Is it valid to sign a contract before construction that stipulates "using the house to offset debt"?

Lu Fa Case [2026] 069

Construction project has not yet begun

Both parties agreed in the contract to “offset debt with property”

The location, size, and price of the property to be used as debt offset are not specified

Is this agreement valid?

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Case Summary

On September 27, 2022, Party A and Party B signed a “Water and Electricity Construction Subcontract,” in which Party A was responsible for the water and electricity installation at Party B’s Glass City Factory. Regarding payment, the contract stipulated that after the project was fully completed and inspected and accepted by Party B’s quality inspection department, 70% of the provisional contract amount would be paid, with one property used to offset this amount; the remaining balance would be paid in progress payments; after acceptance and audit, 95% of the approved amount would be paid; the remaining 5% would be held as a quality deposit and paid after one year. After signing the contract, Party A organized construction personnel and completed the work by the end of December 2022. The project was delivered for use in May 2023. Party A repeatedly demanded payment from Party B, which was ignored. Unable to resolve the issue, Party A filed a lawsuit with the Zaozhuang Intermediate Court, requesting that Party B pay the owed construction funds.

Court Proceedings

The key issue in this case is whether the “property offset agreement” signed by Party A and Party B before construction is valid.

The court, after review, held that Article 28, Paragraph 1 of the “Interpretation of Several Issues Concerning the Application of the Contract Part of the Civil Code of the People’s Republic of China” states that if the debtor or a third party reaches an agreement to offset debt with property before the debt’s due date, the people’s court should determine the validity of the agreement based on the debt relationship. The agreement between Party A and Party B to pay 70% of the contract amount in the form of offsetting with a property is essentially a property offset. At the time of signing the contract, the project had not yet started, and no debt relationship had been established. The basic details of the property to be used for offset—location, size, and price—were not specified. The project was delivered in May 2023, which indicates it had been completed and accepted, and the quality met the requirements. According to the agreement, Party B should pay Party A, but to date, the full amount has not been paid, and Party B has not provided evidence of delivering the property to Party A.

The court ultimately ruled that Party B must pay Party A the construction funds and interest. After the first-instance judgment, Party B appealed, but the second-instance court upheld the original decision. The judgment became final.

Judgment Commentary

In the construction industry, to ease cash flow pressures, construction units often reach property offset agreements with contractors. The timing of such agreements can be before or after project completion. Before project completion, it includes: 1. during bidding or at the signing of the construction contract; 2. during the performance of the construction contract, mainly from start to before final settlement.

Regarding “property offset” agreements made during the bidding or contract signing stage, since the project has not yet started, no debt relationship exists, and the specific amount of debt to be offset cannot be determined. If the details of the property and its market value are not clear, courts generally do not recognize the validity of such offset clauses at this stage. This case falls into this category: since the project had not yet started, the agreement between Party A and Party B to offset with one property was uncertain, lacking key details such as property information and amount, and was too vague to be enforceable. Therefore, Party A’s request for property offset was not supported.

For agreements made during the performance of the construction contract, the nature and validity are more controversial. As the project approaches completion and payment deadlines, the agreements between the construction unit and the owner may be unclear. Different provisions—such as only agreeing on total offset amount or including property location without final settlement—lead to different legal consequences. According to Article 28, Paragraph 2 of the “Interpretation of Several Issues Concerning the Application of the Contract Part of the Civil Code,” if the agreement is made after project completion and payment deadlines, and the property rights are directly transferred to the contractor, it constitutes a transfer of security interest, which can be auctioned or sold to realize the debt, and such agreements are valid. If the agreement specifies that property rights are transferred to the contractor upon signing, it is a pledge, and auction or sale proceeds have priority for debt repayment.

Regarding property offset agreements made after project completion and payment deadlines, the law generally recognizes their validity. According to Article 27, Paragraph 1 of the same interpretation, if the debtor or a third party reaches an agreement to offset debt after the deadline, and there are no legal impediments, the agreement takes effect when mutual consent is reached. Since the debt and property value are usually fixed after settlement, and the agreement does not violate laws or regulations, such agreements are valid.

Legal References

• Civil Code of the People’s Republic of China, Article 401: If a mortgagee agrees with the mortgagor before the debt’s maturity that in case of non-performance, the mortgaged property will belong to the mortgagee, the mortgagee can only be prioritized for repayment from the mortgage property according to law.

• Interpretation of Several Issues Concerning the Application of the Contract Part of the Civil Code, Article 27: If the debtor or a third party reaches an agreement to offset debt after the debt’s maturity, and there are no legal obstacles, the agreement is effective upon mutual consent.

• When the debtor or third party performs the offset agreement, the original debt is extinguished; if they fail to perform after notice and within a reasonable period, the creditor may choose to enforce the original debt or the offset agreement, and courts shall support this unless law or agreement states otherwise.

• If the offset agreement is confirmed by court or made into a mediation document, and the creditor claims rights based on the document’s validity or against good-faith third parties, courts will not support such claims.

• If the debtor or third party enters into an offset agreement with rights they do not own or have authority over, it shall be handled according to Article 19 of this interpretation.

• Interpretation of Several Issues Concerning the Application of the Civil Code, Article 28: When the debtor or third party reaches an offset agreement before the debt’s maturity, courts should determine its validity based on the debt relationship.

• If the parties agree that the debtor will not pay at maturity and the creditor can auction, sell, or discount the property to realize the debt, courts will recognize this agreement. If the property is to belong to the creditor upon maturity, the agreement is invalid, but this does not affect other parts. Courts will support the creditor’s request for auction or sale.

• If the debtor or third party has not transferred rights to the creditor, courts will not support the creditor’s priority claim; if rights have been transferred, it shall be handled according to the relevant judicial interpretations.

Summary of the Supreme Court’s Civil and Commercial Trial Work Conference Minutes, Article 45: When parties reach an offset agreement before the debt’s maturity, and the property has not yet been delivered to the creditor, the creditor’s request for delivery is different from the pledge described in Article 71. Courts should clarify this and advise parties to sue based on the original debt relationship. If parties refuse to amend after clarification, their claim may be dismissed, but they can file a new suit based on the original debt.

Authors: Li Meijuan, Wang Xin, Zhang Heng

Source: Zaozhuang Intermediate Court

Origin: Shandong High Court