Construction and projects in China: overview
A Q&A guide to construction and projects law in China.
The Q&A gives a high level overview of the main trends and significant deals; procurement arrangements; transaction structures and corporate vehicles; financing projects; security and contractual protections that funders require; standard forms of contracts; risk allocation; excluding liability, including caps and force majeure; contractual provisions covering material delays and variations; appointing and paying contractors; subcontractors; licences and consents; projects insurance; employment laws; health and safety; environmental issues; corrupt business practices and bribery; bankruptcy/insolvency; public private partnerships (PPPs); dispute resolution; tax and mitigating tax liability; and proposals for reform.
To compare answers across multiple jurisdictions, visit the construction and projects Country Q&A tool.
This Q&A is part of the global guide to construction and projects law. For a full list of jurisdictional Q&As visit www.practicallaw.com/construction-guide.
Overview of the construction and projects sector
China has one of the largest construction markets in the world. The construction sector is a key industry for China's domestic economy. However, it is currently experiencing unequal growth paths, fluctuations and downturn.
The Chinese government has taken action, including increasing the growth of the real estate market to prevent the construction sector from a continuous downturn. In November 2013, the 3rd Plenary Session of the 18th Central Committee of the Communist Party of China stated that China's new reforms should focus on promoting more sustainable and qualitative development and growth. In 2014, the government issued ''China's New-Style Urbanization Plan (2014-2020)'', which further identifies the requirement for sustainable and qualitative growth and sets targets for ''green, smart and cultural cities''.
In November 2015, the government issued the 13th release of the Five Year Plan, which plans to expand the infrastructure construction market. It is foreseeable that the construction sector will find a new balance that brings more sustainable growth in 2016.
In 2015 December, the National Development and Reform Commission approved the cross-river channel construction project, linking Shenzhen City to Guangzhou City, one of the biggest projects in China. Work on the Shenzhen side of the channel began late last year and the major works will follow in 2016 The entire project is estimated to cost RMB 42.4 billion.
The second Beijing International Airport is currently under construction in Beijing's Daxing district. On its estimated completion in 2019, the airport will cover an area of 70,000 square meters and will be the biggest airport in the world.
In 2015, according to China Railway Corporation, China spent RMB820 billion on rail projects and put more than 9,000 kilometers of new track into operation. China has 19,000 kilometers of high-speed rail.
China is continuously executing its social housing programme and plans to build 36 million affordable and subsidised apartments between 2011 and 2015. The government built more than 7.7 million housing units in 2015, with a total investment of RMB1,540 billion.
The main parties involved in a project are:
Project management company.
Certified project supervising agency (the role is primarily to represent project owners for ensuring the contractors' materials and workmanship are in accordance with design specifications and mandatory national construction quality standards).
Chartered quantity surveyor (responsible for carrying out estimates and measurements of construction work progress, and verifying bills of quantities submitted by the contractor).
Owner-designated subcontractors (such as interior design and decoration companies, landscaping contractors, and so on).
Material suppliers and subcontractors engaged by the general contractor.
For projects involving large-scale production facilities (such as nuclear power stations and petrochemical projects), owners often choose a design-build and engineering, procurement and construction (EPC) model.
International investors sometimes prefer separately engaging foreign-owned conceptual designers.
A newly established foreign enterprise without an experienced local project management team may choose the engineering, procurement and construction management (EPCM) method. Under this model, an EPCM consultant undertakes engineering design, advises on procurement, and oversees and manages construction works, but does not physically construct the plant. The EPCM consultant negotiates construction and supply contracts on behalf of the owner, but each contract is concluded between the owner and contractor or supplier.
In the residential and commercial real estate sectors, an owner usually enters into separate contracts with a design institution and a general contractor. Under this method, the owner retains a designer to design and produce tender documents on which prospective general contractors will bid, and then enters into a build-only contract with the chosen general contractor.
There is no visible distinction between the types of procurement arrangements used by international and local contractors or consultants. Local contractors on domestic projects can elect to use standard form contracts issued by the Ministry of Construction. However, domestic projects with a foreign aspect, can adopt international forms of contract, such as contracts by the International Federation of Consulting Engineers.
If financial resources permit, most developers choose to set up wholly owned special purpose vehicles (SPVs) for real property projects.
If a developer does not have sufficient capital, it can involve other investors by means of:
A joint venture (in which two or three partners form a joint venture corporation).
A joint development (in which partners first incorporate their own project company, and then jointly develop the project by entering into a joint development agreement).
Contractual arrangements between an owner and the builder (the primary investor will engage a partner to construct the project, and use the ownership of part of the project as compensation).
If a project involves foreign capital and falls under the "restricted foreign investment" category published by the State Council (China's cabinet), Chinese law requires setting up a Sino-foreign joint venture structure (sometimes with the Chinese partner holding a majority ownership). Projects falling under this category include (Catalogue for the Guidance of Foreign Investment Industries (Amended in 2015)):
Urban gas, heating power and water supply and drainage pipe.
Power grid systems.
Cinemas and large theme parks.
The structures for projects involving international contractors or consultants are the same as for local projects, however, projects that involve foreign capital can face extensive requirements (see above, Local projects).
Bank loans continue to be the primary financing tool for most local construction projects. Before issuing the loan, a bank must verify that the owner has committed at least 35% of its own cash for developing the real estate project and 30% for other projects. For foreign-invested owners, the maximum amount they can borrow is subject to a capped debt-to-equity ratio prescribed by relevant administrative regulations. Direct inter-company loans are generally not permitted under Chinese law except in the form of a shareholder loan. As a result, a local owner is legally required to borrow from banks or other financial institutions or use a bank-involved entrusted loan structure. In practice, the use of loans from related or affiliated parties, who are neither financial institutions nor shareholders, is a common practice in capitalising real estate development companies.
In recent years, the Chinese government has implemented ways of increasing the growth of the real estate market, such as by confirming financial support for provincial-level public projects, and further opening up the local market to foreign investors. In August 2015, the government cancelled the requirement that a foreign invested real estate company must fully pay its registered capital before applying for domestic loans, foreign loans, or settlement of foreign exchange loans.
