11 April, 2018
1. Major Cases in in the Field of Conventional Engineering Construction
[Case One] Impact of the Termination of a General Contract on the Existence of a Subcontract1
1.1 [Facts]
On 8 December 2003, America General Electric Plastics (China) Co., Ltd.2 (hereinafter referred to as the “Employer”) awarded Samsung Engineering Co., Ltd. (hereinafter referred to as “Samsung”) as the General Contractor of a rehabilitation project which involved a dosage control room and an unloading shed PLG station, an office and a heating room as well as a production workshop (hereinafter referred to as the “Project”). Employer and Samsung signed an EPC contract for the Project.
Afterwards, the General Contractor subcontracted the civil works to Fujian Civil Engineering Construction Co., Ltd. (hereinafter referred to as the “Subcontractor”).
On 15 November 2004, due to delays in work, the General Contractor informed the Subcontractor to suspend the works.
On 31 December 2004, the General Contractor reached and signed a Settlement Agreement with the Subcontractor, which provided the completion date of the civil works after the resumption thereof.
On 16 December 2005, the Employer gave a written notice to the General Contractor to terminate the EPC contract on 31 December 2005, on the grounds that the Subcontractor had failed to finish the work by the agreed completion date, 30 June 2005. The General Contractor confirmed in writing the termination of the EPC contract.
On 19 December 2005, the General Contractor gave a written notice to the Subcontractor that the EPC contract between the Employer and the General Contractor had been agreed to be terminated and such termination would be effective on 31 December 2005. Consequentially, the contract between the General Contractor and the Subcontractor would be terminated 14 days after the notice date, and the Subcontractor must then leave the site immediately and make a delivery of Project-related construction documents as well as other relevant documents.
The Subcontractor replied by letter that because the Subcontractor suffered a significant loss out of the General Contractor’s breach of contract, the Subcontractor would stay and protect the construction site in accordance with the law until an agreement regarding exit fee and compensation issues had been reached, and a formal termination agreement had been signed, during which period no other entities had the right to interfere with it.
On 31 December 2005, the Employer wrote to the Subcontractor requiring the latter to leave the site unconditionally by 15 January 2006. Afterwards, the Employer informed the Subcontractor to participate in the on-site delivery meeting, but the latter continued to refuse to leave.
On 27 February 2006, the Employer initiated a lawsuit against the Subcontractor, petitioning the court for an order requiring the Subcontractor to leave the Project site immediately, and applying for advance execution at the same time.
On 9 March 2006, the Subcontractor filed a separate lawsuit against the General Contractor and the Employer, petitioning the court for an order requiring the General Contractor to continue to execute the Settlement Agreement; however, it subsequently changed its petition to terminate the Settlement Agreement and confirm its’ entitlement to a preemptive right to payment. The General Contractor made a counterclaim in that case to terminate the Settlement Agreement. On 20 December 2011, the latter case was decided at final instance that it was an employer – general contractor – subcontractor relationship amongst the parties concerned, that the Settlement Agreement was terminated (however the termination date thereof was not made clear), and that the Subcontractor was entitled to a preemptive right to payment.
1.2 [Key Issues]
Firstly, is the Subcontract subordinate to the General Contract?
Secondly, when was the Subcontract (i.e. the Settlement Agreement) terminated?
Thirdly, is there a lawful ground for the Subcontractor not to leave the construction site?
1.3 [Judicial Reasoning]
Firstly, on the issue whether the Subcontract is subordinated to the General Contract, the concerned parties held different opinions. Both the Employer and the General Contractor contended that the Subcontract was subordinate to the General Contract and was part of the EPC contract; as such, the termination of the EPC contract would inevitably cause the termination of the Subcontract. While the Subcontractor contended that as per the final judgment of the separate case, the two contracts were independent to each other with no relationship of subordination.
Both the court of first instance and the court of second instance stand for Subcontractor, opining that although the General Contract and the Subcontract are related to some degree in terms of their contents, they are two independent contracts from the perspective of the law and with no principal-subordinate relationship. The termination of the EPC contract between the Employer and the General Contractor through negotiation does not bind the Subcontractor as the Subcontractor is not a party thereto and thus does not affect the effectiveness of the Subcontract (i.e. the Settlement Agreement).
However, the SPC retried the case and overruled the opinion of the court of original instance in terms of the substantial outcome, despite the SPC recognizing that the Subcontract between the General Contractor and the Subcontractor was valid and independent to the General Contract. The SPC held that the existence of the General Contract was the prerequisite and basis for the entry into and performance of the Subcontract and that, after the termination of the EPC contract, Samsung (i.e. the General Contractor) had lost the legal status as the General Contractor and thus the Subcontract between the General Contractor and the Subcontractor lost the necessity and possibility to continue to be implemented, which results in the impossibility of performance of the Subcontract. As such, the Subcontract shall be terminated, and even though the General Contractor may possibly take on liability towards the Subcontractor, such shall not constitute the grounds for hindering the termination of the Sub-Contract. In other words, the termination of the General Contract will inevitably cause the termination of the Subcontract.
