As a civil law country, the legal system of China is mostly derived from that of Germany and Japan. 'Civil law' in China has a wide-ranging meaning, including laws governing both civil and commercial activities. In other words, commercial contractual activity is considered as a part of civil activities. Correspondingly, the General Principles of the Civil Law of the People's Republic of China, revised in 2009 (the General Principles of the Civil Law) and General Rules of the Civil Law of the People's Republic of China (2017) (the General Rules of the Civil Law) stipulate the general principles and rules of commercial activities, such as the capacity of parties, the elements and validity of civil juristic acts, etc., while the Contract Law of the People's Republic of China (1999) (the PRC Contract Law) is the core and specific law that governs commercial contracts and commercial disputes.
The Contract Law was promulgated by the National People's Congress of China (NPCC) on 15 March 1999 and came into effect on 1 October 1999. During the past 20 years, the Supreme People's Court (SPC) has promulgated two interpretations on the issues concerning the application of PRC Contract Law, and several interpretations on commercial contracts dispute resolutions.
The General Principles of the Civil Law, General Rules of the Civil Law, the PRC Contract Law, the interpretations by the SPC and the opinions of SPC on some specific contracts or cases constitute the whole hierarchy of substantive governing laws and policies regarding commercial contracts and commercial litigation, while the Civil Procedure Law of the People's Republic of China, revised in 2017 (the PRC Civil Procedure Law) defines the procedures. The PRC Civil Procedure Law introduces settlement, mediation, litigation and arbitration as the main four ways of dispute resolution. It also sets out the litigation procedure, from jurisdiction, first instance, second instance and trial supervision to execution procedures. With the increase in financial disputes in recent years, China is trying to set up specific courts, the financial courts, to promote the professional resolution of financial disputes.
ii CONTRACT FORMATION
According to the PRC Contract Law, capable parties are free to enter into a contract in written, oral or other forms by themselves or through authorised agents. Commercial contracts are usually made in writing.
i Key clauses of a contract
Generally, a contract contains the following clauses:
(1) titles or names, and domiciles of the parties; (2) subject matter; (3) quantity; (4) quality; (5) price or remuneration; (6) time limit, place, and method of performance; (7) liability for breach of contract; and (8) methods of dispute resolution.2
Depending on the transaction habits and the legal knowledge of parties, not all contracts contain all of the aforementioned clauses. Interpretation of the Supreme Court on Certain Issues Concerning the Application of the PRC Contract Law (II) (Interpretation II) further clarifies the essential clauses of contracts. Where disputes arise over whether the parties have concluded a contract, the contract shall be deemed concluded if the name of the parties, the subject matter and quantity of the contract can be recognised.
ii Invitation to offer, offer and acceptance
Where there is an offer and an acceptance, there is a contract. An offer is an expression of intent to contract with others. The contents of an offer must be specific and definite and it shall be indicated in the offer that the offeror will be bound once they have accepted. In order to increase the ratio of contracting, a party may take some measures to invite others to make an offer to them, such as commercial advertisements. If the content of a commercial advertisement is so specific and definite as to comply with the offer, the commercial advertisement will be deemed as an offer. An acceptance must be made by the offeree within the given time of the offer. The content shall be consistent with the offer. If the content of an acceptance substantively modifies the contents of the offer (for example, the subject matter, the quantity or price, etc.), or the acceptance reaches the offeror after the time limit, it will be deemed a new offer. A contract is established when the acceptance becomes effective.
Generally, a legally established contract becomes effective upon the establishment of that contract.3 Sometimes a legally established contract does not take effect simultaneously, mainly in the following situations.
- Where it is provided by the laws or regulations that a contract shall only take effect upon approval or registration, these provisions shall govern. For example, if it is provided that a contract established in the establishing or altering of a foreign-invested enterprise shall be effective only upon the completion of approval by authorities, the contract shall take effect upon the date of approval. Without approval, the court shall uphold that such contract has not come into effect through the process of litigation.4
- Parties may attach conditions to the effectiveness of a contract. Regarding conditions for its entry into effect, the contract shall become effective upon the satisfaction of such conditions, before which, the contract is established, but is not deemed to have taken effect.
