China Contract Law: Getting Clearer

One role of China’s Supreme Court is to provide guidance on interpreting China’s statutes. These interpretations are directed at two fundamental issues. First, Chinese statutes tend to be short and general. Conflicting interpretations of such general wording is possible. Since China has no form of stare decisis, the only way to resolve such conflicts is via guidance from China’s Supreme Court.

Second, most Chinese legislation is quite new and is based on foreign models. Without an historical background in the concepts, China’s lower courts sometimes interpret the legislation in a manner clearly contrary to the intent of the drafter. Guidance from the Supreme Court serves to correct these aberrant interpretations.

In accord with this role, the PRC Supreme Court recently released Some Explanations of Questions Arising Under the PRC Contract Law 中华人民共和国合同法若干问题的解释 (“Explanation”), which became effective on May 13, 2009 and can be found here. The PRC Contract Law arises in virtually every commercial transaction in China. This post will discuss several of the provisions of the Explanation that are of particular importance for foreign companies operating in China.

Explanation 2: The Contract Law at Article 10 provides that contracts can be formed through a writing, orally or through “other means.” The Explanation states that if the conduct of the parties is sufficient to show the parties intended to enter into a contract, then the courts should enforce such contract as a contract formed by “other means.” There are two important points to notice here. First, many of our clients (and many Chinese businesspersons) believe that an oral contract is not enforceable under Chinese law. This is not true. Article 10 of the Contract Law clearly provides that oral contracts are valid and enforceable. Second, there is a general trend in the Chinese courts to limit enforcement of oral contracts. The Supreme Court constantly battles against this trend. This Explanation is an example of this. Lower courts have avoided enforcing contracts arising from conduct, and the Supreme Court is now pushing the courts to expand their jurisdiction to cover such contracts.

Explanation 3: This Explanation provides that if a party announces publicly that it will make a payment to any person who completes a certain task, this is a contract enforceable under the contract law. This provision makes clear that unilateral contracts are enforceable under the Contract Law. This clarifies a difficult issue. The plain wording of the Contract Law suggests that only multi-party contracts fall within the scope of the Contract Law. This Explanation would exclude unilateral contracts of reward or gift. However, such an exclusion is not consistent with other interpretations of the Contract Law and actual judicial practice in China. This Explanation clarifies the matter and makes clear that unilateral contracts are valid under Chinese law. In this regard, note that China follows the German approach to contracts and has no requirement for consideration. Thus, a “naked promise” is enforceable under Chinese law.

Explanation 4: In the case of a written contract, if the parties fail to state the location where the contract was concluded, the court must make this factual determination. As a general rule, the location for the execution of the contract will be the place where the last signature was affixed. Note that this whole issue can (and should) be resolved in the contract by setting out the governing law and the location for dispute resolution.

Explanation 5. In China, when contracting with individuals, it is common for the individual to sign with a fingerprint. This fingerprint is usually taken as the equivalent of a corporate seal used by a legal person. This Explanation states that such a fingerprint will be taken as the equivalent of a signature under seal, even if the party does not actually sign his name.

Explanations 6, 9 and 10: These Explanations are concerned with the issue of form contracts or contracts of adhesion. The Contract Law provides for a series of highly restrictive rules relating to form contracts. Many foreign parties ignore these provisions and then are surprised when their contracts are not enforced by Chinese courts. This often happens even when the contracts provide that they are governed by foreign law, because the Chinese courts take the position that the Chinese form contract rules are a matter of public policy that cannot be waived. Any such waiver will not be enforced by Chinese courts. The form contract rules are similar to consumer contract rules that have been adopted in Europe. However, there is a major difference that causes even Europeans to make mistakes in this area. The European rules protect only consumers. The Chinese rules are much broader and apply to all contracts, regardless of the status of the parties. Since Chinese companies have a strong tendency to use form contracts, these rules are very important within the Chinese system.

The basic form contract rules are as follows:

  • The party making use of the form contract must use reasonable means to clearly identify those provisions of the contract that limit or eliminate its liability to the other party. Upon request, such provisions must be explained.
  • The following provisions of a form contract are void:
    • To eliminate one’s own liability.
    • To increase the liability of the other party.
    • To exclude the important rights of the other party.
    • To exclude liability for physical injury to the other party.
    • To exclude liability for negligence or intentional damage.
  • In the event of a dispute in interpretation, form clauses are interpreted against the drafter.

These provisions are contradictory and quite difficult to apply in practice. The Explanation provides some guidance as follows:

Explanation 6: This Explanation states simply that if a form contract meets all of the above requirements, then it is a valid contract. This prevents lower courts from dismissing form contracts out of hand.

Explanation 9: If the party that provides the form contract fails to explain an exculpatory provision and the other party requests that such a provision be invalidated, the court shall comply with such request. This then raises the following question: how is it possible to prove conclusively that an exculpatory provision has been explained? It appears to me that it will be virtually impossible to offer such proof, which suggests that all such provisions should be considered to be voidable under Chinese law. Perhaps the only way to do this would be to provide a written explanation and to require the other party to sign something indicating that it received and read that explanation.

Explanation 10: Any provision of a form contract that fails to comply with the provisions of the Contract Law governing form contracts should be declared void by the court. This applies only to the offending provision, not the entire contract. That is, the obligations remain in place, only the exclusions are voided. Where a party has priced its contract obligations assuming that the form exculpatory provisions will be enforced, the result can be an unexpected and disadvantageous shift in the bargain.

Explanation 19: Debtors in all jurisdictions often seek to avoid collection actions by transferring some or all of their assets to a third party. When this transfer is made at an unfairly low price, this impairs the interest of legitimate creditors. Such a practice in the known as a fraudulent conveyance or a fraudulent transfer. Fraudulent conveyance is a common tactic in China and Article 74 of the Contract Law is written to combat such practices. Article 74 provides that if an asset is conveyed to a third party at a “clearly unreasonable price,” the creditor can petition to have the conveyance declared void.

Explanation 19 sets the standard for determining what constitutes a “clearly unreasonable price.” First, the court must determine the market price for the property. This is done based on the government standard price or the price in the local market. Then, any price that is 70% or less than the determined price is “clearly unreasonable”. The creditor needs to prove nothing more regarding the motive for the transfer or the relation of the transferee to the debtor: the proof of an unreasonably low price is sufficient.

Explanation 29: Since it is based on civil law, Chinese contract law is far more flexible with respect to remedies than the common law. China makes no distinction between law and equity. As a result, in addition to money damages, Chinese law provides for specific performance, contract (“liquidated”) damages, deposit, loss of bargain damages and incidental damages. Most importantly, the use of one remedy does not exclude the application of another remedy. For example, if contract damages are not sufficient to compensate for a party’s actual damages, Article 114 of the Contract Law provides that the injured party can request that the court order payment of an amount sufficient to allow for complete relief. However, to prevent abuse, the reverse is also true. Contract Law Article 114 provides that where stipulated contract damages are “excessively higher than actual damages”, the defendant may request a reduction in the amount. Explanation 29 provides that an amount 130% higher than actual damages will generally be considered “excessively high.” However, the burden of proof in establishing the amount of actual damages is on the defendant. In the absence of clear proof, there is a strong tendency for Chinese courts to accept the stipulated contract damage amount.

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