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PRC Supreme Court Issues New Interpretation on the Application of Laws when Trying Construction Contract Dispute Cases


Introduction

On 29 September 2004, the Supreme People's Court published the Interpretation by the Supreme People's Court Regarding the Application of Laws for Trying Disputes Arising from Construction Contracts Cases (2004 No. 14) ("the Interpretation"), which will be implemented on 1 January 2005. Whilst Supreme Court Interpretations are not law (as only the Standing Committee National People's Congress technically has the right to interpret laws under the PRC Legislation Law), their practical impact is similar, because they are likely to be applied in practice by the local courts.

The Interpretation provides that prior to its official effective date, where there are any inconsistencies between the Interpretation and other existing Supreme People's Court Interpretations, the Interpretation will prevail. Therefore, in a practical sense, the Interpretation is already in force.

This Newsflash summarises and, where appropriate, comments on the following salient items referred to in the Interpretation.

  1. Qualification Certificates for Regulated Works ("QQCS") (Articles 1 and 5)
  2. Forfeiture of Monies obtained by a Contractor for Unlawful Acts (Article 4)
  3. Consequences of a Construction Contract being Void (Articles 2 and 3)
  4. Consequences of a Construction Contract being Terminated (Articles 8,9 and 10)
  5. Prepayments made on Behalf of the Employer (Article 6)
  6. Liability of Employer for Quality Defects(Article 12)
  7. Consequences of the Building being Put into Use by the Employer Before Completion Acceptance Testing Certification (Article 13)
  8. Disputes on Completion Dates for Building Works (Articles 14 and 15)
  9. Calculation of Value of Construction Project Variation Works (Article 16)
  10. Interest on Late Payments (Articles 17 and 18)
  11. Yin- Yang Contracts (Article 21)
  12. Joinder of Defendants in Legal Proceedings brought by the Employer (Article 25)
  13. Liability of Parties Responsible for the Repair and Maintenance of Buildings (Article 27)

1. Qualification Certificates for Regulated Works ("QQCS") (Articles 1 and 5)

The Interpretation reiterates the requirements regarding QQCs for regulated works and indicates that failure to comply with the requirements will make the contract void. It provides that:

  • Where a main contractor has failed to obtain the requisite QQC, exceeded the scope of its QQC, borrowed the QQC of another company, the construction contract is to be declared void.
  • Where a main contractor has exceeded the scope of its QQC at the time of performing the construction contract, but has obtained the requisite grade of QQC before completion of the works, the construction contract should not be declared void.

Lovells comment: This seems to echo Article 26 of the PRC Construction Law ("Construction Law"). Contractors who have a QQC but do not have the requisite grade of QQC could, theoretically, still undertake works requiring a higher grade providing that they are sure that they can obtain the requisite QQC prior to completion of the works, without the contract being declared void. This is, however, a risky strategy to adopt, given the uncertainties as to the timing for processing of a QQC application and the risk of rejection. It also does not address the issue of liability for breach of Article 26 of the Construction Law which would be breached by undertaking a construction works project without the requisite QQC.

2. Forfeiture of Monies obtained by a Contractor for Unlawful Acts (Article 4)

Where a main contractor has unlawfully "borrowed" the QQC of another company, or unlawfully assigned works under a construction contract, or entered into unlawful sub-contracting arrangements, the courts may, pursuant to Article 134 of the General Principles of Civil Law, confiscate the monies unlawfully obtained by such main contractor.

Lovells comment: This Article once again echoes Article 26 of the Construction Law on "borrowing" of QQCs. The second part refers to Article 28 of the Construction Law which provides that:

"No contract undertaking unit may assign the whole of its undertaken building project to a third party, nor may a contract undertaking unit, after having "dismembered" the whole of its undertaken building project under the guise of sub-contracting, separately subcontract it out to third parties."

The question this provision raises is why is there a need to refer to the General Principles of Civil Law when Articles 66 and 67 of the Construction Law already provide for the confiscation of illegal income and other remedies in such cases. Does this really add anything new?

3. Consequences of a Construction Contract being Void (Articles 2 and 3)

If a construction contract is declared void, this will evidently impact upon the works and on any outstanding payments. The Interpretation contains detailed provisions dealing with such situations.