- Parties may attach a time limit for the contract's entry into effect. The contract shall take effect upon the expiration of such time limit.
iv Valid, revocable and void contracts
A legally valid contract shall meet the following requirements:
- the parties are of full capacity while contracting;
- the intent and content expressed are genuine and out of the free will of parties; and
- the contract does not violate any mandatory provisions of laws, regulations or public policies.
In commercial transactions, if the contract is reached in the name of the principal by a person with no power of agency, overstepping the power of agency or an individual whose power of agency has expired, the contract may be valid and binding on the principal, if it is ratified by the principal.
If the contracting expression is not genuine or not out of the free will of parties, the contract might be revocable in the following situations:
- the contract was reached due to serious misunderstandings;
- the contents of the contract are obviously unfair to one party; or
- the contract was reached by fraud, coercion or by taking advantage of the other party's unfavourable position.
The right to revoke a contract shall be exercised through a court or an arbitration institution within one year from the date that the cause of revocation is known or ought to be known.
A contract shall be void under any of the following circumstances:
- the contract is concluded by fraud or coercion by one party, and damages the interests of the state;
- the contract is concluded by malicious collusion to damage the interests of the state, a collective group or a third party;
- an illegitimate purpose is covered up;
- the contract damages public interests; or
- the contract violates mandatory provisions of laws and regulations.
If one part of a contract is void yet does not affect the other parts, the other parts shall remain valid.
v Negligence in contracting
If one party acts against the principle of good faith and causes the losses of the other party while contracting, the party might be held liable under any of the following circumstances:
- negotiating in bad faith in the name of contracting;
- deliberately concealing important facts or providing false information of contracting; or
- acting in other ways against the principle of good faith.
III CONTRACT INTERPRETATION
i Choice-of-law principles
Domestic contracts shall be governed by PRC laws. Unless explicitly provided, parties are not allowed to choose the governing laws of domestic contracts. According to Article 6 of Interpretation of the Supreme People's Court on Several Issues Concerning the Application of the Law of the People's Republic of China on Foreign-Related Civil Relations (I), where it is not explicitly provided that parties may choose applicable laws for foreign-related civil relation, the choice of such laws by the parties shall be deemed as invalid.
For foreign-related contracts, the parties may expressly select the law applicable in accordance with laws. Once selected, the court shall not support the claim that the choice of law is invalid on the grounds that the law chosen by the parties in the contract has no actual connection with the foreign-related civil relation in dispute.5 Where the application of foreign laws may harm the social and public interests of China, the relevant Chinese laws shall apply.6 Detailed rules are mainly provided in the PRC Contract law, the People's Republic of China on Application of Law in Foreign-related Civil Relations, and Interpretation of the Supreme People's Court on Several Issues Concerning the Application of the Law of the People's Republic of China on Foreign-Related Civil Relations (I).
ii Contract interpretation
Article 125 of the PRC Contract provides the basic principle of contract interpretation. Where disputes arose between the parties on the understanding of any clause of the contract, the meaning of the clause shall be determined according to the words and terms used, the relevant clauses, the purpose of the contract, commercial practices and the principle of good faith.
If a dispute arose over the understanding of a standard term, the term shall be interpreted based on general understanding. Where there are two or more interpretations for such term, the interpretation unfavorable to the party providing such term shall prevail. Where the standard terms are inconsistent with non-standard terms, the latter shall be adopted.
Where there are no clauses or no explicit clauses on the quality, price or remuneration or place of performance in an effective contract, the parties may reach a supplementary agreement. If the parties failed to reach a supplementary agreement, the content shall be determined in accordance with the relevant clauses of the contract or commercial practices. Article 62 of the PRC Contract Law provides rules on clarifying these clauses.
