Annual Review On Construction Dispute Resolution In China (Series 1) – Newly-Promulgated Laws And Regulations.

1 August, 2019

 

1. OVERVIEW

 

1.1 The “DIO” Reform of the Construction Industry Has Been Further Deepened, Which Has a Far-Reaching Impact on the Construction Dispute Resolution in China.

 

In 2018, China continued to deepen the transformation of government functions and the reforms to “delegate power, improve regulation and optimize services” (hereinafter referred to as the “DIO Reform”). Two of the reform measures shall have a far-reaching impact on the field of construction dispute resolution. 

 

The first major reform measure is that, in the first half of 2018, the National Development and Reform Commission of People’s Republic of China (hereinafter referred to as the "NDRC") introduced new provisions on the engineering projects that must be subject to bidding. The measure greatly reduces the scope of projects that must be subject to bidding, especially for projects within commodity housing, municipal engineering, science, education, culture and health, tourism, ecological environmental protection and other fields in which social capital is more active, and that no longer falling within the scope of "large infrastructure, public utilities and other projects that are related to social public interests and public security that are subject to bidding". This significant change would eliminate or reduce, via root, a series of difficult disputes due to the over-broad scope of the projects required to call bidding, for example, the invalidation of the contracts without bidding and the “black and white contracts”.1

 

The second major reform measure is that, according to the overall deployment of the State Council on the pilot program of the reform of the examination and approval system for construction projects, the Ministry of Housing and Urban-Rural Development (hereinafter referred to as the “MOHURD”) has cancelled the record-filing system for construction contracts on 28 September 2018. Excessive administrative regulation during the implementation of the record-filing system for construction contracts is one of the institutional sources resulting in the phenomenon of “black and white contracts”. The cancellation of the record-filing system may bring new challenges and far-reaching impact on the forms of “black and white contracts” and the ways to settle disputes.

 

1.2 The Interpretation II on Issues Concerning the Application of Law for the Trial of Cases of Dispute over Construction Contracts Has Been Formally Promulgated by the Supreme People’s Court (hereinafter referred to as the “SPC”), and Construction Dispute Resolution in China Has Entered a New Era.

 

On 29 October 2018, the SPC adopted in principle the Interpretation II on Issues Concerning the Application of Law for the Trial of Cases of Dispute over Construction Contracts (Fa Shi [2018] No.20) (hereinafter referred to as the “Judicial Interpretation II on Construction Contracts”). The Judicial Interpretation II on Construction Contracts was officially promulgated on 29 December 2018 and shall come into force as of 1 February 2019. 

 

The formulation of the Judicial Interpretation II on Construction Contracts shall be an objective need to adapt to the changes in investment and operation modes and regulatory policies in the construction industry. Especially at times in 2018 when the scope of the projects that must be subject to bid invitation was substantially reduced and the record-filing system for construction contracts cancelled. But the laws and regulations such as the Contract Law of the People's Republic of China (hereinafter referred to as the "Contract Law"), the Construction Law of the People's Republic of China (hereinafter referred to as the "Construction Law") and the Bidding Law of the People's Republic of China (hereinafter referred to as the "Bidding Law") remain unchanged, the question of how to adapt to the new development of construction practices needs further judicial wisdom and judicial plans. 

 

Meanwhile, the formulation of the Judicial Interpretation II on Construction Contracts is also an objective need to meet the challenges of judicial trials in construction project disputes. Since the implementation of the Interpretations on Issues Relating to Application of Laws for Trial of Construction Contract Dispute Cases (hereinafter referred to as “Judicial Interpretation I on Construction Contracts”) which came into effect in 2004, the number of construction contract dispute cases and the dispute amount have increased significantly. In 2017, the people’s courts nationwide heard 102,900 construction contract cases of first instance. In 2018, the people’s courts nationwide heard 113,200 construction contract cases of first instance. In judicial practice, new types of cases and problems keep emerging, which puts forward new challenges for unifying the judgment standards for construction contract disputes. 

 

In this context, the promulgation and implementation of the Judicial Interpretation II on Construction Contracts are of great significance to unify the judgment standards nationwide and solve the common problems in disputes over construction projects. 

