11 April, 2018
1. Overview
1.1 Further “DIO” Reform in Construction Industry
It was in 2017 that the reform to delegate power, improve regulation and optimize services (hereinafter referred to as the “DIO reform”) in the construction industry went further. The DIO measures that have been implemented in the construction industry in 2017 have made a significant influence on the domestic EPC field.
Although China has already initiated the exploration and practice of EPC since 1980s, the progress thereof, however, was more dependent on market internal drivers (especially in industrial engineering sectors) and the promotion by central ministries and commissions, especially the Ministry of Housing and Urban-Rural Development (hereinafter referred to as the “MOHURD”). In 2017, the State Council explicitly proposed to accelerate developing the EPC approach, which has been greatly promoting the development and practice of EPC throughout the country. However, during the course of the State Council’s proposal, a severe problem that local governments acted of their own free wills arose, which urgently will require standardization and unification by superordinate laws.
1.2 Sustained Development in Overseas Contracting Business
According to the statistics of MOFCOM, in 2017, China reached a turnover of USD 168.59 billion in overseas contracted projects, up 5.8% year on year and the value of newly-signed contracts was USD 265.28 billion, up 8.7% year on year, among which countries alongside the Belt and Road routes took up more than 50% of the overall turnover and value of newly-signed contracts.1
The “threshold” of market access for overseas construction projects has been greatly cut down after the State Council abolished the Overseas Contracting Qualification System and Approval of Overseas Contracted Projects System in 2017，which is expected to greatly promote the growth of overseas construction business of China, meanwhile it may also bring adverse effect of aggravating fierce competition, which in some sense is “a hope mingled with fear”.
1.3 New Challenges Facing Dispute Resolution of Construction Industry
Compared with the development of the construction industry, there is always a lag effect in construction dispute resolution. For this reason, similar to the previous annual review, key issues of nationwide construction dispute resolution in 2017 still focus on issues such as validity of the “black and white contracts”, affiliated enterprises, illegal assignment and illegal subcontracting, construction cost appraisal, quality of the work and preemptive right, most of which are of Chinese characteristics.
However, from 2015 to 2017, the types and key issues of disputes over construction contracts have undergone some important changes, which are as follows:
Firstly, influenced by macro-economic situation and industrial policies, for industrial projects where EPC approach is more popular such as projects of coal, chemistry, construction materials, iron, and steel, and so on, a number of EPC contracts have been in prolonged suspensions or even terminated and the number of disputes over EPC progress payments or settlement payment caused by termination of EPC contracts has been increasing. Taking such cases as examples of disputes over EPC contracts adjudicated by the Supreme People’s Court (or “SPC”) in recent years, among the 16 cases found on China Judgments and Decisions website by keywords “EPC” or “Turnkey projects”, 13 of them were finally judged or ruled within 2015 to 2017, among which were 5 cases in 2015, 3 cases in 2016 and 5 cases in 2017.2Fields of the 16 cases mainly revolve around environmental protection engineering (5 cases), chemical engineering (4 cases) and new energy engineering (3 cases). Although disputes over EPC contracts also involve issues such as bidding, qualification and so on, the key issues of EPC contracts can be greatly varied from those of contracts for conventional construction (based on design-bid-building approach) as the former emphasizes more the nature of the contract and is apparently more consistent with the game rules in international construction markets.
Secondly, as the Belt and Road Initiative is further implemented, the number of disputes that are related to overseas construction projects being adjudicated within China has increased year by year. Based on the characteristics of overseas construction projects and the parties’ demands thereof for dispute resolution, we are of the opinion that Chinese domestic arbitration institutes would play a more active role therein, where the following are some examples: the Beijing Arbitration Commission/Beijing International Arbitration Center (“BAC/BIAC”) together with the Kuala Lumpur Regional Centre for Arbitration (“KLRCA”) and the Cairo Regional Center for International Commercial Arbitration (“CRCICA”) jointly proposed “One Belt One Road Arbitration Initiative”; CIETAC Silk Road Arbitration Center was officially established in Xi’an, Shanxi Province on 8 September 2017. In BIAC, major types of foreign-related engineering cases were construction contract, design contract and subcontract of labor service. The average amount in dispute was RMB 52 million.
