Hello, this is attorney Bae Gi-hyeong of Cheongchul Law Firm.

On construction sites, it is not uncommon for a prime contractor (the principal) to arbitrarily cut the progress payments or subcontract payments owed to a subcontractor under various pretexts. One issue that frequently arises in practice is when the prime contractor unilaterally deducts amounts from the construction payment under the name of a 'direct-labor input cost', claiming that it supplied materials or manpower on the subcontractor's behalf.

For the subcontractor, costs it never agreed to are unfairly deducted, causing severe cash-flow difficulties. Many ask whether they can go beyond simply recovering the wrongfully taken payment and hold the prime contractor liable for punitive damages for its high-handed conduct.

Today, we explain the principle prohibiting wrongful deduction under the Subcontracting Act (Fair Transactions in Subcontracting Act), together with the relevant statutes and the courts' standards for awarding punitive damages of up to three times the loss when payments are wrongfully deducted as direct-labor input costs.

Wrongful Direct-Labor Deduction and Treble Punitive Damages: Subcontracting Act Articles 11 and 35

[Question] If a prime contractor cuts subcontract payments as direct-labor input costs without the subcontractor's consent, can the subcontractor go beyond recovering the deducted amount and also claim punitive damages?

[Answer] If certain requirements are met, the subcontractor may seek punitive damages of up to three times the loss incurred under Article 35(2) of the Fair Transactions in Subcontracting Act (the Subcontracting Act).

The current Subcontracting Act Article 11 (Prohibition of Wrongful Deduction) strictly prohibits a principal from abusing its superior bargaining position to wrongfully reduce the subcontract payment agreed upon at the time of placing the order. In an actual court precedent, where a principal unilaterally deducted progress payments as direct-labor input costs without the subcontractor's consent, the court clearly recognized this as a 'wrongful deduction' prohibited under the Subcontracting Act (see Seoul Central District Court, Judgment of June 14, 2019, Case No. 2016Gahap533325).

Furthermore, to root out such malicious unfair trade practices by prime contractors, the Subcontracting Act expressly provides that a party who causes loss to a subcontractor by violating the prohibition on wrongful deduction shall bear liability to compensate within a range not exceeding three times the amount of the loss.

However, it must also be kept in mind that recognition of a wrongful deduction does not mechanically and automatically mean that the full three times the loss will be awarded as damages.

When calculating punitive damages within the threefold cap, the court comprehensively considers the following factors under Subcontracting Act Article 35(3), recognizing only part of the amount or appropriately limiting it.

1. Intent behind the violation

The court examines whether the principal acted with intent in making the wrongful deduction, and to what extent it was aware of the risk of causing loss.

2. Scale of the harm

The court assesses how large the harm caused by the unlawful act was, not only to the subcontractor but also to other related parties.

3. Economic benefit obtained

The court determines the damages by taking into account the scale of the economic benefit that the principal wrongfully obtained through the unlawful act.

Securing Evidence of Refusal to Accept Deduction and Maximizing the Award

In practice, when a prime contractor attempts to wrongfully reduce subcontract payments under the name of direct-labor input costs or other pretexts, it is important to clearly record one's refusal to consent through a content-certified mail and the like, and to thoroughly gather supporting evidence (actual input records, notice of refusal to settle, etc.).

In addition, in a lawsuit seeking punitive damages, one must not stop at proving the fact of the wrongful deduction; rather, to obtain the maximum possible award, one must actively demonstrate the principal's intent and unlawfulness, as well as the substantial harm suffered by the subcontractor, in line with the criteria of Subcontracting Act Article 35(3).

Disputes over wrongful reduction of subcontract payments involve a precise analysis of the construction details intertwined with the complex requirements for punitive damages under the Subcontracting Act, so the conclusion can vary greatly depending on the case. A specific legal review from the outset is therefore essential.

Cheongchul Law Firm, drawing on a deep understanding of Subcontracting Act violation cases on construction sites and punitive-damages practice, provides the optimal legal solution to help subcontractors recover their wrongfully taken payments and rightful entitlements. If you are facing difficulties due to wrongful deductions or unpaid progress payments, we encourage you to consult with the experts at Cheongchul Law Firm.

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Attorney Bae Gi-hyeong, having worked at the Defense Installations Agency and the construction/real estate teams of major law firms, has rich experience and capability in providing legal advice across the entire process of government-procurement projects including large-scale construction works, national defense installation projects, SOC construction projects, and other government contracts and construction works, as well as in resolving related litigation. Please feel free to contact him whenever you need assistance regarding government-procurement works, private construction works, public procurement contracts, state property, local property, and public property.

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Cheongchul Law Firm is composed solely of attorneys from Korea's five largest law firms, the prosecution, and corporate legal teams, and responds not with a single attorney but with a team of specialists in the fields relevant to the case. Going beyond resolving a specific issue, Cheongchul provides comprehensive solutions for the business as a whole, offering legal consulting focused on ultimately achieving what the client wants. If you need help reaching your goals, please do not hesitate to contact Cheongchul.