Last year, my observation on investment in the wind power industry was that the timing might be right, but investors should be patient and be prepared for challenges.

In fact, some international wind farm developers have pulled out under the pressure of continuing low returns on investment.

Some of the major causes of low returns are as follows:

(a) difficult grid connection – the grid enterprises managing the state monopoly business have no financial incentives to provide timely grid connection to renewable energy power plants, and there is no effective mechanism to compel them to connect new producers, nor any unified technical standards for connection.

(b) unfavorable pricing – the local stated-owned power plants have no pressure to make profits, and they won many wind projects by tendering below-cost output prices; also the formulas and processes for tariff setting are still being worked out, and remain unpredictable (especially for independent producers).

(c) inexperience – foreign investors may lack the local connections and know how of both incumbent power companies and new independent local competitors, and as a result face higher costs and more obstacles across the board.

The central government has been aware of these problems and in response recently promulgated amendments to the 2006 Renewable Energy Law taking effect on April 1, 2010 (the “2010 Amendments”). The 2010 Amendments aim to clarify some statutory ambiguities and solve some policy problems, but still provide only fairly general guidance. More detailed implementing regulations are expected to be issued in the coming months.

Perhaps the single most important innovation in the 2010 Amendments is a new focus on renewables outtake. In particular, there is now a further requirement that the state energy authority and power administration take responsibility to supervise the implementation of the requirement, provided for in the 2006 Renewable Energy Law, that all power generated by renewable energy shall be purchased by the grid operators so long as the renewable power generation facilities and connection to the grid satisfy relevant technical criteria. To help ensure this outcome, the state energy authority and power administration, together with the state financial department, are mandated to jointly determine a minimum ratio of renewable energy to total power to be purchased by grid enterprises, based on the total generated power volume.

Although technical criteria for network connection have not yet been published, drafting and internal discussions are underway at the power administrations. Balance will be important, since there will be serious downsides to technical requirements that are either too low (hazardous for the network as a whole) or too high (unnecessarily raising costs for renewable power producers).

It is also worth mentioning the 2010 Amendments’ mandate for the state treasury to establish a renewable energy development fund. This fund will be sourced from ad hoc funds in the annual budget and from renewable energy surcharges, and might be used to compensate grid enterprises for their increased costs of purchasing renewable power.

Certainly, the 2010 Amendments reiterate the central government’s commitment to facilitating investments in wind and other renewable power projects. However, in the absence of rational and transparent sales, tariff and technical interconnect regimes, the investment environment will continue to be challenging and risky, and the current distortions in the market will persist.

The Tort Law marks a milestone in PRC legislative history, and will have myriad implications for diverse areas of private and commercial activity.

As a construction lawyer, I am particularly interested in Article 86 of the Tort Law concerning liability for loss and damage caused by collapse of construction works.

Although the Tort Law has been in planning for some time, it seems to have been influenced by some very recent events. Much attention has been focused on the recent milk scandals as a catalyst for the product liability aspects of the legislation. But it is also widely speculated that Article 86 was driven by the recent case of a building collapse in Shanghai in June 2009. The collapse of a 13-floor building at Shanghai’s “Lotus Riverside” apartment complex was perhaps one of the top 10 local news events of 2009 in Shanghai. The accident killed one worker on site and left 489 home buyers without their expected homes (in many cases, costing all of their life savings). The collapse has been blamed on improper construction methods.

Quality problems have long plagued the construction industry in China. “Tofu Building” is the cheeky term used by the local press to describe such shoddy construction projects. Clearly, to some extent, this situation reflects a failure of the current legal and regulatory regime. Hence, there is little humor in this situation for Chinese policymakers.

Although there are administrative sanctions and contractual remedies for poor construction quality, tort legislation has been less than robust. Tort protections are especially important in addressing harm to innocent third parties who would not be entitled to compensation as a matter of contract.

No doubt in recognition of this, the Tort Law has clearly placed liability for collapse of construction works on the contractors and developers who are best able to avoid them in the first place.

Since 1987, Article 126 of General Principles of Civil Law (“GPCL”) has provided that:

“If a building or any other installation or an object placed or hung on a structure collapses, detaches or drops down and causes damages to others, its owner or manager shall bear civil liability, unless he can prove himself not a fault.”

GPCL Article 126 creates a rebuttable presumption that the current property owner or manager is liable in these cases. But these are quite disparate cases – there is a potentially immense difference between the types of causation involved in items falling from a building and in a building itself collapsing. In cases where the building itself collapses, the current owners or managers would have very little opportunity to prevent the harm. Hence, there seems to be little reason to hold them primarily liable. On the other hand, the original contractor and developer, the parties best situated to prevent catastrophic building collapse, are not included (even secondarily) as potentially liable persons here.

To remedy this and other issues in relation to personal injury liability under the GPCL, in 2003 the Supreme People’s Court issued an interpretation (“Interpretation”) that, among other things, clarified the application of GPCL Article 126. Specifically, Article 16 of the Interpretation clarified that, if the collapse is caused by design or construction defects, the responsible designer and contractor can also be held directly liable to injured parties.

