-contracting

• Enforcement of the project supervision system.

The directions were intended to strengthen the enforcement of the Construction Law and to improve the regulation of the PRC construction market. At the same time as issuing the directives, the MOC indicated that it would be reviewing the Construction Law with a view to issuing a revised and consolidated law.

The revised Construction Law has now been published, and it contains some very important changes from the original. In this Commentaries, we will highlight some of the most significant issues.

The Scope of the Revised Law. The original Construction Law applied to all "construction activities" in China, which were defined in Article 2 as the construction of all types of building and auxiliary facilities as well as the installation of ancillary circuitry, ducts, and equipment. Accordingly, the original Construction Law only covered building works and electrical and mechanical ("E&M") works associated with building works. It did not apply to civil engineering projects.

The revised law, on the other hand, applies to "construction projects or construction works," which are defined as "building construction, civil works and associated facilities." Therefore its scope would appear to be wider than that of the original. Similarly, the definition of "construction activities" has been significantly expanded: It now covers "survey, design, construction, installation, decoration, maintenance and repairs as well as dismantling in relation to construction projects; production and supply of construction structures, accessories and fittings; project management services, construction supervision, tendering agency services, construction costing advisory services, engineering technology consulting services, inspection and measurement services conducted in connection with construction projects."

This is a very significant expansion for the following reasons:

• For the first time, civil works are brought within the ambit of the Construction Law and the jurisdiction of the MOC.

• Project management services are now specifically included under the scope of the Construction Law, as are quantity surveying services insofar as they can be classified as construction costing advisory services or inspection and measurement services.

We will expand on the significance of these points in the specific sections that follow. Suffice to say, we believe that the revised Construction Law could have a considerable impact on the manner in which foreign contractors presently conduct their business in China.

Licensing Requirements. A new section on the licensing requirements for individuals has been added in the revised Construction Law. This requires that "professional and technical personnel engaging in construction activities" must hold the appropriate skill qualification certificate. Accordingly, architects, surveyors, engineers, costing engineers, supervision engineers, construction engineers, and landscape architects can only conduct professional and technical activities after being certified and only within the scope of their certification. This provision will apply to foreign professional and technical staff if they are involved in construction activities (which now includes project management) in China.

Firms engaging in survey, design, construction, supervision, costing consultancy, tendering agency, inspection, or measurement for construction activities are also required to have appropriate skill qualification certificates before they will be permitted to conduct construction activities within the scope of their certificate. Firms are classified into categories depending on their registered capital, the number of professional and technical staff, equipment, and project track record.

Professional Liability Insurance. The revised Construction Law encourages individual certified professional and technical practitioners as well as construction and design firms to purchase and maintain professional liability insurance. This is a new requirement, and although it is not mandatory, it is understood that the State promotes professional liability insurance.

Procurement and Contract Award. Tendering and bidding activities must be conducted with openness, fairness, and equality. The revised Construction Law specifically refers to the PRC Tendering and Bidding Law, which will apply to the tendering of construction works, where the Construction Law is silent.

A new requirement is that construction works that are publicly funded or financed must use the standard forms of construction contracts published by the MOC. Construction contracts are also required to specify the scope of work, time for completion, quality, and price (including provisions concerning advance payments and progress payments).

New provisions have also been added to require the payment of interest where payment under the construction contract is late. Interest is to be calculated on the basis of two times the amount of the late payment at the prevailing bank lending rate. In addition, the owner may be required to compensate the contractor for other losses (including liquidated damages) as a result of the late payment. These provisions appear very harsh but are no doubt designed to encourage prompt payment and discourage non-payment of workers, which has been a major problem in China recently.

The signed construction contracts must be filed by the owner (the procuring party) with the local construction administrative authority within 30 days of execution, and where there is a significant change to the contract (no indication is given as to what would constitute a significant change), this must be filed by the owner within 15 days of the change. The requirement to file the contract is enforced by the fact that if there is a dispute over contract terms, it is the contract filed with the local construction administrative authority that will govern.

The revised Construction Law emphasizes that the State promotes general contracting and depending on the nature of the construction works, the owner may procure the entire package of survey, design, construction, and operation from a general contractor. This follows on from the MOC Guidance Opinion on EPC & Project Management issued February 13, 2003, which encouraged Chinese contractors to undertake more general contracting-type operations.

