Project General Contractor:Calling for the Chinese EPC model

On December 31, 2019, the Ministry of Housing and Urban-Rural Development ("MOHURD") and the National Development and Reform Commission jointly issued the Measures for Administration of Project General Contracting for House Construction and Municipal Infrastructure Projects (the "PGC Measures"), which became effective on March 1, 2020.

In the international construction market, especially when involving manufacturing or power equipment, factory plants or similar facilities, infrastructure projects or other types of construction projects, EPC mode is commonly adopted; that is, an integrated general contract including project engineering, equipment and material procurement and civil work construction -  also known as a "turnkey project". The most popular EPC template contract was published by the International Federation of Consulting Engineers (in French: Fédération lnternationale Des lngénieurs Conseils, FIDIC), Conditions of Contract for EPC/Turnkey Projects. However, EPCs are rarely adopted in the Chinese construction market. A binary mode is commonly adopted in China, with a design institute responsible for engineering design and a construction company taking charge of civil construction works. Such a construction contracting practice is largely due to the statutory regulations on itemized construction qualifications, the regulatory construction project filing mechanism, and the official contracting contract templates. 

In 2003, the Ministry of Construction (the predecessor of MOHURD) issued the Guidance Opinions on Cultivation and Development of Project General Contracting and Project Management Enterprises, in which the concept of project general contracting ("PGC") was officially mentioned for the first time. In 2011, MOHURD and the State Administration for Industry and Commerce issued the Model Contract for General Contracting of Construction Projects (Trial). On May 20, 2016, MOHURD issued Several Opinions on Further Promoting the Development of PGC ("Several Opinions on PGC"), which provided a number of specific rules relating to PGC. Notwithstanding the above, the Chinese construction market for a long time continued to follow the traditional pattern of "design and build", i.e. separate design and construction general contracting ("CGC"). After MOHURD issued two drafts for public comments on December 26, 2017 and May 10, 2019, the PGC Measures were officially issued in the form of a ministerial regulation at the end of 2019. This PGC statutory instrument has become the ultimate authority in China – prior to this, all the PGC-related regulations were merely MOHURD ministerial guidance notes. 

Preconditions for adopting PGC

Under the current approval system for housing and infrastructure construction projects, PGC contracts can be awarded upon completion of a preliminary design for a project involving state-owned capital. For the majority of construction projects not involving state-owned capital, e.g., privately-funded projects, the administrative prerequisite is obtaining the construction project approval from the competent development and reform commission (so-called "Li Xiang").

Although the amended PRC Tender and Bid Law and its Implementation Regulations have cancelled the mandatory tendering requirement for construction projects not utilizing state-owned capital, in practice, many privately-funded construction projects still adopt a tender and bid approach for selecting the general contractor. Under CGC, a bidder usually formulates the price quote based on drawings and bills of quantities provided by the client or its consultant. Under the PGC Measures, the client shall provide tender requirements (equivalent to the client requirements in the EPC conditions), the hydrogeology, engineering geology, topography and other geological survey data, as well as the feasibility study report, scheme design or preliminary design, etc. PGC bidders are required to provide a lump sum quotation based on the above basic data. In addition, in accordance with the PGC Measures, the PGC contractor for privately-funded projects is recommended to accept a fixed lump sum quotation, which may not be adjusted unless in exceptional circumstances, as agreed in the contract. Conversely, under the Several Opinions on PGC, PGC projects may adopt the pricing model of either the fixed lump sum or cost-plus-profit. In this way, the fixed lump sum price affords higher requirements for Chinese contractors in terms of price quoting and project cost management. 

Dual qualification for PGC contractors

Chinese law stipulates multiple engineering qualifications for construction, including general contracting, design, survey, construction management, quantity surveying, etc. Projects with different scales and in different trades must engage professional institutions with the corresponding trade and grade of qualifications. In the past, the commonly adopted "design plus CGC" construction mode has brought higher requirements to the client in respect to the project management team and competency of the construction professionals. The segregation of responsible parties for engineering drawing and civil construction work often leads to disputes between the client, design institute and general contractor, on design error, client variation, design change, construction change, etc. 

