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Annual Review on Construction Dispute Resolution in China (2020) (Part 1)——Newly-Promulgated Laws and Regulations

2020.11.26 ZHOU, Xianfeng (Elvis)、WANG, Shuning、YANG,Tianbolun

1. OVERVIEW


1.1 Issuance and Implementation of a Batch of Major Laws and Normative Documents in Construction Industry  


In 2019, China had continued to deepen the reforms to "delegate power, streamline administration and optimize government services", particularly focusing on the "delegation of government power and strengthening regulation" of the construction funds and payments. First, the Standing Committee of the National People's Congress (hereinafter referred to as the "NPC Standing Committee") has officially passed the revised version of theConstruction Law of the People's Republic of China (hereinafter referred to as the "Construction Law"), which officially stipulates that the construction permits for construction projects should implement a "commitment mechanism for which construction funds have been raised sufficiently". Second, the State Council has promulgated two administrative regulations, namely, the Regulation on Government Investment and the Regulation on Ensuring Wage Payment to Migrant Workers, which clearly stipulate that the funds needed for government-funded projects shall not be provided in advance by the construction contractor and the change of the project and investment estimates shall be subject to strict supervision. Besides, in order to solve the problem of default on the payment of wages of migrant workers, the Regulations mandate the implementation of management systems such as "the project employer shall provide payment guarantee to the construction contractor" and "if a subcontractor defaults on the wages of migrant workers, the general contractor shall pay off them unconditionally first, and then make recourse in accordance with the laws", etc.


Law of the People's Republic of China on Bid Invitation and Bidding (hereinafter referred to as the "Bidding Law"), as one of the two basic laws in the construction industry in China, has been on a process to be comprehensively revised. The National Development and Reform Commission of People's Republic of China (hereinafter referred to as the "NDRC") has released the revised draft and solicited public comment on 3 December 2019. 


For regulations in the field of engineering, procurement and construction (hereinafter referred to as "EPC Projects"), the long-awaited Measures for the Administration of General Contracting of the House Building and Municipal Infrastructure Projects (hereinafter referred to as the "Project General Contracting Management Measures"), after two years of soliciting opinions, were finally issued jointly by the Ministry of Housing and Urban-Rural Development of People's Republic of China (hereinafter referred to as the "MOHURD") and the NDRC at the end of 2019. The "Dual Qualifications" system for EPC contractors established by such Measures has attracted attention. For details of our analysis, please refer to the "EPC Projects" in Section 4.2 hereof.


1.2 A Series of Breakthrough and Typical Cases Have Appeared in Construction Dispute Resolution Field. Meanwhile, Construction Dispute Resolution Practice Has Been Also Facing Major Challenges of the 2019 Novel Coronavirus Pneumonia Epidemic (hereinafter referred to as "COVID-19")


In 2019, the construction dispute resolution practice in China has developed in depth, and a series of typical cases and rulings of the Supreme People's Court of People's Republic of China (hereinafter referred to as the "Supreme People's Court" or "SPC") with certain innovation, breakthroughs and criticality have been promulgated. For example, the validity of a contractor's commitment to waive its preemptive right to the project financing bank shall depend on whether the loan of project is actually used for the payment of the project. For another example, if the authority of judgment determines that the construction contract shall be invalid and explains it to the parties, but the parties still insist on their claims based on the validity of such contract, the authority of judgment may reject such claims. In addition, the equipment procurement and installation projects that account for the major proportion of an industrial project shall be identified as the "main part" of the industrial construction project and thus the subcontracting of such projects does not necessarily constitute the "illegal subcontracting of the main structure". Please refer to Part 3 "Case Studies" for our detailed analysis of the typical cases of the Supreme People's Court.


It should be noted that the outbreak of COVID-19 since January 2020 has affected all aspects of domestic and overseas constructions, and has already had a significant impact on the performance of construction contracts. Questions such as whether COVID-19 shall constitute force majeure, change of circumstances, as well as how the various losses and risk consequences caused by COVID-19 shall be allocated in accordance with applicable laws and agreements have become hot topics in the industry. Please refer to Section 4.1 "The Effect of COVID-19 on the Performance of Construction Contracts and the Framework Principles for Risk Allocation" for our relevant analysis.


