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Introduction

The Civil Code of the People’s Republic of China came into force at the start of 2021. This is a milestone for the development of the legal system in China. The Civil Code has been praised for its scientism and systematism in terms of legislative techniques and is expected to decrease disagreements among separate laws, regulations and judicial interpretations in the civil field and aims to meet the demands of a continually evolving society and economy.

When the Civil Code came into effect, it replaced nine previous separate laws. These included: the Marriage Law, the Succession Law, the General Principle of the Civil Law, the Adoption Law, the Guarantee Law, the Contract Law, the Real Right Law, the Tort Law and the General Provisions of the
Civil Law.

This article introduces the major changes in the Civil Code compared with previous laws and analyses its effects on the construction industry.

Rules applied to the construction industry

Rule classifications

There are two types of rules that govern the construction industry: civil rules and administrative rules.

Civil rules

Parties involved in construction activities are the employer and the contractor together with the designer and the engineer. As parallel parities, their rights and obligations are regulated by civil laws such as the Contract Law and the Tort Law.

Consequently, the newly adopted Civil Code makes some changes to the construction industry.

Administrative rules

Due to the widely public consequences of construction activities, there are administrative rules governing entities in the construction industry and rules to prevent loss and damages arising from construction industry activities.

The Civil Code has replaced the Contract Law and Tort Law. The respective judicial interpretations of these former laws have consequently lost power. However, the administrative law that regulates the construction industry, appropriately the Construction Law, remains in effect.

Aspects of civil rules changed by the Civil Code

In the construction industry, prior to the introduction of the Civil Code, the relevant laws were: the Tort Law, General Provisions of Contract Law, the Particular Provisions for Construction Contracts of Contract Law, and two Interpretations of the Supreme People’s Court on Issues concerning the Application of Law in the Trial of Cases Regarding Disputes over Contracts of Construction Projects (‘Judicial Interpretation’).

Changes made to the general provisions of contract law

Two changes were introduced to the rules in the General Provisions of the previous Contract Law which will have an impact on the construction industry: the provisions about quality standards and the application of the principle known as ‘Change of Circumstance’. These are discussed below.

Quality requirement

In the former rules

Sub-clause 2 of Article 62 of the Contract Law stipulates that

‘when the contractual provisions about quality requirement are not clear, and the parties did not make any supplements to the agreement and the quality requirement cannot be determined according to the contractual provisions or trading customs, then the national standard or industry standard shall apply, and if there is no such national standard or industrial standard, then the normal standard or the specific standard consistent with the purpose of the contract shall apply.’ (emphasis added)

Although the above article provides some guidance when there is no clear standard in the contract for quality requirement, the standard reference is vague as it only gives the parties further options to choose from without providing a preferred approach. Disputes may arise when the parties are unable to agree on which standard to select.

In the newly adopted Civil Code

Article 511 of the Civil Code specifies the sequence of the application to different standards: first is the mandatory national standard, followed by the recommended national standards, then the industrial standards, while the normal standard and the standard consistent with the purpose of contract is last.

The new Civil Code narrows down the options to one and reduces the difficulties to the parties and judges in finding and applying the appropriate applicable standard.

The principle: Change of Circumstance

The Civil Code applies the Change of Circumstance principle (‘Qing Shi Bian Geng’). This principle is sourced from the case law Krell v Henry,¹ and sets out the doctrine of frustration of purpose in contract law.

In the former rules

The Change of Circumstance principle was put into the draft version of the Contract Law in 1999 but removed from the final version due to concerns raised over the abuse of the principle by the breaching party.

Without this principle, the affected party may only resort to force majeure events to terminate or amend the contract to avoid unfair consequences. By comparison to the Change of Circumstance principle, force majeure has a clearly narrower scope and therefore cannot provide enough relief to the affected party in an adverse situation.

After having accumulated enough experience and having seen the insufficiency of reliance on force majeure to provide relief, the Supreme People’s Court adopted this principle in the form of judicial interpretation to the Contract Law in 2009 as follows:

‘Article 26. Where any major change which is unforeseeable, is not a commercial risk and is not caused by a force majeure event after the establishment of a contract, if the performance continues it is obviously unfair to the other party or cannot realise the purposes of the contract and the party files a request for the modification or rescission of the contract with the People’s Court, the People’s Court shall decide whether to modify or rescind the contract under the principle of fairness and in light of the actual causes of the case.’²

In the newly adopted Civil Code

In the Civil Code, it is written as:

‘Article 533. Where the basic conditions of a contract undergo a material change unforeseeable by the parties at the time of contracting which is not a commercial risk after the formation of the contract, rendering the continuation of the performance of the contract unconscionable for either party, the adversely affected party may renegotiate with the other party; and if the renegotiation fails within a reasonable time limit, the party may request the People’s Court or an arbitration institution to modify or rescind the contract.’