Article 86 of the Tort Law deals only with collapse, providing:

”Where any building, structure or facility collapses, causing any harm to another person, the construction employer and contractor shall be liable jointly and severally. After making compensation, the construction employer or contractor shall be entitled to be reimbursed by other liable persons if any.

Where the collapse of any building, structure or facility, which causes any harm to another person, is attributed to any other liable person, the other liable person shall assume the tort liability.”

With this new Article 86, we have a new bright-line rule for primary liability in the case of construction collapse. Article 86 rests primary liability for building collapse squarely with the employer and contractor. In place of the previous rebuttable presumption of fault for current owners / managers, there is now strict liability for employers and contractors. We also have a broader and more objective rule of reason in relation to secondary or contributory liability, insofar as any other person contributing to the collapse, whether contemporaneous, upstream or downstream to the original employer/contractor, can also be held liable.

Although the Tort Law has changed the formal statutory liability rules in relation to collapse of construction works in China, in the final analysis, the formal and practical significance of this change may not be very great.

Formally, the Supreme People’s Court has long since clarified that the original employers and contractors could be liable in building collapse. Practically, those parties are the most obvious targets for liability in the event of building collapse, and under current practice the employer and contractor are already joined whenever possible, even without the new rule. But, since most developers in practice usually use special purpose vehicles (SPVs) to carry out their projects, dissolving the SPVs on completion, recourse to the original developing parties may be less available than the Tort Law seems to assume. It therefore appears that the contractors may well end up being the easiest targets at the end of the day.

Hence, while Article 86 represents a rationalization and refinement of the liability rules in this area, it will no doubt take much more than this marginal formal change to begin to reverse the deeply entrenched incentives causing the proliferation of Tofu Buildings in China.

Most employers like the certainty of a fixed price contract from their contractors for their construction projects. Usually, they are required to have fixed price contracts by their financiers. In return for keeping to a fixed price, contractors in theory are allowed to charge a premium for assuming greater risks. This does not however happen in practice very much. But contractors continue to sign up to fixed price contracts because competition for contracts in China is very keen and employers are generally in a much stronger bargaining position than contractors, at least at the tender stage.

However, contractors who find themselves in a position where the contract price is fixed but their costs have increased since signing the contract may have a possible way out. The Interpretation II on Several Issues Concerning the Application of the PRC Contract Law promulgated by the PRC Supreme Court on 13 May 2009 introduced a principle of “significant change of circumstances” into the law of contract in China. Under this principle, the court is entitled to vary a contract or declare a contract discharged if a significant change in the objective circumstances occurring after contract formation renders the fulfillment of the purpose of the contract impossible or the continued performance of the contract manifestly unfair to one party.

In the context of construction contracts, the rule of “significant change of circumstances” provides a potential ground for a contractor to apply to the court to increase the contract price on the basis that the circumstances upon which the fixed price was originally agreed have changed significantly since the signing of the contract. The contractor must however prove a number of things to the court.
Firstly, the contractor needs to show the court that the new circumstances do not constitute a “commercial risk”. The Interpretation does not define the term “commercial risk”. The Guidance Opinion of the Interpretation issued by the Supreme Court however requires the court to take into consideration the market conditions and the circumstances of a particular case together with the following important factors to differentiate a “commercial risk” from a “significant change of circumstances”. A new circumstance will not be a “commercial risk” if:

(a) it is generally not foreseeable in the view of the general public;

b) its effect is far beyond the contemplation of a reasonable man;

c) it is not capable of being prevented or controlled; and

d) the nature of the transaction in question is not one of high risk and high return.

Secondly, the contractor will need to prove that the continued performance of the contract will render the fulfillment of the purpose of the contract impossible or manifestly unfair to the contractor. It is not often that the purpose of a contract becomes impossible to fulfill due to a change of circumstances. It is likely that we will see more reliance on the “manifestly unfair” argument. In this regard, the overriding principle of “fairness” in Chinese contract law comes into play and it requires the rights and obligations of contracting parties to be agreed on the basis of “fairness”. What is “manifestly unfair” is not defined in the Interpretation but the courts in China generally have a wide discretion in determining what is fair or unfair.

I personally do not think that the Chinese courts will apply the principle of “significant change of circumstances” liberally to vary or discharge a contract. If the courts apply the guidelines of the Guidance Opinion strictly, I think it will be difficult for a contractor to be able to prove a “significant change of circumstances”. After all, an experienced contractor will find it difficult to prove that a circumstance or its effects, in particular price fluctuation of materials or labour, is not foreseeable or cannot be prevented or mitigated in some way. More often than not, the particular circumstance was foreseeable but the contractor had to under price to win the contract and therefore left no margin of error in his price. This is perhaps best reflected by the fact that for the contracting business in China, a profit margin of 1 to 3% is the norm.