Based on the principle provided by the PRC Contract Law, the courts have developed some rule in interpreting contracts.
- Where parties dispute on the clauses of a contract, the true meaning of the parties shall be explored, the first of which is to explore the meaning of the words and terms used. This is the contextual interpretation. Other methods of interpretation might be used only when the contextual interpretation fails to determine the explicit and real meaning of the parties.7
- The interpretation of a contract shall never go against the true meaning of the parties. It is the basis and an important source for judgements to respect to the agreement of the parties and the original intention.8
- The interpretation of a contract may provide a criterion for the court the determine whether one party has breached the contract. Considering the purpose of private lending, if the borrower refuses to provide financial statements and relevant materials, the lender will not be able to supervise the use of the loan. Therefore, such behaviors of the borrowers constitute a breach of contract.9
IV DISPUTE RESOLUTION
There is no such requirement like minimum amounts for litigation in China. Once the conditions set in Article 119 of the PRC Civil Procedure Law are satisfied, the parties may litigate the contract disputes to the court.
- The plaintiff must be a citizen, a legal person or other entity with direct interests in the case.
- The defendant must be identifiable.
- The claim must be specific and clear supported by specific facts and grounds.
- The dispute should fall into the range of civil actions and the jurisdiction of the court.
Though there is no requirement of minimum amounts, the SPC and the higher courts in various provinces have released some information regarding adjusting the criteria for the jurisdiction of higher courts, intermediate courts and primary courts over civil and commercial cases of the first instance. On 30 April 2019 the SPC released a new circular, which came into effect on 1 May 2019 and, according to which, if the amount disputed is less than billion yaun, the case shall fall in the jurisdiction of intermediate courts.
In recent years, some special courts and tribunals have been founded to handle certain types of disputes more efficiently, mainly the intellectual courts and tribunals and the financial courts and tribunals. Intellectual courts have been founded in Beijing, Shanghai, and Guangzhou, while intellectual tribunals have been established in some provinces, such as Tianjin, Jilin, and Henan, etc. On 1 January 2019, the SPC intellectual tribunal was founded. With the emerging of financial disputes, Shanghai Financial Court was founded on 20 August 2018 to handle all the financial civil cases and financial-related administrative cases. Later, the first two cross-regional financial tribunals in Jiangxi were established in Nanchang on 8 October 2018. Though specific financial courts and tribunals have not been established in Beijing, according to the Announcement10 of the Beijing Higher Court, the Beijing No. 4 Intermediate Court shall exercise jurisdiction over all the cases involving financial loan contracts disputes and insurances disputes.
Though some special courts and tribunals were founded to handle certain types of disputes, the traditional division of duties among different tribunals within the same court is being broken. Previously, commercial disputes are usually distributed to the No. 2 tribunal or a certain fixed tribunal, now with the reform of extensive civil trial, a commercial dispute might be randomly distributed to any tribunal.
Besides litigation, the PRC Civil Procedure Law also introduces settlement, mediation, and arbitration as alternative dispute resolutions. It is important to note that on 29 June 2018, the China International Commercial Court (CICC) is established by the SPC to adjudicate international commercial cases. The Fourth Civil Division of SPC is responsible for coordinating and guiding the two international commercial courts. The aim of CICC is to promote connectivity of litigation, mediation and arbitration to form a convenient, expeditious and low-cost 'one-stop' dispute resolution platform. The CICC practices the 'first instance being final'. The judgments and rulings made by the CICC are final and binding on the parties and with legal effect.11 On 29 May 2019, the Second International Commercial Court heard its very first case in an open hearing for a shareholder qualification conformation case among the plaintiff Ruoychai International Group Co Ltd and the defendant Red Bull Vitamin Drink Co Ltd and the third party Inter-Biopharm Holding Ltd. There were some innovations in this case, for example, the opinion of the minority was recorded in the judgment. It is believed to be a good start for parties to resolve international commercial disputes through litigation in China.
