Rule changes for priority compensation in construction

By Zhang Miao and Gong Ming, Hylands Law Firm
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With the new judicial interpretation on construction projects now in effect, changes have also been introduced in other interpretations regarding such projects. So, what are the changes in the judicial rules that affect cases of priority compensation?

张淼, Zhang Miao, Partner, Hylands Law Firm
Zhang Miao
Partner
Hylands Law Firm

The Interpretation of the Supreme People’s Court on the Application of Laws in the Trial of Cases of Disputes over Construction Contracts of Construction Projects (I) (new judicial interpretation on construction projects) came into effect on 1 January 2021. New changes have also taken place in the corresponding contents of:

(1) The Interpretation of the Supreme People’s Court on the Application of Laws in the Trial of Cases of Disputes over Construction Contracts of Construction Projects;

(2) the Interpretation of the Supreme People’s Court on the Application of Laws in the Trial of Cases of Disputes over Construction Contracts of Construction Projects (II) (original judicial interpretation on construction projects);

(3) and the Reply of the Supreme People’s Court on the Priority of Compensation for Construction Projects (original reply on priority of compensation).

Requesting compensation priority

As article 37 of the new judicial interpretation on construction projects stipulates, if a decoration engineering project meets the conditions of conversion into money or auction, the contractor can claim priority compensation for the part from the conversion into money or auction of such decoration engineering project in the total project price.

According to the provisions of article 18 of the original judicial interpretation on construction projects, the premise for a contractor to claim priority of compensation is that it is the owner of the building. However, in practice, a decoration engineering project related to buildings and structures is a kind of construction engineering project. The original restrictive provisions make most contractors who rent buildings for decoration engineering projects unable to exercise priority for compensation.

The above-mentioned new judicial interpretation has relaxed the restrictive conditions for a contractor to claim priority of compensation for the project price to a certain extent, but due to the attributes of a decoration engineering project attached to buildings, there will be certain difficulties in, and disputes over, how to utilise it in the process of conversion into money and auction in the future.

Discount compensation

Article 24 of the new judicial interpretation stipulates that if the construction contract of a construction project is invalid, one party concerned may request to make discount compensation to the contractor, according to the actually performed contract.

The above-mentioned article is amended with reference to the provisions of articles 157 and 793 of the Civil Code on the legal consequences of invalid contracts, ensuring that a unified standard is applied in the current laws. Meanwhile, the settlement of an invalid contract has been changed from “settlement of construction project price with reference to actually performed contract” to “discount compensation”, which increases the risk and uncertainty of invalid contract settlement in future judicial practice to a certain extent.

宫铭, Gong Ming, Associate, Hylands Law Firm
Gong Ming
Associate
Hylands Law Firm

Clarify the sequence

According to article 36 of the new judicial interpretation, the priority of compensation for construction projects enjoyed by a contractor in accordance with article 807 of the Civil Code is prior to mortgage and other creditor’s rights.

The above-mentioned provisions come from article 1 of the original reply on priority of compensation. There has been some controversy in academic circles about the right nature of the priority of compensation for construction projects, and the main controversial point is whether the nature of priority is classified as property right or creditor’s right.

With the implementation of the above-mentioned provisions, the prior sequence of the priority of compensation for construction projects shall be stipulated by the judicial interpretation of higher precedency of legal effect. As far as the priority of compensation for construction projects is concerned, where there is a special secured creditor’s right and a general unsecured creditor’s right on the property of the employer, a contractor’s project price takes precedence over the above-mentioned creditor’s rights and is repaid first, with no need to consider whether the contractor’s project price occurs earlier or later than other creditors.

When a contractor realises the priority of compensation for the project price, it is not necessary to consider whether the property of the employer is sufficient to pay off all the debts.

Change of time limit

The largest change in the new judicial interpretation is on the time limit for contractors to exercise the priority of compensation for construction projects.

Article 41 of the new judicial interpretation stipulates that a contractor shall exercise the priority of compensation for a construction project within a reasonable period of time, but the maximum period shall not exceed 18 months, counting from the date on which the employer should pay the price of the construction project. This changes the time limit for exercising the priority of compensation from “six months from the date on which the employer should pay the price of the construction project” to “no more than 18 months”.

In practice, as construction projects often involve multi-party rights and obligations, settlement procedures are very cumbersome and complex, and it is very difficult for construction enterprises to exercise the priority within six months, so their own interests are easily damaged.

The new provisions require contractors to exercise the priority of compensation for construction project within a “reasonable period of time”, but it is not further explained whether the parties concerned can agree on the exercise period, and whether the agreed exercise period can be opposed to the 18 months period in the above-mentioned amended article.

In addition, there is no further explanation in this amendment on the controversial “date on which the employer should pay the construction project price” in previous practices. These two issues still remain to be explained by the Supreme People’s Court.


Zhang Miao is a partner at Hylands Law Firm. She can be contacted on +86 10 6502 8925 or by email at zhangmiao@hylandslaw.com

Gong Ming is an associate at Hylands Law Firm. She can be contacted on +86 10 6502 8732 or by email at gongming@hylandslaw.com