United States: Interpretation Of The Supreme People’s Court On The Law As It Applies To Construction Disputes In China

During December 2003, the PRC Supreme People’s Court issued a consultation paper on the application of PRC law to the adjudication of construction disputes. The purpose of the consultation paper was to give guidance on the application of law to disputes arising out of construction contracts and construction projects, so that such disputes can be dealt with in an accurate and timely manner and in accordance with the provisions of the General Principles of Civil Law of the PRC, the PRC Contract Law, Construction Law, Bidding Law, and the Law of Civil Procedure, and in line with the practical reality of civil trials.

Some of the important issues addressed by the Supreme People’s Court in the consultation paper are discussed below. It should be recognized that many of these provisions have been included because of cases brought before the courts, and the Supreme People’s Court is attempting to ensure consistency of interpretation in construction disputes.

The consultation paper stresses the need for contractors to obtain appropriate statutory qualification certificates and goes as far as to declare construction contracts void where they are entered into by contractors without the correct qualification. Similarly, contracts will be declared void where contractors seek to use the qualifications of other contractors (either through joint venture, assignment, or affiliation), or where a project required to be put to tender under the Bidding Law has not been put to tender.

Nevertheless, if an unqualified contractor obtains the required qualification grading during the course of executing the contract works, the relevant contract will be deemed to be valid.

The consultation paper recognizes that the tendering and award of construction contracts should be open and fair, and accordingly, the Supreme People’s Court has declared that where pursuant to a tender process a contract is awarded to a contractor and, with the intention of prejudicing other bidders, the owner subsequently uses its stronger position to force the contractor to execute another contract with a different contract price or contract period, the courts will deem the original contract to be the valid contract.

Assignment of a construction contract is only possible with the consent of the owner. This prevents contractors freely assigning construction contracts without the owner’s knowledge and serves to help ensure that the quality and safety of construction projects are not compromised.

The consultation paper recognizes the primacy of the rates and prices contained in the construction contract and provides that where there are discrepancies between the PRC standard schedule of rates for projects as published by the construction profession supervisory department, and the methods and standards as agreed in the construction contract, the provisions stated in the contract shall prevail.

Further, in the event that a construction contract provides for a lump-sum fixed price, neither party will be permitted to apply to the court to change the price, except if any change in the design results in the increase or decrease of the project price, the value of the increased or decreased portion will be calculated according to the methods and standards contained in the contract. Therefore, other than in the case of change orders or variations, lump-sum fixed price means what it says!

The consultation paper also deals with how to calculate the project price in the event that a construction contract is terminated. In such circumstances, the project price is to be calculated based on the quantities of work completed by the contractor according to the calculation method and standards stipulated in the contract. If the contractual provisions are unclear, the project price is to be calculated in accordance with the standard schedule of rates applicable for projects at the time the contract was executed.

The consultation paper also stresses that Article 34 of the Law of Civil Procedure concerning the exclusive jurisdiction of the People’s Courts is not applicable to construction contract disputes. This recognizes the ability of the parties to a construction contract to provide for arbitration of any disputes and as such is in line with the June 2001 opinion issued by the Ministry of Construction and the Legal Office under the State Council promoting the use of arbitration for construction disputes.

Where there are disputes between the owner and the contractor, proceedings should be commenced in the People’s Court or either party should apply to the arbitration authority for arbitration under the arbitration agreement.

Interest can be claimed by contractors where owners delay in making payment. The consultation paper provides that in such cases, the owner will be liable to pay interest from the date following the date when the payment became due and payable as agreed in the contract.

In the event that the project price is determined by the construction costs determination method (as opposed to the rates and prices in the contract) and upon the application of any or both parties, the time for accrual of interest is:

1. from the date following the date as and when the project price became due and payable as agreed in the contract, if the application is made on the part of the owner;
2. from the date of judgment, if the application is made on the part of the contractor;
3. from the date of issuing the proceedings by the plaintiff, if the application is made by both parties.

The consultation paper also provides that the owner shall pay interest to the contractor where the contractor has incurred costs for the execution of work (presumably when the contract is terminated or void, even though this is not stated clearly). This is not the common practice outside China where such expenditure is part of the contractor’s costs that need to be spent in order to earn its profit (and hence the owner is not liable to the contractor for interest). The consultation paper appears to treat such costs as disbursements paid on behalf of the owner.

The problem of delay or failure to make payments has always been recognized as an important issue in construction projects.

Article 286 of the Contract Law provides a special remedy to the contractor in the event that the owner fails to pay the contract price in accordance with the contract. Under this Article, the contractor may apply to the court (a) to auction the construction project and (b) for a priority for payment out of the proceeds of the auction.

The Supreme People’s Court attempted to clarify the application of Article 286 in its Interpretation dated June 20, 2002. In line with the Government’s particular attention to this issue, as revealed by the various notices and reports issued by the Government (including the State Council) since November 2003, the consultation paper clarifies some remaining uncertainties.

In particular, the consultation paper stipulates:

1. that the reasonable period for performance by the owner following a demand for payment from the contractor, is not less than one month;
2. the procedures in respect of the contractor’s application to the enforcement division of the People’s Court for an auction of the construction project;
3. further clarification of the scope of the contractor’s priority for payment vis à vis the owner and/or other contractors and/or subcontractors; and
4. any undertaking by the contractor to waive its priority pursuant to Article 286 is valid.

Overall, these interpretations by the Supreme People’s Court are a welcome clarification of the law as it affects construction contracts and projects in the PRC. In many ways, the Supreme People’s Court is taking a very practical and pragmatic approach to construction disputes, which is consistent with the approach adopted in many foreign jurisdictions.

The ability for a contractor to recover payment by way of auction is a relatively novel approach from an international standpoint. Nevertheless, given the massive real estate development taking place in China, much of which is underfinanced, this is a welcome protection for contractors.