Hello, I am Attorney Bae Ki-hyung of Cheongchul Law Firm.

When a prime contractor at a construction site cannot withstand cash flow problems and files for corporate rehabilitation (so-called court receivership), the construction site falls into great confusion. Subcontractors, worried they will not recover their unpaid construction proceeds, rush to demand direct payment of their subcontract amounts from the project owner.

At such times, however, project owners and the prime contractor's court-appointed administrators often refuse payment, arguing that "under the Debtor Rehabilitation Act, all creditor enforcement is frozen (prohibited), so we cannot make direct payments." From the subcontractors' perspective, with the prime contractor on the brink of collapse, it is bewildering whether their last lifeline — the direct payment claim — is also legally blocked. Because enormous sums are at stake, fierce legal battles ensue.

Today, I will explain through clear statutes and precedents whether the commencement of rehabilitation proceedings against a prime contractor qualifies as the "inability to pay" that triggers direct payment under the Subcontracting Act, and how the Supreme Court rules when the Debtor Rehabilitation Act's claim-freeze provisions clash with the Subcontracting Act's direct payment system.

Commencement of Prime Contractor Rehabilitation and Subcontract Direct Payment: Inability to Pay and Insolvency Law Conflict

[Question] When a prime contractor enters corporate rehabilitation proceedings, can the subcontractor demand direct payment of subcontract amounts from the project owner on that basis? Can the project owner refuse payment based on the Debtor Rehabilitation Act?

[Answer] The commencement of the prime contractor's rehabilitation proceedings constitutes a lawful ground for direct payment under the Subcontracting Act, and the project owner cannot refuse direct payment by relying on the Debtor Rehabilitation Act.

Fair Transactions in Subcontracting Act (Subcontracting Act) Article 14 Paragraph 1 Item 1 (하도급법 제14조 제1항 제1호) expressly provides that a direct payment claim arises when the prime contractor has suspended payment, become bankrupt, or fallen into "a similar circumstance such that the subcontract amount cannot be paid (inability to pay)" and the subcontractor requests direct payment of the subcontract amount.

On this point, the Supreme Court Decision of March 12, 2009, Case No. 2008 Da 65839 held that the phrase "a case where payment cannot be made" refers to an objective state in which the debtor lacks the capacity to pay and is generally and continuously unable to pay debts that should be paid immediately. The commencement of rehabilitation proceedings against the prime contractor falls within the "other similar circumstances" referred to in the provision, or constitutes an objective state of inability to pay, and therefore qualifies as a lawful ground for a direct payment claim.

In practice, the most fiercely contested issue is the conflict with the Debtor Rehabilitation and Bankruptcy Act (Debtor Rehabilitation Act, 채무자 회생 및 파산에 관한 법률). The Debtor Rehabilitation Act prohibits compulsory execution based on rehabilitation claims once rehabilitation proceedings commence (Article 58, 제58조) and bars repayment or extinguishment of obligations except in accordance with the rehabilitation plan (Article 131, 제131조). Project owners cite these provisions to argue that they cannot pay subcontractors directly.

However, the Supreme Court Decision of June 28, 2007, Case No. 2007 Da 17758 prioritized the Subcontracting Act's direct payment system and set the following clear standards.

1. A Direct Payment Claim Is Not Compulsory Execution

The Court held that a subcontractor's direct payment claim under the Subcontracting Act does not constitute the "compulsory execution based on a rehabilitation claim" prohibited by Article 58 of the Debtor Rehabilitation Act.

2. The Repayment-Prohibition Rule Cannot Exclude Direct Payment

The Court ruled that, when rehabilitation proceedings are commenced against the prime contractor, the repayment-prohibition rule in Article 131 of the Debtor Rehabilitation Act cannot be construed as excluding the application of the direct payment rules under the Subcontracting Act.

3. Direct Payment Amounts Are Not Reduced Even After Rehabilitation Plan Approval

The Court further made clear that even where the prime contractor's rehabilitation plan is approved without complication and a portion of the principal and all interest on the subcontract claims are written off (forgiven), the subcontractor's already-arisen direct payment claim against the project owner cannot be deemed reduced pursuant to that rehabilitation plan. This is because, under Subcontracting Act Article 14, the project owner's direct payment obligation arises and, simultaneously, the subcontractor's claim against the prime contractor is extinguished to that extent.

Key Point: Do Not Wait for the Rehabilitation Plan — Deliver the Direct Payment Request Notice Promptly

Ultimately, in practice, when there are signs that the prime contractor is in financial distress or that rehabilitation proceedings will commence, the subcontractor should not vaguely wait for the prime contractor's rehabilitation plan, but must deliver the "direct payment request notice" to the project owner as promptly as possible.

This is because both the formation of the right and the determination of the prime contractor's inability to pay are judged based on "the moment the subcontractor's declaration of intent to request direct payment reaches the project owner." Only if the direct payment request arrives at the project owner before any provisional attachments or preservation measures by the prime contractor's other general creditors can the subcontractor fully protect its construction proceeds.

Subcontract amount disputes entangled with the prime contractor's insolvency intersect not only with the Subcontracting Act's direct payment requirements but also with the complex legal doctrines of insolvency law (the Debtor Rehabilitation Act). Outcomes can vary significantly with the facts, so specific legal review is necessary from the earliest stage.

Drawing on a deep understanding of complex cash flows at construction sites and of insolvency and subcontracting law, Cheongchul Law Firm provides optimal solutions to secure the subcontractor's rightful construction proceeds as the top priority — even amid the crisis of corporate rehabilitation. If you are struggling with unpaid subcontract amounts due to the prime contractor's bankruptcy or rehabilitation, please consult with the experts at Cheongchul Law Firm.

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Attorney Bae Ki-hyung previously served at the Defense Installations Agency and in the construction/real estate teams of major law firms, where he provided legal advice across the full lifecycle of large-scale construction projects — including public-procurement construction, defense facility projects, and SOC construction projects — and resolved related litigation. He brings extensive experience and capability to public-procurement construction, private construction, public procurement contracts, and matters involving state property, local government property, and other public assets. Please contact him whenever you need assistance.

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Cheongchul Law Firm is composed exclusively of attorneys from Korea's top 5 major law firms, the prosecution service, and corporate legal teams. Rather than relying on a single attorney, we assemble teams of specialists in fields relevant to each case. Cheongchul goes beyond resolving isolated legal issues to provide comprehensive solutions across the client's entire business — legal consulting focused on helping clients achieve what they ultimately want. If you need help reaching your goals, please do not hesitate to contact Cheongchul.