The Complex Commercial Litigation Law Review: China

Overview

As a civil law country, the legal system of China is mostly derived from those 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 to fall under 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 the 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, while the Contract Law of the People's Republic of China (1999) (the PRC Contract Law) is the core specific law that governs commercial contracts and commercial disputes.

On 28 May 2020, the National People's Congress adopted the Civil Code, which came into effect on 1 January 2021. It also replaced nine laws: the Marriage Law, the Law of Succession, the General Principles of the Civil Law, the Adoption Law, the Security Law, the Contract Law, the Real Right Law, the Tort Law and the General Rules of the Civil Law.

The Civil Code has 1,260 articles, as well as general and supplementary provisions, and it has six other parts relating to property rights, contracts, personality rights, marriage and family, inheritance and tort liabilities. The Chapter on contracts comprises three Subchapters, 29 sections and 526 articles, accounting for almost half of the Civil Code. The codification of the Civil Code involved the systematically integrating the existing norms of the civil legal system in China to form a Code with rigorous structure, and complete and coherent content.

To apply the Civil Code, the Supreme People's Court (SPC) has promulgated several interpretations on issues concerning property rights, security systems and period of effect for application of Civil Code, etc.

The Civil Code and the interpretations and opinions of the SPC on some contracts and cases constitute the hierarchy of substantive governing laws and policies regarding commercial contracts and commercial litigation. 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 set up the Shanghai Financial Court in 2018 and the Beijing Financial Court in 2021 to promote the professional resolution of financial disputes.

Contract formation

According to the Civil Code, the 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 the parties, not all contracts contain all the aforementioned clauses.

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 content of an offer must be specific and definite, and it must be indicated in the offer that the offeror will be bound once he or she has accepted.

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 must be consistent with the offer. If the content of an acceptance substantively modifies the content of the offer (e.g., the subject matter, the quantity or price), or the acceptance reaches the offeror after the time limit, it will be deemed a new offer. The Civil Code also makes it clear that if the acceptance is made within the time limit for acceptance but is unable to reach the offeror in time under the usual circumstances, it will be deemed a new offer.3 A contract is established when the acceptance becomes effective.

According to Article 490 of the Civil Code, 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 Civil Code.

iii Effectiveness

Generally, a legally established contract becomes effective upon the establishment of the contract, except where the law stipulates or the parties agree otherwise.

Where a contract is subject to approval or other procedures in accordance with laws and regulations, a party's failure to comply with the procedures for approval or other formalities that affects the effectiveness of the contract will not affect the validity of the provisions concerning those obligations and other relevant provisions. The other party may hold it liable for breach of those obligations. 4

Parties may attach conditions to the effectiveness of a contract. Regarding conditions for its entry into effect, the contract becomes effective upon the satisfaction of those 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 must meet the following requirements:

  1. the parties are of full capacity while contracting;
  2. the intent and content expressed are genuine and out of the free will of parties; and
  3. 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:

  1. the contract was reached owing to material misunderstandings;
  2. the content of the contract is obviously unfair to one party owing to this party's dangerous or unfavourable position or lack of judgment; or
  3. the contract was reached by fraud, coercion or by taking advantage of the other party's unfavourable position.

The right to revoke a contract is exercised through a court or an arbitration institution within a certain time limit, which varies according to the circumstances. The right to revoke a contract shall be extinguished under any of the following circumstances:

  1. the party does not exercise the right of revocation within one year, or the party who is materially led to misunderstanding does not exercise the right of revocation within 90 days of the date that the party knows or should have known the cause for revocation;
  2. the party who is coerced does not exercise the right of revocation within one year of the date that the coercion ceases; or
  3. the party waives the right of revocation by an explicit statement or by the act after the party knows the cause for revocation.

In any case, if the party does not exercise the right of revocation within five years of the date that the contract is concluded, the right of revocation shall be extinguished.