Although the principle of “significant change of circumstances” is a useful argument to employ for a contractor seeking to vary a fixed contract price, it is likely that most contractors will continue to rely more on the overriding Chinese contract law principle of fairness to achieve the same objective. In conclusion, it is perhaps interesting to note that in the context of liquidated damages, the Supreme Court in a recent opinion said (roughly translated) “In the current more difficult market conditions in doing business faced by companies, with respect to the issue of the amount of an agreed penalty being significantly higher than the actual loss caused by a breach, the contract law principles of good faith and fairness should be applied, and the purpose of a penalty being mainly compensatory and secondarily punitive in nature adhered to, so as to prevent parties using party autonomy as a reason to agree excessive penalties”.

The literal meaning of Jian Li in Chinese is “project supervisor” and it refers to someone engaged by the owner to supervise the contractor on matters like construction quality, progress of works and cost control. The Jian Li’s main role is really to ensure that a project is constructed safely and to the quality standards as required under law. The appointment of a Jian Li is mandatory for certain types of construction projects in China, for example projects funded by international development agencies, infrastructure projects and public utilities projects.

The concept of a Jian Li in China originated in the 1980s, early years in China’s transition to market economy. In those days, it was common practice for employers to manage construction projects on their own without any external professional support. The obvious problem was that inexperienced employers often ended up with projects with quality problems because the contractors were not properly supervised or managed in their work. Poor quality buildings and works were a major headache for the industry. The introduction of a Jian Li was part of an effort by the government to resolve this problem. Although appointed by the employer, the Jian Li is primarily intended to play a statutory role similar to that of an independent checker of works which we see in many countries.

In the last three decades, we have seen a massive influx of foreign investors relocating their manufacturing operations to China. Factories were and continue to be put up all over the country at an amazing speed. Most of these factories were built and will continue to be built by local Chinese contractors. Foreign contractors have not been able to get a foothold in the Chinese construction market due to a variety of reasons including restrictions on market entry, the tough requirements to obtain and maintain a contractor’s license and most importantly the inability to compete with the local Chinese contractors on pricing.

However, many foreign investors who are new to China are not used to working with the local Chinese contractors. They do not know for sure if the local Chinese contractors will build their factories in China to the same standards as their factories elsewhere. They therefore often look to the foreign contractors or construction professionals that they have used elsewhere to build their factories for help in managing or supervising the construction of their projects in China.

Many foreign contractors and construction professionals have come to China with the objective of servicing the foreign investors. Many of them have in fact followed their clients to China. Most of these foreign contractors and construction professionals have chosen to set up “project consultancy” companies employing both foreign and Chinese construction professionals. The business that a project consultancy company is licensed to undertake is however fairly limited, but it is relatively easy and cheap to set up. Although not ideal, with the right contract structures, these project consultancy companies have been able to service their clients’ needs adequately. Many become involved from the very start of a project, helping their clients with site selection and due diligence, right up to the ultimate delivery of the completed project to the clients.

On many projects, one would often find the foreign owner appointing a Jian Li as well as a project consultant. The project consultant’s role is usually wider than that of the Jian Li but it would invariably also involve ensuring that the project is built to the correct standards and quality. The Jian Li is however primarily concerned with ensuring that statutory standards and quality are met andthe project consultant is concerned with ensuring that contractual standards and quality are met. Although statutory and contractual requirements often overlap, the former are often less stringent than the latter. This gives rise to a risk that the Jianli and the project consultant in performing their respective supervision duties on a project may give inconsistent messages to the contractor if they are not properly coordinated.

One would have thought that it would be more efficient for one party to perform the duties of both the Jian Li and the project consultant. Most owners would certainly prefer a single point of responsibility. It would at least avoid any inconsistency in performance of their respective duties. For a long time, this was not possible. To set up a Jian Li company, one has to be licensed by the construction authorities. Before 2007, foreigners were not allowed to set up or acquire interest in a Jian Li company.

On 26 March 2007, the Regulations on the Administration of Foreign-invested Construction Service Enterprises was introduced which allows foreigners to set up or acquire interest in Jian Li companies. This was part of China’s effort to fulfill its World Trade Organization commitment to open up the construction engineering services sector. However, despite the Regulations, the market has not seen the setting up of many foreign invested Jian Li companies. Why is this?

I can think of a few reasons. I suspect the main reason is the regulatory limitations. Similar to construction and design companies, Jian Li companies must obtain Skill Qualifications Certificates (SQCs) from the construction authority before they can carry out business. The SQCs are classified into several grades which determine the size and scope of the projects that the holder is permitted to work on. A newly set up Jian Li company is only allowed to apply for the lowest grade of SQC and has to wait for at least two years to apply for a higher grade. This is obviously not appealing to foreign investors as it will take too long before they are able to upgrade to a SQC that will allow them to undertake the bigger projects that they desire.

Local protectionism may also be a factor hindering the growth in numbers of foreign-invested Jian Li companies. One of my clients recently complained to me that his proposal to acquire a Chinese Jian Li company was rejected by the local construction authority. I asked him about the reasons for the rejection. My client said that he believed the real reason was that the authority is keen to protect the local Jian Li companies from foreign competition. The official response from the local construction authority was that the review of our client’s application could not take place because the central construction authority has not issued any detailed implementation rules for the Regulations yet. And so we wait…