In local residential real property projects, it is not uncommon for a project owner to require the general contractor to make a capital contribution as a pre-condition for awarding the construction contract. Typically a contractor might forego the advance payment for mobilisation and purchasing materials. If the owner fails to meet the monthly payment schedule, the contractor must continue its works and fund the construction out of its own pocket. Sometimes, contractors voluntarily make promises on capital contribution as a means to obtain projects. Under a 2006 government decree, this practice is prohibited in government-funded projects.
In addition to the practice, developers are seeking alternative financing through:
Venture capital and private equity funds.
Issuing corporate bonds.
Initial public offerings (IPOs).
International projects with foreign capital
Many international projects are entirely equity financed by the developer, partially because no offshore borrowing (including third-party loans and shareholder loans) has been permitted since 2007, as well as due to difficulties in obtaining local loans. These foreign investors include listed or privately held offshore real estate companies, and funds.
The Catalogue for the Guidance of Foreign Investment Industries (Amended in 2015) removed ''real estate'' from the Catalogue of restricted foreign investment industries. However, foreign investors must set up an onshore company to invest in the Chinese real estate market. Offshore intermediate holding companies are commonly set up between the foreign investors and their Chinese onshore SPVs. Many of these holding companies are incorporated in Hong Kong to take advantage of the more favourable preferential treatment under various mainland China-Hong Kong investment treaties.
The branches and representative offices of foreign institutions established in China (except for the companies that are approved to operate real estate businesses) and the foreign individuals that work or study in China can purchase residential houses for personal use. It is foreseeable that government scrutiny over the foreign investment in China's real estate market will be reduced.
In November 2015, the Ministry of Commerce and the State Administration of Foreign Exchange issued ''Further Improving the Filing of Foreign Investments in Real Estate'' to simplify the administrative procedures for foreign-funded real estate companies and to cancel the registry publication procedures on the website of the Ministry of Commerce. However, after the acquisition of real estate there is likely to be continued scrutiny and the Ministry of Commerce may conduct random inspections on foreign-funded real estate enterprises on a quarterly basis.
A fifth of all construction spending in China involves public works projects. The majority of infrastructure projects are financed by central and local governments.
In May 2013, the Chinese government announced plans to further relax ownership restrictions on large public infrastructure projects by allowing the private sector involvement of developer owners, project operators, and financiers.
Some projects have been funded by international organisations, including the World Bank (for example, the Hubei Yiba Highway Project and the GuiGuang Railway Project).
Security and contractual protections
Lenders that provide debt financing usually ask for a full security package, including:
A mortgage on the land use rights and the buildings under construction.
A pledge over the equity interests of the developer.
A charge over existing and future accounts receivables.
Somewhat unique to China, loan agreements signed with asset-management companies may require collateral of up to three times the value of the loan.
If a developer does not have strong credit, the lender may require a third party guarantee. There are professional guarantee companies which can provide such third party guarantees in exchange for service fees ranging from 2% to 3.5% of the amount secured under the guarantee.
Banks often require developers to present proof of the payment obligation (such as signed contracts and invoices) before releasing loan proceeds. The payments are sometimes disbursed directly from the lender to the payee's accounts, to prevent the borrower from misusing the funds for non-project related purposes.
In terms of equity investments, many institutional investors request retraction rights exercisable on a fixed date (fixed dates) and for a fixed price. From 2007, foreign equity investors are no longer allowed to demand fixed-return guarantees from their Chinese partners in Sino-foreign joint ventures (see Question 3, Local projects).
Standard forms of contracts
For local projects, the most commonly used standard form of contract has been the Model Construction Project Contract, published by the former Ministry of Construction in 1999. An updated version came into effect in 2013.
Similar model contracts also exist for:
Project supervision services.
Chinese law does not require project owners and contractors to adopt standard contracts. However, Chinese construction contracts must be filed with the local Construction Commission (municipal or county level), and there is a tendency among some local governments to require the use of the Model Construction Project Contract. In some jurisdictions, no major modifications to the standard form are allowed, for example, the parties may be prevented from:
Agreeing to a higher amount of liquidated damages.
Substantially modifying the allocation of contract risk.
If the local government permits the parties to adopt their own contracts (see above, Local projects), many foreign investors (especially those in the manufacturing and infrastructure sectors) prefer the standard form contracts published by the Fédération Internationale des Ingénieurs-Conseils (FIDIC).
Allocation of risk is subject to the parties' agreement. For example, the contractor often bears the risks of project overrun costs including:
Inaccurate cost budgeting.
Price escalation of material.
Uncertainties relating to the availability of material.
Labour cost increases.
A contractor can mitigate these risks by stipulating in the contract that if escalation of material and labour costs exceeds a certain limit (for example, over 3%), the owner must increase the contract price.
Other risks commonly allocated to contractors are:
Project safety and quality risks.
Unanticipated ground conditions.
Due to fierce competition in the construction sector, many contractors undercut their competitors in the bidding process by agreeing to a low lump sum contract price with the hope that they will be able to recover costs by means of variations, threat of delay and suspension of work, or even a labour strike. While risky, contractors may often succeed with this tactic if the project owner is eager to complete the project on time for commercial reasons.
The contractor can contractually exclude or restrict its liability through:
A cap on liability.
Low liquidated damages.
Exclusion of indirect or consequential loss.
Parties to a construction contract should not assume that the courts will always enforce an exclusion clause. If a strict application of the clause will produce manifest injustice to one party, the court can make an equitable adjustment to the contract (for instance, if actual damages substantially exceed the capped amount).
Under the law, liability can be limited, in whole or in part, if the underlying damage is caused by a force majeure event or a material change of circumstance as defined by the relevant judicial interpretations issued by the Supreme People's Court (see Question 10).
Liability for bodily or personal injury cannot be excluded, and liability for property damage cannot be excluded if it is incurred deliberately or due to gross negligence (PRC Contract Law).
Caps on liability
The parties typically include a cap on damages so that they do not exceed the value of the project, or a percentage of the project for larger construction projects.
Parties would also typically include a bar against recovery of indirect damages. The owner and the contractor sometimes agree to a cap on delay damages caused by the contractor, ranging from 5% to 10% of the contract price. Whether those limits will be agreed, and at what rate, is often determined by the relative bargaining power of the parties. Liabilities relating to construction defects are often not capped.