  • If the construction contract is void, but the works meet the requisite completion acceptance testing certification standards, then the main contractor will be entitled to claim payment from the owner in accordance with the construction contract.
  • If the construction contract is void, but the works do not meet the requisite completion acceptance testing certification standards, then:
  1. where the works meet the requisite standards after repairs, the owner will be entitled to require the contractor to meet the costs of rectification.
  2. where the works do not meet the requisite completion acceptance testing certification standards after repairs, the contractor will not be entitled to payment under the construction contract.

Lovells comment: In other words, the contractor will not get paid its final account after completion until the works are up to standard and completion acceptance testing certification has taken place. This gives the employer leverage to get the contractor to do the necessary further works where the contract is void, but the completed works are not up to standard.

4. Consequences

of a Construction Contract being Terminated (Articles 8, 9 and 10)

According to Articles 8 and 9 of the Interpretation, a construction contract may be terminated due to default by the employer. The Interpretation sets out the specific circumstances in which the courts will support an application by the owner to terminate a construction project works contract (e.g. where the contractor has expressly or by its conduct indicated it will not comply with its main obligations under the contract, or where the contractor unlawfully assigns or subcontracts out the contracted construction project or where the completed project is not up to the required quality standard and the contractor refuses to carry out the repairs and restorations) and conversely, the circumstances in which the courts will support an application by the contractor to terminate, due to it becoming impossible to carry out the construction works as a result of the following:

  • where it has not been paid in accordance with the agreement,
  • where the main construction materials, parts and equipment it has provided do not conform to mandatory standards; or
  • where the owner has not complied with its obligations to provide assistance under the contract.

According to Article 10 of the Interpretation, upon termination, the provisions applicable to void contracts will be applicable to terminated contracts.

Lovells comment: Accordingly, applying Article 10, it appears that upon termination, the employer may, for example, contend that the works do not meet the requisite completion acceptance testing certification standards, and if the employer is successful in such claim, the main contractor will not be entitled to any payments for the work done under the construction works contract until the rectification works have been successfully carried out.

5. Prepayments made on Behalf of the Employer (Article 6)

According to Article 6 of the Interpretation, where a main contractor enters into a prepayment arrangement with the employer, then:

  • the express provisions in an agreement regarding the prepayment will be given effect;
  • the amount of interest on the prepayment shall not exceed the PBOC interest rate for the same period for the same category of loan;
  • where there is no agreement regarding prepayment of capital sums, the prepayment will be regarded as part of the monies owing under the construction contract;
  • where there is no agreement regarding the amount of interest for the prepayment, interest shall not be recoverable.

Lovells comment: This serves as a warning to contractors who agree to make prepayments on behalf of the employer to set out the provisions on repayment of both the capital sum and interest (including the applicable interest rate) in the relevant construction contract. The interest rate should not exceed the corresponding PBOC interest rate, otherwise it will be unenforceable to that extent. PBOC's interest rates tend to be low and may not reflect the foreign contractor's cost of capital.

6. Liability of Employer for Quality Defects(Article 12)

An employer will be liable for defects in the quality of works in the following circumstances:

  • providing defective designs;
  • providing or specifying materials, parts, or equipment which do not accord with compulsory standards;
  • nominating sub-contractors for specialist sub-contract works.

If the contractor is at fault, the contractor shall be responsible for the corresponding liabilities.

Lovells comment: As a result of Article 12, employers will need to ensure that they get indemnities from the relevant design institute/entity for defective designs in their contracts and from equipment suppliers for nonconforming materials, parts or equipment leading to quality problems with the works. If the employer nominates specialist sub-contractors, it will need to put in place similar arrangements in the contract.

7. Consequences of the Building being Put into Use by the Employer Before Completion Acceptance Testing Certification (Article 13)

Where the employer puts the building into use prior to completion acceptance testing certification of the works without approval, the courts will not give their support to allegations from the employer that the quality of the portion of the building it has put into use does not meet the standards set out in the construction contract, provided that the contractor shall still bear civil liability for the quality of the foundations and main structure during their reasonable usage life span.

Lovells comment: "Without approval" presumably is a reference to getting approval/consent from the various government departments who have to sign off on a new building in China as part of completion acceptance testing before it can be put into use (i.e. occupied).