1.3 Sustainable Development of Overseas Construction Contracting


China's overseas construction contracting reversed the unfavorable situation of the decline in both completed turnover and newly signed contract value in 2018, and reached a new peak. The completed turnover of China's overseas project contracting revenue was CNY 1.19275 trillion, up 6.6% from the previous year (equivalent to USD 172.9 billion, up 2.3% from one year ago), and the newly signed contract value was CNY 1.79533 trillion, up 12.2% from one year ago (equivalent to USD 260.25 billion, up 7.6% from one year ago).1  In addition, 6,944 overseas construction contracts have been newly signed by the Chinese enterprises in 62 countries along the Belt and Road, with a contract value of USD 154.89 billion, accounting for 59.5% of the contract value newly signed during the same period, up 23.1% from one year ago; the completed turnover is USD 97.98 billion, accounting for 56.7% of the total amount in the same period, up 9.7% from one year ago.2


Although the completed turnover of China's overseas contracted projects revenue and the newly signed contract value have reached a new peak, it is worth noting that the share of China's overseas project contracting business is accelerating to the top central state-owned enterprise contractors, and a large number of small and medium-sized foreign contractors are becoming increasingly difficult to operate overseas, and more and more enterprises are closing or even going bankrupt. Under such circumstances, the frequency of disputes over overseas projects is increasing, and various cross-border and cross-jurisdictional problems are increasing. 


We have selected a case regarding independent guarantee fraud disputes which has been finally adjudicated by the Supreme People's Court under Part 3 "Case Studies". This case was caused by the civil war in Libya and related to the dispute over the confirmation of bankruptcy claims, which should be a typical reference to similar disputes. Please refer to Case 4 under Section 3.3 for our detailed analysis.


1.4 PPP Dispute Resolution


The Supreme People's Court has issued the Provisions on Several Issues Concerning the Trial of Administrative Agreement Cases (hereinafter referred to as the "Judicial Interpretations on Administrative Agreements") at the end of 2019. This Judicial Interpretation's definition of administrative agreements and its negation of the arbitrability of administrative agreements will have significant impacts on the dispute resolution mechanism of various types of public-private partnership agreements (hereinafter referred to as the "PPP Agreement"). Please refer to "Relationship between PPP Agreement and Administrative Agreement, and the Arbitrability of PPP Agreement" under Section 4.3 for our detailed analysis of this hotspot issue. 


2. THE MAJOR UPDATES OF LAWS AND REGULATIONS AND OTHER NORMATIVE DOCUMENTS


2.1 Conventional Construction Engineering


2.1.1 Revision of the Construction Law by the NPC Standing Committee


On 23 April 2019, the NPC Standing Committee passed the Decision on Revising Eight Laws including the Construction Law of the People's Republic of China, of which the amendments to the Construction Law shall be implemented as of the date of promulgation. This revised version of the Construction Law is mainly aimed at amending Article 8 "Application for Construction Permit". Specifically, in addition to limiting the types of planning permits, eliminating the miscellaneous provisions and shortening the limit of the examination and approval period, a core change is that one of the conditions for applying the construction permit (i.e. the construction funds shall be available) is amended to "the requisite funds arrangements for construction shall be in place", that is, when the project employer applies for a construction permit, it is no longer necessary to submit the "certificate or guarantee issued by the bank stating that the funds are in place" and the "letter of commitment or other supporting documents certifying that there is no default in project payments as of the date of application", instead, the project employer shall only need to provide the "letter of commitment proving that construction funds are available".3


The implementation of the "commitment mechanism for which construction funds have been raised sufficiently" for the construction permit is one of the measures to promote the reform of the approval system for construction projects , which will help reduce the capital cost of the project employer. However, if the issuing authority does not supervise the project employer for fulfilling its commitments properly or does not blame the project employer for not fulfilling its commitments, it may also lead up to the risk of the project employer delaying payment of the project funds.