Secondly, on the issue of when the Subcontract was terminated, both the court of first instance and the court of second instance held that, pursuant to the fact that the judgment of the separate case did not provide a specific termination date, the Subcontract (i.e. the Settlement Agreement) shall be terminated as of the date that the judgment of that separate case came into effect, i.e. on 20 December 2011. However, the SPC held that in view that the termination of the General Contract will inevitably cause the termination of the Subcontract, in this case, the termination date of the Subcontract shall be synchronically in line with that of the General Contract, i.e. on 31 December 2005.
Thirdly, on the issue whether there was a lawful basis for the Subcontractor not to leave the construction site, both the court of first instance and the court of second instance held that the Subcontractor enjoyed the right to possess the involved construction site based on the Subcontract. Such right became effective since the day the Subcontract came into effect and would not be extinguished till the lawful termination of the Subcontract, i.e. on 20 December 2011. But the SPC held that the Subcontractor’s leaving the site is an inevitable consequence of the termination of the Subcontract and the Subcontractor’s right in personam against the General Contractor shall not prevail over the Employer’s right in rem towards the construction site; therefore, the Employer’s claim for the Subcontractor to leave the construction site by 15 January 2006 shall be supported.
1.4 [Review of Dispute]
This case started from December 2005 and the SPC entered the final judgment in December 2016, spanning more than 10 years from the beginning to the end. This case is of practical and instructive significance in the current construction engineering field, especially in the industrial EPC field where disputes related to contract termination have been increasing. Its value concretely embodies as follows:
Firstly, the SPC explicitly recognized that there isn’t a principal-subordinate relationship between General Contract and Subcontract, and that the general contract and the subcontract are independent of each other. Nonetheless, the termination of the former will cause the termination of the latter synchronically.
Secondly, the SPC explicitly recognized that a Subcontractor has no right to occupy the construction site after the termination of Subcontract, otherwise it shall constitute a breach of contract or infringement in tort. This is of great reference significance in preventing misconduct in practice where construction units claim for creditor’s rights or preemptive rights by occupying the construction site.
Thirdly, we paid special attention to one opinion delivered by the SPC in this case that, as a result of Article 268 of the Contract Law of People’s Republic of China (hereinafter referred to as the “Contract Law”) which provides that the Client may terminate the Contract of Hired Work at any time, but it shall bear the liability for making compensation for losses if the Contractor suffers such losses therefrom, the client of the Subcontract, i.e. the General Contractor, may also terminate the Subcontract at any time as per this Article. It is the first time the SPC confirms in a judgment that the employer of a construction contract is entitled to a legal right to terminate the contract at any time in accordance with the provision of Article 268 of the Contract Law.
What is to be stressed here is that even if in the international construction field, where the employer being contractually entitled to a right of arbitrary termination or termination for convenience is a customary practice, in China’s construction field it is a different story. On one hand, the PRC’s standardized model construction contracts rarely grant the right of termination for convenience to the employer.3 On the other hand, whether or not an employer may enjoy the statutory right of arbitrary termination pursuant to Article 268 of the Contract Law was often handled inconsistently in judicial practices, among which a typical negative view was taken by Guangdong Higher People’s Court in its Answers on Knotty Issues Concerning Cases of Disputes over Construction Engineering Contracts (Yue-Gao-Fa [2017] No.151). 4
2. Major Cases in the Field of EPC
[Case Two] Actual Implementation and Satisfaction of Conditions for Payments on Milestones under EPC Contract Splitting Model5
2.1 [Facts]
On 25 September 2013, Longchuan Hongyu Anxin New Energy Technologies Co., Ltd. (hereinafter referred to as the “Employer” or “Party A”) signed an EPC contract with Shaanxi Dahua Electric Engineering Co., Ltd. (hereinafter referred to as the “EPC Contractor” or “Party B”) concerning 2×15MW biomass power plants in Longchuan County, Yunnan Province, for which the parties agreed to adopt EPC approach of design, procurement, construction and service for the works and fixed lump sum as the pricing method.