Firstly, in the previous rules, the Change of Circumstance principle can be applied only when it cannot fall within a force majeure. But in the newly adopted Civil Code, the precondition ‘not caused by a force majeure’ is removed.

The removal of the ‘force majeure versus change of circumstance’ dichotomy gives the affected party one more option to remedy itself in circumstances where it is difficult to prove the material change as a force majeure.

Secondly, a mandatory pre-suit discussion or renegotiation process is added in the Change of Circumstance principle.

The renegotiation requirement echoes the most fundamental principle of contract law – the principle of freedom of contract – as it creates an opportunity for the parties to negotiate and amend the contract so that the contract can continue to be duly performed rather than terminated.

Therefore, there is one more option beyond force majeure which is of great importance to both the employers and contractors. Together with the mandatory pre-renegotiation process, the newly adopted Civil Code responds to the call for a flexible and clear definition for the Change of Circumstance principle.

Changes made to the particular provisions of contract law

Settlement rule when construction contract is invalid

Contracts may be invalid by reason of violating compulsory provisions of laws or administrative regulations.

In the construction industry, subcontracting the entire contract or affiliation (‘Gua Kao’ means an entity without the qualifications performing the contract under the name of another entity with the qualifications), which would significantly affect the quality of works, often renders the construction contracts invalid.

In the former rules

The previous Contract Law did not contemplate this problem and therefore provided no answer. To settle disputes of this nature, the Supreme People’s Court provided guidance in the Judicial Interpretation:

‘Article 2.Where a construction contract is invalid, but the construction project passes the inspection upon completion, the contractor’s request for payment of the construction cost by considering the contact for reference shall be sustained.

‘Article 3. Where a construction contract is invalid, and the construction project does not pass the inspection upon completion, the matter shall be handled separately according to the following circumstances:

• If the restored construction project passes the inspection upon completion, and the employer requests the contractor to bear the restoration expense, such request shall be sustained;

• If the restored construction project does not pass the inspection upon completion, and the contractor requests payment of construction costs, such request shall not be sustained.

‘With respect to the losses arising from the fact that the construction project does not pass the inspection upon completion, the employer shall, if it has any fault, also bear its civil liabilities, accordingly.’

In the newly adopted Civil Code

The Civil Code pulled this rule from the Judicial Interpretation into ‘law’, and refined it as follows:

‘Article 793. Where a contract for construction project is void, and the construction project passes the acceptance inspection, the contractor may be compensated by liquidation with reference to the stipulation about the project price in the contract.

‘If a contract for construction project is void, and the construction project fails the acceptance inspection, action shall be taken according to the following circumstances:

(1) If the construction project as repaired passes the acceptance inspection, the employer may request the contractor to bear the repair costs.

(2) If the construction project as repaired fails the acceptance inspection, the contractor has no right to request equivalent-value compensation with reference to the stipulation about the project price in the contract.

‘If the employer is at fault for the loss caused by the nonconformity of the construction project, the employer shall be correspondingly liable.’

Firstly, the modification from ‘inspected at the time of completion to be qualified’ to ‘passes the acceptance inspection’ removed the requirement of ‘completion’, allowing progressed works, works completed in stages and uncompleted works to be compensated as well as completed works. The contractors would no longer need to continue incurring costs and providing labour to complete the non-existing contract in order to be compensated.

Secondly, the inclusion of the words ‘compensated/compensation’ instead of ‘payment of construction cost’ is consistent with the logic that payment of the contract price only happens under a valid contract.

Thirdly, the modification from ‘shall’ to ‘may’ also grants the judge discretion holistically to decide whether or not to support the claim for compensation. This contrasts with the previous position which rigidly asked judges to support the contractors’ request unconditionally, which to a certain extent encourages the acts banned by law and is not conducive to cultivating positive competition within the construction industry.

Right to terminate a construction contract

Another rule that was promoted from the Judicial Interpretation to a provision in the Civil Code is the right to terminate a construction contract.

