26 August 2015

Whether a Sub-Contractor Is Entitled to a Construction Lien?

This article was written by Deng Yong(Counsel), Lin Jia(Partner) and Wu Wei(Associate)

The problem of delayed payments to builders is ancient and is one of the most frequent litigation actions. Article 286 of the Contract Law and the “Official Reply on Issues Concerning the Construction Lien” issued by the Supreme People’s Court on 20 June, 2002, entitle building contractors to a construction lien, which is an effective tool for the builder’s collection of an unpaid project price. However, due to the complexity and diversity of factual issues in each case, and because the aforementioned provisions are not very detailed, there are differing judicial opinions about how the construction lien works.

Using as an example a case we have handled, we will explore whether the sub-contractor or head contractor is entitled to the construction lien.

Case Brief

Company A, as the project owner and employer, signed a general contract with Company B, agreeing to let a factory expansion project including the pertinent project (hereafter the “Sub-project”) to Company B. Company A was to pay a lump sum fee when Company B delivered the entire project completed and fully functional; and Company B, as the general contractor selected and was responsible for paying the sub-contractors.

Subsequently, Company B sub-contracted the Sub-project to Company C. In the course of performance, Company B and Company C disagreed about the amount of the Sub-project price. However Company A and Company B had already agreed the price for the whole project including the Sub-project, Company B had waived part of its claim for the project price and the agreed price had been paid. Subsequently, Company C sued Company B for the outstanding payment of the Sub-project price and also Company A, the project owner, as jointly and severally liable for Company B’s debt. In addition Company C claimed a lien over the converted into cash or auction price of the Sub-project.

In relation to the lien claim over the cash equivalent or auction price of the Sub-project, the Court at first instance held that the three parties A, B and C constituted a tripartite relationship of “project owner--general contractor--sub-contractor”. The court dismissed Company C’s claim to the lien relying on the Guiding Opinions of the Higher People’s Court of Guangdong Province on the Application of Article 286 of Contract Law in trial (hereinafter “The Guangdong Higher Court’s Opinion on Article 286”) which stated that “the people’s court shall not sustain a sub-contractor’s claim of lien over a project constructed by it ”.

Company C appealed. The Court of Appeal deliberated before deciding that, despite the fact that Companies A and B had already agreed on the price of the whole project including the Sub-project and settled payment, it is important to note that Company B had agreed to waive part of its claim for the price. This meant that, without Company C’s knowledge, Company B had waived part of Company A’s debt before it fully paid Company C’s remuneration. This may have impeded Company C’s right to receive its claimed project price. In addition, Company B never claimed a construction lien. Therefore Company C, as sub-contractor, is entitled to claim a construction lien. The Guangdong Higher Court’s Opinion on Article 286 is only guiding and not a binding ruling. It was intended to apply in situations where the general contractor had already claimed a construction lien, then the people’s court would not sustain a sub-contractor’s claim of lien over the same project. If the general contractor hadn’t claimed a construction lien, which thereby interfered with full payment to the sub-contractor, then the sub-contractor is entitled to claim a construction lien. Accordingly, the Court of Appeal reversed the first instance ruling, and affirmed that Company C was entitled to a construction lien over the Sub-project it had built. But the amount of the claim was limited to the amount of Company A’s partial debt waived by Company B. 

The Issues In Dispute and Different Opinions in Judicial Practice

1. The Issues

This case concerned a sub-contractor’s entitlement to a construction lien when part of a construction project is sub-contracted. Opinions diverge on this issue in practice:

a. Some consider, based on privity of contract, that because there is no direct contractual relationship between the sub-contractor and the project owner, the project owner has no direct obligation to pay the sub-contractor, and because a construction lien is a specific right derived from a contractual right, therefore a sub-contractor has no entitlement to a lien.

b. Others consider that although there is no direct contractual relationship between the sub-contractor and the project owner, the subcontractor should be able to claim a lien because the project owner consented to the subcontract, the sub-contractor is jointly liable with the general contractor for project quality, and to avoid situations where the general contractor fails to claim for the project price or exercise the lien, and particularly to prevent the project owner and the general contractor from causing harm to the sub-contractor’s interests by malicious collusion.

