Earth Research | A brief discussion on the priority right to payment for engineering project costs

Authors: Chen Xia, Wang Xinyu

The priority right to payment for construction projects refers to the right of the contractor in a construction project contract to be preferentially compensated for the value of the project or the auction proceeds after the contractor has completed the construction according to the contract, but the owner has failed to pay the project funds within the contractually stipulated time limit.

Article 807 of the Civil Code

If the owner fails to pay the price according to the agreement, the contractor may urge the owner to pay the price within a reasonable period. If the owner fails to pay within the time limit, except where the nature of the construction project is unsuitable for devaluation or auction, the contractor may agree with the owner to devalue the project, or may request the people's court to auction the project in accordance with the law. The price of the construction project shall be preferentially compensated for the price of the devaluation or auction of the project.

Interpretation (I) of the Supreme People's Court on the Application of Laws in Trying Cases of Construction Project Construction Contract Disputes

Article 35 If a contractor who has entered into a construction project construction contract with an owner requests preferential compensation for the price of the project he/she has built based on the price of the project's devaluation or auction according to the provisions of Article 807 of the Civil Code, the people's court shall support it.

Article 37 If the decoration and renovation project meets the conditions for devaluation or auction, and the contractor of the decoration and renovation project requests preferential compensation for the project price based on the price of the devaluation or auction of the decoration and renovation project, the people's court shall support it.

According to the provisions of the Interpretation (I) of the Supreme People's Court on the Application of Laws in Trying Cases of Construction Project Construction Contract Disputes, the contractor must meet the following conditions to exercise the priority right to payment for construction projects:

(1) There is a construction project construction contract signed between the owner and the contractor. The subject of the priority right to compensation is the contractor who has entered into a construction project construction contract with the owner. The invalidity of the construction project construction contract does not affect the exercise of the priority right to compensation.

（ (2) Qualified Project Quality 。 The project for which the contractor requests priority compensation must be a qualified project. Whether the project is completed or not does not affect the priority right to compensation.

(3) Overdue Payment The owner has not paid the project funds within the contractually stipulated time limit, and the contractor has already issued a notice of default.

(4) The Project Can Be Devalued or Auctioned The priority right to compensation does not apply if the nature of the project is unsuitable for devaluation or auction, such as illegal buildings or projects involving public interests.

According to Article 35 of the Interpretation (I) of the Supreme People's Court on the Application of Laws in Trying Cases of Construction Project Construction Contract Disputes, the subject who exercises the priority right to payment for construction projects is the contractor. However, there are some different views in practice on the scope of the subject of the priority right to payment for construction projects.

The actual contractor here refers to the unit or individual who specifically implements the construction of the construction project after the construction project construction contract is deemed invalid. In practice, this mainly includes subcontracting, illegal subcontracting, and contractors who use borrowed qualifications or rely on others' qualifications.

Some believe that the actual contractor does not enjoy the priority right to payment for construction projects. The minutes of the 21st professional judges' meeting of the First Civil Tribunal of the Supreme People's Court in 2021 clearly state that according to Article 807 of the Civil Code and Article 35 of the Interpretation (I) of the Supreme People's Court on the Application of Laws in Trying Cases of Construction Project Construction Contract Disputes, only the contractor who has entered into a construction project construction contract with the owner enjoys the priority right to payment for construction projects. The actual contractor does not belong to the "contractor who has entered into a construction project construction contract with the owner" and does not enjoy the priority right to payment for construction projects.

There are also cases where the judgment holds that, under specific conditions, the actual contractor enjoys the priority right to payment for construction projects. For example, in case (2020) Supreme People's Court Min Shen 6461, the Supreme People's Court held that since the owner always knew and acknowledged the fact that the actual contractor was using borrowed qualifications to carry out the actual construction, and accepted the deposit paid directly by the actual contractor, and paid the project funds directly to the actual contractor, the Supreme People's Court ruled that the actual contractor enjoys the priority right to compensation within the scope of the owner's arrears of project funds and interest.

According to the judicial view of the Supreme People's Court, it is believed that the assignee of the construction project claim enjoys the priority right to payment for construction projects, which is conducive to the transfer of construction project claims. In judicial practice, the Supreme People's Court (2021) Supreme People's Court Min Shen No. 36 judgment also affirmed this, confirming that the transfer of the principal claim for construction project payment also transfers the priority right to payment for construction projects.

This issue is controversial in academia. According to the judicial view of the Supreme People's Court, it is believed that the invalidity of the construction project construction contract should not affect the exercise of the priority right to compensation. In an invalid construction project contract, the construction costs have been actually paid, and should be paid by the owner. Even if the contract is invalid, it is still beneficial to protect the interests of workers to determine that the contractor enjoys the priority right to compensation for this payment, which is in line with the legislative purpose of the priority right system for construction projects.