 

“Whereof what’s past is prologue.” Just like the practice development track of the Judicial Interpretation I on Construction Contracts, the Judicial Interpretation II on Construction Contracts will generate new problems and face new challenges while solving a series of existing problems. The practice of construction dispute resolution in China is developing along a wavy track.

 

1.3 The Turnover and Contract Value of the Overseas Project Contracting Decrease Concurrently, and the Probability of Overseas Construction Disputes Increases.

 

In 2018, the completed turnover of China’s overseas project contracting revenue was RMB 1.12 trillion, down 1.7% from the previous year (equivalent to US$ 169.04 billion, up 0.3% from one year ago), and the newly signed contract value was RMB 1.6 trillion, down 10.7% from one year ago (equivalent to US$ 241.8 billion, down 8.8% from one year ago).2

 

The decline of China's overseas project contracting market will lead to further intensification of market competition, and the likelihood of disputes will increase dramatically. Among them, disputes between Chinese-funded enterprises over the payments of overseas projects and independent letters of guarantee will become a hot issue that demands more attention from courts and arbitration institutions within China. For example, in order to serve the Belt and Road Initiative, the SPC issued the Provisions on Several Issues concerning the Establishment of the International Commercial Court on 27 June 2018, officially setting up the SPC International Commercial Court and the International Commercial Expert Committee. Also, on 6 September 2018, the Belt and Road Peer and China-Enterprise Dispute Resolution Seminar, jointly held by the Beijing Arbitration Commission/Beijing International Arbitration Center (hereinafter referred to as the “BAC/BIAC”) and the China International Contractors Association, is a forward-looking seminar with prospective and practical value for determining the resolution of disputes arising from overseas projects undertaken by Chinese-funded enterprises. 

 

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

 

2.1 The Rules on Projects Subject to Bidding and the Regulation on the Scope of Infrastructure and Public Utility Projects Subject to Bidding by NDRC

 

On 27 March 2018, the NDRC issued the Rules on Projects Subject to Bidding (hereinafter referred to as the “Order No.16”), with effect from 1 June 2018. The Provisions on the Scope and Scale of Engineering Construction Projects for which Tenders Must Be Invited as promulgated and implemented on 1 May 2000 (promulgated by the former State Development Planning Commission on 1 May 2000, hereinafter referred to as the “Order No.3”) shall be abolished. 

 

On 6 June 2018, the NDRC promulgated and implemented the Regulation on the Scope of Infrastructure and Public Utility Projects Subject to Bidding (hereinafter referred to as the “Regulation No.843”), defining the “scope of large infrastructure and public utility projects not specifically subject to the bidding process” in Order No.16. 

 

Both Order No.16 and Order No.3 define the engineering projects that must be subject to bidding by means of “scope + scale”, that is, only the projects that simultaneously meet the requirements of scope and scale shall be subject to bidding.

 

2.1.1 Scope of the Project that Required to Call Bidding

 

Order No.16 narrows the scope of “projects totally or partially invested with the state-owned funds or financed by the State”. In the original Order No.3, the engineering construction projects that are invested with the state-owned funds or financed by the State, no matter what the actual proportion is, shall fall within the scope of projects legally subject to bidding. However, the definition in Order No.16 is confined to two circumstances: (1) the projects utilise more than RMB 2 million budget fund which accounts for more than 10% of the project’s investment amount; and (2) the projects using the fund from a state-owned enterprise or public institution which is controlled or dominated by the fund. 

 

With respect to the scope of the “large infrastructure or public utility projects” for which bidding is required, Regulation No.843 has reduced the categories of projects from 12 categories (as regulated in the original Order No.3) to 5 categories, specifically including: (1) energy infrastructure projects such as coal, petroleum, natural gas, power, new energy, etc.; (2) transport infrastructure projects such as railways, highways, pipelines, water transport, as well as public aviation airports and A1 general airports, etc.; (3) communication infrastructure projects such as telecommunication hubs and telecommunication information networks, etc.; (4) water conservancy infrastructure projects such as flood control, irrigation, drainage, water diversion (supply), etc.; and (5) urban rail transit, etc. Regulation No.843 has also deleted the miscellaneous clauses concerning “Other Infrastructure Projects” and “Other Utilities” in the original Order No.3 to avoid any arbitrary expansion of the scope of “Large-scale Infrastructure, Applicable Utilities” in practice. 

