Legal risk control of contractors under the Civil Code

By Yu Peng and Yang Jie, DOCVIT Law Firm
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On 1 January 2021, China’s civil legal system formally entered the era of the Civil Code. The Civil Code and relevant judicial interpretations have optimised the original legal provisions on the construction industry by detailing the handling rules when project quality standards are ambiguously agreed and by allowing the concerned parties to negotiate about changing the contract based on the principle of change of circumstances.

余鹏, Yu Peng, Senior partner, DOCVIT Law Firm
Yu Peng
Senior partner
DOCVIT Law Firm

Moreover, the code and the relevant interpretation, in line with the current situation of the industry, have established the settlement standards for the circumstance where the construction contract is invalid, and also particularly strengthened the protection of the rights of actual constructors. Considering the important position of the contractor in the construction contract relationship of construction projects, the authors analyse the potential risks brought by the new stipulations and the corresponding risk control measures.

Three hidden troubles

The employer can exercise the special termination right

At present, subcontract, illegal subcontract, borrowing qualifications and other chaotic phenomena in the construction industry have not been fundamentally improved. As the legal constructor of a construction project, a contractor is confronted with a long period of contract performance, huge investment and high labor cost. If the employer exercises the right to terminate the contract due to subcontract or illegal subcontract, not only the contractor will be unable to make use of the relevant right protection mechanism, but also probably face the risk of bearing liability for breach of contract to the employer. Such problem is particularly prominent when a project is close to completion. The agreement on similar situations shall be reflected in the terms of the general contract.

At the time of discount compensation, a contractor may not obtain the full price

The basic rules of China’s civil law in handling invalid civil legal acts are as follows: if the property is obtained by an actor as a result of an invalid civil legal act, it shall be returned if it can be returned; and if it cannot be returned or there is no need to return, it shall be subject to discount compensation. Also, the party at fault shall compensate the other party for the losses suffered therefrom. Although the construction contract of a construction project is invalid from the beginning, the contractor has materialised the input of labor, materials, machinery and management into the construction project through its construction acts. The construction project is a specific object with exclusive purpose, and it is neither suitable to be returned nor easy to be realised, so it belongs to the property that cannot be returned and shall be used for discount compensation in accordance with the law.

The Civil Code empowers the court or arbitration organs greater discretion, stipulating that the amount of discount compensation shall be judged at the discretion based on the fault degree of both parties instead of referring to the agreement of contract. The view that “invalid contract is treated as effective” in previous judicial practice has been corrected after the implementation of the Civil Code. In the case of invalid contract, the nature of the contract price obtained in accordance with the new stipulations has been changed to “compensation”. Therefore, it is possible that a contractor facing a future legal risk might be compensated at a lower price than the contract price.

A contractor has no right to claim the project payment for unqualified projects

Construction project contract is very complex and diverse, and the core issue lies in project quality. Although “completion” is no longer a necessary condition for the project payment when the contract is invalid, project quality has constantly remained the focus of the new stipulations. If the project quality does not meet the standards after acceptance inspection, the employer shall have the right to require the contractor to cover the repair cost; if the repaired construction project is still unqualified after acceptance inspection, the contractor will directly lose the right to claim for discount compensation as of the agreed project price in the contract.

杨洁, Yang Jie, Partner, DOCVIT Law Firm
Yang Jie
Partner
DOCVIT Law Firm

Risk control measures

Optimise shareholding structure

Establish a scientific and reasonable subsidiary and/or branch structure so as to reduce the dependence on outsourcing. Establish a sound organisational structure and compliance system, strengthening performance management and quality control, and carrying out construction according to a scientific plan. Put the real-name certification system in place at the construction site and strengthen the management and control of legal subcontractors.

Integrate internal resources of enterprise

Strengthen the direct management capability at the construction site, and strictly control project quality. Since the contractors executing subcontract and illegal subcontract do not actually participate in the construction process, they are unable to control the quality and safety risks at the construction site in time, and actually lose control of the construction period. Quality problem control is not only a rigid requirement of industry supervision, but also a lifeline for construction enterprises. Contractors must always impose high standards and strict requirements upon themselves and actively abide by laws, regulations and industry standards.

Optimise the ability of performing contract

Although the new stipulation holds a negative attitude towards the contractor’s claim for discount compensation of a contractor when the construction project is unqualified, the fault party responsible for the contract invalidity may be the employer or both the employer and the contractor. The new stipulations also require that, if the employer is at fault for the loss caused by the unqualified construction project, it shall bear the corresponding liability. Obviously, the new stipulation still encourages the contractors to strictly perform their contract. In addition, even if a contract is invalid, the employer can still realise the use value of the project if the project meets the design requirements and standards according to the actual situation and progress of the construction. Based on the fact that the employer has actually gained profit, the contractor may require a corresponding degree of compensation. Therefore, it is of great significance for contractors to optimise their contract performance ability.

The Civil Code clearly attaches importance to the quality of construction projects, responds to the urgent needs of the industry, and balances the rights and interests of all parties concerned from a fair point of view. In this new era, it is of great importance for contractors to raise risk awareness of legal compliance and establish a sound organisational structure.

Yu Peng is a senior partner and Yang Jie is a partner at DOCVIT Law Firm

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