(By Shi Weidong)On 4 January 2019 the Supreme Court of China promulgated the Legal Interpretation (II) of Issues Concerning the Application of Laws Relating to Construction Work Contract Disputes (“Interpretation II”) .
The promulgation of the Interpretation II marks the first time in the past fourteen years that the supreme court gives a detailed explanation of laws relating to construction work contracts since the Legal Interpretation (I) of Issues Concerning the Application of Laws Relating to Construction Work Contract Disputes (“Interpretation I”) was carried out on 1 January 2005.
Based on the Interpretation I, the Interpretation II consisting of 26 clauses is intended to: (a) gather common opinions of different courts and practical experience in dealing with legal cases in different regions; (b) give further explanation of laws and create rules; (c) use a single set of applicable laws to enable works on construction projects to be done successfully, regulate the building market and protect interests of all parties; and (d) address urgent problems while considering future development of the building industry.
This article summarizes and comments on major parts of the Interpretation II based on the principles of the Interpretation II, values in accord with it, and its effect on the building industry.
I. Further Regulation of the Building Market
1.Rectification of chaos in the bidding market
Article One If there is any discrepancy between material matters such as scope, duration, quality, price, etc. of the construction work agreed in the construction work contract between the bid solicitor and the bid winner and ones in the bid winner contract, if one of the parties involved claims that rights and obligations under the bid winner contract should apply, the court should decide in favor of this claim.
If in addition to the bid winner contract there is another contract between the bid solicitor and the bid winner in respect of buying a house to be built at a price obviously higher than the market price, building house facilities for free, offering benefits or donations to an entity responsible for construction work or with the intention to lower the price of the construction work dishonestly, if one of the parties involved claims that the contract materially violates the bid winner contract and therefore should be found as invalid, the court should decide in favor of this claim.
Article Nine After the outsourcer has solicited bids for the project that are not required by law, if the construction work contract between the contractor and the outsourcer materially violates the bid winning contract and one of the parties involved claims that the bid winner contract should apply when determining the price of the construction project, the court should decide in favor of this claim, provided that there is no other construction work contract made between the project owner and the contractor due to a change in objective circumstances that could not be foreseen at the times of bid solicitation and submission.
Article Ten If there is any discrepancy in scope, period, quality or price of the construction work between the construction work contract and the bid solicitation or submission documents or notice to the bid winner, and one of the parties involved claims that the bid solicitation or submission documents or the notice to the bid winner should apply when determining the final price of the project, the court should decide in favor of this claim.
“Collusive and dishonest bids” have long existed in the building market of our country to “rig bids” illegally by modifying the bid winner contract or acting in a way that indirectly violates other agreement between the parties involved and to avoid provisions of the Tender Law relating to mandatory tender offer that applies to particular projects for contractors and compulsory restrictions on making an agreement between the bid solicitor and the bid winner that materially violates the bid winner contract.
To fight against these activities in the building market, based on Article 21 of the Legal Interpretation I that “if a construction work contract materially violates a bid winner contract registered”, the final price of the work should be based on the bid winner contract registered” and the Interpretation II further clarifies criteria with respect to the final price and expands its application scope to stop these illegal activities by giving strength to arguments for the invalidity of these illegal activities during the trial.
2.Punishment for illegal leases of approvals and licenses
Article Four If an unqualified entity or person signs a construction work contract in the name of a qualified construction business and the outsourcer who claims that the lessor and the lessee should be held jointly liable for losses such as poor quality of the construction work arising from the lease of the qualifications, the court should decide in favor of this claim.
Losses arising from a lease of an approval or a license for a construction business mainly include poor quality, delay, etc. of the construction work and losses arising from invalidity of the construction work contract due to the lease of the approvals or license.
Based on the above, Article 66 of the Construction Law of our country states that based on the provision that “the business responsible for the construction work and the entity or person on behalf of the business should be jointly liable for losses arising from non-compliant quality standards for the project”, according to the Interpretation II the supreme court aggravates the joint liability for a lease of an approval or a license to increase the cost of illegal lease of approval and license.
3.Legal elements of approval for a construction plan
Article Two If the parties involved request for confirmation of the invalidity of the construction work contract by claiming that the outsourcer hasn’t obtained necessary approval for the construction plan such as permit for the construction work plan, the court should decide in favor of this request if the outsourcer hasn’t obtained necessary approval for the construction plan such as permit for the construction work plan before suing to the court.
If the outsourcer can but fails to obtain necessary approval and requests for confirmation of the invalidity of the construction work contract by claiming that the approval hasn’t been obtained, the court should not decide in favor of this request.
Subject to this clause, if the parties involved have no approval for the construction plan such as the permit for the construction work plan, and claim that the construction work contract should be deemed as invalid, the court should decide in favor of this claim. This clause also sets out rectification measures and exceptions.
Based on the above, the supreme court issued the Interpretation II with three conditions: (a) the parties involved request for confirmation of the invalidity of the contract; (b) the parties involved cannot rectify it before suing to the court; (c) the construction work contract could be found as invalid in the event of – “approval for the construction plan such as permit for the construction work plan”, provided that the outsourcer does not delay the process of obtaining such approval. The purpose of this provision is to emphasize the importance of the approval for the construction work plan and improve regulations for the building market.