 

2.1.2 Standard of Scale of the Project that Required to Call Bidding

 

Order No.16 has doubled the standard for estimated contract value specified in the original Order No.3, of which (1) the estimated contract value for a single contract of construction has been increased from RMB 2 million to RMB 4 million; (2) the estimated contract value for the purchase of important equipment, materials and other goods has been increased from RMB 1 million to RMB 2 million; (3) the estimated contract value for the service of survey, design, supervision and other services has been increased from RMB 500,000 to RMB 1 million. Meanwhile, Order No.16 deleted the provision of "if the estimated contract value of a single contract is lower than each sub-standard but the total investment of the project exceeds RMB 30 million, bidding must also be conducted" in the original Order No.3.

 

2.1.3 Authorities of the Local Governments

 

Order No.16 deleted the provision of “the people’s governments of provinces, autonomous regions and municipalities directly under the Central Government may, based on actual circumstances, prescribe specific scope and scale standards of tendering in their respective regions, but shall not narrow the scope of tendering prescribed herein” as regulated in the original Order No.3, which is conducive to unifying the scope and standards of compulsory tendering in various regions of the country. 

 

The implementation of Order No.16 and Regulation No.843 issued by the NDRC has a significant and far-reaching impact on the field of PRC construction dispute resolution. Due to the substantial limit of the scope of bidding required and the national unification, a large number of projects are no longer in the scope of bidding required projects, therefore, the positive effects will be: on the one hand, the ineffectiveness of the contract due to “failure to conduct bidding as required” will be reduced significantly; on the other hand, the circumstance where the tenderee and the successful bidder enter into a separate agreement deviating from the substantive content of the bid-winning contract (i.e. “black and white contracts”) will be reduced significantly. Despite this, it should be noted that:

 

First, although the provision “the people’s governments of all provinces, autonomous regions and municipalities directly under the Central Government may, according to actual conditions, specify the scope and scale of local projects for which tendering must be carried out, but shall not narrow the scope of projects for which tendering must be carried out as specified herein” as regulated in the original Order No.3 is deleted by Order No.16, Order No.16 does not explicitly prohibit local governments from formulating detailed implementing rules. Therefore, it is not excluded that the local government will expand the scope of the projects that must be tendered through administrative means, so that the “black and white contracts” problems may continue to be generated.

 

Second, in practice, for some projects beyond the scope of projects required for bidding by Order No.16 and Regulation No.843, some employers are still contracting through bidding for different reasons such as fixed thinking and compliance need. In this regard, according to Article 9 of the Judicial Interpretation II on Construction Contracts, for the project not subject to bidding, if the employer voluntarily adopts the bidding methods, once the employer and the contractor otherwise conclude a contract that deviates from the substantive content of the bidding contract, unless the parties can prove the “occurrence of changes unforeseen at the time of invitation to tender and bidding”, the problems of “black and white contracts” may still occur to a large extent.

 

2.2 The Circular on Carrying out the Pilot Reform of the Examination and Approval System for Construction Projects by the General Office of the State Council

 

On 14 May 2018, the General Office of the State Council issued the Circular on Carrying out the Pilot Reform of the Examination and Approval System for Construction Projects (hereinafter referred to as the “Circular”), deciding to carry out the pilot reform in Beijing Municipality, Tianjin Municipality, Shanghai Municipality, Chongqing Municipality, Shenyang Municipality, Dalian Municipality, Nanjing Municipality, Xiamen Municipality, Wuhan Municipality, Guangzhou Municipality, Shenzhen Municipality, Chengdu Municipality, Guiyang Municipality, Weinan Municipality, Yan’an Municipality and Zhejiang Province. 

 

The Circular calls for carrying out the whole-process and whole-coverage reform of the examination and approval system for construction projects, in accordance with the arrangements made to deepen the DIO Reform and improving regulations and services to optimise the business environment. The time for examination and approval of construction projects in pilot areas will be cut by half by 2018, when a framework and a management system for such purpose would be established. In 2019, the reform of the examination and approval system for construction projects will be carried out across the whole nation, and the time frame of examination and approval will be reduced to 120 working days in the first half of the year. By 2020, a nationally unified system for the examination, approval and management of engineering construction projects will be basically established. 

