Professional Interpretation

Abstract: The case where the employer fails to make payments on schedule after the engineering is completed can frequently occur in the dispute over the construction engineering contract, which will seriously damage interests of the contractor and building workers. Therefore, Article 286 of the Contract Law specifies that the contractor enjoys the priority of compensation for funds of the construction engineering and can agree to discount or apply to the court for auction and enjoy the priority of compensation for purpose of the engineering. However, there is right conflict among the contractor, the employer and the bank in the real life. Therefore, it is common that the contractor waives the priority of compensation in advance or afterwards and it is also controversial that whether such behavior is effective in the practice. The new judicial interpretation further interprets such problem. 

The real estate and infrastructure team of Beijing DOCVIT Law Firm will interpret adjudication rules for waiving the priority of compensation of the engineering funds in the juridical practice and deeply discuss the problems existing in the practice application in combination with its years of experience according to the new regulation, so as to help parties under the construction engineering contract to understand related laws and clarify the transaction cost. 

I. What is the priority of compensation? 

As stipulated in Article 286 of the Contract Law, “If the employer fails to make payments according to the agreement, the contractor may urge the employer to make payments within the reasonable period. If the employer fails to make payment as scheduled, the contractor may agree with the employer to discount the engineering or apply to the people’s court to make auction for the engineering by laws, except for those that shall not be discounted or auctioned according to the nature of the construction engineering. Funds of the construction engineering shall be paid in priority out of proceeds from the liquidation or auction of the project.” Under the clause, the contractor is endowed to enjoy the priority of compensation for the discount or auction payments of the engineering to enable creditor's rights of the engineering funds to be prioritized for realization when the employer fails to make payments as scheduled. 

Approval of the Supreme People's Court for the Priority of Compensation for Funds of the Construction Engineering affirms that: “The construction engineering constructor has priority of compensation over the mortgage right and other creditor's rights.” It can be seen that the priority of compensation for funds of the construction engineering not only influences interests of the employer, but also has significant influence on interests of other creditors and mortgagees of the employer. It is a choice of value made by the law when there is related interest conflict based on the demands in maintaining public interests and rights of building workers and is a legal right endowed to the contractor by the law, which may be exercised at decision of the parties. But the contractor is under unequal weaker position than the employer and the bank issuing the loan in the building market. In the practice, the contractor has to always sign a format contract with the employer and waive the priority of compensation in order to win the engineering. Therefore, there is a large controversy about whether the waiver of the priority of compensation is effective in the juridical practice and it is common that there are different judgements for the same case. 

II. The waiver of the priority of compensation is effective in principle. 

(I) The Supreme Court holds an attitude that: Respect the autonomy of will in principle. 

Article 23 of Explanations of the Supreme Court about Trial of Applicable Laws for Disputes over the Construction Engineering Contract (II) in force on February 1, 2019 specifies that: “if the employer and the contractor agree to waive or restrict the priority of compensation for funds of the construction engineering, damaging interests of building workers and the employer advocates that the contractor does not enjoy the priority of compensation for funds of the construction engineering according to the agreement, the people’s court will not support it.” The Supreme Court firstly shows its attitude that it believes that in principle, the agreement about waiver or restriction of the priority of compensation is effective without prejudice to interests of building workers. The priority of compensation for funds of the construction engineering, a legal civil property right, shall be a kind of private rights. The party holding the private right can either execute it or waive it. The laws shall not intervene with such behavior so long as it is true will of the right holder. It is legal that the contractor chooses to waive the priority of compensation for funds of the construction engineering based on certain market situation to make the employer timely get the bank loan. 

Most of the arguments against the effectiveness of the waiving behavior consider that the priority of compensation for funds of the construction engineering is established in Article 286 of the Contract Law not only for purpose of protecting interests of the contractor, but also for guaranteeing salary rights and interests of building workers, so as to maintain harmony and stability of the society. If it is allowed to cancel it through the agreement, it will be against with the original intention for establishing the system of the priority of compensation. Why does the new judicial interpretation choose to protect the autonomy of will of parties under the Construction Contract for Construction Engineering after value judgement? 