Settlement and mediation do not conflict with litigation. Parties can resolve their disputes through settlement and mediation before and during litigation. Mediation by the court is considered as part of the litigation procedure. A mediation statement issued by the court is legally binding to both parties. If one party fails to exercise the duties in such a statement, the other party can apply to the court for enforcement. However, if the parties want to resolve their disputes through arbitration, there shall be a clear and valid arbitration agreement, which might be included in the primary contract or be reached during dispute resolution. The arbitration agreement will exclude litigation from the dispute resolution. Some arbitration institutions are also trying to introduce settlement and mediation into arbitration. According to the rules of the Beijing Arbitration Committee (BAC), parties can resort to mediation before and during arbitration as well. This is a trend that may develop and explore diversified dispute resolutions in the next few years.
V BREACH OF CONTRACT CLAIMS
The parties shall fully perform their obligations in good faith. The liability for breach of contract applies the principle of strict liability. The fault or negligence is not a basic element of a claim for breach of contract. Where a party fails to perform the contractual obligations or the performance does not comply with the terms of the contract, the other party shall file a claim for breach of contract. The plaintiff bears the burden of proof. To file a claim for breach of contract, the plaintiff shall submit preliminary proofs along with the complaint to prove that: (1) there is a valid contract; and (2) the other party has breached the contract. The plaintiff does not have to be a 'clean hand'. If the plaintiff breaches the contract as well, the defendant may file a counterclaim.
The rules of proof in complex commercial litigation is the same as that in other civil litigations, which are specified in Several Provisions of the Supreme People's Court on Evidences in Civil Litigation. Evidence shall comprise the following categories: statements of the parties, documentary evidence, physical evidence, audiovisual materials, electronic data, the testimony of witnesses, expert opinions and records of inspections and examinations. Evidence shall be verified before it can be admitted and taken as a basis of facts.12 Evidence formed out of China should be notarised and legalised to become qualified evidence in litigation. It is worth noting that in the very first case of CICC, there are some innovations in rules of proofs of international dispute resolution. For example, notarisation and authentication was not taken as a compulsory requirement for evidence formed out of China. Generally evidence in English shall be translated into Chinese. However, if both parties agree that the evidence in English may not be translated into Chinese, the court might accept evidence in English.13 If these innovations can become new rules of evidence, the proceedings of international disputes resolution will be greatly simplified.
VI DEFENCES TO ENFORCEMENT
The most common ways parties seek to avoid enforcement of contractual obligations or challenge claims of breach of contract are as follows.
- There is no contract or the contract is void or revocable. The definitions of Void contracts and revocable contracts in PRC Contract Laws can be found above in section II. To seek the defence that the contract is revocable, a party shall request the court or an arbitration institution to first revoke the contract. The right to revoke a contract shall be extinguished if the party fails to exercise their right within one year from the date the cause for revocation is known or shall be known.
- The limitation period has expired. The limitation of action for commercial contract litigation is three years in China. A limitation of action shall run from the date when an obligee knows or should have known that his or her rights have been infringed and who the obligor is.14
- The contract may be rescinded as provided in the contract or in PRC Contract Law. According to Article 94 of PRC Contract Law, even if it is not agreed in the contract, a party may rescind the contract under any of the following circumstances: (1) the purpose of the contract is rendered impossible to achieve due to force majeure; (2) one party to the contract indicates, expressly or by conduct, before the expiry of the performance period, that it will not perform its principal obligations; (3) one party to the contract delays performing its principal obligations and fails to perform the same within a reasonable time period after being urged to do so; (4) one party to the contract delays performing the obligations or commits other acts in breach of the contract, resulting in the impossibility to achieve the purpose of the contract; or (5) other circumstances as provided by the laws.