 

Among a series of reforms provided in the Circular, those that have direct impact on the contracting parties of construction projects mainly include:

 

First, optimising the stages of approval. The examination and approval procedures for construction projects are mainly divided into four stages: the land use planning permit, the engineering construction permit, the construction permit, and the completion acceptance. 

 

Second, simplifying the items and conditions subject to examination and approval. To be specific, the Circular has cancelled some required filing such as the filing of construction contracts, the filing of the design review of construction energy efficiency etc.; for a privately-invested housing construction project, the developer concerned may decide at its own discretion the way to issue the contract for the project. 

 

Third, the merger of examination and approval matters. Including the technical examination such as examination of fire safety design and civil defence design into the examination of construction drawing design documents; handling of project quality and safety supervision formalities and construction permit on a consolidated basis; joint inspection within stipulated time by planning, land, fire safety, civil defence, archive, municipal utilities authorities and organisations, etc., on a unified acceptance drawing and acceptance standards for the completed project, and issue an unified acceptance opinion. 

 

Fourth, adjusting the sequence of examination and approval. Such assessment items as environmental impact assessment, energy conservation assessment and seismic safety assessment are no longer the conditions for project examination and approval or verification. The opinions from preliminary review of land use may be used as a certificate of land use to apply for the permit in the planning of the construction project, and the approval for land use could be obtained before the construction permit. Application for installation of water supply, power supply, gas, heat, drainage, communications and other municipal public infrastructure shall be handled after the issuance of the construction permit in advance; the relevant facility construction shall be completed in the project construction phase, and access matters shall be directly handled after the completion acceptance. 

 

In order to ensure the smooth progress of the reform of the examination and approval system for construction projects, the MOHURD has sorted out more than 90 laws, administrative regulations, rules, normative documents and standard specifications related to the examination and approval of construction projects at the national level, and proposed specific revision suggestions for the first batch of 18 laws, regulations and policy documents, including:

 

First, with respect to the Administrative Measures on Tender Invitation and Bidding for Construction of Buildings and Municipal Infrastructure Projects (MOHURD Order No. 89). The main revisions are as follows: (1) the certification matters are reduced, as the capital certification documents issued by banks are required to be included in the bidding documents is deleted; (2) the record-filing step is cancelled, as the content requiring the awarded bidder to submit its construction contracts for record-filing to the competent departments is deleted; (3) the relevant content on the qualification management on bidding agencies is deleted; and (4) the preconditions for construction licensing are reduced, as the interim and ex-post regulation over the composition of the bid evaluation committee, submission of written reports on the bidding and other acts are strengthened, and the preconditions for the construction permits are deleted. 

 

Second, with respect to the Administrative Measures for Construction Permits of Construction Projects (MOHURD Order No.18). The main revisions are as follows: (1) further cutting down on the items to be proved, as the condition of “proof that the construction fund is in place” of construction permits is revised to “the letter of commitment that the construction fund has been in place”, and the competent department of housing and urban-rural development will step up interim and ex-post regulation at the same time; (2) cutting down on the preconditions for construction permits by removing the requirements of “the letter of commitment on no arrears of project payment” and “the entrusted for supervision for a project required to be entrusted for supervision under regulation” as construction licensing conditions; and (3) shortening the time frame for examination and approval by reducing the time limit for examination and approval of construction permits from 15 working days to seven working days. 

 

Third, with respect to the MOHURD Notice on Further Strengthening Administration of Construction Permits for Construction Projects (Jian Ban Shi [2014] No. 34). The main revisions are as follows: (1) the items to be proved are reduced, and the financial certificate is revised as “the letter of commitment that the construction funds have been put in place”; (2) the informing and commitment system shall be implemented, and interim and ex-post regulation shall be strengthened. Should an applicant fail to fulfil its commitment, the construction permit shall be revoked and the applicant shall be investigated for corresponding liability. Meanwhile, the misconduct of the applicant shall be disclosed to the public; and (3) the preconditions for construction permits shall be simplified by deleting the “letter of commitment that no project payment in arrears” and the “supervision contract or information on engineers and technicians” in the sample form of application for construction permits. 

 

Fourth, with respect to the Notice on Strengthening the Energy Conservation Examination of Civil Construction Projects (Jian Ke [2004] No. 174) and the Notice on Doing a Good Job in Publicity, Implementation and Supervision of the Design Standard for Energy Conservation of Public Buildings (Jian Biao Han [2005] No. 121). These two documents have been repealed, and the building energy-saving design review and filing have been cancelled. 