A contract shall be void under any of the following circumstances:

  1. one party colludes with another party to reach a contract that impairs others' legitimate rights and interests;
  2. the contract violates public order and good morals; or
  3. the contract violates mandatory provisions of laws and regulations (an exception applies where the mandatory provision does not render the contract void).

If one part of a contract is void yet does not affect the other parts, the other parts 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 may be held liable under any of the following circumstances:

  1. negotiating in bad faith in the name of contracting;
  2. deliberately concealing important facts or providing false information of contracting; or
  3. acting in other ways against the principle of good faith.

Contract interpretation

i Choice-of-law principles

Domestic contracts are governed by PRC laws. Unless explicitly provided, parties are not allowed to choose the governing laws of domestic contracts. According to Article 4 of the 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) (amended in 2020), 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. 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 law may harm the social and public interests of China, the relevant Chinese law shall apply.6 Detailed rules are mainly provided in the Civil Code, the People's Republic of China on Application of Law in Foreign-Related Civil Relations and the 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) (amended in 2020).

ii 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 and the principle of good faith.7

Where a contract is concluded in two or more languages, and it is agreed that all versions are equally authentic, the words and sentences in each version are presumed to have the same meaning. In case of any discrepancy in the words and sentences used in different versions, they shall be interpreted in accordance with the relevant terms, nature and purpose of the contract as well as the principle of good faith.8

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 the term, the interpretation unfavourable to the party providing the term shall prevail. Where the standard terms are inconsistent with non-standard terms, the latter shall be adopted.

The courts have developed some rules in interpreting contracts.

  1. Where parties dispute on the clauses of a contract, the true meaning of the parties shall be explored. The first step 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.9
  2. The interpretation of a contract shall never go against the true meaning of the parties. It is the basis and is an important source for judgments to respect the agreement of the parties and the original intention.10
  3. The interpretation of a contract may provide a criterion for the court to 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 behaviour of the borrowers constitutes a breach of contract.11

Dispute resolution

There is no such requirement as 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.

  1. The plaintiff must be a citizen, a legal person or other entity with direct interests in the case.
  2. The defendant must be identifiable.
  3. The claim must be specific and clear, supported by specific facts and grounds.
  4. The dispute should fall within the range of civil actions and the jurisdiction of the court.

Although there is no requirement regarding 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 circular that came into effect on 1 May 2019, according to which if the amount disputed is less than 5 billion yuan, 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.

On 1 January 2019, the SPC Intellectual Tribunal was founded. With the emergence of financial disputes, the Shanghai Financial Court was founded on 20 August 2018 to handle all 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.

Although specific financial courts and tribunals have not been established in Beijing, according to the Announcement12 of the Beijing Higher Court, the Beijing No. 4 Intermediate Court shall exercise jurisdiction over all cases involving financial loan contracts disputes and insurances disputes.

Some special courts and tribunals were founded to handle certain types of disputes; however, the traditional division of duties among different tribunals within the same court is being broken. Previously, commercial disputes had usually been distributed to the No. 2 tribunal or a certain fixed tribunal; now, with the reform of extensive civil trial, a commercial dispute may be randomly distributed to any tribunal.

In addition to litigation, the PRC Civil Procedure Law also introduces settlement, mediation and arbitration as methods of alternative dispute resolution. On 29 June 2018, the China International Commercial Court (CICC) was established by the SPC to adjudicate international commercial cases. The aim of the CICC is to promote connectivity of litigation, mediation and arbitration to form a convenient, expeditious and low-cost 'one-stop' dispute resolution platform. The judgments and rulings made by the CICC are final and binding on the parties, with legal effect.13

On 29 May 2019, the Second International Commercial Court heard its first case in an open hearing for a shareholder qualification conformation case between the plaintiff Ruoychai International Group Co Ltd, the defendant Red Bull Vitamin Drink Co Ltd and the third party Inter-Biopharm Holding Ltd. There were some innovations in this case, such as the opinion of the minority being 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, which 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 dispute through arbitration, there must be a clear and valid arbitration agreement, which may 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 also resort to mediation before and during arbitration. This is a trend that may develop and involve the exploration diverse dispute resolution methods in the next few years.