- The obligations of both parties shall be performed simultaneously. Where both parties have obligations towards each other and there is no order of priority in respect of the performance of the obligations, the parties shall perform the obligations simultaneously. One party has the right to reject the other party's request for performance before the other party's performance of the obligations, or if the other party's performance does not comply with the terms of the contract.
- The party who shall perform its obligations first has not rendered the performance. Where both parties have obligations towards each other and there is an order of priority in respect of the performance of the obligations, if the party who shall perform its obligations first (the former) has not rendered the performance, the other party has the right to reject the former's request for performance. If the former's performance does not comply with the terms of the contract, the other party has the right to reject the corresponding request for performance.
- The defence of unease. The party who shall perform its obligations first may suspend the performance if there is conclusive evidence that the other party falls under any of the following circumstances: (1) the other party's business conditions are seriously deteriorating; (2) the other party has transferred its property and taken out its capital secretly to evade debts; (3) the other party loses its business creditworthiness; or (4) other circumstances showing that the other party loses or will possibly lose its capability to perform its obligations. If a party suspends their performance without conclusive evidence, they shall be liable for breach of contract.
VII FRAUD, MISREPRESENTATION, AND OTHER CLAIMS
There is no such concept as 'quasi-contract claims' in China, yet it might be recognised by the court in the name of other claims. According to Article 35 of the PRC Contract Law, where a contract is required to be concluded in written form as provided for by the laws and administrative regulations or as agreed by the parties, and the parties fail to conclude the contract in written form but one party has performed its principal obligations which have been accepted by the other party, the contract shall be deemed as established. In this case, since there is no contract or terms agreed by both parties, if one party fails to perform its obligations, the other party shall seek remedies provided by the PRC Contract Law.
Fraud, misrepresentation and obviously unfair situations are all causes provided by the PRC Contract Law to revoke the contract, as discussed above. Sometimes, the fraud, misrepresentation or other wrongdoings of one party might constitute a tort. The claim of tort and the claim of breach of contract are not allowed to be brought up at the same time. In the event that the breach of contract by one party infringes upon the personal or property interests of the other party, the injured party is entitled to request the breaching party to assume liabilities for breach of contract in accordance with the Law, or to request the breaching party to assume liabilities for infringement in accordance with other laws.15 The elements, rules of proofs, compensations, and limitation of actions of the tort claim diversify from that of breach of contract claims. One party may choose one claim to file based on the facts of the case.
Where a party to a contract fails to perform the contractual obligations or the performance does not comply with the terms of the contract, the party shall bear liabilities for breach of contract, such as continuing its performance of the obligations, taking remedial measures or compensation for losses. If it falls into the situations of revocable contracts or terminable contracts, one party can also request to revoke or terminate the contract.
i Continue to perform
To seek for continue to performance, the following requirements shall be met: (1) one party breaches the contract; (2) it is possible for the defaulting party to continue to perform its obligations; and (3) the observant has requested the defaulting party to continue to perform.
ii Taking remedial measures
There may be various forms of remedial measure for different types of contracts. For example, if the terms in relation to quality are not met and there is no agreement in the contract on the liability for breach of contract or such agreement is unclear, the injured party may, in light of the nature of the subject matter and the degree of loss suffered, select in a reasonable manner to request the other party to bear liabilities for breach of contract in such form as repair, replacement, reworking, return of the goods, and reduction in price or remuneration.16
iii Compensation for losses (damages)
Based on different types of default performance, there are damages for alternative performance, damages for delay of performance and 'simple' damages. if one party fails to perform the contractual obligations or the performance does not comply with the terms of the contract, thereby causing losses to the other party, the amount of damages shall be equal to the losses caused by breach of contract, including benefits receivable after the performance of the contract, provided that it shall not exceed the probable losses caused by breach of contract which was foreseen or ought to have been foreseen by the breaching party at the time of conclusion of the contract. The clause of damages is a basic clause in a commercial contract. The parties may agree that the defaulting party shall pay liquidated damages of a certain amount based on the extent of the default acts or may agree upon the method for calculating damages.17
The remedies above do not conflict with each other. The observant may seek for both continuing to perform and damages as well. Where one party fails to perform the contractual obligations or the performance fails to comply with the contract, if the other party still suffer from other losses after continuing performance, the party shall compensate for such losses.