 

From the perspective of dispute resolution of construction works, in a series of above reform measures of the MOHURD, the one with most impact is that of cancelling the construction contract filing system. The common view of the industry would be that the long-existing phenomenon of “black and white contracts” will disappear accordingly. However, in our opinion, the record-filing system for construction contracts shall only be the final stage of a series of contract filing under the filing system stipulated by the Measures for the Bidding of the Construction of Housing and Municipal Infrastructure Projects (Order No. 89). In fact, the filing of the construction contract has been conducted in the stage of “Bidding Document Filing” as prescribed in Article 19 of the above Order No. 89.3 In other words, if the filing system of the bidding documents continues, only the cancellation of filing system for construction contracts cannot fundamentally eliminate the phenomenon of “black and white contracts”. On the contrary, the issue of “black and white contracts” may take on a more complicated form and relevant dispute settlement may face new challenges.   

 

2.3 The Administrative Measures for the Identification and Investigation of and Punishment against Illegal Acts during Contract Awarding and Contracting of Construction Projects by the MOHURD

 

On 3 January 2019, the MOHURD issued the Administrative Measures for the Identification and Investigation of and Punishment against Illegal Acts during Contract Awarding and Contracting of Construction Projects (Jian Shi Gui [2019] No.1) (hereinafter referred to as the “Document No.1”), which was implemented on 1 January 2019. The Administrative Measures for the Identification and Investigation of and Punishment against Illegal Acts during Contract Awarding and Contracting of Construction Projects (for Trial Implementation) (Jian Shi [2014] No.118) (hereinafter referred to as the “Document No.118”) issued by the MOHURD and implemented as of 1 October 2014 shall be repealed accordingly. 

 

In China, the illegal activities such as illegal contract awarding, contract transfer, illegal subcontracting, affiliation and others shall not only be the main reasons of invalid construction contracts, but also the main factors in construction engineering dispute resolution. Therefore, although the above measures are only administrative regulatory documents with lower level of effectiveness, their impact on the practice of dispute resolution of construction projects in the specific identification standards for the relevant illegal activities deserves greater attention in the industry. 

 

Compared with the original Document No.118, the changes in Document No.1 focus on the following aspects:

 

2.3.1 With Respect to the Illegal Contract Awarding

 

First, the provision that “the construction unit separately issues the unit project or part of the project within the scope of the construction contract” in the original Document No.118 has been deleted. The reason might be: on the one hand, it is to avoid duplication with the identification of the cases related to “contracting out a project after dividing it into several parts”; on the other hand, if it does not constitute “contracting out a project after dividing it into several parts”, the illegal act shall be a civil breach of contract and shall not be deemed as administrative violations.4

 

Second, the provision that “the construction unit violates the construction contract and requires the contractor to select its designated subcontracting unit through various forms” in the original Document No.118 has been deleted. The reason might be: (1) the Construction Law, the Regulations on the Quality Management of Construction Projects and other lex superior5have not prohibited the designation of subcontracting projects; (2) although Article 7 of the Administrative Measures for the Subcontracting of Housing and Municipal Infrastructure Projects (Decree No.19) issued by the MOHURD on 27 August 2014 provides that “no project developer may directly designate a project subcontractor”, this provision actually does not have any lex superior, and therefore no specific administrative penalties have been set; and (3) for the civil liability of the subcontractor directly designated by the employer, according to Article 12 of the Judicial Interpretation I on Construction Contracts by SPC, if the employer directly designates the subcontractor, resulting in defects in the quality of construction projects, the employer shall bear the responsibility of fault. Therefore, it is not appropriate to investigate this illegal activity in accordance with administrative violations.6

 

2.3.2 With Respect to Illegal Contract Transfer, Affiliation and Subcontracting 

 

(1) Several special circumstances identified in the original Document No.118 in accordance with “affiliation” are now identified in accordance with “contract transfer”.

(2) It is clearly specified that “the circumstance that a parent company assigns a construction project it has undertaken to its subsidiary having the status of independent legal person” shall constitute “contract transfer”. 