In view of the above new development trends of construction dispute resolution, this Annual Review will focus on EPC and overseas construction projects.
1.4 Development of Regulations on PPP Becoming Focus
The national meeting of financial work was held in July 2017, in which the prevention and control of financial risks was promoted to the height of influencing national security, and thus the risk of local governments’ hidden debt became the focus once again. In this situation, relevant central ministries and commissions promulgated a series of regulatory documents in November, regulating PPP projects more rigorously than ever.
As far as the PPP dispute resolution is concerned, there was no major PPP contract-related cases with nationwide influence taking place in 2017, but this should be just a temporary phenomenon. With the above-mentioned regulatory documents continuously influencing the business environment, it is predicted that there might be an explosion of disputes over termination of PPP contracts from 2018 to 2019, which can be found in detail in Section IV of Part II, below.
2. Newly-Promulgated Laws, Regulations and other Regulatory Documents
2.1 In the Field of Conventional Construction (Based on the Design-Bid-Build Approach)
2.1.1 Research Opinions on Local Regulations on Taking Audit Results as Basis of Completion Settlement for Government-Invested Construction Projects (Fa-Gong-Wei-Han [2017] No.2) by the Standing Committee of the National People’s Congress, Legislative Affairs Commission (hereinafter referred to as the “SCNPCLAC”)
In May 2015, China Construction Industry Association submitted to SCNPCLAC the Letter on the Application for Legislation Review of Local Regulations on Taking Audit Results as Basis of Completion Settlement for Construction Projects.
On 22 February 2017, SCNPCLAC issued Research Opinions on Local Regulations on Taking Audit Results as a Basis of Completion Settlement for Government-Invested Construction Projects (Fa-Gong-Wei-Han [2017] No.2), explicitly requiring that two kinds of regulatory provisions shall be deleted and corrected, which are (1) those that directly provide for audit results to serve as the basis of completion settlement and (2) those that provide for a clause that stipulate the audit results to serve as the basis of completion settlement must be included in bidding documents or in the contract. However, as for the third kind of regulatory provisions which provides that the employer may set out in bidding documents or in the contract a clause providing for audit results to serve as the basis of completion settlement is not in violation of the law nor exceeding the legislative power of local governments.
On 5 June 2017, the Record-Filing and Review Office of SCNPCLAC replied to China Construction Industry Association by letter (i.e. the “Reply Letter to Application for Legislation Review of Local Regulations on Taking Audit Results as Basis of Completion Settlement for Construction Projects” (Fa-Gong-Bei-Han [2017] No.22)), which further clarified that “local regulations, which directly provide for audit results to serve as the basis of completion settlement, or a clause that the audit results to serve as the basis of completion settlement must be included in bidding documents or in the contract, restrict the civil rights and exceed the legislative power of local governments and thus shall be corrected.”
This was the first time the legislature issued opinions on administrative audit regarding the implementation of construction contracts, which is of great significance to fundamentally resolve the longstanding disputes over completion settlement between the administrative audit authorities and the parities to construction contracts.
2.1.2 Interpretation II on Issues Concerning the Application of Law for the Trial of Cases of Dispute over Construction Contracts (Draft for Solicitation) by the SPC
In July 2017, the SPC issued Interpretation II on Issues Concerning the Application of Law for the Trial of Cases of Dispute over Construction Contracts (Draft for Solicitation) with 5 aspects, 36 articles in total, soliciting for social comments on issues such as validity of the contract and its related questions, settlement for construction costs, construction cost appraisal, protection for rights of actual construction undertaker and preemptive right to construction payments. The draft Judicial Interpretation II on Construction Contract has drawn wide attention and deep discussion of practitioners.