2.1.2 Regulation on Government Investment issued by the State Council


On 14 April 2019, the State Council issued the Regulation on Government Investment (State Council Order No.712), which came into force on 1 July 2019. The Regulation specifically regulates government investment acts and shall be another important administrative regulation in the investment field in addition to the Regulation on the Administration of the Confirmation and Recordation of Enterprise Investment Projects (State Council Order No.673). This Regulation solves the problems of the lack of superior law in government investment administration, and the lack of authority, guidance and binding of existing rules and regulatory documents in China.


The Regulation on Government Investment consists of 7 Chapters and 39 Articles, which regulates the government investment behaviors from the aspects of the decision-making, planning, implementation, supervision and legal liability. The new rules in the Regulation related to the construction field are mainly reflected in the following aspects:


 (1) It Is NOT Allowed to Require the Contractor to Construct with Deferred Payment in Government Investment Projects


According to Article 22 of the Regulation on Government Investment "the funds required for government investment projects shall be guaranteed in accordance with relevant regulations. For a government investment project, it is not allowed to require the contractor to construct with deferred payment", this provision means that after the implementation of this Regulation, funding by the contractor in government investment projects will constitute a violation of "mandatory provisions" in the administrative laws and regulations. However, there is currently no authoritative interpretation as to whether such provision shall be a "mandatory provision specifically addressing the validity of contracts" and whether it may affect the validity of construction contracts.


Meanwhile, for the illegal act of "requiring the contractor to construct with deferred payment in government investment projects", Article 34 of the Regulation stipulates that the corresponding legal responsibilities of the project employer shall be to "make rectifications; the appropriation of relevant funds shall be suspended or terminated, or the appropriated funds shall be recovered; the construction activities shall be suspended or terminated". Although these legal responsibilities are borne by the project employer, it will also obviously and directly affect the performance of the construction contract, especially if the funds are stopped from being allocated or the construction is required to be stopped or postponed, the contractor may suffer additional cost losses. However, issues such as how the contractor's right to claim such losses can be effectively protected, and whether the contractor may be liable for part of the losses because it knows in advance that the construction fund is illegal are still need to be explored and practiced.


 (2) Impact on the Design Responsibility of the Employer in EPC Projects 


According to Article 9 of the Regulation on Government Investment, the project employers of government investment projects shall prepare project proposals, feasibility study reports and preliminary design and submit the same to the competent investment department or any other relevant department for approval under the government investment administration authority and prescribed procedures. The project employers shall strengthen the preliminary work for the government investment projects, ensure that the depth of the preliminary work meets the prescribed requirements, and shall be responsible for the authenticity of the project proposals, feasibility study reports, preliminary design and other attached documents in accordance with the laws.


The Regulation also requires that the project employers to be responsible for the authenticity of the preliminary project documents such as the preliminary design. This will have a profound impact on the risk allocation of the design responsibilities of the parties to the EPC contract. However, the design responsibilities of the project employers here shall be limited to "authenticity" and does not involve "accuracy" and "integrity". Understanding of the meaning and the scope of the "authenticity" may become a potential dispute issue.


 (3) Strict Supervision on Construction Change


According to Article 21 of the Regulation on Government Investment "any government investment project shall be implemented according to the construction site, construction scale and construction content approved by the competent investment department or any other relevant department; if it is proposed to change the construction site or make major change in the construction scale or construction content, a report shall be submitted to the original approval department for approval under the prescribed procedures".


If the project employer has "changed the construction site of a government investment project or made major changes to the construction scale and construction contents without approval", then according to Article 34 of the Regulation, the project employer shall make rectifications as ordered, the appropriation of relevant funds shall be suspended or terminated, or the appropriated funds shall be recovered, the construction activities shall be suspended or terminated. Besides, the person-in-charge and directly liable person(s) shall be imposed disciplinary sanctions in accordance with the laws.   


The above provisions have positive significance for restricting the loss of control of investment caused by illegal construction changes in government investment projects from the source, which may lead to complicated disputes of construction contracts.