Contracting. Article 42 of the revised Construction Law states that companies with the relevant survey, design, or construction qualifications may undertake general contracting for construction works in accordance with the scope of their qualification certificate. The use of the word "or" appears to suggest that any one of surveyors, designers, or contractors can undertake general contracting or even EPC-type work in China (the MOC Guidance Opinion on EPC & Project Management refers to EPC as a form of general contracting). However, Article 44 appears to limit this, by stating that in the case of general contracting for the entire works, the general contractor must subcontract the survey, design, or construction, as applicable, where it is not qualified to perform such work. In other words, a general contractor with a Class 1 skill qualification certificate may not be qualified to undertake survey and/or design work as part of the scope of that skill qualification certificate. Accordingly, until such time as combined design and construction skill qualification certificates can be issued, the position of EPC contracting in China remains very unclear. As such, EPC contractors remain the square peg that will not fit into the MOC’s round hole.

Subcontracting. The prohibition on subcontracting the whole of the works remains, as does the requirement for the main contractor to complete the construction of the main structures of the construction works itself. However, the prohibition on sub-subcontracting has been removed. This is surprising, although the requirement for the contractor to manage the subcontracted works perhaps mitigates this. Although not a new provision, the liability of the subcontractor is dealt with somewhat differently when compared with the usual Anglo-American practice. Under Article 45 of the revised Construction Law, the main contractor and the subcontractors are jointly liable to the owner for the subcontracted works. This represents a fundamental difference from the common law rule of privity of contract upon which the "chain of liability" arrangement in Anglo-American jurisdictions is structured.

Project Management. Article 50 of the revised Construction Law provides that firms with relevant survey, design, construction, or supervision qualifications can undertake project management work within the scope of their qualification certificate. As mentioned above, the inclusion of project management in the revised Construction Law is a new approach. Our reading of Articles 13 and 50 as well as the definition of "construction activities" suggests that firms that engage in project management services must obtain a survey, design, construction, or supervision qualification before they can conduct any project management services in relation to construction projects. It would seem therefore that what was previously a grey area has now become more colorful for foreign contractors!

These comments should also be considered in the context of the new Code of Management of General Project Contracting for Construction Projects that was issued by the MOC on July 1, 2004, which is essentially a PRC National Standard on project management.

Safety. There are extensive provisions on safety, which expand on the original Construction Law taking into account the Rules on Safety Administration in Construction and Engineering, which came into effect on February 1, 2004.

Quality. As with safety, the provisions concerning quality are an important part of the revised Construction Law. For example, Article 76 provides that the owner must engage a qualified review agency to review the relevant design and construction documents and such documents can only be used after they have been ratified by the review agency as compliant. The establishment and scope of the review agencies is set out in the Administrative Measures for Review of Construction Design Documents for Building and Municipal Infrastructure Works, which came into effect on August 23, 2004.

Article 78 specifies that a quality warranty program is to be adopted for construction works. The warranty period is to commence on the date of satisfactory completion, and construction firms are encouraged to obtain quality warranty insurance. The scope of this provision is somewhat vague, as the details of the quality warranty measures are still to be formulated by the State Council.

Penalties. Numerous penalties are imposed for breaches of the revised Construction Law in areas such as: disobeying quality or safety standards or arbitrarily compressing the work schedule (fines of between RMB200,000 and RMB500,000), awarding construction works to unqualified entities (fines of between RMB30,000 and RMB100,000 and voiding of the contract), failure to provide payment security (if required) (fines of between 2 percent and 5 percent of the securitized amount), and illegally subcontracting or transferring the works (fines of between 0.5 percent and 1 percent of the contract price). In addition to fines, offending contractors are liable to have their skill qualification certificates downgraded or cancelled.

The revised Construction Law consolidates a number of regulations issued previously and to this extent is very welcome. The extensive provisions on safety and quality and the prohibitions against bribery are also welcome, particularly in an environment where there are many temptations for owners and contractors to cut corners and save time and money at the expense of safety and quality.

The inclusion of civil works within the ambit of the Construction Law is also an improvement, although depending on the nature of the civil works, there may still need to be input from other ministries (e.g., Ministry of Railways etc.) and compliance with other laws will need to be considered.

Foreign contractors may be concerned about the inclusion of project management within the scope of construction activities governed by the revised law, but this is not entirely surprising given the recent regulations that have been issued on this subject.

In 2003 China’s construction industry contributed 7 percent of China’s GDP. There are more than 100,000 construction enterprises in China employing more than 35 million staff. In Beijing alone there are 240 contractors. The construction industry is therefore a very important driver of China’s economic growth. For this reason alone, the revised Construction Law is an important piece of legislation, which will likely have far-reaching consequences for Chinese as well as foreign construction enterprises operating in China.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.