Owner’s rights and responsibilities under the new rules for construction projects

The issuance of the Interpretation (II) on Issues Concerning the Application of Law in the Trial of Cases Involving Disputes over Construction Contracts for Construction Projects by the Supreme People’s Court (hereinafter referred to as the “Interpretation II”) has attracted widespread attention. Most enterprises may act as the owner. Then what are the changes to the owner under the new judicial interpretation?

  1. The Impact of Tendering Procedures on the validity of Contracts

Article 1 of Interpretation I stipulates that a must be tendered construction project failed to go through the tendering procedures, it shall be invalid. Interpretation II prescribes different circumstances regarding the validity of contracts. Article 2 provides that if the parties negotiate on substantive contents before tendering, the winning bid contract may be deemed invalid. This explicitly clarifies that illegal negotiation acts such as “open bidding with secret pre-determination” and “pre-determination before bidding” will invalidate the winning bid contract, aiming to force owners to comply with rules during the tendering procedures. Article 1 provides that if the project is no longer subject to mandatory tendering at the time of filing a lawsuit, the contract shall not be deemed invalid solely on the ground of failure to tender. In other words, for projects that “must be tendered”, if they have become “non-mandatory tendering” projects due to regulatory or policy adjustments at the time of litigation, the contract will not be invalidated solely because of “failure to tender”, reducing compliance risks for legacy projects.

  1. The Owner’s Knowledge Becomes Key to Determine Whether an Affiliated Party Can Sue the Owner Directly

According to Article 4, if the owner “did not know and should not have known” about the qualification lending at the time of contract conclusion, the affiliated party cannot directly break through the privity of contract to claim project payment from the owner. If the owner “knew or should have known” about the affiliation, it shall directly bear the liability for compensatory payment to the actual constructor. Therefore, owners must strictly review qualifications during the contractor selection stage. Meanwhile, at all stages of contract signing, construction, and settlement, owners should avoid contacting and transacting with personnel whose identity as contractors is uncertain to prevent being deemed “knowledgeable”.

  1.  Return to Privity of Contract, to Set Restrictions on Actual Constructors Suing Owners

Article 43 of Interpretation I stipulates that actual constructors may directly sue the owner as a defendant to claim rights, leading to numerous cases in practice where owners are sued unjustly. Interpretation II makes differentiated provisions.

Firstly, in principle, the privity of contract shall not be breached. Article 6 explicitly provides that in cases of prohibited subcontracting and illegal subcontracting, the court shall not support claims for payment from the owner by the party accepting the subcontracting or illegal subcontracting.

Secondly, to set the requirements for exercising subrogation rights. Actual constructors may exercise subrogation rights only if the prerequisite is met. The prerequisite is that the contractor is negligent in exercising matured claims or accessory rights related thereto, affecting the realization of its matured claims. Owners can effectively block recourse in subrogation lawsuits by strictly implementing payment milestones and improving payment ledgers.

  1.  Fixed Lump-Sum Contracts Are Generally Non-Adjustable, Owner’sBudgets Becomes More Controllable

Article 9 stipulates that fixed-price contracts are generally not subject to price adjustments due to fluctuations in labor and material costs. However, two exceptions are reserved. If parties have agreed otherwise, or “changed circumstances” as stipulated in the Civil Code occur, then price adjustments may be claimed.

There is a special situation, if a fixed lump-sum construction contract is terminated midway, and the parties cannot reach an agreement on the completed part (with qualified quality), Article 10 sets a rule for calculation: “the proportion of the project price of the completed part to the total project price may be determined by reference to the pricing standards, pricing methods, or relevant norms in the engineering construction field issued by the construction administrative department at the place where the construction project is located at the time of contract conclusion, and the project price of the completed part shall be determined by multiplying this proportion by the fixed lump-sum price agreed in the contract.” The rationality and practicality of this rule seem to be highly controversial.

  1.  Owners’ “Delaying” Settlement Behaviors Are Regulated

In practice, it is very common for owners to delay payment on grounds such as incomplete audits or postponed commencement dates for retention funds due to uncompleted completion procedures. Article 13 provides that if an audit is cited as a reason, unless otherwise agreed by the parties, the court may determine the time limit for issuing the audit conclusion based on the project scale, cost, and complexity, with a maximum of one year from the date the contractor submits the completion settlement documents. The aforementioned one-year limit does not apply if the delay is caused by the contractor’s failure to cooperate in providing materials. Article 14 provides that the retention fund refund period commences from the date the contractor exits the site; if the construction contract is terminated after the contractor exits, it commences from the date of termination.

  1.  Contract Termination and Quality Liability

Article 15 explicitly provides that after contract termination, the owner has the right to request the contractor to hand over the construction site and construction materials, helping the owner quickly organize subsequent construction and reduce losses. Article 16 clarifies the quality repair procedure, requiring the owner to fulfill the pre-procedure of notifying the contractor for repair before claiming quality repair costs.

In conclusion, Interpretation II clarifies the boundaries of owner’s rights and imposes higher requirements on owner’s standardized project management, namely, focusing on full-cycle management including preliminary compliance review, process performance supervision, and capital risk control.