 (4) Strict Supervision on Investment Estimate


According to Article 23 of the Regulation on Government Investment, the construction investment in a government investment project shall, in principle, not exceed the approved investment estimate. If it is necessary to increase the investment estimate due to adjustments to national policies, price increases or major changes in geological conditions or others, the project employer shall propose an adjustment plan and sources of funds, and submit them to the original preliminary design approval department or the investment estimate approval department for approval under the prescribed procedures; in the case of budget adjustments or changes, the relevant laws, administrative regulations and relevant regulations of the country on budget shall be abided by.


In practice, if the construction cost of a government investment project exceeds the investment estimate, it may substantially impede the performance of the construction contract and the relief of rights. In particular, in the case where the contract stipulates that "the settlement of the price shall be subject to the conclusion of the administrative audit", it may be more difficult for the project contractor to claim its legitimate rights and interests.


Therefore, in the process of signing and fulfilling the construction contract, for situations that do not fall within the scope of "adjustments to national policies, price increases or major changes in geological conditions or others" that necessary to increase the investment estimate, especially when there may be major construction changes that cause the investment estimates to be exceeded, all parties concerned shall attach great importance to such circumstance and strictly control the contractual risks.


2.1.3 Regulation on Ensuring Wage Payment to Migrant Workers issued by the State Council


On 30 December 2019, the State Council officially released the Regulation on Ensuring Wage Payment to Migrant Workers (State Council Order No.724) (hereinafter referred to as the "Payment Regulations"), which came into effect on 1 May 2020.


In domestic and overseas construction fields, not only the number of migrant workers is highly concentrated, but also the legal relationships involved are more diverse, which will make the issues of the wages in arrears of migrant workers more serious, and related dispute resolution will become more complicated. In view of this, in Chapter 4 of the Payment Regulations, a series of special provisions were specifically designed for the construction field, including payment guarantee for construction prices, longest payment period for labor costs, separation of labor costs and construction prices, special salary account, real-name system management, advance settlement and salary payment by general contractors, wage guarantee and other institutions. These institutions will have a structural impact on the rights and obligations of all relevant entities in the construction field, including the project employer, general contractors, subcontractors, and migrant workers. Among them, several institutions that have a great impact on the rights and obligations of various parties, and may even break the principle of the privity of contracts shall include:


 (1) Mandatory Payment Guarantee provided by the Project Employer


According to Paragraph 1 of Article 24 of the Payment Regulations "the project employer shall provide guarantee for the payment of construction prices to the contractor", this means that the guarantee for payment of construction prices has been transformed from the matters agreed by the parties into mandatory provisions under administrative regulations. Besides, according to Article 49 and Article 57 of the Payment Regulations, if a project employer fails to provide the guarantee for the payment of construction prices, thus causing wage arrears to migrant workers, the new projects and credit records of the project employer will be affected; and "if no correction is made within the time limit, project stoppage shall be ordered and a fine of not less than CNY 50,000 nor not more than CNY 100,000 shall be imposed".


The above compulsory provisions on the system for the payment guarantee of construction prices have a positive significance for resolving disputes from the source over arrears in construction prices, including arrears in wages of migrant workers. However, considering the objective transaction status of the employer and the contractor in the construction market, whether the system for the payment guarantee of construction prices can be truly implemented and how to avoid the "black and white guarantee" problem similar to the "black and white contracts" still need to be tested through practice.


 (2) Responsibility of Project Employer for Arrears of Wages of Migrant Workers Due to Illegal Acts


According to Article 36 and Article 37 of the Payment Regulations, if the project employer has any of the following illegal behaviors which results in arrears of wages of migrant workers, the project employer shall pay off the arrears:


First, if the construction project is awarded to an individual or an entity that does not have legal qualifications;


Second, if the construction project violates the laws and regulations concerning territorial spatial planning or construction.