In the former rules

Previously, other than the provisions about rights to terminate a contract in the General Provisions of Contract Law, the parties to a construction contract might invoke the clauses in Judicial Interpretation to terminate the contract.

For example, Article 9 of Judicial Interpretation provides that:

‘Where an employer is under any of the following circumstances, thus causing the contractor to be unable to carry out the construction work, and the employer still does not perform its obligations within a reasonable period after being notified, the contractor’s request for rescinding the contract on construction project shall be sustained: […] (3) It does not perform the assistance obligations as stipulated in the contract.’

In the newly adopted Civil Code

The above rule is retained in Article 806 of Civil Code, amended by deleting the words ‘as stipulated in the contract’. This amendment enlarges the scope of ‘assistance obligations’ beyond contractual stipulation when the contractor finds it impossible or unreasonably difficult to continue the contract without assistance from the employer. The effect of this is to close the door on employers and force contractors to devote unreasonable efforts that may result in an unfair contract.

From the perspective of fairness, a businessperson should not be forced to win a contract while suffering loss. The removal of the words ‘as stipulated in the contract’ fills the gap between the Judicial Interpretation and principles of fairness.

Results when the employer refuses to pay properly

In the former rules

Article 264 of the replaced Contract Law provides as follows:

‘Where the ordering party fails to pay the remuneration or cost for the materials, etc to the contractor, the contractor is entitled to lien upon the work results, except as otherwise agreed upon by the parties.’

Under contracts of works (‘cheng lan’) and provisions for contracts of works, this may apply to construction contracts when there is no relevant or applicable rule in the construction contract.

However, there was only a right to a ‘lien’ on the work, which may not apply to construction contracts as construction works are not movable properties and cannot be subject to a lien. Therefore, contractors cannot invoke the ‘right to lien’ to hold the construction works as leverage to negotiate with the employer for full and timely payment.

In the newly adopted Civil Code

Article 783 of the contracts for works in the Civil Code provides that:

‘Where the ordering party fails to pay the remuneration or cost for the materials, etc. to the contractor, the contractor is entitled to lien upon the work results or refuse to make delivery, except as otherwise agreed upon by the parties.’ (emphasis added)

There are two different understandings in respect of the above clause:

1. The contractor may not be entitled to refuse delivery

Article 807 of the Civil Code provides that:

‘If the employer failed to pay the price in accordance with the contract, the contractor may demand payment from the employer within a reasonable period.

‘Where the employer fails to pay the price at the end of such period, the contractor may enter into an agreement with the employer to liquidate the project, and may also petition the People’s Court to auction the project in accordance with the law, unless such project is not fit for liquidation or auction in light of its nature. The construction project price shall be paid in priority out of proceeds from the liquidation or auction of the project.’

Based on above clause, when the employer fails to pay the contractor appropriately, this clause provides that the contractor has a right to be paid in priority out of proceeds from the liquidation or auction of the project. In such circumstances, Article 807 will prevail over Article 783 of the Civil Code.

2. The contractor may refuse to deliver

Provisions in the chapter of Contracts of Works may apply to construction contracts when there is no relevant applicable rule in the chapter of construction contracts.

As there is no specific stipulation for refusing to make delivery, when the employer fails to pay the remuneration or cost of the materials to the contractor, the contractor can refuse to deliver the project per Article 783 of Civil Code.

Article 783 (in the chapter of Contracts of Works) and Article 807 (in the chapter of Construction Contracts) shall be applied at different stages. The right to refuse to make delivery under Article 783 can be used in negotiation to improve the prospect of the contractor being compensated. Article 807 may only be used when there is an extreme settlement such as where liquidation or auction cannot be avoided.

Therefore, in this context, Articles 783 and 807 are complementary and both can be applied at different stages.

Changes made to the provisions on building liability of Tort Law

One key feature of construction contracts is that the works, though belonging to the employer after completion and handover, will to an extent be public, as the buildings and premises will be used by people. This may cause harm to third parties when quality issues occur.

The Civil Code made two major changes in this regard.

Tort liability for building collapse

In the former rules

To compel contractors to be responsible and improve the quality of construction, and to ensure the wronged parties obtain remedy rapidly, the Tort Law of China (2010) placed strict liability on the employer and contractor in respect of occasions where a building collapses and causes harm to third parties.

