While the global economy is suffering from COVID-19 related recession and political unrest, the construction industry has been hit especially hard by surging prices of materials and wages. Subcontractors in particular are suffering huge losses. To cushion the harsh blow to contractors and subcontractors, the Korean government has introduced a mechanism called “Supply Cost Linkage System” effective September 2022. Through this system, increases in raw material prices can be automatically reflected and incorporated into construction costs. This system, however, is not mandatory under the current law, and several bills to amend the Fair Transactions in Subcontracting Act (the “Subcontracting Act”) are being introduced one after another.
Key Features of the Proposed Amendment
The purpose of the proposed amendment to the Subcontracting Act is to make it mandatory to reflect any increase in the price of raw materials to the subcontract payment in order to ease the burden on subcontractors. One of the key features is the requirement on the principal contractor to reflect and include any additional costs in the subcontract payment in case the price of main raw materials rises more than 3%1. If the main contractor refuses to do so, correction orders may be imposed.
The proposed amendment also attempts to remedy the current practice in private construction projects where it is customary to include a special contract provision preventing adjustment of payments due to price fluctuations. Once amended, the Act will prohibit any unfair provisions in construction contracts that restrict the right of subcontractors to request adjustment of subcontract payments during the contracting term.
Another proposal to amend the Act was to include an extraterritorial jurisdiction provision2. If ratified, all foreign companies entering into subcontract agreements with Korean subcontractors will be subject to the Subcontracting Act.
Ramification on Future Construction Contracts in the International Context
If the Subcontracting Act is amended as proposed, subcontractors may be better protected from singularly bearing all the losses from increased raw material prices. Such quick response by Korea’s National Assembly is unique compared to other countries.
Similar legal devices exist in countries such as Australia and Singapore. For instance, in Singapore, the Building and Construction Industry Security of Payment Act (the “SOP Act”) facilitates timely payments and smooth cash flow between contractors and subcontractors3.
However, the SOP Act is mainly concerned with protecting subcontractors from delayed payments or non-payment4, rather than offering a solution for problems arising from significant differences in material costs from the time a contract was signed and when the materials are bought by the subcontractors.
Under California’s construction law, the general rule is that contractors and subcontractors are stuck with the price stated in the contract unless a specific clause allows them to pass on significant price increases for materials to others5. There is no statutory protection for subcontractors other than a contractual provision allowing them to negotiate a different payment scheme following significant price increases in materials over passage of time.
If amended, Korea’s Subcontracting Act will offer extraordinary, if not unprecedented, protection to Korean subcontractors and enable them to minimize losses caused by the sweeping inflation.
1News Articles (Incoming Bills to Reflect Increase in Raw Material Prices for Subcontracts - (dnews.co.kr) (Sept. 6, 2022); Introduction of Bills to Amend the Subcontracting Act - (asiae.co.kr) (Sept. 7, 2022)).
2News Article (Proposed Amendment to Apply the Subcontracting Act to Foreign Companies - (gnnews.co.kr) (Aug. 25, 2022)).
3The Building and Construction Industry Security of Payment Act in Singapore and its Implications (lawtimes.co.kr) (Aug. 7, 2018).
4Enforcing payment for construction work in Singapore under the Building and Construction Industry Security of Payment Act | Practical Law (thomsonreuters.com) (Oct. 1, 2016).
5Building Materials Price Increase Clause for Contractors and Subcontractors – Three Options, Article written by William L. Porter, Esq., Building Materials Price Increase Clause for Contractors and Subcontractors – Three Options - Porter Law (2021).