II. Further Guidance for Application of Laws
1.How to deal with losses arising from invalidity of a contract
Article Three Any of the parties involved that asks the other party to pay for a loss in case of the invalidity of a construction work contract shall bear the burden of proof on the other party’s fault, the amount of the loss and the causal relationship between the loss and the fault.
If the amount of the loss could not be calculated and any of the parties claims that the amount of the loss should be determined according to quality standards, duration of the construction work, payment date of the project price and other matters specified in the contract, the court could make its decision based on the severity of each party’s fault, causal relationship between the fault and the loss, etc.
Based on current laws and regulations of our country, losses incurred in case of the invalidity of a contract are categorized into two types: (a) losses arising from invalidity of the contract (Pursuant to Article 58 of the Contract Law, “the faulty party shall pay for losses of this type”); (b) losses arising from performance of the invalid contract (For example, pursuant to Article 284 of the Contract Law, “if the construction work is suspended or delayed for a reason attributable to the outsourcer”, such person shall take action to make up for or reduce losses arising therefrom) and pay to the contractor for losses and expenses arising from stoppage, slowdown, reshipment, relocation of machines and equipment, excessive materials and components, etc”.
This clause is intended to make parties to a construction work contract aware that if the contract becomes invalid causing clauses relating to liability for breach not to apply, they can claim liquidated damages and to emphasize that in this circumstance the case should be decided based on construction project management rules and mandatory obligations of outsourcers and contractors.
In addition, this clause complies with the legal principle of calculating the amount of damages based on the amount of losses incurred, considering the fact that due to complicated and special qualities of a construction work contract outsourcers and contractors often find it difficult to prove the amount of actual losses and obtain remedies, grants parties involved the right to decide the amount of losses according to the agreed quality standards, period for the construction work and payment date of the project price.
2.How to deal with a price claim based on liability for a breach of quality standards
Article Seven In a construction work contract case brought by a contractor, if the outsourcer counterclaims liquidated damages, reasonable costs of repair, rework and reconstruction and other damages against the contractor, the court can deal with the counterclaim as part of the case brought by the contractor.
In a project price case brought by a contractor, the outsourcer usually disagrees with the contractor’s claim about the project price for the reason of liability for a breach of quality standards.
The Legal Interpretation II restates the contractor’s legal right of action by giving the contractor in the above case “the right to counterclaim liquidated damages, reasonable costs of repair, rework and reconstruction and other damages”, in order to emphasize that this reason is a cause for an independent case. In other words, the court should not decide in favor of the contractor who argues only based on this reason without filing a counterclaim, but could suggest the contractor file a counterclaim or bring another case.
The clause is intended to confirm that the project price is only in consideration of materialized labour and its calculation is in no relation to liability for breach to help parties who have established a construction work contract relationship and local courts dealing with construction work contract cases to distinguish meanings of the terms “liability for breach” and “deduction from a project price”.
3.How to deal with an evaluation application filed after a final price is agreed
Article Twelve If any of the parties involved that have made an agreement for the final price of a construction project before suing to a court applies for evaluation of the construction project price, the court should not approve this application.
Article Thirteen If any of the parties involved that have entrusted a relevant entity or person to give advice on the price of a construction project before suing to a court does not accept this advice and applies for evaluation of the price, unless the parties explicitly agree to be bound by this advice, the court should approve this application.
Article 3 of the Price Law of our country states that prices of most commodities and services are subject to adjustment of market prices and prices of very few commodities and services are subject to government guidance or decision. Construction work prices are subject to adjustment of market prices in our country.
Based on this, Article 22 of the Interpretation I by the supreme court states that “if any of the parties that have agreed on a fixed price for a project requests for evaluation of the project price, the court should not approve this request”. In addition to accepting “agreed” prices, Article 12 of the Interpretation repeats the nature of prices of a project that conform to “market prices” and is intended to avoid cases in which mutual agreement between parties to a construction work contract is negated by legal evaluation.
The supreme court respects final prices mutually agreed by the parties involved and restricts the scope of the agreement between the parties. Pursuant to Article 23 of the Legal Interpretation, the act of the parties “entrusting a relevant entity or person to give advice on a construction project” before suing to a court should not be deemed to make an agreement for the final price, in which case if one of the parties applies for evaluation of the price, unless it is explicitly agreed in advance to be bound by it, the court should approve this application.
4.How to deal with a subrogation litigation case brought by the constructor
Article Twenty Five Pursuant to Article Seventy Three of the Contract Law, if the constructor takes subrogation action for a subcontractor’s or an illegal contractor’s negligence in exercising its right as a creditor, the court should decide in favor of the person responsible for doing construction work.
Pursuant to Article 26 of the Interpretation I stating that “if the constructor sues a subcontractor or an illegal contractor to a court, the court should accept the case; if a person responsible for doing the construction work sues the outsourcer to a court, the court could add the subcontractor or illegal contractor to the parties involved in the case”, in case of a subcontract or an illegal contract, a person responsible for doing the construction work can sue the outsourcer that is not a party to the contract.
Based on this, except in the event of an illegal contract or subcontract, Class 3 “people responsible for doing construction work” in the engineering industry of our country, i.e. people doing construction work in the name of a qualified construction business could not sue to the outsourcer according to the Interpretation I.
This clause is intended to make this type of people aware that if legal conditions are met, they can take subrogation action by directly claiming related rights against the outsourcer pursuant to Article 73 of the Contract Law.