Interest on construction costs under invalid contracts

By Xu Yinzhe, City Development Law Firm
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Invalid construction contracts are a common problem that construction lawyers need to face. In the daily preparation of litigation documents, the author often encounters problems concerning how to claim relevant interest on construction costs under invalid construction contracts. The author makes a brief analysis here based on his own experience.

XU YINZHE, Partner, City Development Law Firm
XU YINZHE
Partner
City Development Law Firm

As the interest on construction costs is fructus civiles, will the acquisition of the interest be affected if the construction contract is invalid? As to the nature of the interest on construction costs, Civil Division I of the Supreme People’s Court (SPC) points out in the book, Understanding and Application of Judicial Interpretation of the Supreme People’s Court on Project Construction Contract: “The nature of the interest of the construction cost in arrears paid by the employer is fructus civiles.” Paragraph 2 of article 116 under the Property Law provides: “Fructus civiles shall be obtained by the parties concerned as stipulated by them; where it is not stipulated or clearly stipulated, it shall be obtained in accordance with the practices of trading.”

In current judicial practice, some still hold that the legal effect of a construction contract will adversely affect the appeal for the interest on construction costs, but the author understands that since the nature of the interest on construction costs is fructus civiles, the income is not subject to change because of the invalidity of the construction contract. It is different from the liability for breach of contract that must be based on the premise of the validity of contract.

As long as the legal relationship of the project construction contract exists, even if the construction contract is invalid, it will generate corresponding fructus civiles once the time of payment for the construction cost is confirmed, and the defaulting party must pay appropriate consideration.

Must interest on overdue payments under an invalid construction contract be calculated based on the contractual stipulation, as are construction costs? Article 56 of the Contract Law stipulates: “A contract that is null and void or revoked shall have no legally binding force ever from the very beginning.”

Therefore, the clauses concerning time of payment and relevant terms concerning interest on overdue payment agreed upon in the original construction contract must have no legally binding force from the very beginning, due to the invalidity of the construction contract.

However, article 2 of the SPC Interpretation on Issues Concerning the Application of Law in the Trial of Cases Involving Disputes over Project Construction Contracts provides: “Where a project construction contract is invalid, but the construction project is accepted as qualified at the time of completion, the contractor’s request for payment of the construction cost by reference to the contractual stipulations shall be supported.”

According to this provision, in practice, if the quality of construction is accepted as qualified, in case of an invalid construction contract, construction costs must be paid by reference to the contractual stipulations. This judicial interpretation has become almost universal since being issued more than 10 years ago. Based on this, some courts have ordered that the interest on overdue payments associated with construction costs be calculated by reference to the stipulation under the invalid contract. Some courts prefer to instead handle the case according to article 17 of the interpretation.

How should we treat the provisions of article 18 under the interpretation? Article 18 of the interpretation provides three timelines for the calculation and payment of the interest on construction costs in arrears, respectively: the date of delivery; the date of submission of the documents on settlement upon completion; and the date of the filing of the suit.

For each construction project, if the parties have no contractual stipulations at the time of interest calculation, or the contractual stipulations are not clear, relevant interest on construction costs in arrears must be calculated based on the specific circumstances, as well as the provisions of Article 18.

However, these provisions do not specify the starting time for calculating the interest in the case of an invalid construction contract. The author understands that the application of these provisions is based on the premise that the contract is still valid.

When should we start calculating the interest on overdue payments of construction costs under an invalid construction contract? Some hold that, since construction costs under an invalid contract can be paid by reference to the contractual stipulations as long as the quality of the construction is accepted as qualified, relevant interest on construction costs must also be calculated based on the contractual stipulations. Others hold that provisions of article 18 under the judicial interpretation do not expressly exclude invalid construction contracts, therefore it must also apply to invalid construction contracts.

Still another view holds that claims for construction costs and interest under invalid construction contracts are based on the premise that the construction project is accepted as qualified. Once the quality of the construction project is confirmed, payment terms of construction costs and interest must be enforceable immediately.

The author believes that: (1) payment terms of construction costs under an invalid construction contract become enforceable upon final acceptance of the construction project; (2) the interpretation of “final acceptance of the construction project” must be based on the provisions of article 14 under the judicial interpretation; (3) the specific time node for accounts payable must be calculated based on the claim of the contractor; (4) the interest of overdue payments of construction costs under an invalid contract must be calculated and paid from the time when the contractor proves its claim (for example, by sending a written letter of collection); and (5) if the contractor is unable to demonstrate that it has claimed for payables after “final acceptance of the construction project”, the interest of the overdue payment of construction costs must be calculated from the date of filing of the suit.

To understand the issues concerning interest on construction costs under an invalid contract, start with the cognition of the nature of the interest on construction costs. As fructus civiles, related claims for interest can be filed together with the claims for construction costs.

With regard to the specific time to calculate the interest on construction costs under an invalid contract, although the author holds that the interest must be calculated in accordance with the claims of the contractor upon the acceptance of the construction project, this issue, however, remains controversial in judicial practice, and the lawyer should analyze case by case to maximize the interests of the clients.

Xu Yinzhe is a partner at City Development Law Firm

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