Breach of contract claims

The parties must 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 proof along with the complaint to prove that there is a valid contract and that 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 are the same as in other civil litigation, which are specified in Several Provisions of the Supreme People's Court on Evidence in Civil Litigation. Evidence comprises 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 must be verified before it can be admitted and taken as a basis of facts.14 Evidence from outside China should be notarised and legalised to be qualified in litigation.

In the CICC's first case, there were some innovations in the rules of proof in respect of international dispute resolution. For example, notarisation and authentication were not deemed to be compulsory requirements for evidence outside China. Generally, evidence in English is translated into Chinese; however, if both parties agree that the evidence in English need not be translated, the court may accept evidence in English.15 If those innovations become new rules of evidence, the proceedings of international disputes resolution will be greatly simplified.

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.

  1. There is no contract or the contract is void or revocable: the definitions of void contracts and revocable contracts in the Civil Code can be found in Section II. To seek the defence that the contract is revocable, a party must request the court or an arbitration institution to first revoke the contract. The right to revoke a contract must be exercised within a certain time limit, which varies according to the circumstances.
  2. The limitation period has expired: the limitation of action for commercial contract litigation is three years in China. The Civil Code provides a four-year limitation period for litigation or arbitration owing to disputes over contracts of international goods sales and the import and export of technology.16 A limitation of action runs from the date when an obligee knows or should have known that his or her rights have been infringed and the identity of the obligor.17
  3. The contract may be rescinded as provided in the contract or in the Civil Code: according to Article 563 of the Civil Code, even if it is not agreed in the contract, a party may rescind the contract under any of the following circumstances:
    • the purpose of the contract is rendered impossible to achieve owing to force majeure;
    • 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;
    • one party to the contract delays performing its principal obligations and fails to perform the same within a reasonable period after being urged to do so;
    • one party to the contract delays performing the obligations or commits other acts in breach of the contract, resulting in the impossibility of achieving the purpose of the contract; or
    • other circumstances as provided by the laws.
  4. Notice: the parties may rescind an indefinite contract involving a continuing obligation to perform at any time, provided that reasonable notice is given to the other party prior to doing so.18
  5. Renegotiation: the Civil Code provides that in cases where there is a significant change in the basic conditions of the contract that could not have been foreseen by the parties at the time of conclusion of the contract and that is not a commercial risk, continuing to perform is manifestly unfair to one party. If the adversely affected party fails to renegotiate the contract with the other within a reasonable period, the party may request a court or arbitration to modify or terminate the contract.
  6. 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 performance, 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, or the other party's performance if it does not comply with the terms of the contract.
  7. The party who performed 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 performance, if the party who must 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.
  8. 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 has lost its business creditworthiness; or (4) there are other circumstances that show that the other party has lost or will possibly lose its capability to perform its obligations. If a party suspends its performance without conclusive evidence, it shall be liable for breach of contract.

Fraud, misrepresentation and other claims

Fraud, misrepresentation and obviously unfair situations are all causes provided by the Civil Code to revoke the contract, as discussed above. Sometimes the fraud, misrepresentation or other wrongdoings of one party 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.19

The elements, rules of proof, compensation and limitations of actions of tort claims differ from those of breach of contract claims. One party may choose one claim to file based on the facts of the case.

Remedies

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 bears liability for breach of contract, such as continuing its performance of the obligations, taking remedial measures or compensation for losses. If the contract is revocable or terminable, a party can request to revoke or terminate the contract.

i Continue to perform

To seek for continuance of performance, the following requirements must be met:

  1. one party has breached the contract;
  2. it is possible for the defaulting party to continue to perform its obligations; and
  3. the observer has requested the defaulting party to continue to perform.

ii Taking remedial measures

There may be various forms of remedial measures for different types of contracts. For example, if the performance is not met and there is no agreement in the contract on 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 liability for breach of contract in such form as repair, replacement, reworking, return of the goods, and reduction in price or remuneration.20

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 the breach of contract, including benefits receivable after the performance of the contract, provided that it does not exceed the probable losses caused by the breach of contract that had been was foreseen or ought to have been foreseen by the breaching party at the time of conclusion of the contract.