2.1.3 Decisions on Amendments of the Bidding Law and Regulations on Implementation of the Bidding Law (Draft for Solicitation) by the National Development and Reform Commission of People’s Republic of China (or “NDRC”).
On 29 August 2017, to further the DIO reform in bidding field, to reinforce the applicability and foresight of the bidding system and to promote transformation of governmental functions, NDRC drafted the Decisions on Amendments of the Bidding Law and Regulations on Implementation of the Bidding Law (Draft for Solicitation). What is high profile in the proposed amendments are the limitation of Winning Bid at the Lowest Price Rule, the change of approach to determine the winning bidder and the establishment of the System of Publication of Contract Implementation.
2.1.4 Notice on Issuing Standardized Bidding Documents for the Procurement of Equipment and Other Four Standardized Bidding Documents (Fa-Gai-Fa-Gui [2017] No.1606) by nine state departments and commissions
On 4 September 2017, NDRC together with eight other state departments and commissions jointly issued a series of standardized bidding documents, including Standardized Bidding Documents for Procurement of Equipment of People’s Republic of China (2017 Edition), Standardized Bidding Documents for Procurement of Materials of People’s Republic of China (2017 Edition), Standardized Bidding Documents for Surveying of People’s Republic of China (2017 Edition), Standardized Bidding Documents for Design of People’s Republic of China (2017 Edition) and Standardized Bidding Documents for Supervision of People’s Republic of China (2017 Edition). So far, after ten years, the standardized bidding documents system, which is provided for in Clause 4 of Article 15 in the Regulations on Implementation of the Bidding Law to be applied for projects under mandatory bidding procedure, has been basically formed.
2.2 In the Field of EPC
2.2.1 Opinions on Promoting Sustainable Healthy Development of Construction Industry (Guo-Ban-Fa [2017] No.19) by the General Office of the State Council
On 21 February 2017, the General Office of the State Council issued Opinions on Promoting Sustainable Healthy Development of Construction Industry (Guo-Ban-Fa [2017] No.19) (hereinafter referred to as the “Opinions”), for the first time proposing towards the nationwide construction industry to “accelerate implementing EPC”, “prefabricated buildings shall adopt an EPC approach in principle” and “government-invested projects shall improve construction management mode and take the lead in promoting EPC.”
After the release of the Opinions, local governments issued in succession a mass of administrative documents concerning EPC. These administrative documents, however, provide for different standards and requirements upon issues such as whether or not the early-stage consultancy unit can act as the EPC contractor, whether or not an EPC contractor shall have both design and construction qualification certificate and whether or not a subcontractor is entitled to re-subcontract in an EPC project, which urgently need normalization and standardization.
2.2.2 Administrative Measures for EPC Projects of Housing Construction and Municipal Infrastructure (Draft for Solicitation) (Jian-Shi-She-Han [2017] No.65) by MOHURD and other local regulations
To fully implement the Opinions and to improve the EPC management system, Department of Construction Market of MOHURD issued Administrative Measures for EPC Projects of Housing Construction and Municipal Infrastructure (Draft for Solicitation) on 28 December 2018. It is of help to improve the situation where localities act of their own wills in relation to the EPC management system, and is of great significance to form a nationwide unified system of EPC market in housing construction and municipal infrastructure sectors.
Prior to the issue of Draft Measures for EPC, on 4 September 2017, the General Office of MOHURD issued Costs Components of EPC Projects (Draft for Solicitation), which aimed to standardize the costs components of EPC projects and effectively control the funds of projects, thereby increasing the efficiency of construction. This was the first instance of EPC policy development in China, and is of great value in practice. It is noteworthy that Zhejiang Province took an earlier step than MOHURD and had formally promulgated Pricing Rules of EPC Projects of Zhejiang Province (For Trial) on 11 December 2017, which became effective on 1 January 2018 and made Zhejiang the first province in China to implement local pricing rules of EPC projects.