While these caps are relatively standard on international projects, Chinese contract provisions differ in one key respect. A court or arbitral body adjudicating a breach of contract can amend the terms of the contract if they are overly one-sided or onerous to a party. In addition, liquidated damages amounts may be increased or decreased if they do not accord with the actual injury or vary from industry practice.
Force majeure clauses are commonly included in Chinese construction contracts and are enforceable. Force majeure events typically cover:
Even where not included in the contract, the concept of force majeure is contained in the PRC Contract Law.
A contractor can also rely on the equitable principle of material change of circumstances. This applies to situations where there is an exceptional economic event (such as an exorbitant increase in material costs) that could not have been foreseen by a reasonable contractor at the time of entering into the contract. Under such circumstances, the contractors can elect to either:
Terminate the entire contract.
Petition the court to amend the contractual terms in their favour.
Under most contracts, when delays are attributed to the contractor's fault, the owner is entitled to liquidated damages calculated on a daily basis. In the event of prolonged delays, the owner has the right to terminate the contract and remove the contractor from the site.
For delays caused by the owner, the contractor is entitled to an extension of completion, and costs incurred because of the delay (for example, idling costs, re-mobilisation costs, material storage costs and other resulting costs and expenses). Many owners, however, will not agree to compensate for lost profit.
Local project disputes over delays can differ from international disputes. It would be common in an international dispute to have expert scheduling opinions regarding the source, the extent and the attribution of the days of delay. It would be unusual in China to see a detailed scheduling analysis, including detailed critical path analysis.
The owner is permitted to change the scope of work and make variations. Material variations are dealt with by executing a change order. The contractor may be entitled to additional cost and an extension of time. Both parties typically agree on any price adjustment before the contractor proceeds with the additional work. Certain types of variations can be adjusted based on a price adjustment index attached as an appendix to the contract. If there is no prior written agreement, both parties can also reach agreement by referring to a standard construction unit price index published by the local government.
Other negotiated provisions
If a contract is awarded through a tender process, it is unusual for the contractor to be able to negotiate material contractual terms.
Where a contract is privately negotiated without a tender process, contractual provisions which are often subject to intensive negotiations include the following:
Scope of works (including division of responsibilities among the general contractor and various subcontractors designated by the owner).
Liquidated damages amount and cap on liability.
Insurance provisions (for example, scope of exclusions, limits of indemnity, policy extensions and so on).
Security (such as a performance bond, advance payment guarantee, and withholding payment).
Architects, engineers and construction professionals
A tender process is required on certain but not all projects. The majority of projects, even private, of significant scale are subject to tender. Generally, the owner selects and engages construction professionals, such as:
Project supervising agencies.
Chartered quantity surveyors.
Large real estate development companies normally do not engage a third party quantity surveyor as they have their own in-house cost engineers to measure bills of quantities submitted by the contractor. Hiring a project supervising agency is mandatory for certain types of projects, such as:
Large-scale residential developments.
Due diligence of the contractor should play a larger role in Chinese projects than elsewhere. In particular, the practice of licence borrowing in China requires greater due diligence of tenderers. Licence borrowing is where a smaller contractor or ad hoc group of workers uses a larger company's name and licences to get the project. As a consequence, the tenderer may not have the experience or licences claimed, and in the event of a dispute, the owner may have difficulty enforcing its rights because the:
Named contractor is in fact not actively involved.
Licence borrower may be under capitalised.
Licence borrower has no vested interest in the reputation of the named contractor.
Construction professionals generally execute separate service agreements. If the owner wishes to retain an offshore engineering design firm to provide services beyond conceptual and schematic design, a tripartite agreement should be entered into between the owner, the offshore designer, and a qualified Chinese design institution. Another legally permissible option is to sign a joint design agreement between the offshore engineering design firm and the qualified Chinese design institution.
Under these professional services agreements, parties can agree to cap liabilities up to:
The contract price.
A fixed amount.
The maximum insurance coverage for the specific risk.
Payment for construction work
Methods of payment
Construction contract payment structures are subject to mutual agreement. Many construction contracts in China use a fixed lump sum method under which the contract price is fixed. Invariably, the contract provides for ways in which the contract price can be adjusted, for example:
Materials and labour cost escalation.
Delays caused by unforeseeable events.
As in many jurisdictions, other structures are used, such as cost-plus contracts (that is, where the contractor is paid for allowed expenses plus profit, time and materials, and so on), depending on the nature of the project and the needs of the parties.
Payments are usually made by wire transfer and telegraphic transfer.
In our experience, under some construction contracts, the owner withholds 10% to 20% of each progress payment until the project has received final acceptance, and this is in addition to the typical 5% retention money payable at the end of the warranty period.
Under a 2006 national decree issued by the former Ministry of Construction, where a real estate development project has a value over RMB10 million, the owner must obtain a payment guarantee issued by a bank or surety company in favour of the contractor. In some localities, the minimum guarantee amount is 10% of the contract price.
If an owner defaults in making payments to the contractor, the contractor can apply to the court to (Article 286, PRC Construction Law):
Have the construction project auctioned.
Recover the outstanding payments from the proceeds of the auction.
In terms of payment priority, the contractor's right of recovery is ranked above mortgage rights and other trade debts, but below home buyers who have signed pre-sale agreements with the owner and paid more than half the purchase price.
A contractor's priority right can be waived. In some domestic projects, the financing bank will demand that the owner sign a waiver agreement with the contractor as a precondition for granting the loan. The contractor may choose to sign such an agreement in order to undertake the project.
In most contracts, the owner prohibits the general contractor from using payments earmarked for subcontractors for other purposes (for example, to support the general contractor's other projects). The owner is not liable to pay a subcontractor directly, unless the general contractor has not received payment from the owner.
The parties can agree to make the general contractor responsible for works performed by owner-designated subcontractors. In exchange, a general contractor will receive management and supervision fees, typically around 2% of the value of the subcontracts.
In the absence of such an agreement, Chinese law requires that project owners bear joint and several liability for quality defects caused by owner-designated subcontractors. In practice, however, if the owner can prove that the general contractor has or should have been aware of the defects but failed to order the subcontractor to make remediation, the general contractor may also be asked to assume liability. This is based on the legal doctrine that general contractors have a statutory duty to oversee subcontractors' work.