This indicates that by putting any part of the building into use before completion acceptance testing certification has been completed, the employer has, in effect, waived its right to dispute whether the quality of the works is up to the contractually agreed standard in relation to that part. However, despite the employer using the building ahead of time, the contractor is still liable for the quality of the foundations and main structure during the reasonable usage life span. It is not clear here whether the implication is that contractors are, in such cases, not to be held liable for meeting contractual standards for quality in relation to the other elements of the building.

8. Disputes on Completion Dates for Building Works (Articles 14 and 15)

Where there is a dispute as to the completion date of the works, the completion date shall be determined as follows:

  • where the works pass the completion acceptance testing certification, the completion date is the date when the works pass completion acceptance testing certification;
  • where the contractor submits a report for completion acceptance testing certification, but the employer delays in carrying out completion acceptance testing certification, the completion date shall be the date when the report was submitted;
  • where the employer puts the building into use prior to completion of the works and completion of acceptance testing certification, without approval, the completion date shall be the date when the change in occupation takes place.

Lovells comment: These Articles provide useful guidelines to help ascertain the official completion date when it is disputed as this is often a trigger for payments to contractors etc. By using the building before completion acceptance testing certification without approval, or if the employer delays in processing a report from the contractor requesting completion acceptance testing certification, the employer effectively waives its rights and advances the deemed completion date to the date of the change in possession/occupation or the date of submission of the report to it respectively.

The Interpretation also provides that where there are disputes as to the quality standards of the works prior to completion, and if, upon checking, the quality complies with the relevant standard, the completion date shall be extended by the time taken for checking.

9. Calculation of Value of Construction Project Variation Works (Article 16)

Where design changes result in variations in the quantity or quality of the works, and the parties fail to reach agreement on the price for the variation works, the parties may make reference to calculation methods or standards for price calculations published by the local construction department at the time when the construction contract was signed.

Lovells comment: The key issue here is that the pricing standard will be fixed at the time when the construction contract was signed, not at the time when the variation was made. This provision is not mandatory and, in our view, is best avoided, as it opens up something of a pandora's box. Depending upon whether the market is going up or down, either the employer or the contractor will emerge the winner from this "lottery". It does not rule out the parties making their own contractual arrangements on how to price variations, which is far preferable, in our view.

10. Interest on Late Payments (Articles 17 and 18)

If the construction contract is silent, then the published PBOC interest rates for loans of the same type during the same period will be used to calculate interest on late payments.

The Interpretation contains provisions as to when interest would fall due.

Lovells comment: This serves as a useful guideline for contractors when claiming interest on late payments, - where no provision has been made in this regard. It also serves as a reminder that is important for contractors to make their own contractual provisions in this regard, as this will then be applied rather than the default position as set out in the Interpretation.

11. Yin-Yang Contracts (Article 21)

Where the terms of a construction contract approved via the tender process are different from the terms of another construction contract for the same project, the construction contract approved via the tender process will be used as the definitive version for the purposes of the works price settlement account.

Lovells comment: This is a further provision to address the yin-yang contract scenario, although it differs from the provisions in the draft revised PRC Construction Law, which refers back to the version of the contract filed for the record with the local MOC. See previous Newsflash on the draft revised PRC Construction Law.

However, Article 19 of the Interpretation provides that where there are disputes over the quantity of works, the contractor may rely on informal written documents prepared in the course of the works as evidence to prove whether or not works were actually done.

12. Joinder of Defendants in Legal Proceedings brought by the Employer (Article 25)

Where are there are disputes regarding the quality of the works, the employer may join the main contractor, the subcontractors, and the parties who actually performed the works as co-defendants in any legal proceedings.

Lovells comment: This overcomes any possible objection to being joined in the proceedings by the contractor who actually performed the works but in the name of another qualified contractor, on the basis it does not have a contractual relationship with the employer.

13. Liability of Parties Responsible for the Repair and Maintenance of Buildings (Article 27)

Where a party is responsible for maintaining a building, and if that party fails to carry out its maintenance obligations, and if the failure results in the destruction of the building or personal injuries or property damage, that party shall be liable for compensation.

However, if the party responsible to maintain a building and/or the owner of the building and/or the project owner is at fault in the destruction of the building, each shall bear its corresponding liability.

Lovells comment: This Article raises important liability considerations for property management companies which have undertaken maintenance obligations under a property management contract.

Lovells Construction Newsflash
November 2004



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