In practice, when a contractor undertakes a domestic project involving fiscal funds, government investment, or state-owned capital, the project owner often seeks to ensure that the project settlement aligns with the audit conclusion or financial review results. To this end, the payment clauses in the contract may stipulate that “the final settlement amount shall be subject to the results of the government audit or financial review”, or may be simplified to phrases such as “subject to the audit results”, “subject to the superior authority’s audit results”, or “subject to the project owner’s audit results”.

However, during the construction process, it is common for project changes and claims to arise. For various reasons, the parties involved may fail to properly complete the verification and claim procedures, resulting in the final audit or financial review amount being significantly lower than the project costs incurred. Alternatively, the project owner may delay initiating or completing the audit or financial review procedures, leading to a situation where, even years after project completion and acceptance, the project payment remains unsettled. The owner may then use this as a reason to delay payment, giving rise to disputes between the parties.

Typically, the project owner will insist that the settlement be carried out in accordance with the audit or financial review clause, while the contractor may seek to challenge or circumvent this provision. Under what circumstances will audit or financial review clauses be upheld by judicial authorities, and under what circumstances may they be set aside? This article, drawing on judicial practice, will provide legal recommendations from the perspectives of both project owners and contractors to help them mitigate risks.

Audits and judicial approach

According to the provisions of China’s Audit Law and the Administrative Provisions for Fiscal Investment Review, audits and financial reviews are forms of administrative supervision exercised by the state. They are not inherently connected to the final settlement of construction projects in civil or commercial legal disputes, nor do they automatically have binding legal force on such settlements.

With respect to the practice of delaying project settlement and payment on the grounds that audits or financial reviews were not completed, current judicial opinion is relatively clear and consistent. The Supreme People’s Court and several high courts across the country have issued relevant documents stating that only where the contract expressly stipulates that the audit or financial review conclusion shall serve as the basis for settlement may the parties rely on such conclusions for settlement purposes. Otherwise, the courts will not uphold such claims.

Such clauses may be set aside in narrowly defined circumstances, typically in three situations: (1) the contract wording is unclear and does not explicitly require an administrative audit conducted by a government agency; (2) the parties later reach a lawful and valid settlement agreement that expressly excludes the audit or financial review clause (see Chongqing Construction Engineering Group v China Railway 19th Bureau Group, 2012); and (3) the project owner either delays initiating the audit, delays issuing the audit results, or produces findings that are not objective or accurate, rendering them unusable (see People’s Court case database (2021) Ning 01 Min Chu No. 18).

Risk prevention

Risk prevention recommendations for the project owner. For project owners who generally wish for the audit or financial review clauses stipulated in the contract to be applicable at the time of final settlement, the following points should be noted:

(1) Clarity of contractual terms. The standard expression should be “the administrative audit results of the government audit authority shall serve as the basis for the final settlement between both parties”, rather than the “owner’s audit”;

(2) Consistency of contractual terms. The project owner should ensure that the settlement basis set out in the contract, bidding documents, supplementary agreements and procedural records is consistent to prevent contradictions that could create confusion and spark disputes;

(3) Timely initiation of audit or financial review procedures and prompt issuance of reports and conclusions. If delays are caused by the contractor’s failure to co-operate in providing materials, the project owner should retain corresponding evidence; and

(4) Ensuring the legality of audit or financial review procedures and objectivity and accuracy of conclusions. If the audit or financial review procedures are unlawful, or the conclusions are inaccurate or repeatedly inconsistent, the court may exclude their application and appoint a judicial appraisal.

Risk prevention recommendations for contractors. During bidding and contract formation, contractors should set clear requirements regarding audit and settlement clauses: first, specify the audit authority and audit period; second, clarify the procedures for objections to audit results; and third, guard against procedural pitfalls, including requirements for the time limits, formats, delivery and approval levels for changes, certifications and claims arising after disputes.

During contract performance, for key matters such as project changes, certifications, claims, and the verification and pricing of materials or equipment, contractors must retain written evidence. Contractors should also initiate relevant procedures within time limits stipulated in the contract to provide proof during litigation that audit or financial review results do not correspond to the actual project situation or contractual terms.

At final settlement, if the project owner deliberately delays the initiation of an audit, financial review, or related procedures, or if the results are inconsistent with the facts, the contractor should promptly issue a written demand and consider initiating litigation or arbitration to assert its lawful rights and resolve disputes through judicial appraisal.

At the same time, whether the settlement review is carried out by the project owner (an “owner’s audit”), by a government audit authority, or by a fiscal review body, the contractor shall preserve relevant evidence throughout the process. Such evidence should include, but is not limited to:

(1) records of the settlement procedures; (2) the identities of cost consultants and auditors; (3) verified bills of quantities; (4) confirmed material prices; (5) agreed unit prices for additional items; (6) adjustments for fluctuations in labour and material costs; (7) lists of disputed or outstanding works; and (8) records of document transmission. The contractor should ensure this evidence is fixed and maintained in the course of performance to minimise the scope of potential disputes.

After initiating litigation, some contractors, due to financial pressure or desire for prompt settlement, often make unprincipled concessions on disputed items during the first instance in exchange for early payment. This practice carries significant risk: For projects requiring multiple rounds of review and audit, the second instance or subsequent authorities may further reduce, or compress, amounts already confirmed based on the first instance result, harming the contractor’s interests.