Article 24 of the PRC Construction Law prohibits a general contractor from dividing up the work among several subcontractors. The general contractor must complete the main part of the construction project himself. Specialist subcontractors are engaged for technical or specialised works such as interior decoration, landscaping, and sewage systems. The legislative intent is to ensure that the general contractor who receives the tender is the party who is primarily responsible for completing the work. Illegal subcontracting to non-qualified third parties is the cause of various quality problems in China's construction industry.
Local contractors and construction professionals
To carry out any work in China, whether in the public or private sector, the contractor must be incorporated and be qualified by the Ministry of Housing and Urban-Rural Development (MOHURD) (China's national construction administration authority, formerly known as the Ministry of Construction) or its local branches. This applies to:
Almost all specialist subcontractors (for example, interior decoration, landscaping, and electrical installation specialists).
Construction professional firms providing services in survey, design, project consultancy and project supervision.
International contractors and construction professionals
International engineering design firms. For international engineering design firms, three options are available in order to work in the Chinese market:
First, foreign design firms can undertake conceptual and schematic design work outside China, with off-shore services and payment to the foreign entity.
Second, pursuant to MOHURD Circular 78, a design firm incorporated in a foreign jurisdiction can undertake engineering work for a PRC project if that foreign firm jointly co-operates with a qualified PRC design institute (see Question 15). However, the foreign firm's engineering services must be performed entirely outside China, and this contracting method is not available for foreign invested design enterprises (FIDEs) incorporated in China. In this case, the foreign designer should not undertake to render construction drawings as that is solely within the purview of a PRC-licensed design firm.
Finally, the foreign design firm can incorporate an FIDE in China, either as a:
wholly foreign owned enterprise; or
Sino-foreign joint venture company.
In terms of qualification requirements, an FIDE must meet the same standards as those applicable to local Chinese design firms in the same qualification class, including the minimum amount of registered capital, requisite number of technical personnel and project experience (see above, Local contractors and construction professionals). Additional requirements are set out under MOHURD Circular 114 and Circular 18, which are rather onerous and are generally perceived as trade barriers.
Pursuant to MOHURD Circular 30 and Circular 161, a qualified engineering design firm, other than providing design services, can also act as an EPC general contractor if its design license allows it to do so. If that firm does not have the requisite qualifications for performing construction work, it is allowed to subcontract the construction work to a construction contractor. MOHURD regulations are silent on whether an offshore engineering design firm (not an FIDE) is permitted to carry out EPC projects in collaboration with a PRC design institute. In practice, a number of foreign engineering firms have entered into joint venture consortium arrangements with qualified PRC design institutes to undertake EPC projects in China. Legal practitioners hold divergent views on the legality of this structure.
International construction companies. Foreign invested construction enterprises (FICEs) must have the same qualifications as local construction companies to apply for licensure (see above, Local contractors and construction professionals). In addition, FICEs can only undertake projects where
Projects are built exclusively with foreign investment.
Foreign funding constitutes 50% or more.
Joint projects with less than 50% of foreign investment cannot be independently implemented by Chinese construction enterprises due to technical difficulties.
Projects financed by international financial organisations.
Domestic projects that are technically challenging for Chinese contractors (see below, Other requirements for international contractors).
International construction and professional service companies must generally obtain the same Chinese qualifications as local companies (see above, Local contractors and construction professionals).
International project management companies. Other than FIDEs and FICEs (see above), there are four additional local qualifications available for foreign invested companies:
Dealing with construction permits is a time-consuming and bureaucratic process in China.
A project owner is responsible for obtaining the following permits and approvals:
An approval of the project business proposal from the national or local Development and Reform Commission (China's macroeconomic planning body). The project business proposal must be accompanied by:
an environmental impact assessment report;
a work safety pre-evaluation report; and
an occupational hazards pre-evaluation report.
An approval of the construction project planning and design plan from the responsible Urban Planning Department.
A construction land-use planning permit from the responsible Urban Planning Department.
A land-use title certificate from the local branches of the Ministry of Land and Resources (private entities are not permitted to own land in China, and can only acquire the right to use the land from the state).
A construction project planning permit from the responsible Urban Planning Department, with joint review and approval by other government authorities including:
Environmental Protection Authority;
Land Administration Authority;
Construction Administration Authority; and
Fire Protection Authority.
A certificate of safety operation from the Safety and Quality Supervision Office of the responsible local Construction Commission.
A construction permit from the local Construction Commission.
In addition, the project owner (or general contractor under a design-build or EPC contract) must submit construction drawings for review and filing with:
The government-authorised building drawing examiner.
The local Fire Protection Authority.
Any other government bodies required by local regulations.
The tender process can be organised on a public or private basis. Key construction projects which have significant national or regional influence must adopt a public tender process unless an exemption is granted. Regardless of the nature of the tender process, the owner must conduct the tender under the supervision of a local Construction Commission's Tendering Administration Office.
During the construction, inspection of the construction work is regularly carried out by the owner's representative, and the project supervising agency. The Quality and Safety Monitoring Office (administered under the local Construction Commission) may conduct random on-site inspections throughout the construction phase.
On completion, the following jointly inspect the quality of the works and produce documentation stating the results of their inspection:
The owner's representative.
The project supervising agency.
The general contractor's representative.
This documentation must be signed by all the parties and filed with the local Quality and Safety Monitoring Office.
In addition, the owner must obtain various occupancy permits from:
Urban Planning Department.
Public Security Authority.
Fire Prevention Authority.
Environmental Protection Bureau.
People's Defence Office.
The local Construction Commission must carry out a completion inspection if the project is of a certain scale or significance.
The following types of insurance must be maintained:
Workers' compensation contribution, administered by the local social security administrative centres.
Contractor's personnel engaged in dangerous operations accidental injury insurance, a commercial insurance policy, which is compulsory in most localities, although optional under the PRC Construction Law.
Professional liability insurance for designers and surveyors. In some local jurisdictions, there are mandatory rules requiring designers and surveyors to obtain professional liability insurance for certain types of projects. For example, in Shenzhen, engineering design and survey firms must purchase insurance when providing services on:
public projects (for example, public infrastructure or residential projects); and
projects funded by governments, state-owned enterprises, international organisations, or foreign loans.