 (3) Responsibility of the General Contractor for Advance Payment of Wages of Migrant Workers

According to Article 30 and Article 36 of the Payment Regulations, the general contractor shall undertake the responsibility for advance payment of migrant workers' wages under the following circumstances:


First, if the subcontractor defaults on the wages of migrant workers, the general contractor shall pay off them first, and then make recourse in accordance with the laws. It should be noted that no prerequisites are set for this circumstance, therefore, as long as the subcontractor defaults on the payment of wages of migrant workers, the general contractor shall be obliged to make the payment first.


Second, if migrant workers' wages are in arrears during the assignment of the construction project, the general contractor shall pay them first, and then the general contractor may make recourse in accordance with the laws;


Third, if the general contractor illegally subcontracts or lends the qualification certificate, which results in arrears of wages of migrant workers, the general contractor shall take responsibility to pay off such migrant workers.


The above provisions mean that, in terms of the issues of the payment of the migrant workers' wages, the general contractor can no longer argue on the basis of "privity of contracts" no matter for legal subcontracting, assignment, illegal subcontracting or affiliation.


 (4) Rules on Entrustment of Salaries of Migrant Workers to the General Contractor


According to Article 31 of the Payment Regulations, the system in which the wages of migrant workers from the subcontractor are entrusted to the general contractor shall be implemented in the field of project construction. The basic procedures are as follows: the subcontractor shall evaluate the workload of the migrant workers on a monthly basis and prepare a payroll, which shall, after being signed for confirmation by the migrant workers themselves and coupled with the progress of the project for the month, be submitted to the general contractor; the general contractor shall, according to the payroll prepared by the subcontractor, directly pay the wages to migrant workers through the special accounts of themselves, and provide the subcontractor with the voucher for the wage payment.


Corresponding to the aforesaid "system in which the wages of migrant workers from the subcontractor are entrusted to the general contractor", Article 28 of the Payment Regulations also stipulates that the general contractor shall be staffed with labor managers in the project department, who supervise and manage the labor and employment of subcontractors, obtain knowledge of information on the employment, attendance and wage payment on the construction site, and review the payroll for migrant workers prepared by subcontractors. The subcontractors shall cooperate with them on that.


Both the above-mentioned "system in which the wages of migrant workers from the subcontractor are entrusted to the general contractor" and the requirement that "the general contractor shall be staffed with labor managers in the project department and employment of subcontractors shall be subject to all-round supervision" will greatly affect and change the long-formed management mode and trading habit between the general contractor and the subcontractors.


In conclusion, the Payment Regulations has taken the guarantee of the payment of migrant workers as the starting point, and has broken through the privity of contracts to a greater extent. The Payment Regulations reconstructs the rights and obligations among the project employer, the general contractor, the subcontractor and migrant workers by opening up the upstream and downstream payment chains of the general contract and the subcontract. This has posed great challenges to the related parties in contract management, fund management, employment management and legal risk management and so on.


2.2 EPC Projects — Project General Contracting Management Measures Issued by the MOHURD and the NDRC


On 23 December 2019, the MOHURD and the NDRC jointly issued the Project General Contracting Management Measures (Jian-Shi-Gui [2019] No.12), which came into effect on 1 March 2020.


The Project General Contracting Management Measures has not only absorbed the good experience in the practice, but also made major adjustments on some core issues, which will have a profound impact on the trading rules of the EPC market. Besides, this Measure was jointly formulated and promulgated by the MOHURD and the NDRC, which will also help to improve the status of this Measure in the market (especially for government investment projects).


It should be noted that, subject to the administrative management system of "barriers between higher and lower levels or between different departments and regions" in the construction field in China, the scope of application of the Project General Contracting Management Measures shall be the construction of housing and municipal infrastructure projects. The impact of this Measure on other industries, especially in the field of industrial engineering, still has large uncertainties. Therefore, for the avoidance of doubt, unless otherwise specified, the "EPC project" described below shall be limited to housing construction and municipal infrastructure projects, and should not be applicable to other construction areas.