On progress payment, Clause 5.2.3 of Volume II of the Contract provided that the materials and documentation required for application for payments include: (1) 4 copies of progress payment application, (2) close-out report and Acceptance Certificate on the relevant milestone, (3) statement of quantities of work that have been actually completed in correspondence with the completed milestone, (4) certificate of delivery of process technology documents that shall be handed over on the completed milestone, (5) other documentation on the amounts added or deducted in this payment in accordance with the provisions of the Contract. Clause 5.2.4 further provides the conditions for payments as: (1) a complete package of documentation has been handed over in accordance with Clause 5.2.3 and has been examined and verified by Party A’s representative, (2) Party B has issued invoices in accordance with the payment amounts determined by Party A and provided corresponding tax-paid proof at the same time.
Milestones and amounts of progress payments were provided in the Contract, and included: (1) main building’s foundation soil exceeded zero meter and first concrete applied for No.1 column of line A, 15% of the total contract value shall be paid, (2) first steel frame for boiler delivered to the site and civil works reached the operation level, 10% of the total contract value shall be paid, (3) civil works of main building (steam engine room and deoxygenation room) completed (roof sealed), 10% of the total contract value shall be paid, (4) hydrostatic test for No.1 boiler finished, 10% of the total contract value shall be paid, (5) No.1 steam turbine’s cylinder buckled, 15% of the total contract value shall be paid, (6) 72-hour commissioning and delivery for trial production for No.1 Unit finished, 10% of the total contract value shall be paid, (7) No.2 Boiler foundation handed over for installation and steel frame successfully hoisted, 10% of the total contract value shall be paid, (8) hydrostatic test for No.2 boiler finished, 5% of the total contract value shall be paid, (9) No.2 steam turbine’s cylinder buckled, 5% of the total contract value shall be paid, (10) 72-hour commissioning and delivery for trial production for No.2 Unit finished, 5% of the total contract value shall be paid, (11) at the end of the one-year warranty period, 5% of the total contract value shall be paid.
Article 1 of Appendix 5 “Inspection, Test and Taking-over” of Volume III of the Contract provides, “… the Undertaker shall provide, inter alia, all such standards and specifications for engineering tests on equipment and materials, test records and quality control plan by the Manufacturer as are required hereby…” Article 2 provides, “… Party B shall be responsible for the quality of final products and all the costs of tests shall be borne by the Undertaker. Quality activities Party A participates in, including witnessing and signing witness reports, shall not exempt Party B from taking responsibilities for quality and for penalties in respect of quality or progress therefrom. In the event that Party B fails to effectively work in compliance with this Section, Party A shall have the right not to issue the Progress Payment Certificate. Party B may go through progress payments formalities in accordance with relevant provisions in the business contract, provided that Party B has worked effectively and delivered to Party A the relevant proofs in accordance with provisions herein and that Party A has accordingly issued Progress Payment Certificate after examining and reviewing the documentation.”
Funds for this Project were mainly loans from national financial institutions, which required such funds to be used for specified purposes and be paid directly to the project management and construction units. Therefore, the Employer and EPC Contractor split the EPC contract in the following structure:
Engineering (E) part: on 24 October 2013, the Employer and the engineering unit signed a Survey and Design and Engineering Management Contract.
Procurement (P) part: on 28 October 2013, the Employer, EPC Contractor and the equipment supplier signed a Complete Set of Equipment Procurement Contract, stipulating that payments shall be made to the equipment supplier by the Employer on milestones for payments and the equipment supplier may deliver such equipment to the EPC Contractor after receiving the payments from Employer.
Construction (C) part: on 31 October 2013, the Employer and the Construction unit signed a General Contracting Construction Contract. Afterwards, the EPC Contractor signed a separate Construction Contract of Building and Installation Project for the Whole Plant with the Construction unit.
During the implementation of the EPC contract, the EPC Contractor claimed for the Employer to pay progress payments in arrears of RMB 53,485,080 in aggregate. The Employer refused to pay such on the ground of dissatisfaction of conditions for progress payments.
2.2 [Key Issues]
Firstly, was the EPC Contract valid?
Secondly, was the EPC Contract actually implemented?
Thirdly, had the conditions for progress payments been satisfied?
2.3 [Judicial Reasoning]
Firstly, on the validity of EPC Contract, the Employer contended that the EPC Contractor only had design qualification and thus was not qualified to engage in an EPC project, insomuch that the EPC contract was invalid. In this regard, the court opined that the EPC Contractor has Grade B qualification for engineering design in the electric power industry. Both the Qualification Standards for Engineering Design promulgated by MOHURD and the qualification certificate issued to the EPC Contractor provides that entities with engineering design qualification may engage in EPC projects, project management and other relevant technical and consultative management services in correspondence with the permitted scope of the qualification certificate. Hence, the EPC Contractor may engage in EPC business. As for the plea by Employer that the involved project scale is 2×15MW and exceeds the permitted scale for the EPC Contractor’s qualification, the court opined that the involved project (a biomass power plant) is attributed to the new energy project in the electric power industry, the design scale of which is not classified in the Classification Table of Design Scale for Construction Projects in Electric Power Industry promulgated by MOHURD; and hence, such Employer’s plea was refused.