In Beijing, foreign or non-Beijing design and survey firms must submit proof of professional liability insurance to the government when undertaking Beijing local projects. Otherwise, they must provide a third-party guarantee, or documentary evidence demonstrating that they have adequate financial resources to self-insure the risk.
Employers may require that contractors provide the following non-compulsory insurance, or procure it themselves:
All-risks construction insurance, which covers property damage suffered by the owner and the contractor.
Third party liability insurance, which covers both personal injuries and property damages.
Professional liability insurance for architects, engineers, and other professional consultants (where there is no mandatory local requirement).
In international projects, foreign owners or professional consultancy firms often take out and maintain non-compulsory professional liability insurance, whereas this type of policy is usually not viewed as necessary in domestic projects.
For large infrastructure projects, owners can retain the services of professional insurance brokers for overall risk management. For example, China’s Three Gorges Dam project hired Willis Insurance Brokers Co Ltd (a leading global insurance advisory firm) to provide comprehensive insurance advice and solutions.
Generally, there are no labour law requirements for hiring local employees. A general contractor can:
Hire construction labourers directly.
Recruit workers through a labour dispatch company which acts as an intermediary.
Engage a labour subcontractor.
About 90% of China's vast urban construction force is made up of migrant labourers from the countryside. Throughout China's construction industry, there are many illegitimate "labour brokers" acting as intermediaries between the contractors and migrant workers looking for work in the cities. These labour brokers have been the target of periodic government crackdowns. They operate without a labour dispatch business licence or labour subcontracting qualification, and usually do not provide any safety training or make social security contributions for their workers. Wages arrears have become a chronic phenomenon.
Construction enterprises can employ foreign workers as technical and management personnel.
If a foreign employee intends to work in the PRC for a period longer than three months, generally he:
Must obtain an alien employment licence and a work visa (Z visa) before entry into China.
Shortly after entry, obtain a:
work certificate (from the local labour bureau);
residency permit (from the local public security bureau).
The PRC Labour Law and the PRC Labour Contract Law are the two primary pieces of legislation governing employment relationships in China. Some of the key issues an employer should bear in mind are:
The legal requirement to sign a written labour contract.
Minimum pay requirements (the applicable rate is set by each local government, and therefore varies from city to city).
The obligation to make overtime payments unless an exemption certificate is issued by the local labour bureau.
The mandatory requirement to make timely and full workers' compensation contributions to the responsible government body.
The mandatory payment of a "hot temperature subsidy" to employees who work outdoors or who work in hot temperatures during the summer.
Workers' rights to form trade unions.
There is no statutory redundancy payment required at the end of a project, although an employer can seek to terminate its employees by reason of general redundancy. An employer can only do this when it is necessary to terminate:
20 or more employees.
Fewer than 20 employees, accounting for at least 10% of the entire workforce.
To terminate by reason of general redundancy, the employer must apply to the government for approval, and meet one of the following conditions:
The employer is undergoing reorganisation under the PRC Enterprise Bankruptcy Law.
The employer faces serious difficulties in business operations.
There is a switch of production, introduction of a major technological innovation, or update of a business method.
Inability to perform the labour contract due to changed economic circumstances, where those circumstances are considered to be the basis on which the contract was agreed (this is similar to frustration of contract in common law jurisdictions).
Health and safety
Contractors must follow a large number of national and local health and safety regulations. The key national regulations in this area are:
Regulations on the Administration of Work Safety of Construction Projects 2004.
PRC Law on Prevention and Control of Occupational Diseases 2011 Revision.
MOHURD requires a contractor to appoint at least two full-time health and safety officers if the contract price exceeds RMB10 million, to ensure that sites are properly regulated and that all health and safety regulations are properly implemented. A construction company's qualification may be suspended or revoked if it is found to be liable for catastrophic site accidents. The entity may also face administrative fines, and responsible individuals could face criminal prosecution.
Environmental impact assessments (EIAs)
Before applying for project approval and other necessary permits to commence construction, the owner is responsible for engaging a qualified environmental consulting firm to prepare an EIA. When assessing impacts, both the construction and operational phases of a project must be considered. Once the EIA is approved, the project must be constructed in accordance with the basic designs set out in the EIA. If major changes occur with respect to the project's nature, scale or location, the EIA must be revised and re-submitted for approval.
The most relevant governing statutes are:
PRC Environmental Impact Assessments Law 2003.
Measures for the Administration of Environmental Protection Check and Acceptance of Completed Construction Projects 2002.
Regulations on the Administration of Construction Project Environmental Protection 1998.
Owners must also follow mandatory national technical standards, local rules and industry-specific guidelines if applicable to their particular projects.
Government inspection and monitoring
The local Environment Protection Authority is responsible for:
Inspecting pollution control facilities required to be installed on site before commencing construction.
Conducting follow-up monitoring of a project's actual environmental impact during the construction phase.
If the actual environmental impact of the construction or operation of the project does not comply with the approved EIA (see above, Environmental impact assessments (EIAs)), the project owner may be required to adopt remediation measures.
Air and water pollutants
An owner must apply for permits to discharge air and water pollutants. The Environment Protection Authority calculates the applicable discharge fees depending on the discharge volume. Usually when the discharge exceeds the prescribed standards, the owner must propose a plan or time frame for reducing the discharge. Discharge permits carry terms of three to five years, and are renewable.
Construction waste management
Disposal of construction waste is mainly regulated by the local administrative department in charge of city appearance and sanitation, under the Administrative Provisions on Urban Construction Waste 2005. A number of municipalities have enacted local regulatory measures to fill gaps left by the national level regulations.
Since 2005, the Chinese government has issued a series of national laws and regulations to promote energy efficiency in building construction, including:
PRC Renewable Energies Law 2009 Revision.
PRC Energy Conservation Law 2007 Revision.
Regulation of Energy Conservation in Civil Buildings 2008.
Interim Measures on Energy-Saving of New Fixed Asset Investment Projects 2010.
These rules impose mandatory requirements on owners and contractors to use energy efficient building materials and adopt energy-saving technology in heating, air conditioning, ventilation and lighting systems.
