Hello, this is Attorney Bae Ki-hyung of Cheongchul Law Firm.

When a prime contractor on a construction site faces financial distress or insolvency, leaving subcontractors at risk of nonpayment, the 'direct payment of subcontract proceeds' system (under which the subcontractor claims payment directly from the project owner) is the most powerful tool for protecting subcontractors.

In practice, however, subcontractors most often confuse and mishandle one critical issue: the difference between when a 'tripartite agreement' on direct payment exists, and when the subcontractor unilaterally 'requests' direct payment without such agreement. Without a clear understanding of this timing, the subcontractor may end up unable to recover anything because another creditor of the prime contractor has already obtained a provisional attachment.

Today I will explain the differences in the requirements for the right to direct payment under the Subcontract Act, comparing tripartite direct payment agreements with unilateral requests by subcontractors.

When the Right to Direct Payment of Subcontract Proceeds Arises — Tripartite Agreement vs Unilateral Request

Article 14(1) of the Fair Transactions in Subcontracting Act (Subcontract Act) lists several grounds on which the right to direct payment arises, and the timing of that right differs entirely depending on whether the ground is an 'agreement' between the parties or a 'request' based on a statutory cause.

1. Where a Tripartite Direct Payment 'Agreement' Exists (No Request Required)

This refers to cases where the project owner, prime contractor, and subcontractor have 'agreed' that the subcontract proceeds will be paid directly. According to Supreme Court precedent, in such cases the right to direct payment arises immediately upon the formation of the tripartite agreement, without any need for the subcontractor to separately request direct payment from the owner. Following amendments to the Subcontract Act, the formation of the direct payment agreement alone is now sufficient to give rise to the right to direct payment (Supreme Court Decision dated November 29, 2007, Case No. 2007Da50717).

2. Where the Subcontractor's 'Request' for Direct Payment Is Essential

By contrast, even without a tripartite agreement, a subcontractor can still receive direct payment when certain statutory causes specified in the Subcontract Act occur. Representative examples include: (i) where the prime contractor becomes unable to pay due to insolvency or bankruptcy; (ii) where the prime contractor delays payment of the subcontract proceeds two or more times; and (iii) where the prime contractor fails to perform its obligation to provide payment guarantees for the subcontract proceeds.

It must be noted that the mere occurrence of these causes does not automatically give rise to the right to direct payment. The subcontractor must make a 'declaration of intent requesting direct payment' to the project owner, and only at the moment that notice reaches the owner does the subcontractor's right to direct payment arise — extinguishing the prime contractor's claim for construction proceeds to that extent (Supreme Court Decision dated April 26, 2017, Case No. 2014Da38678).

Practical Key Point — The Time the Direct Payment Notice Reaches the Owner Determines the Right

In practical terms, the 'time' that triggers the right is decisive.

This is because, if another creditor of the prime contractor obtains a provisional attachment or attachment over the construction proceeds claim before the subcontractor's declaration of intent for direct payment reaches the owner (or before a tripartite agreement is formed), then to the extent of the secured claim amount, the subcontractor's right to direct payment does not arise. In other words, a delayed direct payment request leaves the subcontractor unable to secure the subcontract proceeds against the attaching creditor (Supreme Court Decision dated December 24, 2014, Case No. 2012Da85267).

Therefore, when cash flow on site deteriorates and direct payment grounds such as the prime contractor's payment delays arise, subcontractors should not wait passively. As soon as the requirements are satisfied, they should swiftly deliver a 'direct payment request' notice to the owner — for example, by certified mail — which is the key measure for protecting their construction proceeds.

Disputes over direct payment of subcontract proceeds involve complex factual issues, such as the chronological order of arrival of direct payment notices and the validity of tripartite agreements, and the outcome may differ greatly depending on the circumstances. Specific legal review from the earliest stage is therefore essential.

Cheongchul Law Firm draws on a deep understanding of the complex cash flows in construction sites and the legal principles governing subcontracts to provide optimal solutions for safeguarding our clients' rightful construction proceeds. If you are facing difficulties due to nonpayment of subcontract proceeds or direct payment issues, please consult with the experts at Cheongchul Law Firm.

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Attorney Bae Ki-hyung has worked at the Defense Installations Agency and the construction/real estate teams of major law firms, providing legal advice on the entire process of large-scale construction projects, defense facility projects, SOC construction projects, government contracts, and other public construction matters, and has extensive experience and expertise in resolving related litigation. If you need assistance regarding government construction, private construction, public procurement contracts, state-owned property, local government property, or other public assets, please feel free to contact him at any time.

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Cheongchul Law Firm is composed entirely of attorneys with backgrounds at Korea's top five law firms, the prosecution service, and corporate legal teams. Rather than relying on a single attorney, Cheongchul forms teams of specialists in the relevant fields to handle each case. Going beyond resolving isolated issues, Cheongchul provides comprehensive solutions covering the client's entire business, focused on ultimately achieving what the client wants. If you need help reaching your goals, please do not hesitate to contact Cheongchul.