Firstly, the contractor’s performance of the priority of compensation to get the engineering funds does not mean that the building workers can timely get the salaries and waiving the priority of compensation does not necessarily damage legitimate rights and interests of the building workers. Although the legislative purpose in Article 286 of the Contract Law is to guarantee rights and interests of the building workers, it is established mainly for the purpose of protecting individual interests of the contractor. Secondly, there is a circumstance where the contractor gets a better price by waiving the priority of compensation in the practice, which is more beneficial to guarantee rights and interests of the building workers. And the laws shall not deny the autonomy of will that does not damage interests of the third party. Finally, the laws have endowed them with legal priority of compensation in order to guarantee rights and interests of the contractor and building workers. Excessive interference with the autonomy of will of parties under realization of the legislative purpose is not beneficial to the free transaction. Therefore, the judicial interpretation specifies that waiver of the priority of compensation is effective in principle, which is supported by reasonable interpretations. 

(II) Non-voluntary waiver shall be invalid. 

While there is a great disparity between the employer and the contractor in the market position. Therefore, the contractor has to accept exacting terms required by the employer in order to get the construction engineering project, including waiver of the priority of compensation for the engineering funds. Under such case, it appears that the contractor waives its right of its own accord, but it is not its true will. Therefore, whether the waiver of the commitment made by the contractor is effective shall be judged according to Article 143 of General Provisions of Civil Law. If the contractor can prove that the commitment is not made of its own accord, but for yielding to the format contract of the employer or other unfair reasons, such waiver shall be invalid. 

In fact, it is difficult to prove that the waiver is not made of its own accord in the practice, which is also one of important reasons why many persons consider that the waiver of the prioritized authorization shall be invalid. However, it is impossible that there is full equality between the market entities. Different market positions can generate different contracting statuses. Such unequal laws and judicatures shall be respected so long as they are within certain scope and limit. More attentions shall be paid on maintaining freedom of contract, market order, transaction efficiency and transaction safety in the commercial transactions and sufficient opportunities shall be given to commercial entities to fully negotiate the price, which is different from the value orientation that more attentions are paid on protecting general interests of the social public in the civil transactions. 

(III) Risk control – The contractor can properly waive the priority of compensation 

During the engineering construction, the contractor may choose to raise funds from the banks or other entities for the purpose of solving the fund problem. But legal priority of compensation weakens the will of banks to release the loan to the contractor. Therefore, the contractor often agrees with the employer to waive the priority of compensation for the purpose of making the employer timely obtain the financing and making the contractor timely get the engineering funds. Under such case, usage of the expressions, such as “waiver of the priority of compensation for the engineering’ can lead to that the contractor loses its priority of compensation for other ordinary creditor’s rights and make the contractor suffer from unreasonable damages in the interests. 

Therefore, the contractor can make the expression of relative waiver (restriction) when promising to waive the priority of compensation, for example, it can state that the waived objects only include the financing objects (namely, loan banks), and the waiver scope is limited to the priority of mortgage over creditor's rights of the engineering funds and also state the reasons for such waiver, so as to eliminate the priority sequence lagging caused by other reasons.  Proper waiver of the priority of compensation can not only accurately achieve the purpose of the waiver, but also protect legal rights of the contractor from damages, so as to guarantee rights and interests of the building workers and achieve the legislative purpose in Article 286 of the Contract Law. 

III. The waiver damaging interests of the building workers shall be invalid. 

(I) Maintain the legislative purpose in Article 286 of the Contract Law 

The building workers are builders and consummators of the engineering and the constructional engineering is materialization of the labor of the building workers. If the construction enterprise runs into difficulties in the operation and funds, the salary rights and interests of the building workers will not be guaranteed. Therefore, the realization of creditor's rights of funds of the construction engineering will directly decide the liability property of the contractor, and then decide whether the building workers can achieve their legal salary rights and interests. If the contractor agrees to waive or restrict the priority of compensation for funds of the construction engineering, leading to that the creditor’s rights of the engineering funds can not be realized, thereby causing deterioration of the assets and liabilities, so that it is unable to pay salaries to the building workers, such behavior shall be considered to go against the intention for establishing the system of the priority of compensation in Article 286 of the Contract Law. It is also clarified in the new judicial interpretation as below: If the contractor agrees to waive or restrict the priority of compensation for funds of the construction engineering, damaging interests of the building workers, the employer shall not advocate that the contractor does not enjoy the priority of compensation for funds of the construction engineering according to the agreement, namely, the waiver of priority of compensation shall be invalid if it damages interests of the building workers. 