The Chinese government updated its building energy codes in 2007, which include:
Design standards, which address compliance with building energy codes at the design stage. The design specifications must meet the standards before the project can obtain a land-use permit (see Question 19).
Acceptance codes, which address compliance with building energy codes at the construction stage, and require owners and contractors to conduct energy efficiency inspections during the final acceptance of a construction project.
Due to lax government enforcement, there are great challenges in implementing and enforcing these requirements outside the major cities.
In December 2014, the standards for measuring, accounting and reporting of carbon emission from buildings were released. There is currently no mandatory legislation requiring project owners to meet carbon emissions or climate change targets.
In March 2013, China's National Development and Reform Commission released technical rules for certifying low-carbon products. The new voluntary certification system covers a variety of products including building materials such as window glass and cement. Products certified through the new system may eventually be eligible for tax incentives or other government support (such as receiving favourable treatment in government procurement). Around this same time, the Ministry of Finance placed environmental tax reform (including a carbon tax) on the new tax reform agenda that China will seek to implement over the next five years.
Prohibiting corrupt practices
Under PRC Law, there are two broad categories of bribery:
Government official bribery. This is defined as an offer of property, to a state functionary, in return for a benefit or for assistance in obtaining a benefit. The term state functionary covers not only an individual who fits the traditional notion of "government official", but also anyone who performs public service in a state-owned enterprise or civil organisation, and sometimes even includes any person assigned by state authorities to perform public service in a non-state-owned enterprise.
Commercial bribery. This involves an offer of bribes to employees of private enterprises in return for benefits.
US, UK, and Canadian companies and their PRC-incorporated subsidiaries may also face prosecution in their home countries for engaging in bribery of foreign public officials.
The Chinese government has acknowledged that corruption in the construction industry has been a serious problem. Many of the high-profile building collapse accidents have been linked to official corruption and commercial bribery.
The following penalties may apply:
Government official bribery. Both individuals and corporations can face criminal liability if they offer bribes beyond the monetary threshold. The threshold amount for the prosecution of (Supreme People's Procuratorate's Standards for Cases of Bribery (2000)):
an individual offeror is RMB10,000; and
a corporate entity offeror is RMB200,000.
The threshold can be less (but not less than RMB100,000 for a corporate entity) if the bribery involves:
securing illegal benefits;
giving bribes to three persons or more;
giving bribes to Chinese Communist Party or government leaders, judicial personnel, or administrative enforcement agents; or
causing substantial damage to national or public interests.
An individual can be sentenced to criminal detention (meaning detention under police custody for a period no less than one month but no more than six months), or a fixed-term imprisonment of no more than ten years, depending on the severity of the offence. A corporate entity is subject to a fine, and the person who is directly responsible for the offence may be punished as an individual offender.
Commercial bribery. Both the offer and acceptance of commercial bribery payments could, based on the amount of the bribe and its seriousness, be subject to administrative liability or criminal penalties. According to the Standards for Filing Criminal Cases under the Jurisdiction of the Public Security Bureau for Investigation and Prosecution (2010), an amount reaches the Public Security Bureau's investigation and criminal threshold if it exceeds:
for an individual, RMB10,000; and
for a corporate entity, RMB200,000.
There is no minimum statutory threshold triggering an administrative investigation under the PRC Anti-Unfair Competition Law. In the experience of the authors, the authorities do not generally investigate corporate entity offenders if the amount involved is less than RMB200,000, and the Public Security Bureau may be more concerned when the amount involved exceeds RMB500,000. However, the appetite for prosecution will vary with the location and is heavily dependent on the facts. The penalty for such an offence is between RMB10,000 and RMB200,000, with any illegal income also confiscated.
In most construction contracts, the owner and contractor typically agree that the contractor's bankruptcy or insolvency constitutes grounds for termination. If the owner elects to terminate the contract, it will typically call on the advance payment guarantee and performance guarantee to compensate for delay and damages arising out of the contractor's non-performance and additional costs incurred to procure a new contractor. The contractor's bankruptcy administrator can claim against the owner for work already performed but not yet paid.
Traditionally, investment in infrastructure development in the PRC has been dominated by the government. Although a preliminary PPP legal framework was set up by the central government in the 1980s, a cumbersome approval process and lack of detailed implementation rules have hampered its initial growth.
From the early 2000s, many local governments sparked interest in PPPs for public infrastructure projects by inviting both domestic and foreign capital. For example, both Beijing and Shenzhen have detailed rules governing procedures for private investment in public infrastructure under the build-operate-transfer (BOT) model. In Beijing, almost half of the Olympic sports facilities were constructed under the PPP-concession model. In Shenzhen, the No 4 metro line project was built by Hong Kong MTR Corporation under a concession agreement, along with a 30-year operation right based on the BOT model.
For Beijing's No 4 and No 9 metro line projects, the local government adopted a different model called installation-operation-transfer (IOT), under which the government invested in civil construction works and retained the ownership, while the private sector partner invested in mechanical and electrical equipment and has the right to operate the metro line facilities for the 30-year concession term. At the expiration of the concession term, the facilities operated by the private investor will be transferred back to the government.
In mid-2012, the Chinese government adopted new policies encouraging private investment in public infrastructure sectors including:
Public transport systems.
Water and power lines.
Since June 2012, a number of ministries have issued detailed implementation rules aimed at streamlining approval procedures and providing government subsidies.
In September 2013, the State Council issued the Opinions on Strengthening Urban Infrastructure Construction, which again encourages private investment in public infrastructure sectors.
From 1994, the Chinese government began to attract foreign companies to participate in the investment, construction and operation of infrastructure projects mainly through the BOT and build-transfer methods. The key national level regulations on encouraging and managing domestic-invested and foreign-invested PPP projects are the:
Circular on Attracting Foreign Investment through BOT Model 1995.
Circular on Issuing the Operational Guidance on the Modes of Cooperation by Governments and Social Capital (for Trial Implementation) 2014.
Administrative Measures on Concessionary Operation of Urban Public Utilities 2015 Revision.
Measures for the Administration of Infrastructure and Public Utility Franchises 2015.
A number of provincial and municipal governments have promulgated regulations governing PPP projects within their jurisdictions. Confirmation of actual, current practice in the location where a project is situated is vital in developing a sound legal strategy to address specific concerns about the risks that may arise in a particular project.
