China: Building In China — Some Legal Considerations

Last Updated: 28 October 2011
Article by Nick Molan

Recent data on the Chinese construction market confirmed it as the second largest in the world, and it is expected to surpass the U.S. to take the number one spot by 2020. Since the Central Government indentified the significance of the construction industry for China's modernisation plans during the early 1980s, the industry has boomed to the point that today construction-related output is valued at US$1.4 trillion, equivalent to approximately 24 percent of China's GDP. The current strength and expected growth of the construction market is underpinned by China's rapid population growth, an accelerated trend towards urbanization, increased industrial output and the increased infrastructure and other capital needs stemming from the foregoing.

However, although China's economy has become increasingly open, particularly since China's accession to the World Trade Organization in 2001, the construction industry remains relatively protected by a combination of

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Mainland China is governed by a multi-tiered civil regime which is constantly evolving at the hands of the central, provincial and municipal governments.

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legal, political and economic mechanisms which must be understood and managed by foreign construction and services firms hoping to tap into this market. In this article we set out some of the legal considerations which should be borne in mind when considering the relative advantages and disadvantages for foreign construction companies of seeking to do business in China.

Legal Barriers to Foreign Construction Companies

According to the National Statistics Bureau of China, there are approximately 59,000 construction enterprises in China, but only 351 foreign firms (not including firms from Hong Kong or Macau) that have registered activity on the Mainland. Interestingly this number has been steadily decreasing since 2004, when the number stood at 386. The majority of these foreign companies are based in Beijing and Shanghai, they employ (on average) approximately 300 people, and realised a combined total profit in 2009 of almost US$350 million.

However, focusing on wholly foreign-owned companies can be misleading, given that (as a general rule) foreign companies must team up with a local partner (either in joint venture or by creating a special purpose company) to be eligible to work in the Chinese market. This obviously involves a degree of risk, both in selecting a suitable partner and forming a cohesive working unit with that partner on an ongoing basis. Nonetheless, it also reflects a general underlying symbiosis between foreign companies, whose strength often lies in their technical and management know-how, and local companies, whose strength often lies in their manpower, local knowledge and connections.

A key exception to this general prohibition on foreign construction companies operating in China in their own right is that foreign firms may be awarded contracts for construction projects financed by foreign governments, international and multilateral organizations (most notably, the World Bank and the Asian Development Bank) or foreign companies. This is generally a good fit, given that in scope and technicality these projects are often complex, which provides sophisticated foreign contractors with an advantage over their lower cost domestic competitors for such work.

Legislative Framework

Mainland China is governed by a multi-tiered civil regime which is constantly evolving at the hands of the central, provincial and municipal governments. The following laws passed by the central government are of particular significance for the construction industry (and apply equally to local participants, foreign companies and foreign/local joint ventures):

  • The Contract Law of the PRC, notably Chapter 16 which defines a construction project contract to include survey contracts, design contracts and project construction contracts. Chapter 16 also sets out certain general principles for tendering, contractual terms, supervision and inspection of the site and works, and remedies;
  • The Construction Law of the PRC, which regulates construction licensing, contracting, supervision of construction projects, occupational health and safety, project management and quality regulation; and
  • The Invitation and Submission of Bids Law of the PRC, which standardizes the procurement process (including bid invitation and submission) for projects with a bearing on public interest, including large-scale infrastructure and public utility projects, and projects which are funded by the Chinese government, foreign governments or multilateral organizations.

In addition to these laws of general application, there are a number of laws which have been prepared by the Ministry of Construction (the Central Government Ministry which has general oversight for construction activities and the construction industry in China) specifically targeting foreign firms operating in China.

These include:

  • The Regulations on Administration of Foreign Invested Firms;
  • The Regulations on Foreign Invested Construction and Engineering Firms; and
  • The Regulations on the Management of Foreign Funded Urban Planning Service Enterprises, each of which seeks to reconcile the general construction laws described earlier with various laws governing foreign investment in China, including the Sino-Foreign Equity Joint Ventures Law and the Wholly Foreign-Owned Enterprises Law.

The above represents a sample of the major legislation which is likely to apply to a foreign-owned construction company doing business in China. It is important to remember, however, that behind this are a significant number of further laws, regulations, directives, issues papers and memoranda issued by different levels of China's bureaucracy which must be considered in reaching a decision about whether to participate in a particular project. However there is a growing number of law firms and other specialist advisers, both inside China and elsewhere, who are able to assist companies in navigating this complex field.

Standard Form Contracts

As with many jurisdictions, standard form contracts have been introduced within the Chinese construction industry to improve the efficiency of the contract negotiating process and to manifest certain generally accepted principles about the way business is done in the market.

Foreign contractors generally draw comfort from the fact that FIDIC conditions of contract have been widely used in China for the delivery of major construction projects for a number of years now. It is important to recognize, however, that the FIDIC form is primarily used for projects financed by foreign governments, international and multilateral organizations or foreign companies.

For projects procured by the Chinese public sector or state-owned enterprises, there are a significant number of Chinese standard form contracts, and their use in a project may be influenced by the industry in which the project is situated or the nature of the procuring entity. The most important general form of construction contract is the Model Conditions of Contract for Works of Building Construction, released by the Ministry of Construction and the State Industrial and Commercial Administration Bureau in 1991 and re-issued in a revised second edition in 1999. This general form of agreement and related forms are constantly being revised and refined with reference to prevailing international trends and developments in relevant laws.

Most recently, the National Development and Reform Commission released draft versions of the Standard Project Design and Construction Main Contractor Bidding Documents and the Simplified Standard Construction Project Bidding Documents (which are basically simplified versions of the Standard Documents for Tendering of Construction Projects issued in 2007). The public consultation process regarding these drafts closed at the end of December 2010, and many had been expecting final versions to be released in the first half of this year. However, at the time of writing this article, these were yet to be published.

In addition to the forms of contract published by the government bodies identified above, many other public bodies and state-owned companies have also created standard conditions of contract for their works, including (by way of example) the Ministry of Water Conservancy, the Ministry of Electricity and the State Industrial and Commercial Administration Bureau.

To Build or Not to Build?

The Chinese economy has become synonymous with boundless enthusiasm and potential, and few people challenge the fundamental role which the construction industry has played and will continue to play in the future of that growth.

This article has discussed some of the preliminary legal issues which a construction enterprise should consider when deciding whether to pursue business opportunities in China. Of equal importance will be considerations regarding the economics and commerciality of such opportunities, cultural constraints to doing business in China and the organizational fit (in the case of a joint venture structure) within an enterprise's broader structure. That said, in light of prolonged economic difficulties in more familiar markets, it may be timely for skilled foreign construction companies to consider a foray into China.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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