Secondly, on the issue of whether or not the EPC contract was actually implemented, the Employer contended that the EPC contract was not actually implemented as it only had an equipment procurement contractual relationship with the EPC Contractor while the design unit and construction unit were two other entities. Nevertheless, the EPC Contractor contended that such EPC contract was actually implemented as the contracts signed by the Employer respectively with the design unit and construction unit were both for the purpose of loan requirements and were not implemented. The court found that, pursuant to the established facts, the EPC Contractor was the one that actually performed the design work while the actual construction unit was also a subcontractor of the EPC Contractor. Combined with the minutes of weekly meetings, correspondences among the parties and letters for application of progress payments, the court eventually recognized that the EPC contract was actually implemented.
Thirdly, on the issue of whether or not the conditions for progress payments for certain milestones had been satisfied, the EPC Contractor contended that despite the application for progress payment on the first milestone (main building’s foundation soil exceeding zero meter) did not meet the conditions agreed in the contract, the consent by the Employer on paying such payment indicated that both parties had reached an agreement in changing the milestones for progress payments. The court opined that, as per Article 1.5 of Volume II of the EPC contract which provides that “unless otherwise made in writing, marked with date, clearly aimed at the Contract and approved and signed by the authorized persons by both parties, any addendum or amendment to this Contract is invalid”, the effect of the consent by the Employer on making the first payment shall be constrained only to the first milestone and the validity of such consent cannot be extended to change all the other conditions for payments. In addition, the EPC Contractor did not submit evidence to prove the parties had reached a written agreement on the change of conditions for progress payments on milestones. Since the EPC Contractor did not submit the materials for payment application in accordance with Clause 5.2.3 of the EPC contract (especially the relevant technical documents, including standards and specifications for engineering tests on procured equipment and materials, test records and quality control plan of Manufacturers), which caused the Employer to be unable to account for the amount of the progress payment, the Employer may thus refuse to pay the progress payment by exercising its right of defense against the advance performance and such refusal is not a breach of contract.
2.4 [Review of Dispute]
Firstly, this case is the first time the SPC confirms that the Qualification Standards for Engineering Design promulgated by MOHURD can serve as the legal basis for recognizing the market access for EPC projects. Regarding the qualification for EPC, after the State Council Decisions on Cancellation of the First Batch of Administrative Approval Items (Guo-Fa [2002] No.24) abolished the administrative approval of the qualification for EPC, the previous Ministry of Construction (now the “MOHURD”), had issued a series of administrative regulatory documents and departmental regulations6 providing that the enterprises with Engineering Design Qualification or General Contracting Construction Qualification may engage in EPC projects. However, the superordinate legislations such as Construction Law, Regulation on the Administration of Quality Management of Construction Projects and Regulation on the Administration of Survey and Design of Construction Projects were mainly enacted on the basis of a construction management system in which a line was drawn between designing and building; and thus, due to the lack of support from the superordinate legislations, whether the aforementioned administrative regulatory documents and departmental regulations of MOHURD can serve as the legal basis of market access for EPC projects remains controversial in practice. For instance, Beijing and Tianjin Municipalities still require EPC contractors to be qualified with both design qualification and construction qualification.7 In such situation, this case shall have reference significance in unifying the courts’ approach in dealing with such disputes about the validity of contracts arising out of qualification for EPC.
Secondly, in the domestic practice of EPC projects, especially those industrial EPC projects based on equipment production and technology, it is a common practice that parties concerned would split the EPC contract in consideration of loans raising and tax planning. However, the more complicated transactional structure of contracts may easily make the real legal relationships among relevant parties more difficult to be recognized, the relevant facts of performance (such as payment and settlement) more difficult to be found out, the liability scopes of each party more difficult to be defined, and moreover, there might be dispute resolution clauses in conflict among different contracts. In this case, the process of the court’s analysis of the key issue whether or not the EPC contract was actually implemented reflects a typical characteristic of EPC contract dispute of this kind.
Thirdly, in this case the EPC Contractor filed a lawsuit against the Employer on progress payments. In the terms of the conditions for progress payments on milestones, especially the relevant technical documents, the court precisely seized a typical characteristic of industrial EPC projects of this kind which distinguishes EPC projects from conventional construction projects; that is, “the involved project is an EPC project in the electric power industry which includes a mass of equipment procurement and technical issues, the construction is just one side thereof.” It is praiseworthy that the court lawfully protected the conditions explicitly agreed by both parties for progress payments by taking into account the characteristics of EPC projects.
