Subcontractor bankrupt: can constructor sue contract issuer?

By Cheng Ruomiao and Wang Anyi, Leaqual Law Firm
0
346

Amid the global economic slowdown and pandemic pressure on the financial landscape, a number of enterprises have gone bankrupt, including, among others, construction companies. Once entering the reorganisation process, depending on its mode of profit and operation, migrant workers often become creditors of reorganised enterprises.

In such cases, will the protection of interests of migrant workers and protection of the rights and interests of other creditors lead to conflict, and how can such conflicts be resolved in litigation? This remains a key issue to be addressed.

Background

Although the law clearly prohibits illegal subcontracting and affiliation in construction projects, such violations are not uncommon in practice, especially for highly qualified construction enterprises. When the actual constructor is unqualified for the target project, it has to affiliate itself to a qualified constructor in order to undertake the project. In such a situation, the project involves three parties: the project owner as the contract issuer, the qualified construction company as the subcontractor and the unqualified enterprise as the actual constructor.

Cheng Ruomiao, Leaqual Law Firm
Cheng Ruomiao
Senior Partner
Leaqual Law Firm

The specific operation mode is as follows: The qualified subcontractor hands over the entire project to the actual constructor, and the project payment is first paid by the project owner to the subcontractor who will, after deducting a certain proportion of payment as management fee, pay the remainder to the actual constructor. This practice is in fact quite common.

If a subcontractor under the above-mentioned mode enters bankruptcy reorganisation after having received the project owner’s payment but is unable to settle with the creditor (i.e. the actual constructor) individually under relevant laws and regulations before the reorganisation plan is in place, how can the rights and interests of migrant workers be protected? Does the actual constructor have the right to bypass the subcontractor and directly sue and claim its rights against the project owner?

Lawsuit parties

Certain actual constructors have indeed initiated lawsuits with the contract issuers as defendants and the subcontractors as co-defendants or third parties. In view of the fact that the subcontractor has already entered reorganisation, by law, its administrator should respond to the lawsuit on its behalf. In such cases, the parties may claim their respective rights on various grounds.

Firstly, from the perspective of the actual constructor, according to articles 42 and 43 of the Judicial Interpretation on Construction Contract Disputes in Construction Projects (I) issued by the Supreme People’s Court (SPC), the actual constructor would argue that since it undertook the actual construction work, it therefore has a direct claim against the owner, as long as providing evidence of its implementation of the construction contract.

The administrator, however, would argue that after the subcontractor enters the reorganisation procedure, all creditors should wait for the distribution scheme to be laid out in the reorganisation plan. The administrator’s view may be mainly based on the following:

Wang Anyi, Leaqual Law Firm
Wang Anyi
Associate
Leaqual Law Firm

(1) Articles 43 and 44 of the Judicial Interpretation on Construction Projects (I) stipulate that in illegal subcontracting, the actual constructor can make a claim directly against the project owner, but do not provide that an actual constructor “borrowing” the licence from the subcontractor should have the same right.

Thus, the provisions do not directly apply to the actual constructors so affiliated to the subcontractor. In addition, the SPC clarified in Tianjin Jianbang v China Metallurgical Construction (2017) that the company affiliated to the subcontractor has no right to directly sue the contract issuing party, or require it to discharge the payment obligation. Instead, it may only settle with the subcontractor to which it is affiliated. Therefore, an actual constructor affiliated to a subcontractor cannot directly claim against the project owner;

(2) According to Several Specific Issues in Current Civil Trial Work (currently in force) addressed by the SPC in December 2015, in labour subcontracting the contract issuer is liable for the actual constructor within the scope of unpaid project price only when non-payment for subcontracted construction work leads to inability to pay wages to migrant workers. In addition, in Dalian Hengda Machinery Factory v Dalian Chengda Construction Engineering Service (2015), the SPC also clarified that the actual constructor’s direct claim against the contract issuer is intended to protect the interests of the migrant workers, which does not directly apply to professional subcontracting. Accordingly, the scope of the actual constructor’s direct claim in illegal subcontracting is therefore limited to unpaid wages of the migrant workers in labour subcontracting;

(3) According to articles 21 and 23 of the Bankruptcy Law, and article 110 of the Minutes of the National Courts’ Civil and Commercial Trial Work Conference, after acceptance of reorganisation, any new lawsuit against the debtor claiming debt payoff should be rejected. The plaintiff should declare its creditor’s rights to the administrator instead. Therefore, the administrator will request the court to reject the plaintiff’s lawsuit based on the above viewpoint.

Judicial precedents

Judges have made different decisions in response to the above situation. Some affirmed the actual constructor’s claim, ordering the project owner to make direct payment to the actual constructor, in a bid to protect the interests of the migrant workers. Others dismissed the plaintiff’s claim, affirming the administrator’s viewpoint that creditor’s rights should not be exercised until the reorganisation plan setting out the debt service scheme came into place.

For example, construction contract disputes in the bankruptcy reorganisation of 17 companies, including Tianjin Urban Construction Group, involved many cases matching the above scenarios. As a member of the administrator team for Tianjin Urban Construction Group’s reorganisation project, this author took part in the trial and hearing of the case. But although all cases were heard at local courts in Tianjin, the decisions varied.

It can be concluded that judges have certain discretion in such cases – and may hand out verdicts according to their own judgment and precedents. This author hopes that amendments to the Bankruptcy Law will fill the gap; and as the reorganised company is being reborn, the interests of both migrant workers and legitimate rights and interests of other creditors would be fully protected, which together would safeguard the stability of the financial sector.

Cheng Ruomiao is a senior partner and Wang Anyi is an associate at Leaqual Law Firm

Leaqual Law Firm

12/F, Tower A, ZT International Center

10 Chaoyangmen South Avenue

Beijing 100020, China

Tel: +86 10 5365 2379
E-mail:

908180699@qq.com

https://www.lglawyer.cn/