Although MOHURD has issued various opinions encouraging PGC since 2003, it has not triggered a specialized PGC qualification. It was permissible under both the Guidance Opinions on General Contracting and Several Opinions on PGC for a contractor with one of the corresponding grade of qualifications on either design or CGC to undertake PGC works. A PGC contractor may sub-contract the design or civil construction works for which it does not have the corresponding qualification. Even in the draft PGC measures issued by MOHURD on May 10, 2019, a single design or CGC qualification appropriate for the project scale was sufficient for PGC works. However, according to Article 10 of the officially issued PGC Measures, a PGC contractor must have both the engineering design and CGC qualifications, the grade of which should be competent for the project scale, or alternatively, a design institute and CGC contractor with the competent grade may form a consortium for PGC works. As such, China has officially adopted a dual qualification mechanism for PGC. While the reason for the authority changing the PGC management from single qualification to dual qualification needs to be clarified, we expect to see significant changes in the Chinese construction market: 

Firstly, there will be more single-qualification general contracting companies and design institutes seeking to obtain cross trade qualifications in order to become legally qualified PGC contractors. Article 12 of the PGC Measures encourage design institutes to apply for CGC qualification. A design institute already holding comprehensive engineering design qualification, industry trade or civil work grade A design qualifications may apply for the grade A CGC qualification directly within the corresponding trade. Similarly, CGC companies may apply for the corresponding grade engineering design qualification within the same trade. A contractor already holding grade A or above CGC qualification may apply for grade A engineering design qualification directly within the corresponding trade. The completed PGC projects can be referenced as the corresponding design and CGC works. In the specific regulatory review and approval practice MOHURD still needs to clarify whether direct mutual recognition of the CGC and design qualifications will suffice, or whether the respective statutory requirements for professional personnel and equipment related to a corresponding qualification are still required. 

Secondly, we will see more PGC consortia consisting of CGC contractors and design institutes. The PGC Measures explicitly request that, a PGC contractor hold both engineering design and CGC qualifications that are appropriate for the scale of the project, or alternatively, a consortium of a design institute and a CGC contractor with corresponding qualifications may also work. Neither drafts of the PGC measures mentioned PGC consortia. Previously, various implementation opinions from local provincial governments on general contracting consortia varied greatly. For example, in the Jilin Province, only one - either the design institute or the CGC contractor – is permitted to undertake PGC works, but not in the form of a consortium. Where a consortium concludes a PGC contract and undertakes construction work, it poses a more complex allocation of risk and responsibility to both the client and the contractor. The PGC Measures stipulate that, all consortium members jointly conclude PGC contracts and bear joint and several liability towards the client. Such a provision tends to protect the interest of the client more effectively, and seems in line with the international EPC practice. However, the consortium members are, on top of the PGC contract, to formulate detailed and explicit agreements regarding the allocation of rights, obligations and risks between the consortium members.  

Risk allocation under PGC

Under PGC or EPC, most project construction-related risks, such as design, procurement, construction etc., are borne by the contractor. Considering the specific construction market in China, regulatory authorities have specifically stipulated risk allocation principles under Article 15 of the PGC Measures. The following risks are to be borne by the client: 

(1) Price fluctuation of major construction materials, equipment and manpower beyond the contract range;

(2) Change of contract price caused by change of law; 

(3) Completion time and cost change due to unforeseeable geological conditions;

(4) Completion time and cost change attributable to the client; and 

(5) Completion time and cost change due to force majeure. 

Under the traditional "design + CGC" mode, especially in a fixed lump-sum price contract, it appears that the contractor bears more risk for cost and completion time. However, in practice, due to the segregated responsibilities of the design institute and CGC contractor, and that 100% accuracy of construction drawings is usually not realistic, disputes between the client and CGC contractor largely exist in relation to inflated cost, completion time delay, or quality defects attributable to change of drawings. Where PGC is adopted, in principle, other than the five risks listed above which are to be borne by the client, other risks in relation to cost, completion time and quality are to be borne by the contractor. It is worth noting that, unlike the PGC Measures, in accordance with the FIDIC Conditions of Contract for EPC/Turnkey Projects, those risks which are listed under Article 15, paragraph (1) of the PGC Measures (labor, materials, equipment), and under Article 15, paragraph (3) (unforeseeable geological conditions) are to be borne by the contractor, unless otherwise agreed by the parties. In practice, subject to a specific legal system, for those unforeseeable factors that seriously affect the contractor's construction cost, the contractor may still claim for price adjustments based on significant change of circumstances.   