3. Major Cases in the Field of Overseas Construction Project
3.1 [Case Three] The Nature of Independent Guarantee and Recognition of Exceptions of Fraud for Independent Guarantee8
3.1.1 [Facts]
China Machine New Energy Development Co., Ltd. (hereinafter referred to as the “General Contractor” or “CMNC”) contracted to build the 2×15MW power plant in Guatemala as the General Contractor awarded by Jaguar Energy Guatemala LLC (hereinafter referred to as the “Employer” or “JEG”).
On 27 November 2008, a Supply and Service Contract of Boiler in terms of 480t/h circulating fluid bed boiler under the project of JAGUAR 2×15MW power plant was entered into between China Western Power Industrial Co., Ltd. (hereinafter referred to as the “Subcontractor” or “Western Power”) and CMNC, agreeing that Western Power would provide CMNC with boiler equipment, technical data and technical services, which were necessary to the Guatemala power plant project. The total contract price was RMB 180 million.
On 8 February 2010, the Employer, the General Contractor and the Subcontractor entered into Subcontractor Undertaking Agreement, stipulating that JEG was entitled to a step-in right under the Supply and Service Contract of Boiler. The agreement specified that: if the General Contractor breached the EPC contract, including but not limited to the General Contractor’s material breach under the Supply and Service Contract of Boiler resulting in the Subcontractor’s termination of the same, and thereby caused the Employer to terminate the EPC contract, then the Employer would have the right to step-in under the Supply and Service Contract of Boiler in lieu of the General Contractor and could further assign the Supply and Service Contract of Boiler; Once receiving the notification of step-in, the Subcontractor shall render full support to its implementation and shall be liable to the Employer or his designated person as a replacement to the General Contractor
On 2 June 2010, Western Power applied to Zigong Sub-branch of China Construction Bank (hereinafter referred to as the “Zigong CCB”) for Performance Guarantee in respect of the Supply and Service Contract of Boiler. On 9 June 2010, Agreement of Issuing Guarantee was entered into between Western Power and Zigong CCB, providing that Zigong CCB shall issue the guarantee in favor of CMNC with a sum of RMB 25.65 million. On the same day, Zigong CCB issued Performance Guarantee to CMNC, stating that: “We hereby as the guarantor undertake unconditionally and irrevocably: Upon receipt of your first written notification of claim, we must pay the amount of money specified under the provisions of the guarantee, but not exceeding the amount specified in the above guarantee, to your designated account within five working days of the bank, without the principal’s consent or your company’s submitting certificates or statement of reasons. The guarantee is an unconditional and irrevocable direct obligation of the guarantor. Before making a request to us, we will not require your company to claim the above-mentioned sum from the principal first. We hereby agree that no amendment, alteration or supplement to the contract will relieve our obligations under the guarantee, and any amendment, alteration or supplement of the contract need not be notified to us. The guarantee shall become effective immediately and shall expire on 30 December 2013.”
On 29 November 2013, the Employer gave the notice of exercising step-in right to Western Power. JEG claimed that CMNC had defaulted, which caused the Employer to become entitled to exercise the right of termination under the EPC contract, and the right of step-in to become the general contractor and assume the right of Supply and Service Contract of Boiler. The Employer hereby chose to exercise the right of termination, intervened to become the general contractor, and assumed the transfer of Supply and Service Contract of Boiler (which shall remain in force). Western Power should be responsible to the Employer in lieu of the General Contractor.
CMNC subsequently sent notices to Western Power by fax and mail. It claimed that it had given a takeover notice to the Employer prior to the intervention of the Employer. Thus, the Employer had been changed to CMNC and the intervention by the Employer was invalid and null. It required Western Power not to cooperate with the Employer, otherwise such cooperation would be regarded as constituting a breach of contract, resulting in contractual claims by CMNC.
On 27 December 2013, Zigong CCB received the notification of claim, which required Zigong CCB to perform the obligation of payment under the guarantee as a result of Western Power’s failure to perform fully in accordance with the Supply and Service Contract of Boiler. Then, Western Power sought the judgment to permanently stay the payment under Performance Guarantee.
During the trial, International Chamber of Commerce (ICC) gave the ruling in respect of the dispute between JEG and CMNC, holding that the Employer had terminated the EPC contract effectively.
3.1.2 [Key Issues]
Firstly, whether the Performance Guarantee concerned was an independent guarantee or an accessory contract to the Supply and Service Contract of Boiler;
Secondly, if it was an independent guarantee, whether the claim of CMNC constituted a guarantee fraud.