As a civil law country, the general principles and framework of commercial contracts and commercial dispute resolution are relatively stable and foreseeable in China. The rule that 'the intentions of the parties prevail' has won more attention and respect of the court in litigation. The scope of void contracts has been narrowed by the General Rules of the Civil Law. The contract concluded by means of fraud or coercion by one party, thereby damaging the interests of the State, is deemed as revocable contract instead of void contract.
China is currently working on the coding of civil laws. As mentioned above, the General Rules of the Civil Law took effect in 2017, yet the special rules are still being drafted, of which the contract laws shall be a part. Once drafting is completed, the current PRC Contract Law will no longer be applied. Since the General Rules of the Civil Law have some differences from the general provisions of the PRC Contract Law, the SPC has made some explanations to coordinate their relation and application. Where the relevant provisions of the General Rules of the Civil Law are inconsistent with the general provisions of the PRC Contract Law, the provisions of the General Rules of the Civil Law shall apply. Where the relevant provisions of the General Rules of the Civil Law are inconsistent with the special provisions of the PRC Contract Law, the specific rules of the two shall apply.18
On 7 August 2019, Mr Li Chenggang, the Assistant Minister of Commerce of China, signed the United Nations Convention on International Settlement Agreements Resulting from Mediation (Singapore Mediation Convention) on behalf of China. The lack of a cross-border mechanism for the enforcement of mediated settlement agreements had long been considered a significant obstacle against the development of mediation in international commercial dispute resolution. It is anticipated that mediation may play a more important role in international commercial dispute resolution in China in the future.
1 Yang Zhengyu and Shen Yi are partners at Grandall Law Firm. The authors wish to acknowledge the contributions of Zhang Liming, Wang Liying and Zhang Kai, attorneys in the Beijing office of Grandall.
2 See Article 12 of the PRC Contract Law.
3 See Article 44 of the PRC Contract Law.
4 See Article 1 of Provisions of the Supreme People's Court on Several Issues Concerning the Hearing of Cases about Disputes Involving Foreign-funded Enterprises (I).
5 See Article 7 of Interpretation of the Supreme People's Court on Several Issues Concerning the Application of the Law of the People's Republic of China on Foreign-Related Civil Relations (I).
6 See Article 5 of Law of the People's Republic of China on Application of Law in Foreign-related Civil Relations.
7 See Zibo Wanjie Hospital v. Zibo Boshan Branch of the Bank of China Co., Ltd., Zibo Boyi Fiber Co., Ltd. and Wanjie Group Co., Ltd., SPC, 2007.
8 See Huayuanlu Sales Branch (Zhengzhou) of Guotai Junan Securities Co., Ltd. etc. v. Zhengzhou Branch of China Everbright Bank, SPC, 2006.
9 See Li Zhanjiang, Zhu Limin v. Bei Hongfeng, Shenyang Donghao Real Estate Co., Ltd., SPC, 2014.
10 See the Announcement of the Beijing High People's Court on Performance of Duties by the Beijing No. 4 Intermediate People's Court.
11 About the CICC, http://cicc.court.gov.cn/html/1/219/193/195/index.html.
12 See Article 63 of Civil Procedure Law of the People's Republic of China (Revised in 2017).
13 See 'CICC Has Completed These Things in The Last Year', Sun Hang, the public WeChat account of SPC.
14 See Article 188 of General Rules of the Civil Law of the People's Republic of China.
15 See Article 122 of the PRC Contract Law.
16 See Article 111 of the PRC Contract Law.
17 See Articles 113 and 114 of the PRC Contract Law.
18 Liu Guixiang, Speeches at the National Civil and Commercial Trial Work Conference.