2.3 In the Field of Overseas Construction Projects
2.3.1 The State Council Abolished Overseas Contracting Qualification System
On 1 March 2017, the State Council published Decisions on Revising and Repealing Certain Pieces of Administrative Regulations (Guo-Wu-Yuan-Ling No. 676) (hereinafter referred to as the “Decisions”), deleting Chapter II (Overseas Contracting Qualification) of Regulations on the Administration of Overseas Contracting Projects (which was promulgated on July 21, 2008). This formally marked the end of the longstanding Overseas Contracting Qualification System in China.
The abolition of this system is a symbol of the central government’s concept of governance “to streamline administration and to delegate powers”, which is of positive significance to cut down the threshold of going global for small and medium-sized enterprises and promote further implementation of the Belt and Road Initiative. However, the abolition also intensifies the longstanding fierce competition in the market of overseas construction projects and thus a series of new hard tasks and challenges are faced by various types of market entities, industry self-discipline organizations (like China International Contractors Association) and even dispute resolution institutions within China.
2.3.2 The State Council Abolished the Approval System of Bid (Negotiation) for Overseas Contracted Projects
The Decisions also abolished the approval system of bid (negotiation) for overseas construction projects in the meantime. On November 13, 2017, MOFCOM issued Notice on Well-Conducting Record-filing Management of Overseas Construction Projects implementing classification and categorization management of normal projects where MOFCOM is responsible for record-filings of overseas construction projects by central state-owned enterprises’ headquarters, and provincial commerce authorities are responsible for record-filings of overseas construction projects by local enterprises and central state-owned enterprises’ subsidiaries. Nevertheless, projects in countries (regions) with no diplomatic relations with China or projects involving multiple national interests and major regional security risks are classified as specific projects and still uniformly administrated by MOFCOM.
The implementation of record-filing system for overseas construction projects will simplify the government supervision process and will benefit the Chinese international contractors in improving their efficiency. However, similar to the consequence of the abolishment of overseas contracting qualification, the abolishment of approval system of bid (negotiation) for overseas construction projects may bring adverse impacts as the threshold of the overseas construction market has been cut down, to which we shall pay more attention.
2.4 In the Field of PPP
2.4.1 Regulations of Public-Private Partnership in Infrastructure and Public Services (Draft for Solicitation) by the State Council
On July 21, 2017, Legislative Affairs Office of the State Council issued Regulations of Public-Private Partnership in Infrastructure and Public Services (Draft for Solicitation), which marked an important step in the process of unified top legislation of PPP in China wherein section five concerning “dispute resolution” thereof, the arbitrability of PPP projects is to be confirmed.
2.4.2 Notice on Standardization of Projects Library of Public-Private Partnership (PPP) Comprehensive Information Platform (Cai-Ban-Jin [2017] No.92) by the General Office of the Ministry of Finance
On November 10, 2017, the General Office of the Ministry of Finance issued the No.92 Document aiming to further standardize the operation of PPP projects and to prevent PPP from becoming a new kind of pure financing platform.
Firstly, the No.92 Document provides that the following projects are forbidden to be stored in the Projects Library of National PPP Comprehensive Information Platform (hereinafter referred to as the “Projects Library”), which are: (1) those inappropriate for a PPP approach; (2) those without adequate preparatory works; and (3) those lacking a Pay for Performance System.
Secondly, the No.92 Document also provides that the following projects must be swept away: (1) those without “Two Assessments” being carried out in accordance with relevant regulations; (2) those no longer appropriate for PPP approach; (3) those incompliant with standardized operational requirements, including (i) those where the private party is a government-owned financing platform company yet to be transformed pursuant to relevant regulations, (ii) those adopting the Build-Transfer (BT) approach, (iii) those where the government procurement documents contains discriminatory clauses that obstruct private parties from equal participation, (iv) those where debt financing is yet to be carried out in accordance with agreements, and (v) those in violation of relevant laws and policies where project capital was not contributed on time and in full, or debts are used as equity capital, or private shares are held in the name of a third party; (4) those where public party illegally provides guarantee to raise debt; and (5) those failing to publicize project information in accordance with relevant provisions.
