CHINA (PRC FIRMS): An Introduction to Construction

China’s Construction Industry in 2020 

The construction output of China domestic market was CNY10,084 billion in the first half of 2020, accounting for 6.25% of China’s GDP but down by 1.9% from the same period a year earlier due to the impact of COVID-19. The number of employees in the construction industry also dropped by 4.4% compared with that of last year. However, economic downturn has little impact on large construction enterprises. Almost all of these enterprises have witnessed an increase on revenues compared with the same period of last year, and the value of newly signed contracts even reached a higher level. As to the overseas market, although the revenues significantly went down and dropped by 10.6% in the first half of 2020, the value of newly signed contracts increased by 1.2% and amounted to USD107.2 billion.

The Development of China’s Construction Industry

China's construction industry is still at a stage of “market fragmentation” and there are three folds here:

Firstly the differences lie between state-owned enterprises and private enterprises. The state-owned enterprises are more competitive in the market due to their larger scales and stronger abilities to resist risks. In a situation when the market is shrinking like now, the state-owned enterprises outperform the private ones by growth rate.

Secondly, there are differences between the high-achievers with solid management and quality assets and those under-performing enterprises struggling with management issues. The former kind enjoy a higher market share. In an increasingly competitive construction market and with business becoming more complex than ever, construction firms are all turning their attention to the emerging businesses, which we believe will be dominated by those high-achieving companies, leaving less and less resources for the poorly managed ones.

A third contrast in the industry is between companies running with high leverage and those deleveraged ones. In the background of an economic downturn and a trend of leverage reduction, a growing number of highly leveraged construction companies are going through difficulties and many have gone insolvent. Others who may have survived are selling assets at low prices for self salvation. The chances for companies with heavy debts to survive have grown slimmer.

All these will result in a further stratification of the construction industry and in the future the market is expected to be solidified.

New Laws and Regulations 

China has formally promulgated the Civil Code this year and will formally enact it in 2021. The adjustment to the Chapter of Construction Contract of the Civil Code is mainly about the inclusion of the provisions of null and void, and statutory termination of construction contracts which were originally referred to in the Interpretation of the Supreme People's Court on Issues relating to Applicable Laws for Trial of Dispute Cases involving Construction Contracts, while the remaining provisions of the Civil Code basically inherit the PRC Contract Law.

The implementation of the Administrative Measures on General Engineering Contracting for Housing Construction and Municipal Infrastructure Projects (“EPC Measures”), published by the Ministry of Housing and Urban-Rural Development and the National Development and Reform Commission, has confirmed the legal basis for the model of EPC in China. Generally speaking, compared with the normal construction mode, the EPC Measures have put higher requirements on the general contractor, clarified the general contractor’s main responsibilities in projects, and paid more attention to the management ability and anti-risk ability of them.

The Regulations on Ensuring Payments to SMEs (“SMEs Payments Regulations”), enacted by the State Council, have a profound impact on the construction industry. For SMEs, the SMEs Payments Regulations provide more detailed protective systems in their favour at the level of administrative regulations. For large enterprises, this is no good news as it has added stress on cash flows and raised more requirements on their finance management. The risk to contractors when designating subcontractors has also greatly risen following these new regulations.

Regulations for Guaranteeing the Wage Payment to Rural Migrant Workers (“Payment Regulations”), enacted by the State Council, have upgraded the protection level for rural migrant workers from many aspects and put forward more requirements on the general contractor. If the general contractor violates the Payment Regulations, the general contractor may be subject to punishments such as project suspension and qualification downgrading.

Potential Obstacles for Construction Enterprises and General Tips to Overcome Them

The first obstacle is caused by the economic downturn. Many employers' financial capacity to make payments have been weakened, and some even entered into bankruptcy proceedings. In order to overcome this obstacle, construction enterprises should do full due diligence of the employers’ financial stability and evaluate the project thoroughly. It would be better for construction enterprises not to construct the project without any prior or progress payments. On the other hand, necessary actions, such as negotiations or litigations, should be taken in a timely manner in order to recover payment due when employers are unable to perform the contract.

The second obstacle is that stricter requirements and further burden are on the general contractors following the enactment of the new laws and regulations and the effective ones which are going to be amended. It is necessary for the construction enterprises to establish a practical compliance mechanism and put together a qualified in-house legal team in response to the changes. Meanwhile, construction enterprises should also consult professional lawyers on a regular basis.