This strict liability is powerful as it – regardless of the actual situation or later evidence – directly identifies the employer and contractor as the tortfeasor who should pay damages to the infringed party.

However, construction has never been a simple process as various parties, designers, engineers, supervisors and suppliers of equipment are all involved, of which any one could have caused the defect and should be responsible for the harm. Therefore, strict liability on the employer and contractor is too rigid to be fair.

In the newly adopted Civil Code

To relieve contractors of unreasonable responsibilities, the Civil Code resumes the fault presumption rule instituted by the previous General Principles of Civil Law (1987) through Article 1252:

‘Where any building, structure or facility collapses or subsides, causing any harm to another person, the construction employer and contractor shall be liable jointly and severally, unless the construction employer and contractor can prove the non-existence of quality defect. After making compensation, the construction employer or contractor shall be entitled to be reimbursed by other liable persons if any.’ (emphasis added)

With this ‘unless the construction employer and contractor can prove the non-existence of quality defect’, the employer and contractor have a chance to provide themselves a ‘safe harbour’.

In order to benefit effectively from this ‘safe harbour’, contractors should be advised to collect and keep the documents produced in the process of construction, in case of presumed liability for building collapse.

Tort liability for damages caused by ground/underground construction

Another change is with respect to the words regarding tort liability for damages caused by ground or underground construction.

In the former rules

Article 91 of Tort Law is as follows:

‘Where anyone digs a pit, repairs or installs any underground facility, etc. at a public venue or on a public road but fails to set up any obvious warning sign or take any safety measure, and causes any harm to another person, the person shall assume the tort liability.’ (emphasis added)

In the newly adopted Civil Code

Article 1256 of Civil Code is as follows:

‘Where anyone digs, repairs or installs any underground facility, among others, at a public venue or on a public road and causes any harm to another person, if the person cannot prove that it has set up any obvious warning sign or taken any safety measure, the person shall assume the tort liability.’ (emphasis added)

The amendments from ‘fails to’ to ‘cannot prove that it has’ provides clarification that the liability is presumed and can be overturned by contrary evidence.

This change of wording reduces the previous ambiguity of law in confirming whether it is strict liability or presumed liability, and it reflects the legislators’ clear attitude towards placing the blame on the appropriate party.

As the liability can be overturned, contractors do not need to bear unreasonable liabilities that should be attributed to the real tortfeasor.

Again, this reminds contractors to reasonably manage the construction activities and be aware of the importance of collecting evidence during construction.

Conclusion

The Civil Code is not an entirely new code, more a modification and perfection of existing rules. The rules of the Civil Code remain stable while there are some partial changes made to suit realities. This description is also true for the rules of construction contracts. Below is an overview of the key changes.

The Civil Code has determined the sequence of applying a quality standard when there is no clear contractual agreement about quality standards for works. A clear path to find the applicable quality standard will not only help the disputing parties to mitigate differences, but will also create new behaviour of consciously applying quality standards within the construction industry.

The adoption of the principle of Change of Circumstance provides the affected parties with the flexibility to amend or terminate contracts and highlights the importance of renegotiation before commencing an action.

The settlement rule for invalid construction contracts allows judges holistically to consider all factors when deciding fair compensation to parties.
The enlarged scope of assistance obligations gives contractors more opportunities to defend themselves.

The arguable right to refuse delivery also provides more possibilities to protect contractors from delayed payment from the employer.

The restoration and clarification of the fault presumption principle in the Tort Law section also demonstrates the legislators’ determination to apply fair treatment in tort cases.

From the amendment to the wording of the Civil Code it can be seen that past experiences accumulated through litigation, research and discussions in the legal community of China have influenced the legislators into incorporating relevant developments to provide fairer market competition for all participants in the construction industry.

 

Note

1 Krell v Henry, www.trans-lex.org/311100/_/krell-v-henry-%5B1903%5D-2-kb-740 accessed
5 January 2021.

2 Translations in this article are unofficial translations provided by the authors.

 

Nan Jinlin is a partner at Zhonglun Law Firm in the Shanghai Office, and can be contacted at nanjinlin@zhonglun.com. Xin Zhifeng is an associate at Zhonglun Law Firm in the Shanghai Office, and can be contacted at xinzhifeng@zhonglun.com. Huang Rongcheng is an associate at Zhonglun Law Firm in the Shanghai Office, and can be contacted at huangrongcheng@zhonglun.com.

 

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