Thirdly, the No.92 Document provides that March 31, 2018 is the deadline for completion of cleaning up the Projects Library.
2.4.3 Notice on Enhancing Risk Control of Central State-Owned Enterprises’ PPP Business (Guo-Zi-Fa-Cai-Guan [2017] No.192) by SASAC.
On 17 November 2017, the State-Owned Assets Supervision and Administration Commission of the State Council (or “SASAC”) issued the No.192 Document, strictly regulating and constraining central state-owned enterprises to participate in PPP projects.
Firstly, the No.192 Document requires central state-owned enterprises to take measures to increase project capital contribution while prohibiting them from bearing risks that should be borne by other parties in manners of introducing such funds as are equity in name but debt in nature because of promised fixed payback or buying in subordinated shares. As such, central state-owned enterprises need to replace their own funds into fund finance to enrich project capital by negotiations for amendment and timely settle down the replaced funds to avoid risks arising out of subordinated shares.
Secondly, the No.192 Document also provides that central state-owned enterprises are not allowed to provide security for other shareholders’ equity contributions nor to alone provide credit enhancement measures for debt financing. As such, central state-owned enterprises shall revoke guarantees having been made for other shareholders’ equity contributions and other shareholders (except for government contribution representatives) shall jointly provide guarantees for debt financing in accordance with their respective proportions of shares held in the project company.
Thirdly, the No.192 Document explicitly requires central state-owned enterprises to actively negotiate with partners to improve and perfect defective projects, and to formulate disposal plans for uneconomic or otherwise severely problematic projects one by one. Before the risks of these projects are resolved, central state-owned enterprises are required to suspend current or future projects.
Based on our analysis of the provisions of the No.92 Document and the No.192 Document and combined with the current situation of domestic PPP market, we are of the opinion that it would be very difficult for the relevant parties to meet the rectification requirements by March 31, 2018 as provided in the No.92 Document. As such, unless there is an extension of rectification time, a large number of disputes over PPP contract-related terminations and compensations may arise.
The report is part of the research outputs of the “Annual Review on Construction Disputes in China”. 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.MOFCOM: Director of the Head of Department of Outward Investment and Economic Cooperation on the outward investment cooperation in 2017, at 2.http://www.mofcom.gov.cn/article/ae/ag/201801/20180102699398.shtml，last visited on 18 February 2018.
China Judgments and Decisions Website at http://wenshu.court.gov.cn/，last visited on 16 January 2018. The dockets of the above-mentioned 16 cases are as follows:
(a).(2011) Min-Zai-Zi No.84
(b).(2012) Min-Shen-Zi No.668
(c).(2013) Min-Shen-Zi No.2437
(d).(2014) Min-Yi-Zhong-Zi No.256
(e).(2015) Min-Shen-Zi No.185
(f).(2015) Min-Yi-Zhong-Zi No.144
(g).(2015) Min-Shen-Zi No.2022
(h).(2015) Min-Shen-Zi No.2955
(i).(2016) Zui-Gao-Fa-Min-Zhong No.357
(j).(2016) Zui-Gao-Fa-Min-Zai No.192
(k).(2016) Zui-Gao-Fa-Min-Zai No.53
(l).(2016) Zui-Gao-Fa-Min-Zhong No.695
(m).(2017) Zui-Gao-Fa-Min-Xia-Zhong No.151
(n).(2017) Zui-Gao-Fa-Min-Zhong No.57
(o).(2017) Zui-Gao-Fa-Min-Xia-Zhong No.19
For further information, please contact:
ZHOU, Xianfeng (Elvis), Partner, Jun He
zhouxf@junhe.com