The clause regarding damages is a basic clause in a commercial contract. The parties may agree that the defaulting party pay liquidated damages of a certain amount based on the extent of the default, or they may agree upon the method for calculating damages. Where the amount of liquidated damages agreed upon is lower than the losses incurred, the people's court or an arbitration agency may increase the amount upon the request of the parties; where the amount of liquidated damages agreed upon is excessively higher than the losses incurred, the people's court or the arbitration agency may appropriately reduce the amount upon the request of the parties.

Where the parties agree upon the amount of liquidated damages for delayed performance, the breaching party must perform the obligations after paying the liquidated damages.21

The remedies above do not conflict with each other. The observer may seek both continuance of performance and damages. Where one party fails to perform the contractual obligations or the performance fails to comply with the contract, and the other party is still suffering from other losses after continuing performance, the party responsible for the failed performance shall compensate for those losses.

Conclusions

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 Civil Code aims to create a market environment in which all parties use resources equally by law, participate in competition openly and fairly, and are equally protected by law. This will ultimately lead to high-quality development of the economy.

The rule that 'the intentions of the parties prevail' has gained more attention and respect from the court in litigation. The scope of void contracts has been narrowed by the Civil Code. Contracts concluded by means of fraud or coercion by one party, thereby damaging the interests of the state, are deemed to be revocable contracts rather than void contracts.

Meanwhile, China has been taking more measures to improve the efficiency of litigation and provide more convenience to litigants. Following the authorisation of some courts to carry out the pilot reform regarding the separation of complicated civil proceedings from simple ones in certain cases by the Standing Committee of the National People's Congress in 2019, courts at all levels shall provide cross-border litigants with online case filing guidance, enquiries, video witness for the entrusting of agents, and registration and case filing services in 2021. It is believed that all those measures will significantly promote substantive and procedural justice in China.

Footnotes

1 Shen Yi is a senior partner at Grandall Law Firm. The author wishes to acknowledge the contributions of Wang Liying, Liu Xueyang, Zhang Kai and Liang Yiming, who are all attorneys at the Beijing office of Grandall.

2 See Article 470 of the Civil Code.

3 See Article 486 of the Civil Code.

4 See Article 502 of the Civil Code.

5 See Article 5 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)(Amended in 2020).

6 See Article 5 of Law of the People's Republic of China on Application of Law in Foreign-related Civil Relations.

7 See Article 142 of the Civil Code.

8 See Article 466 of the Civil Code.

9 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.

10 See Huayuanlu Sales Branch (Zhengzhou) of Guotai Junan Securities Co Ltd etc. v. Zhengzhou Branch of China Everbright Bank, SPC, 2006.

11 See Li Zhanjiang, Zhu Limin v. Bei Hongfeng, Shenyang Donghao Real Estate Co Ltd, SPC, 2014.

12 See the Announcement of the Beijing High People's Court on Performance of Duties by the Beijing No. 4 Intermediate People's Court.

13 About the CICC: http://cicc.court.gov.cn/html/1/219/193/195/index.html (last accessed: 13 October 2021).

14 See Article 63 of Civil Procedure Law of the People's Republic of China (Revised in 2017).

15 Sun Hang, 'CICC Has Completed These Things in The Last Year', the public WeChat account of the SPC.

16 See Article 594 of the Civil Code.

17 See Article 188 of the Civil Code.

18 See Article 563 of the Civil Code.

19 See Article 186 of the Civil Code.

20 See Article 582 of the Civil Code.

21 See Articles 584 and 585 of the Civil Code.

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