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Construction contractors are entitled to priority repayment from the proceeds of a project¡¯s sale or auction to settle unpaid invoices. Since construction payments are significant and substantial claims in bankruptcy proceedings, their priority ranking against other debts draws considerable public attention.

This article examines the settlement order between construction payment priority rights and four other types of claim.

Homebuyer rights

While the priority of construction payment claims was originally designed to protect the interests of migrant workers, the expectant rights of homebuyers aim to safeguard their residential rights.

Under the Reply of the Supreme People¡¯s Court (SPC) on the Priority of Construction Payment Claims, issued in 2002, contractors should not assert their priority rights against homebuyers who have paid all or most of the purchase price for a property.

Although this reply was repealed with implementation of the Civil Code, article 29 of the SPC¡¯s Provisions on Several Issues Concerning the Handling of Enforcement Objections and Reconsideration Cases continues to prioritise protection for commodity housing consumers.

Specifically, homebuyers¡¯ rights under a property purchase contract prevail over contractor claims if the following three criteria are met:

1. A legally valid, written purchase contract was signed before the court¡¯s seizure of the property;
2. The property is for residential use, and the buyer owns no other habitable homes; and
3. The buyer has paid more than 50% of the agreed purchase price.

Expenses and debts

Under article 41 of the Bankruptcy Law, the bankruptcy expenses of a bankruptcy case include:

1. Litigation costs;
2. Expenses for managing, liquidating and distributing the debtor¡¯s assets; and
3. Costs, remuneration and staff hiring fees incurred by administrators.

Common benefit debts refer to obligations incurred during bankruptcy proceedings for the benefit of all creditors. These include:

1. Debts arising from administrators or debtors requesting the performance of unfulfilled contracts;
2. Debts arising from negotiorum gestorum (management of another¡¯s affairs) management of debtor assets;
3. Debts arising from unjust enrichment of the debtor;
4. Wages, social insurance payments and related debts necessary for the debtor¡¯s continued operations;
5. Debts caused by personal damages resulting from administrators or related personnel performing their duties; and
6. Debts arising from personal damages caused by the debtor¡¯s assets.

In terms of repayment priority, bankruptcy expenses and common benefit debts take precedence over ordinary claims.

In accordance with article 3 of the SPC¡¯s Provisions (II) on Implementing the Bankruptcy Law, the remaining portion of a debtor¡¯s certain property ¨C after the extinguishment or enforcement of secured rights ¨C can be used to settle bankruptcy expenses, common benefit debts and other bankruptcy claims.

While secured claims have priority over bankruptcy expenses and common benefit debts, construction payment priority rights outrank secured claims. Therefore, bankruptcy expenses and common benefit debts are subordinate to construction payment priority rights.

Employee claims

Under article 113 of the Bankruptcy Law, employee claims primarily include:

1. Unpaid wages, medical expenses, disability subsidies and compensation owed by the bankrupt entity;
2. Unpaid contributions to employees¡¯ individual accounts for basic pension and medical insurance; and
3. Compensation mandated by laws and administrative regulations.

In accordance with the SPC¡¯s reply on Li Hanqiao et al v Southern Securities (2013), retrial disputes over employee rights, performance-based wages and bonuses are classified as ordinary claims and do not qualify as priority claims in bankruptcy proceedings.

As article 113 mandates the precedence of employee claims over other creditors¡¯ rights only after bankruptcy costs and common benefit debts are settled, it entails that employee claims are subordinate to construction payment priority rights.

Tax claims

Article 113 of the Bankruptcy Law also stipulates that tax claims are subordinate to employee claims in repayment. Yet article 45 of the Tax Collection and Administration Law states that tax claims take precedence over unsecured claims and, under certain conditions, even secured claims. This once created a conflict between the two laws regarding the repayment hierarchy, as employee claims are classified as unsecured claims.

However, the conflict was substantially resolved in 2020, when the Announcement of the State Taxation Administration on Several Issues Concerning Tax Collection came into effect. The announcement clarified that unpaid taxes, late payment fees and interest arising from special tax adjustments should be filed by tax authorities in compliance with the Bankruptcy Law.

Specifically, late payment fees and interest from special tax adjustments are to be filed as ordinary bankruptcy claims. Consequently, tax claims will be repaid in the order stipulated by the Bankruptcy Law, with construction payment priority rights prevailing over both employee claims and tax claims.

Takeaways

The priority of construction payment claims in bankruptcy proceedings significantly affects the interests of contractors, homebuyers, mortgage holders and employees.

Typically, construction payment priority rights prevail over mortgage claims, bankruptcy expenses, common benefit debts, employee claims and tax claims in the distribution of bankruptcy assets. But under certain conditions they may rank below homebuyers¡¯ expectant rights.

This framework not only protects contractors¡¯ legal interests but also supports the stability and sustainable growth of the construction market.

Kimberly Liu is a partner at Hui Ye Law Firm. She can be contacted by phone at +86 21 5237 0950 and by email at zhiyu.liu@huiyelaw.com