(1) Construction Projects with Unqualified Quality and Unable to Be Repaired

The qualified quality of the construction project is a prerequisite for the contractor to request preferential compensation for the price of the project he/she has built based on the price of the project's devaluation or auction. If the repaired construction project fails to pass the completion acceptance inspection, the contractor has no right to claim the priority right to compensation.

(2) Unlawful buildings

This refers to situations where construction is illegal in substance and procedure, and cannot be rectified. Specifically, it refers to construction projects that inherently violate land planning and construction planning, have already harmed public interests, as well as situations where although the construction meets planning requirements, relevant procedures have not been completed and cannot be rectified before a substantive court hearing for judicial relief. In conjunction with Article 35 of the "Detailed Rules for the Implementation of the Provisional Regulations on Real Estate Registration", given that such illegal buildings are not legally recognized and valuable buildings or structures, they cannot be registered and cannot be transferred, thus they cannot be transferred through discounted auction.

(3) Construction projects with public, welfare, or common usage properties

For construction projects with public, welfare, or common usage properties, such as construction projects owned by public institutions and social organizations for public welfare purposes (e.g., schools, kindergartens, hospitals, civil defense), highways and municipal projects (e.g., road bridges and tunnels, greening, power generation projects), religious venues, social welfare facilities (e.g., resettlement housing, public rental housing), as well as office buildings or military structures already in use by state organs, the contractor does not enjoy priority in receiving payment and cannot sell them through discounted auction, due to public interest considerations.

Article 41 of the "Interpretation (I) of the Supreme People's Court on Several Issues Concerning the Application of Law in the Trial of Cases Involving Disputes over Construction Project Contracts" stipulates: The contractor shall exercise the priority right to compensation for the construction project price within a reasonable period, but no longer than eighteen months, calculated from the date the project owner should pay the construction project price.

Determining the "date when the construction project price should be paid" requires an objective judgment based on specific actual cases:

Firstly, if the construction project contract clearly stipulates the payment time and method, and the contract has been fully and normally performed, the parties' agreement should be followed. If the contract is invalid, but the construction project has passed final acceptance, the payment time for the project funds can be determined by reference to the contract's stipulations.

Secondly, if the contract is terminated or its performance ceases, specific circumstances should be distinguished:

(1) After the termination of the contract, if the completed construction project is of qualified quality, the starting time for exercising the priority right to compensation should also follow the contract's stipulations. If the project owner and contractor reach another agreement on the payment of project funds after the contract termination, then the payment time agreed in that agreement shall be the starting time;

(2) If there is a dispute between the parties regarding the amount of project funds, and appraisal may be required, and if the parties officially assert their rights to judicial organs or arbitration institutions, and the people's court and arbitration institutions confirm that the project owner owes the contractor project funds, the payment due date should be the date the party filed the lawsuit.

Finally, if the parties have no agreement on the payment time or the agreement is unclear, reference can be made to Article 27 of the "Interpretation (I) of the Supreme People's Court on Several Issues Concerning the Application of Law in the Trial of Cases Involving Disputes over Construction Project Contracts" regarding the starting time for the project owner to pay interest on construction project funds to the contractor:

(1) If the construction project is actually delivered, the delivery date of the construction project shall be the payment due date;

(2) If the construction project is not delivered, but the contractor has submitted the completion settlement documents within the time agreed in the contract after the construction project has passed final acceptance, the date of submission of the completion settlement documents should be recognized as the payment due date;

(3) If the construction project price has not been settled and the project has not been delivered, which mostly occurs when the project is not completed or has not been accepted after completion, the settlement conditions agreed in the contract have not yet been met. In this case, a deemed payment due date should be stipulated, with the date the plaintiff filed the lawsuit in the first instance serving as the payment due date.

Article 40 of the "Interpretation (I) of the Supreme People's Court on Several Issues Concerning the Application of Law in the Trial of Cases Involving Disputes over Construction Project Contracts" stipulates: The scope of the contractor's priority right to compensation for the construction project price shall be determined in accordance with the regulations of the relevant administrative departments of the State Council regarding the scope of construction project prices. If the contractor claims priority compensation for interest on overdue payments of construction project prices, liquidated damages, damages, etc., the People's Court shall not support it.

The contractor can only exercise the priority right to compensation for the construction project price. Losses caused by the project owner's breach of contract (such as liquidated damages, losses from downtime and material price differences due to the project owner's breach, and interest on overdue project payments) do not fall within the scope of priority compensation for the construction project price.