3.1.3 [Judicial Reasoning]
Firstly, on the issue whether the Performance Guarantee concerned was an independent guarantee or an accessory contract of the Supply and Service Contract of Boiler, the court of first instance held that the Performance Guarantee was an accessory contract of the Supply and Service Contract of Boiler. The Guaranty Law of the People's Republic of China stipulates that where the principal contract transfers rights and obligations, related rights and obligations of the accessory contract shall transfer at the same time. Therefore, after the Employer’s exercise of the step-in right, the General Contractor’s rights under the Supply and Service Contract were transferred to the Employer, who inherited the creditor's rights under the Performance Guarantee.
As a result, CMNC no longer enjoyed the right for payment from the issuer of guarantee based on the Performance Guarantee. Therefore, the court of first instance concluded that CMNC was not entitled to request payment from Zigong CCB based on Performance Guarantee. However, the court of second instance held that: an independent guarantee is an undertaking of payment accompanied by documentary conditions. When the beneficiary submits the documents that meet the requirements of the independent guarantee without proving the default facts of the underlying transaction, the issuer, who does not enjoy the right of defense and right of discussion as the principal debtor in a traditional guarantee, shall independently undertake the obligation of payment. Hence, the independent guarantee is independent from the underlying transaction or the issuance application. Based on the provisions of the Performance Guarantee, the court of second instance decided that its nature shall be an independent guarantee. With regard to the Subcontractor’s claim that “the independent guarantee lacks independence because the underlying transaction was a domestic transaction”, the court of second instance invoked Article 23 of the Provisions of the Supreme People's Court on Several Issues Concerning the Trial of Independent Guarantee Dispute Cases（Fa-Shi [2016] No.24）(hereinafter referred to as “Judicial Interpretation of Independent Guarantee”) providing that “Where the parties had agreed to apply the independent guarantee in domestic transactions, but a party subsequently claimed that the agreement on the independence of the guarantee was invalid because the independent guarantee was not foreign-related, such claim shall not be upheld by the people's court”, and accordingly held that the court of first instance was wrong in the application of the Guaranty Law to recognize Performance Guarantee as an accessory contract of the Supply and Service Contract of Boiler, which should therefore be corrected.
Secondly, on the issue whether the claim of CMNC constituted an independent guarantee fraud. The court of second instance invoked Article 18 of the Judicial Interpretation of Independent Guarantee stipulating that “In the trial of the disputes over independent guarantee fraud or handling the application for stay of payment, the people's courts may examine and determine the facts related to the underlying transaction under the specific circumstances set out in Article 12 hereof as claimed by the relevant party”. Although the independent guarantees possess the characteristic of independence, in the cases of examining the independent guarantee fraud, the people's courts have the right to conduct a limited review of the performance of the underlying transactional contract, in order to find out whether or not CMNC had good causes to claim and whether or not a false statement had been made in its statement of claim. The reviewing of the performance of the underlying transactional contract within these limits would not conflict with the independence of the guarantee. The court of second instance held that Western Power, based on the Subcontractor Undertaking Agreement, had no obligation or right of reviewing whether the step-in of the Employer was justified. Once the notice of intervention was received, Western Power had to accept the step-in right of the Employer and fulfill its obligations under the Supply and Service Contract of Boiler to the Employer. Therefore, after the intervention of JEG, Western Power shall directly fulfill the obligations under the Supply and Service Contract of Boiler to the Employer, which did not constitute a default in contract. The dispute between CMNC and JEG on the performance of the EPC contract was a separate legal relationship, which had nothing to do with Western Power. Therefore, it cannot be decided that Western Power had committed an act of default. In this case, as a party under the Subcontractor Undertaking Agreement, CMNC should have, subject to the normal judgment and cognitive ability of a rational third party, been aware that Western Power, in accordance with such agreement, shall unconditionally accept the intervention from the Employer and directly fulfill its contractual obligations under the Supply and Service Contract of Boiler to the Employer. In other words, if the Employer exercised the step-in right, CMNC shall be fully aware that Western Power would fulfill its contractual obligations under the Supply and Service Contracts of Boiler to the Employer in accordance with the tripartite agreement. CMNC’s claim of the existence of the default act of Western Power based on the fact that Western Power directly fulfilled its obligations under the Supply and Service Contract of Boiler was inconsistent with the provisions of the Subcontractor Undertaking Agreement. Therefore, the claim under the independent guarantee asserted by CMNC was an abuse of right, which constituted an independent guarantee fraud in accordance with Subsection 12(5) of the Judicial Interpretation of Independent Guarantee. As a consequence, it was beyond a reasonable doubt in this case that CMNC had committed an independent guarantee fraud. Therefore, Western Power’s application to stay the payment under the Performance Guarantee had factual and legal basis, which was upheld by the court of second instance.
3.1.4 [Review of Dispute]
The case was the very first case applying the Judicial Interpretation of Independent Guarantee in overseas engineering dispute cases after its promulgation by the SPC on 1 December 2016.