2. Judicial Practice in Different Regions

As there are no specific regulatory provisions or judicial interpretations about whether the sub-contractor or main builder are entitled to claim a lien, some regional courts have issued guiding opinions.

a. Under Article 2 of Guangdong Higher Court’s Opinion on Article 286 where a general contractor enters into a sub-contract and provided both general and sub contracts are valid, then a general contractor may claim a lien over the proceeds of sale of the project when a project owner delays payment. But the people’s court will not sustain a sub-contractor’s claim for a lien over the same project. However, if a general contractor fails to claim a lien which results in damage to a sub-contractor, it can then claim a lien against the project owner up to the price for its sub-contract project under Article 73 of the Contract Law. Under Article 7, if a construction contract is invalid, the court will not affirm a contractor’s claim to a lien.

b. The Jiangsu Higher Court’s Guidance on Issues Concerning the Trial of Construction Contract Cases states that, if a construction contract is invalid, the court will not affirm a lien claim.

c. The First Chamber of Civil Suit of Zhejiang Higher Court Replies to Several Difficult Issues in the Trial of Construction Contractual Disputes provides that, if a sub or head contractor has completed the agreed construction and it meets the quality requirement, and if the general contractor fails to claim a construction lien, then the sub-contractor may claim a lien over the project constructed by it up to the amount of the project owner’s outstanding payment.

d. The Anhui Higher Court’s Guiding Opinion on the Application of Law on the Trial of Construction Project Contractual Disputes says that, if the contract is invalid, but the construction project meets quality requirements and is accepted then the law will support a builder’s lien claim. If the sub-or main contractor has completed the works to the required quality, and the general contractor fails to claim a construction lien, then the court will support a sub-contractor’s lien claim over the project built by it up to the amount of the project owners’ outstanding payment.

Our Analysis

The construction lien entitlements of sub and head contractors can be looked at from a number of perspectives.

1. From the Perspective of the Validity of the Sub-Contract

If the sub-contract is invalid, the project owner may have no knowledge about the sub-contract. It won’t, or may not, know if the general contractor fails to pay the sub-contractor. Accordingly the general contractor should be solely responsible for paying sub-contractor claims and it would be unfair to involve the project owner which should be entitled to say it was not privy to the contract.

If there is a valid sub-contract, the project owner usually knows or ought to know about it. It would be aware of the risk that the sub-contractor might exercise a lien, and it has the opportunity to verify with the general contractor and the sub-contractor if any payments have not been made in full.

Therefore, we consider the validity of the sub-contract should be the basic precondition for ignoring the privity of contract rule to protect a sub-contractor’s lawful rights, and the Supreme People’s Court should issue an interpretation outlining the basis for breaking the privity of contract rule.

2. Has the General Contractor failed to Exercise its Lien?

Where there is a valid sub-contract and the general contractor has failed to exercise a lien and damaged the sub-contractor’s interests, then according to Article 73 of the Contract Law, the sub-contractor can claim a construction lien against the project owner, for the amount of the project price owed by the owner. However there is no clear standard to determine whether the general contractor has failed to exercise the lien. This has triggered variations in different cases and undermines the certainty of the law.

In our case example, although Companies A and B settled and full payment was made, and Company B waived part of the project price in consideration of its own default (e.g. late delivery), the appellate court decided that Company B had failed to exercise its lien simply because it waived part of the project price and settled on payment.

We consider that whether the sub-contractor is entitled to a right of subrogation and the construction lien when the project owner and the general contractor have already settled and full payment has been made, will depend on whether the project owner and the general contractor have deliberately reduced the project price by malicious collusion, thereby causing harm to the sub-contractor. This requires the court to examine the facts of each case.

Based on the assumption that the project owner and general contractor have provided prima facie evidence proving that they have settled the payment of the project price, the sub-contractor then bears the burden of proving that the project owner and the general contractor have caused it damage through malicious collusion.

In our case, the Court of Appeal simply held that the general contractor failed to exercise the lien. It did not examine the legitimacy of or justification for Company B waiving part of the project price. We consider that if this is not done it can be unfair to a project owner.

Suggestions

We suggest that legislation and judicial adjudication could be improved.

1.  Advice for legislation

Throughout China’s construction industry sub-contracts are very common. It would be helpful if legislation stipulated a standard clear provision setting out sub-contractor’s rights to a construction lien. In particular it could set out the parties rights to construction liens when either or both of the head and sub-contracts are invalid. This would resolve the problem of the different interpretations by courts in different regions. In addition, issues around the reasons for the failure of contractors to exercise liens and burden of proof need to be further clarified and specified.

2. Advice for adjudication

Where sub-contractors claim construction liens, the people’s court might address the following matters:

a. The validity of the general contract and the sub-contract;

b. Whether the project owner has settled full payment of the project price; if not, then the amount of the outstanding payment and the corresponding construction works will need to be ascertained;

c. Whether the general contractor failed to exercise its lien, or whether the project owner and the general contractor have colluded to cause harm to the sub-contractor’s legitimate interests.

The project owner and/or the general contractor must prove the project price has been settled between them. We consider they should also have the burden of proving the legitimacy and justification for increasing or decreasing the final settlement price (if any). When the project owner and general contractor have evidenced prima facie that the construction project price has been settled, then it is up to the sub-contractor to prove that either the general contractor failed to exercise the lien or the project owner and general contractor colluded to deliberately decrease the construction project price, which has harmed the subcontractor’s legitimate interest in asserting the construction lien. 

Editor’s note: This article was simultaneously published on Chinalawinght.com

This article was originally written in Chinese, and the English version is a translation.

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