Despite the provisions under Article 15 of the PGC Measures in relation to risk allocation, owing to the rather low legislative hierarchy of the PGC Measures, there is still uncertainty as to whether a judicial claim filed based on the PGC Measures will be supported, if a PGC contract lacks concrete agreements. It is suggested that the PGC parties make explicit and detailed risk allocation provisions in the contract. 

 Frequently Arising practical issues missing from the PGC Measures

 Subcontracting: In respect of general contracting of construction projects, regardless of whether CGC or PGC, companies should be encouraged to do professional works within their expertise and trade qualification, while subcontracting those part of works beyond their expertise to other, more qualified, professional organizations or teams. In the draft PGC measures dated May 10, 2019, it was permissible for PGC contractors to subcontract, by way of direct engagement, design or construction works, to a firm holding the corresponding qualification. Regrettably, it was deleted from the officially issued PGC Measures. The PGC Measures eventually adopted dual qualification and, as a result, PGC contractors may be keen to obtain such dual qualifications for both engineering design and CGC. The practical needs in subcontracting design or construction works still largely exist due to the generally varied expertise in design and civil construction. For the PGC Measures, some issues with high practical relevance still need to be clarified further by the regulatory authorities, including whether a dual-qualified PGC contractor may subcontract the design or construction works to a correspondingly qualified professional firm, and whether a subcontracted contractor may further subcontract design or special trade engineering works for those parts other than main structure of the project. 

Regulatory administration: As the authority directly responsible for regulatory matters such as construction project approvals, construction permits, construction project completion acceptances, etc., it is surprising that MOHURD did not address such highly relevant issues in the PGC Measures. One of the reasons why PGC or EPC has so far not been commonly adopted in China, is that there is conflict between (i) the PGC or EPC, which requests one single general contractor to be responsible and independently liable towards the client for all the works, including geological survey, engineering design and construction, and (ii) the current construction administrative system, involving construction contract filing, issuing construction permits, completion acceptance filings, etc., which generally does not accept a single PGC contract for filing purpose.  A rather prominent practical issue is that, on one hand, the administrative authorities have issued multiple legal documents to encourage PGC; and on the other hand, owing to the still quite stubborn regulatory rules, clients and contractors have to execute a series of contracts which, although complying with regulatory requirements, deviate from real life. This has led to a common legal issue of "black and white construction contracts" in the Chinese construction market. In the Administration Measures for Shanghai Municipal PGC Pilot Projects issued by the Shanghai Municipal Commission of Housing and Urban-Rural Development in 2016 and in its implementing rules, efforts have been made to address such a paradox in the form of provincial local rules, which could be referenced by MOHURD and other local construction authorities. 

Tax structuring under PGC

According to the current value-added tax (the "VAT") rules, the VAT rate for engineering design service is 6%, 9% for construction service and 13% for sales of construction materials. Under PGC, practical exploration and official clarification is still necessary on how the different VAT rates should apply to those work contents of the general contractor in survey, design, construction and procurement. For a consortium PGC, one should check with the competent tax authority, and make it clear in the PGC contract and the consortium agreement on how the respective consortium members should issue VAT invoices. 

Legal Analysis is published for the clients and professionals of Shanghai Qin Li Law Firm. The contents are of a general nature only. Readers are advised to consult their advisors before acting on any information contained in this newsletter. For more information or advice on the above subject or analysis of other issues, please contact: 

 

Patrick Yip

 Senior International Advisor

 patyipqinli@qinlilegal.com 

 

 

Cody Chen

codychen@qinlilegal.com 

Alexander Fischer

alexfischer@qinlilegal.com 

Weiheng Jia

weihengjia@qinlilegal.com 

Clare Lu

cllu@qinlilegal.com

Ron Ma

roma@qinlilegal.com 

Jolin Song

jolsong@qinlilegal.com

Xiangyang Ge

xyge@qinlilegal.com 

Zhen Han

zhenhan@qinlilegal.com 

Ping Liu

liuping@qinlilegal.com 

 

 

 

 

 

 

 

 

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