(3) It is clearly specified that “if one party to the consortium neither conducts the construction work nor organises or manages the construction activities, and it collects management fees or other similar fees from the other parties to the consortium, the first party to the consortium shall be deemed as having transferred the project undertaken to the other parties”. 

(4) Cancelling the miscellaneous provisions regarding contract transfer and affiliation. 

(5) Document No.1 deletes the circumstance in which “where, without stipulations in the construction contract and without approval of the project owner, the construction entity transfers part of the project undertaken by it to other entities for construction” mentioned in the original Document No.118.

 

2.3.3 Adding the Linkage Mechanism for the Identification of Illegal Acts

 

Article 14 of Document No.1 provides that: “Upon receiving the suggestion for handling of illegal contract awarding and contracting of a construction project within its administrative areas, or the clues or evidence with respect to the relevant cases, which are sent or transferred by the relevant people’s court, procuratorate, arbitration institutions, audit agency or discipline inspection and supervision department, the competent department of housing and urban-rural development shall be responsible for accepting, investigating, identifying and handling the case according to the law, and timely provide the handling results to the sending or transferring agency”. From the perspective of dispute resolution for construction projects, if the above linkage mechanism can be effectively implemented, it will help increase the cost of illegal activities of the parties concerned, and thereby fundamentally restrict the occurrence of this types of illegal activities.

 

2.3.4 Adding the Limitation of Retroactivity for the Administrative Penalties

 

Article 16 of Document No.1 provides that: “for administrative punishments against illegal contract awarding, contract transfer, illegal subcontracting, affiliation and other illegal acts, the limitation of retroactivity shall be in accordance with the rules in Fa Gong Ban Fa [2017] No. 223.7 The limitation of retroactivity shall be calculated from the date of the final acceptance of the construction projects which are involved in illegal contract awarding, contract transfer, illegal subcontracting or affiliation; if the construction contract is rescinded or terminated before the completion of the project workload, the limitation of retroactivity shall be calculated from the date of rescission or termination of the contract.”

 

2.4 The Judicial Interpretation II on Construction Contracts by the SPC

 

The Judicial Interpretation II on Construction Contracts, consisting of 26 articles in total, provides rules for the validity of construction contracts for construction projects, the settlement of construction prices, the appraisal of construction projects, the preemptive rights to payment of construction prices, the protection of the rights of actual construction undertakers and other issues. For the interpretation of the key points of the Judicial Interpretation II on Construction Contracts, please refer to the discussions in Part 3.

 

2.5 Others

 

The national standard Code for the Identification of Construction Engineering Costs (GB/T51262-2017) was implemented on 1 March 2018. The Code includes seven parts, namely, the general provisions, terminology, basic provisions, basis of appraisal, appraisal, opinions on appraisal, file management, as well as the appendix to the major document formats. In part 5 “appraisal”, the Code specifies the appraisal of contract disputes, lack of evidence, measurement disputes, valuation disputes, construction period disputes, claim disputes, visa disputes and disputes over contract rescission, which has good practicality. The Code focuses on the organic combination of laws and regulations and professional technology, which has positive significance for solving the difficulties and uncertainties in the current engineering cost appraisal work and better standardising project cost appraisal behaviour. 

 

In addition, in order to promote the general contracting of projects, the MOHURD has released the Pricing and Measurement Specifications for General Contracting of Housing and Municipal Infrastructure Projects (Draft for Comment) on 12 December 2018, after the release of the Cost Composition for General Contracting of Construction Projects (Draft for Comment) and the Administrative Measures for General Contracting of Housing and Municipal Infrastructure Projects (Draft for Comment) in 2017. This Specification will become the first pricing measurement norm for general contracting in China, which is of significance for clearing and unifying the general contracting pricing rules and reducing related disputes. However, it must be pointed out that the existence of the Specification (in Draft for Comment version) might be distinctly crossed the border, that is, the specification has been too deeply involved in the specific content of the general contract of the projects.

 

Statement：The report is part of the research outputs of the “Annual Review on Construction Disputes in China (2019)”. All the research outputs will be included in the Annual Review on Commercial Disputes Resolution in China (2019) compiled by the Beijing Arbitration Commission. The Chinese-English bilingual report will be published separately by China Legal Publishing House and Wolters Kluwer Hong Kong Limited in the near future. Welcome attention.