Procurement for PPP projects in China should generally follow the public tender regime set out in the PRC Tendering and Bidding Law and its implementing regulations. The central government or the provincial-level government has the authority to exempt a project from the public tender process. If exempted, the local government can send written invitations to tender to select parties inviting them to bid for the project.
The administration of the tender process is often outsourced to a privately owned professional tendering agency. A tender evaluation committee conducts a tender review and selection, which is typically comprised of government officials and experts with relevant technical or industrial background. If it is a BOT project, after announcing the award, the selected tenderer enters into a concession agreement with the government or its investment arm.
Formal dispute resolution methods
The most common methods of settling construction disputes are litigation and arbitration. The use of adjudication (such as the Dispute Adjudication Board (DAB) under FIDIC forms of contract) has never been popular in Chinese projects.
Government-invested public projects are more likely to use court litigation, whereas private sector contracts and contracts with foreign-owned entities are increasingly resorting to institutional arbitration.
Although not clearly stated in the Chinese law, most leading international arbitration practitioners agree that China's arbitration law only allows "foreign-related" arbitrations to have their seats outside Mainland China. Because almost all the major actors in an onshore construction project are required to be locally incorporated as a PRC legal entity, offshore arbitration is not a viable option because of the lack of a "foreign-related" element.
Courts and arbitration organisations
The Chinese courts are divided into a four-level court system. At the highest level is the Supreme People's Court. Depending on the amount in dispute, a construction lawsuit can be brought in one of the three first instance courts:
The basic level court.
Many courts have judges who specialise in adjudicating construction disputes.
The China International Economic and Trade Arbitration Commission (CIETAC) is the principal arbitration body in China. In addition to CIETAC, there are approximately 180 other local arbitration commissions established under the PRC Arbitration Law, including:
Shanghai International Economic and Trade Arbitration Commission (Shanghai International Arbitration Center) (SHIAC).
Shanghai Arbitration Commission (SAC).
Beijing Arbitration Commission (BAC).
Both CIETAC and BAC have a Dispute Review Board system similar to the DAB mechanism in the FIDIC forms of contract. SAC maintains a separate list of arbitrators who specialise in construction disputes.
Ad hoc arbitration seated in mainland China is not recognised under the PRC Arbitration Law.
Typically, disputes are resolved by negotiation and consultation and, failing these, a dispute would then be referred to arbitration or court litigation. The court or arbitration panel may also conduct mediation on its own initiative or at the request of the parties. There are new mediation centres entering the market, such as that of the China International Economic and Trade Arbitration Commission and that of the Shanghai Commercial Mediation Centre, which has a list of qualified mediators to assist the parties outside the court or arbitration process.
Enterprise income tax (EIT)
All domestic incorporated companies are subject to EIT. If a foreign company is a resident of a country or region that has a tax treaty with China, its business profit will not be subject to EIT unless it is deemed to have a permanent establishment in China and the business profit is derived from that permanent establishment, in which case it must pay EIT on:
China-sourced income derived by the establishment.
Income arising outside of China but effectively connected with such an establishment.
A "permanent establishment" as defined under a typical Chinese bilateral tax treaty refers to a fixed place of business through which an enterprise is wholly or partly carried on, including:
A place of management.
A place of extraction of natural resources.
A permanent establishment also includes a building site, a construction/assembly/or installation project, or connected supervisory activities, but only where such site, project, or activities continue for a period of time as specified in a tax treaty (usually six months). Finally, a foreign company will be deemed to have a "permanent establishment" if it has provided services by sending an employee to China and the actual work period of the employee in China exceeds a specified period of time within one calendar year (usually six months).
In any case, since all foreign real estate enterprises, construction companies, and professional firms must incorporate a PRC entity before they can carry out business operations in China, the tax treaty exemption is only available for a small number of foreign firms that provide construction services offshore (such as engineering design). Some local Chinese tax authorities in remote regions still levy a 10% EIT withholding tax from payments to offshore service providers, disregarding any applicable bilateral tax treaty.
Value added tax (VAT)
China has three types of turnover tax: VAT, consumption tax, and business tax (see below, Business tax (BT)). VAT applies to contractors who:
Supply construction materials.
Provide repair and maintenance services.
Import foreign-made equipment.
Provide consulting services (as of 1 August 2013).
Business tax (BT)
Sellers are subject to BT on the transfer of real property ownership and land use rights.
Most services provided by contractors and professional consultants are subject to BT.
With limited exceptions, where services are received in China, BT is imposed on service providers even if all the services (for example, design services) are performed outside China. The rate of BT for most construction services is 3% of gross revenue.
From 1 January 2012, China started replacing its BT with VAT in some service sectors (such as design services and project management) in Shanghai under the VAT reform pilot programme. The VAT rate for consulting services such as engineering design is 6%.
On 27 May 2013, the Ministry of Finance and State Administration of Taxation further expanded the VAT reform to the rest of the country, effective from 1 August 2013. However, until the government further expands the VAT reform to industrial categories, construction services remain subject to BT.
City construction and maintenance tax and education surcharge
All BT and VAT taxpayers are subject to city construction and maintenance tax, education surcharge, and local education surcharge levied by local governments.
The transferees are subject to deed tax on transfer of real property ownership and land use rights.
Stamp duty applies to both the buyer and the seller to a real property transfer contract.
Land value appreciation tax
Land value appreciation tax is imposed on taxable gains derived from the transfer of real property. This tax is levied on a real estate developer when:
The construction and sale of the project have been completed.
The ownership of the whole project is transferred (when construction has not been completed).
Title to land is transferred (where no building has yet been built).
In addition, taxation authorities have the discretion to require developers to pay land value appreciation tax on the sale of each unit when:
More than 85% of the saleable construction area of a completed building project has been sold.
Less than 85% of the saleable construction area of a completed building project has been sold, but the remaining areas have been leased or are being used by the real estate enterprise for its own use.
Sales have not been completed for three years after a sale permit or pre-sale permit has been granted.
Real estate tax
Enterprises owning real property are subject to real estate tax. Individual property owners are normally exempted from real estate tax on residential housing, with certain exceptions.