The Judicial Interpretation of Independent Guarantee is one of the most important legal documents in the field of overseas construction dispute resolution, against the background of Chinese courts’ serving and safeguarding the Belt and Road Initiative construction and promoting a new round of opening up. First of all, the judicial interpretation unified the judicial rules regarding the jurisdiction of foreign-related independent guarantees and the rules of governing law, with important guiding value towards judicial practice. Next, the contents and highlights of the judicial interpretation are mainly embodied in the following aspects: firstly, the nature of the independent guarantee was clearly defined, and the judicial reasoning was unified; secondly, the rules governing the validity of the international and domestic independent guarantee transactions were unified, and the rights and interests of the parties are equally protected; thirdly, the independence and documentary character of the independent guarantees are confirmed, and the promptness and certainty of payment thereunder are ensured; fourthly, circumstances of fraud and standards of proof are strictly defined, and the exception to the principle of independence is prudently established; fifthly, the procedures of staying payment are strictly regulated, and procedural and substantive justice are safeguarded. Lastly, the judicial interpretation also stipulated the issuance, taking effect, transfer and termination of the independent guarantees.
What makes the case special is that the Subcontractor Undertaking Agreement signed among the Employer, General Contractor and Subcontractor stipulated that the Employer was entitled to a step-in right at the time of terminating the EPC contract, which also became the key to whether the defendant in this case committed independent guarantee fraud or not. The step-in right is more common in international construction projects (especially in project financing transactions), while it is relatively rare in domestic construction practice. In this case, the court fully respected the parties’ agreement and supported the exercise of the step-in right based thereon. The ruling will have a positive demonstration effect in effectively protecting the lawful rights and interests of the parties involved in international construction projects, and in serving and safeguarding the construction of the Belt and Road Initiative. Therefore, the case was also taken as a typical case and selected into the Guidelines for Judicial Rules of Commercial Trial and Adjudication of Sichuan Higher Court.
3.2 [Case Four] Jurisdiction and Application of Law with respect to the Disputes over Overseas Construction Contracts9
3.2.1 [Facts]
On 12 September 2013, Fugong Tenghong Foreign Trade Co., Ltd. (hereinafter referred to as the “Employer”) signed a Labor Contract of Project Contracting with an individual, Mr. Li (hereinafter referred to as the “Contractor”), agreeing that the Employer shall award the work of a section of forest road located in Myanmar to the Contractor for construction, and both parties agreed on a construction period, standard of road excavation, unit price of the construction and payment method.
During the contractual performance, the Employer argued that the Contractor did not perform strictly in accordance with the requirements of the contract, and both parties agreed to terminate the contract. After the termination, both parties disputed the amount of payment at the time of settlement. The Employer alleged that the Contractor only completed 40% of the overall work of the road already constructed, and therefore only agreed to settle the payment for 40% of the work. Instead, the Contractor requested full settlement of all the works of the road already constructed.
3.2.2 [Key Issues]
Firstly, whether Chinese courts have jurisdiction;
Secondly, whether Chinese law should be applied as the governing law.
3.2.3 [Judicial Reasoning]
Firstly, on the issue whether Chinese courts have jurisdiction. The Employer argued that the case should be attributed to the construction contract dispute and, in accordance with Article 28 of the Interpretation of the SPC on the Application of the Civil Procedure Law of the People's Republic of China (Fa-Shi [2015] No. 5) (hereinafter referred to as the "Judicial Interpretation of the Civil Procedure Law") in respect of the exclusive jurisdiction applicable to the construction contract dispute, the case shall be subject to the jurisdiction of the court where the real estate was located, namely Myanmar’s court. Therefore, the trial conducted by the court having jurisdiction over the place of the defendant’s domicile would violate the provision regarding the exclusive jurisdiction.
The SPC determined that, based on the principle of judicial sovereignty, the exclusive jurisdiction of real estate disputes under Article 33 of the Civil Procedure Law of the People's Republic of China is premised on the jurisdiction of the people's courts in civil cases, which could not be used reversely to exclude the jurisdiction of the people’s courts. Although the case involved foreign-related elements, Chinese courts were still entitled to hear the case when the parties did not agree or choose for the case to be decided by foreign courts.
Secondly, on the issue whether Chinese law should be applied as the governing law. Firstly, the Employer argued the case should be attributed to foreign-related case applying the law of the country of Myanmar where the project is located, as in accordance with Article 36 of the Law of the Application of Law for Foreign-related Civil Relations of the People’s Republic of China which provides that “the laws of the place of immovables shall apply to the right in rem of immovables”.