(II) Judicial affirmation of “damage” behaviors. 

The Construction Contract for Construction Engineering is a contract signed by the contractor and the employer, the validity of which shall be limited to the contractor and the employer only in principle. Therefore, it is difficult to affirm which kind of waiver of the priority of compensation may damage legal interests of the building workers. Solutions of The Superior People's Court of Jiangsu Province for Some Problems about Trial of Disputes over the Construction Engineering Contract issued in June 2018 mentions that: “If the contractor waives the priority of compensation for funds of the construction engineering of its own accord, such waiver involving interests of the contractor only shall be valid. But if such waiver damages interests of the third parties, such as actual building workers it shall have no any effectiveness for the third parties.” However, the objects where the priority of compensation is applicable are the engineering funds under the construction engineering contract and legal rights enjoyed by the contractor for the employer hereof. It is difficult to imagine how the third parties, such as the building workers will not be subject to its effectiveness and retain their rights and interests under the circumstance where the contractor waives the priority of compensation of its own accord, causing failure to execute it. The construction engineering contract does not agree the salary rights and interests of the building workers essentially, therefore, there is no case that “if such waiver damages interests of the third parties, it shall have no any effectiveness for the third parties”, so what is the waiver behavior damaging interests of the building workers? 

In Judicial Interpretations of the Supreme People's Court about the Construction Engineering Contract (II) Understanding and Application, it is mentioned when talking about the drafting process of the clause that: “Whether to waive or restrict the priority of compensation for funds of the construction engineering not only concerns interests of the contractor, but also involves payment of salaries of the building workers. The waiver or restriction of the priority of compensation for funds of the construction engineering shall not affect payment for salaries of the building workers.” It can be seen that judgement of the Supreme Court on whether the agreement “damages interests of the building workers” or not depends on whether the contractor’s waiver of the priority of compensation will affect realization of rights and interests of the building workers, such as salaries. It is required that the waiver behavior of the contractor directly affects its ability to pay salaries to the building workers, thereby causing the building workers fail to achieve their due interests by legal ways. Otherwise, it is unreasonable and illegitimate that the laws deny the autonomy of will of waiving the priority of compensation under the circumstance where the building workers can claim for compensation from the contractor who makes salary payment in arrears malevolently by the lawsuit and other relief ways. 

(2018) Z 1081 MC No. 10413 Written Judgement made by Wenling People’s Court supports this view: “When judging whether the waiver behavior damages interests of the building workers, it shall make judgement about whether such behavior affects its overall solvency, namely, it shall mainly consider whether the overall assets and liabilities and cash flow of the contractor are deteriorated to affect the payment of salaries to the building workers due to such waiver.” If it is affirmed that the agreement between the contractor and the employer about waiver or restriction of the priority of compensation for funds of the construction engineering damages interests of the building workers, so that the agreement is affirmed to be invalid only because the contractor conducts individual salary arrears behavior, it will generate negative simulation on the contractor, namely, it will cause the contractor to make salary payment in arrears malevolently, so as to achieve the purpose of continuing to perform the priority of compensation of funds of the construction engineering. The laws shall not support the malevolent arrears of wage and abuse of legal rights of the contractor. 

IV. Conclusion 

On conclusion, the new Judicial Interpretation about the Construction Engineering (II) makes clear the effectiveness of the waiver of the priority of compensation of the contractor that has been controversial for a long time, that is, The laws recognize the autonomy of will of the contractor to choose to waive the priority of compensation for the construction engineering in principle and the waiver behavior conducted by the contractor of its own accord shall be valid. But if the contractor’s waiver of the priority of compensation directly affects its ability to pay salaries to the building workers, such waiver shall be affirmed to damage interests of the building workers and shall be invalid. Meanwhile, the employer and the contractor shall carefully select proper “waiver” way of the priority of compensation and agree the waived objects, waived scope and reasons for waiver in the process of signing the construction engineering contract, so as to prevent their own priority of compensation from unnecessary restriction and more accurately and effectively maintain their own legitimate rights and interests.