A Study on the Interpretation and Application of the Supreme People’s Court’s Interpretation (II) on Issues Concerning the Application of Law in the Trial of Disputes over Construction Project Contracts (Draft for Public Comments) (Mainland China)

Disputes over construction project contracts have long been a high-incidence category in civil and commercial adjudication.  Such disputes involve numerous parties, massive capital flows, and intricate legal relationships, often implicating multiple stakeholders, including employers, contractors, subcontractors, actual constructors, and assignees of construction payments.  Owing to the long-standing prevalence of illegal subcontracting, illegal assignment, and affiliated construction practices in the construction sector, the traditional contract law principle of privity of contract has frequently been challenged in judicial practice, resulting in notable inconsistencies in adjudicative standards.

The Supreme People’s Court previously promulgated the Interpretation (I) on Issues Concerning the Application of Law in the Trial of Disputes over Construction Project Contracts (hereinafter referred to as the “Interpretation (I)”), which addressed matters such as the settlement of project payments, the validity of contracts, and the rights of actual constructors.  However, with the continuous development of adjudicative practice, the existing interpretation has gradually revealed shortcomings, including insufficiently refined rules and an inadequate response to practical realities.  Against this backdrop, the Supreme People’s Court drafted and released the Interpretation (II) on Issues Concerning the Application of Law in the Trial of Disputes over Construction Project Contracts (Draft for Public Comments) (hereinafter referred to as the “Draft for Comments”), with the aim of further unifying adjudicative standards and responding to practical challenges.

This article seeks to conduct a systematic legal analysis of the core provisions of the Draft for Comments, exploring the evolution of rules and underlying value orientations in areas such as the determination of contract validity, the settlement of project payments, the protection of priority rights, and the allocation of liability.

I. Main Contents and Regulatory Highlights of the Draft for Comments

A. Determination of Contract Validity

At the level of contract validity, the Draft for Comments demonstrates a more flexible and pragmatic approach.

1. Dynamic application of the “mandatory bidding” standard: Where a project was subject to mandatory bidding at the time of contract formation but was not tendered, yet at the time of litigation no longer falls within the scope of mandatory bidding, the contract shall no longer be deemed invalid on this basis.  This provision respects changes in the national bidding regime, avoids invalidating a large number of already performed contracts due to policy adjustments, and safeguards transactional stability.

2. Reasonable narrowing of qualification requirements: The Draft for Comments specifies three circumstances in which a contract shall not be deemed invalid, namely: labor subcontracting by enterprises duly registered in accordance with the law, residential decoration not involving the main structure, and small-scale projects below the statutory threshold.  This reflects consideration of segmented markets and the particularities of minor projects, and reduces unnecessary barriers to market entry.

B. Settlement of Construction Project Payments

Settlement of project payments lies at the core of construction disputes, and the Draft for Comments provides clear guidance on several contentious issues.

1. Rules on lump-sum contracts: In principle, fluctuations in market prices during the contract period do not justify price adjustments, while room is reserved for changes in circumstances.  For increases in work volume caused by design changes, and for pricing of completed works in the event of contract termination, reference to local pricing standards or proportional determination of the price is permitted.  This balances the seriousness of contract commitments with the objectivity of project changes and provides an operable solution for the settlement of uncompleted projects.

2. Defining the effect of audit and fiscal review conclusions: The Draft for Comments clarifies the relationship between administrative audit/fiscal review and civil contract settlement.  Only where the parties have expressly agreed shall audit or review conclusions serve as the basis for settlement, and contractors are afforded a remedial avenue to apply for judicial appraisal.  This provision effectively protects the lawful rights and interests of construction parties and prevents employers from indefinitely delaying settlement or issuing unfair conclusions through administrative procedures.

3. Confirmation of the validity of settlement agreements: The Draft for Comments provides that even where the construction contract is invalid, a settlement agreement reached by the parties regarding discounted compensation shall, in principle, be respected.  This reflects respect for the parties’ post hoc autonomy of will and helps encourage negotiation and reduce litigation burdens.

C. Borrowing Qualifications, Assignment, and Illegal Subcontracting

The Draft for Comments constructs a clearer framework of liability.

1. Separation of contract validity and liability allocation: The Draft for Comments makes clear that contracts involving the transfer or lending of qualifications are invalid, and claims by the lending party for qualification usage fees shall not be supported.  However, where the project passes acceptance, the actual constructor is entitled, based on the legal consequences of the invalid contract, to claim discounted compensation or damages from the qualification-lending party.  This achieves a balance between condemning illegal conduct and fairly compensating actual labor input.

2. Differentiated treatment based on the employer’s “knowledge”: The Draft for Comments distinguishes liability pathways based on whether the employer “knew or should have known” of the affiliated construction arrangement.  If the employer was unaware, the actual constructor may not directly assert claims against them, thereby preserving the principle of privity of contract.  If the employer was aware, the court may pierce the contractual façade and, on the basis of finding the relevant contracts invalid, render a judgment requiring the employer to bear direct liability to the actual constructor in light of performance.  This significantly strengthens regulation of malicious employers and intermediary “construction bosses.”

3. Explicit authorization of subrogation actions: For the first time at the level of judicial interpretation, the Draft for Comments expressly provides that entities or individuals borrowing qualifications, or those accepting assignments or illegal subcontracts, may, under prescribed conditions, exercise subrogation rights against the employer.  This opens a new legal avenue for actual constructors at the end of the creditor chain to claim construction payments.

D. Priority Right to Payment of Construction Project Funds

The priority right to payment is a key mechanism for protecting contractors.

1. Definition and exclusion of the scope of the priority right: The Draft for Comments clarifies that losses arising from suspension or idling of work caused by the employer are not covered by the priority right.  This delineates the core of priority right protection as the labor value embodied in the construction project, rather than general breach-of-contract damages.

2. Flexibility in determining the commencement of the exercise period: Building on Interpretation (I), the Draft for Comments further clarifies that the exercise period may commence from the payment date agreed upon in the contract or from the final payment deadline stipulated in a settlement agreement.  Where the payment date is renegotiated due to objective reasons, such as an extension of the construction period, the commencement date may be recalculated based on the adjusted date.  This better aligns with the complex and variable realities of project performance.

3. Extension of the right under specific circumstances: The Draft for Comments provides that where a construction project is damaged, destroyed, or expropriated, the priority right may extend to the corresponding insurance proceeds, compensation, or indemnities.  At the same time, two alternative approaches are proposed regarding whether the priority right transfers together with the assignment of construction payment claims, reflecting ongoing controversy over this issue and leaving room for further discussion.

II. Conclusion

Overall, the Draft for Comments is firmly grounded in the adjudicative practice of construction project contract disputes and provides targeted institutional responses to key issues, such as the protection of actual constructors, the settlement of project payments, and project appraisal procedures.  Its regulatory approach reflects a legislative orientation that, while adhering to the fundamental principles of contract law, appropriately responds to practical needs and balances the interests of multiple parties.

Although the Draft for Comments has not yet formally taken effect, the adjudicative philosophy and rule orientation it embodies are of significant reference value for future judicial decisions and theoretical research concerning construction disputes.  In the subsequent promulgation and application of the formal judicial interpretation, how to achieve a reasonable balance between protecting construction payment claims and maintaining contractual order remains a subject warranting further observation and study.