Regarding this claim, the SPC held that the case was attributed to construction contract dispute instead of real estate right dispute, and therefore the Employer’s argument was not valid. Next, the Employer claimed that the court shall ascertain ex officio foreign laws of Myanmar in accordance with Article 10 of the Civil Procedure Law of the People's Republic of China and related laws. Without ascertaining the laws of Myanmar, the court was wrong in its decision that the concerned contract was void. For this claim, the SPC invoked Article 41 of the Law of the Application of Law for Foreign-related Civil Relations of the People’s Republic of China, which stipulates that “the parties concerned may choose the laws applicable to their contract by agreement. If the parties did not choose, the law at the habitual residence of the party whose performance of obligations can best reflect the characteristics of the said contract or other laws which had the most significant relationship with the said contract shall apply”. In the present case, the parties did not choose the governing law applicable to the disputes in their contract. The Employer also failed to prove that the parties had chosen in an agreement to apply foreign laws for this case. Moreover, both parties to the contract concerned were Chinese citizen or legal person domiciled in China, and the place where the contract was concluded was also in China. Therefore, it was not improper to apply the Chinese law pursuant to the Doctrine of Most Significant Relationship.
3.2.4 [Review of Dispute]
Article 28 of the Judicial Interpretation of the Civil Procedure Law (Fa-Shi [2015] No. 5) stipulates the exclusive jurisdiction regarding the construction contract cases. Opinions vary in practice whether the overseas construction contracts should be subject to the exclusive jurisdiction of the court of the place where the overseas construction project is located, when the parties of main contract or subcontract are all domiciled within the territory of China and did not agree to submit to the jurisdiction of the court where the overseas construction project is located. In particular, we noted that a large number of disputes over jurisdiction have occurred in overseas construction contract disputes entertained by Chinese courts. In this case, the SPC for the first time, through the retrial ruling, made it clear that the exclusive jurisdiction shall not apply in the above circumstance.
Based on the analysis of this case and similar cases in regard of overseas construction project contract disputes between Chinese parties, it would be a more efficient way for the purpose of dispute resolution for the parties to choose in advance in their agreement an arbitration institution in China with rich experiences in foreign-related arbitration.
The report is part of the research outputs of the “Annual Review on Construction Disputes in China (2018)”. All the research outputs will be included in the Annual Review on Commercial Disputes Resolution in China (2018) compiled by the Beijing Arbitration Commission, which will be published by China Legal Publishing House in the near future. Welcome attention.
1. See the Supreme People’s Court Civil Judgment (2016) Zui-Gao-Fa-Min-Zai No.53. The judgment of the case was entered on 19 December 2016 and was publicized on 16 February 2017.
2. The name of the company was changed to SABIC Innovative Plastics (China) Co., Ltd on 28 November 2007.
3. See FIDIC Conditions of Contract for Construction (First Ed. 1999), Article 15.5.
4. With respect to the issue that “whether the employer or the contractor may terminate a construction contract in accordance with provisions of Contract for Work”, Guangdong Higher People’s Court replied that “the right to terminate a construction contract exercised by the employer or the contractor must comply with Article 8 and Article 9 of the Interpretation on Certain Issues Concerning the Application of Law in the Trial of Cases Involving Project Construction Contract Disputes by the Supreme People’s Court. Those contentions to terminate construction contract for convenience on the grounds of Article 268 and Article 287 of the Contract Law shall not be upheld, unless otherwise provided in the contract.”
5. See the Supreme People’s Court Civil Judgment (2016) Zui-Gao-Fa-Min-Zhong No.695 (the judgment was entered on 31 March 2017).
6. Clarification Letter on Issues of Market Access to EPC (Jian-Shi-Han [2003] No.161) by MOHURD, Opinions on Further Promoting the Development of EPC (Jian-Shi [2016] No.93) by MOHURD, Qualification Standards of Construction Enterprises (Jian-Shi [2014] No.159) by MOHURD, Administrative Regulations on Qualifications for Survey and Design of Construction Projects (MOHURD Order No.160, revised in 2015), and so on.
7. Beijing: Regulations on Implementing EPC Bidding for Prefabricated Building Projects in Beijing (For Trial) (Jing-Jian-Fa [2017] No.29); Tianjin: Notice on Pilot Work of Implementing EPC for Construction Projects in Tianjin by Tianjin Urban & Rural Construction Commission (Jin-Jian-Zhu [2017] No.477).
8. See the Sichuan Higher People’s Court Civil Judgment (2017) Chuan-Min-Zhong No.72
9. See the Supreme People’s Court Civil Ruling (2017) Zui-Gao-Fa-Min-Shen No. 629.
For further information, please contact:
ZHOU, Xianfeng (Elvis), Partner, Jun He
zhouxf@junhe.com