Urban and township land use tax
Both enterprises and individuals using land within cities, counties, townships and mining areas must pay urban and township land use tax on an annual basis.
Avoidance of double taxation
Some of the above taxes are subject to an international or bilateral tax treaty which may stipulate a lower rate.
Preferential tax treatment
Preferential tax treatment is available for certain construction projects, such as:
Urban public transportation.
Sewage treatment and waste management facilities.
Affordable housing projects.
Tax mitigation structures may be available and such possibilities should be consulted with accountants and tax lawyers on a case-by-case basis.
Certain tax incentives are available for construction-related business operations, such as:
Purchase of environmental protection or energy conservation equipment.
Sale of self-manufactured products with recycled raw materials.
Construction or development of green projects, such as energy-saving buildings or renewable energy projects.
Other requirements for international contractors
The entry of foreign construction companies into the Chinese market is heavily regulated. Foreign construction companies have only obtained a nominal share of the local market.
To undertake construction work in China, a foreign construction company must establish a local presence by setting up either:
Wholly foreign-owned enterprise.
Sino-foreign joint venture.
After incorporation, this Chinese legal entity must obtain a construction-grade qualification (see Question 18, Local contractors and construction professionals). The construction-grade qualification determines the maximum size and scale of project that the foreign contractor can undertake. For instance, unless the foreign-owned company possesses "Special Grade" qualification, it cannot undertake projects with a value greater than five times its registered capital. Other qualification requirements include:
A minimum number of technical and managerial personnel.
Necessary prior experience.
A good overseas track record.
Foreign design firms are also required to incorporate local entities in China and to obtain qualification certificates from the government if they are to undertake design work inside China beyond conceptual and schematic design services. Almost all these firms possess a "Grade A" qualification. Many of them specialise in industrial design work, such as:
Pharmaceutical manufacturing facilities.
Environmental protection projects.
Preferential treatment is available to design firms established by Hong Kong and Macau investors.
Other than off-shore conceptual design work, foreign firms must work in co-operation with Chinese local qualified design institutions. The design work of many well-known projects in China has been performed under this model, including:
National Grand Theatre (Paul Andreu Architect associated with ADPi and Beijing Institute of Architectural Design).
Beijing Olympic Stadium (Herzog & de Meuron Architekten in association with China Architectural Design & Research Group and others).
Many foreign design firms operate in China as consulting firms without obtaining the necessary design qualification. They co-operate with local qualified design institutions to jointly undertake design services for onshore projects, sometimes going beyond the scope of conceptual and schematic design. Although this occurs in practice, firms must be careful that their services are not extending in areas that would require licensing.
Reform and trends
Construction law practitioners are discussing proposals for reform, including:
Removing or reducing red tape for foreign-invested firms to enter into the Chinese construction market to create a more level playing field.
Harmonising laws and regulations. The myriad of overlapping provisions makes it tricky to be confident about which law might apply to a given issue on a project. For instance, the defect notification period under the former Ministry of Construction's Interim Measures for the Administration of Quality Security Deposit for Construction Projects (2005) does not exceed 24 months, while the Administrative Regulations on the Quality Management of Construction Engineering (2000) issued by the State Council (China's highest executive body) allows for a longer period. The government should take steps to harmonise some of these conflicting provisions in the future.
Important recent developments and trends include:
The PRC Tendering and Bidding Law Implementation Regulations came into effect on 1 February 2012. They aim to enhance transparency, and further refine the procedures to be followed by owners and contractors in the tendering and bidding process.
The ''One Belt, One Road – China 2025'' economic development strategy launched by the Chinese Government in 2015 will be the main driver of international development, including in the construction sector. This economic strategy focuses on inland countries located in the ''new silk road economic belt'' and the ''21st-century maritime silk road''.
Chinese national and local governments are acting to protect migrant workers and monitoring the payments made (or not made) by the contractors who employ them. Notably, some local construction authorities recently issued decrees requiring project owners to settle employment payments first and later seek indemnification from a contractor, despite the fact that those payments are not strictly the owner-developer's responsibility. Non-compliant developers may face administrative hurdles in obtaining government permits and approvals for existing and future projects.
Main construction organisations
China Construction Industry Association
Main activities. This is the largest national construction trade association in China. Its mandate includes building relationships within the industry, government advocacy, policy reform, and public education.
Architectural Society of China
Main activities. This is an academic society with the objectives of promoting architectural technology development, organising domestic and international academic exchange, and providing continuing education to professional engineers.
Shenzhen – Zhongshan Channel Project
Published by: Shenzhen Transportation Commission, December 25, 2015
The second Beijing International Airport Project
Published by: Beijing Plan Commission Daxing Bureau, April 14, 2015
Social Housing Program in 2015
Published by: The Ministry of Housing and Urban-Rural Development of the People's Republic of China, January 12, 2016
The 13th release of the Five Years Plan
Published by: Chinese government
The 18th Central Committee of the Communist Party of China Report
Published by: The State Council Information Office
China's New-Style Urbanization Plan (2014-2020)
Published by: NPC, National People's Congress
Catalogue for the Guidance of Foreign Investment Industries (Amended in 2015
Published by: National Development and Reform Commission and the Ministry of Commerce
Interim Measures on the Review and Management of Total Emission Targets of Key Pollutants in Construction Projects
W. www.mep.gov.cn/gkml/hbb/bwj/201501/W020150106352131751120.pdf (in Chinese)
Published by: China's Ministry of Environmental Protection
Prospects and Challenges on China's ''One Belt, One Road'': A Risk Assessment Report
Published by: The Economist Intelligence Unit
Why China's Economy is Slowing Down
Administration and Associations
The Ministry of Housing and Urban-Rural Development of the People's Republic of China
The Ministry of Commerce of the People's Republic of China
China Building Decoration Association
China Building Materials Federation
China Architectural Design Association
International Construction Decoration Interior Design Association
China Exploration & Design Association
Shenzhen Government Online
China Construction Industry Association
King & Wood Mallesons
Professional qualifications. District of Columbia, Maryland; Attorney-at-law; China, Lawyer
Areas of practice. Dispute resolution; construction and white collar matters.
Languages. English, Chinese
*The author wishes to express her thanks to Michael Zhang and Steven Chen of King & Wood Mallesons for their contributions.