The Project General Contracting Management Measures clearly clarifies the contracting stage of EPC projects, the conditions applicable to mandatory bidding projects, the main content of the bidding documents and recommended model text of the contract, the qualifications of EPC contractors, the conflicts of interest and exceptions of previous consultants, the main types of risks undertaken by the project employer, requirements for EPC project manager, the subcontracting methods and the respective quality and safety responsibilities of the project employer and the EPC contractors, etc. Among them, the new requirement under Article 10 of the Measure that the EPC contractors shall have "dual qualifications" of both engineering and construction qualifications will have a significant impact on the existing market access requirements and contract liability sharing mechanism of the EPC projects. Please refer to "EPC Projects" under Section 4.2 for detailed analysis.


From the perspective of the making, performance and dispute resolution of EPC contracts, the following aspects of the Project General Contracting Management Measures are also worth noting:


First, regarding the time of procurement of the EPC contracts, according to Article 7 of the Project General Contracting Management Measures, an enterprise investment project shall be procured for EPC after the project approval or filing; however, for a project invested by the government, such project shall, in principle, begin the EPC procurement after the completion of preliminary design approval.


Second, regarding the key issue of whether the consultants involved in the early stage of the project can become the EPC contractor, Article 11 of the Project General Contracting Management Measures clearly stipulates that the entrusted employer, project manager, supervisor, quantity surveyor, bidding agent shall not be the EPC contractor of the project; in a government investment project, on the premise that the project proposal, the feasibility study report, and the preliminary design documents have been completed and made public, relevant preparation and evaluation units are eligible to become the EPC contractor of such project. It is worth noting here that Article 11 above does not specify the conditions under which the preparation and evaluation units of the project proposal, the feasibility study report and the preliminary design can be the EPC contractors in enterprise investment projects. According to the text of the provisions, there seems to be no restrictive conditions. However, we believe that it should be more prudent to refer to the conditions of government investment projects and disclose the results of the preliminary consultation and design. In addition, it should also be noted that the Standard Design and Construction General Contracting Bidding Documents of the People's Republic of China (2012 Edition) jointly issued by the NDRC and other eight ministries and commissions still prohibits the consultants involved in the early stage of the project from participating in the bidding of EPC projects. Given that Article 15 of the Regulation on the Implementation of the Law of the People's Republic of China on Bid Invitation and Bidding has clearly stipulated that projects subject to mandatory bidding according to the laws shall use standard bidding documents, the applicability of Article 11 of the Project General Contracting Management Measures is questionable.


Third, with regard to the risk allocation mechanism for EPC contracts, Article 15 of the Project General Contracting Management Measures stipulates that the main risks to be undertaken by a project employer shall include "(i) The part of the price fluctuation range of main construction materials, equipment and labor exceeding the range agreed in the contract as compared with the base price at the time of bidding; (ii) the change in the contract price due to the change in the laws, regulations or policies of the State; (iii) unforeseeable changes in project costs and construction period caused by geological conditions; (iv) changes in project costs and construction period caused by the project employer; and (v) changes in project costs and construction period caused by force majeure". Although the above-mentioned risk allocation mechanism is more fair and reasonable, considering that this Measure is an administrative normative document with a lower level of effectiveness, if enforced by governmental authorities, such Measure may conflict with the legally concluded agreement between the parties, which may trigger new type of "black and white contracts" related issues


1.MOFCOM: 22 January 2020, Ministry of Commerce of the People’s Republic of China Department of Outward Investment and Economic Cooperation, Concise Statistics of China's Foreign Contracting Project in 2019. http://hzs.mofcom.gov.cn/article/date/202001/20200102932442.shtml (accessed 8 Feb. 2020).

2.MOFCOM: 22 January 2020, Ministry of Commerce of the People’s Republic of China Department of Outward Investment and Economic Cooperation, China's Investment Cooperation with Countries along the Belt and Road Initiative in 2019. http://hzs.mofcom.gov.cn/article/date/202001/20200102932445.shtml (accessed 8 Feb. 2020).

3.Please refer to the Decision to Amend and Repeal Relevant Documents (Jian-Fa [2018] No. 98) issued by MOHURD on 30 September 2018 and Notice on Further Strengthening the administration of Construction Permits for Construction Projects (Jian-Ban-Shi [2014] No. 34) issued by MOHURD on 4 September 2014.

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