Hello, this is Attorney Park Jong-han from Cheongchul Law Firm.

In the case of a construction contract, when the client or contractor pays an advance payment, how will the advance payment be settled later? In particular, if the construction contract is terminated, the method of settling the advance payment may become an issue.

[Question]

Settlement method for advance payments in construction contracts

[Answer]

A. Principle

An advance payment is a payment made to the contractor in advance of the total construction cost that will be paid to the subcontractor in relation to the overall construction. Therefore, if a reason arises for the subcontractor to return the advance payment due to reasons such as the contract being terminated or canceled after the advance payment has been made, the advance payment will naturally be applied to the 'progress payment for work completed' without any separate declaration of set-off, unless there are special circumstances (see Supreme Court Decision 99Da55519, December 7, 1999). That is, if the contractor has remaining construction payments, they are obligated to pay only that amount, and if there is a remaining advance payment, they hold the right to claim that amount back.

If the progress payment claim has been 'temporarily seized' or 'seized' and the contract is terminated or canceled, resulting in a claim for the return of the advance payment, if the contractor made the advance payment before the temporary seizure or seizure took effect, the advance payment will be naturally applied to the unpaid amount of the progress payment corresponding to the work completed, despite the temporary seizure or seizure, and the effect of the temporary seizure or seizure will only apply to the remaining construction payments.

On the other hand, if there exists a subcontract, and the regulations under the Act on the Fair Transactions in Subcontracting (hereinafter referred to as 'the Subcontracting Act') for direct payment of subcontracting costs apply, if a reason for termination or cancellation of the contract occurs after the advance payment has been made, the 'progress payment related to the work completed by the subcontractor will be deducted from the advance payment and direct payment of subcontracting costs will apply only to the remaining construction payment' (see Supreme Court Decision 2007Da40109, September 20, 2007). Thus, the provisions regarding direct payment of subcontracting costs must be interpreted to mean that if there are remaining construction payments after applying the advance payment to the progress payment, the subcontracting costs must be directly paid to the subcontractor (see Supreme Court Decision 97Da5060, December 12, 1997).

B. Exception

However, how to determine the details of the progress payment to be applied to the advance payment is governed by the agreement between the parties to the construction contract.

If, under the Subcontracting Act, a reason for direct payment of subcontracting costs arises and the contractor directly pays the subcontracting costs to the subcontractor, and if an 'exceptional settlement agreement' has been made to exclude the corresponding amount from the details of the progress payment applied to the advance payment, the contractor cannot be relieved of their obligation to pay the subcontracting costs to the subcontractor on the grounds that the unpaid advance payment has been applied to the progress payment (see Supreme Court Decision 2010Da31211, May 13, 2010). However, this applies only when the subcontractor has a direct payment claim.

Furthermore, even if there was an exceptional settlement agreement, if before the reason for the contractor making direct payment of the subcontracting costs occurred, the advance payment has been applied to the progress payments, causing the contractor's payment obligation for the construction cost to be extinguished (for example, if the contract was terminated before the subcontractor requested direct payment), the contractor will no longer be obligated to pay subcontracting costs to the subcontractor (see Supreme Court Decision 2014Da2144327, January 23, 2014).

As such, we have briefly looked at the settlement method for advance payments in construction contracts. In disputes related to construction projects, the relevant laws are quite complex, and there is a need for expertise due to the characteristics of the construction field. Awareness and experience of not only court judgments but also practical cases, administrative interpretations, and dispositions are essential. Therefore, I highly recommend seeking the assistance of Attorney Park Jong-han, who has expertise in construction and real estate and experience in various dispute resolutions.

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