China: Second Judicial Explanation On PRC Contract Law

Last Updated: 15 September 2009
Article by Edith Chen

This article was first published in Asian Counsels country files,

A discussion of issues such as formation, validity, performance, termination and damages

On 24 April 2009, the PRC Supreme Court issued the Second Judicial Explanation on the PRC Contract Law ("Second Judicial Explanation"). This Second Judicial Explanation treats contract law issues that were not covered or remained unclear in the existing legislation and the first judicial explanation.

1. Formation of a contract

Article 1 of the Second Judicial Explanation clarifies the existence of three indispensable elements for formation of a contract: contract parties, contract object and quantity. Failure to agree on other matters should "generally" not impair formation of a contract, unless the law otherwise provides or the parties otherwise agree upon.

2. Effectiveness of a contract

  1. A contract signed by a person with limited civil capacity or without due authorisation shall be deemed retroactively effective as of its execution, when afterwards duly recognised by a statutory agent or represented party (Article 11 of the Second Judicial Explanation).
  2. The start of the represented party to perform the contract may qualify as de-facto recognition of the contract (Article 12 of the Second Judicial Explanation).
  3. In response to Article 52 of the PRC Contract Law, Article 14 of the Second Judicial Explanation explains that only the violation of a "mandatory legal provision affecting the contract effectiveness" will invalidate a contract.

3. Standard contract clauses

The party who provides standard contract clauses shall remind the other party of clauses that exempt or restrict its liability, and explain such clauses when the other party requests. If the party fails to do so, and the other party hence remains unaware of the concerned clauses, the court will support an application of such other party for cancellation of them (Article 9 of the Second Judicial Explanation).

4. "Default" before contract effectiveness

For a contract that become effective when approved by or filed with a government authority, the failure of the party responsible for handling such procedure to duly handle may render it liable for losses incurred by the other party (Article 8 of the Second Judicial Explanation).

5. Cancellation of debtors' transactions or disposal acts

Articles 18 and 19 of the Second Judicial Explanation extends the application of Article 74 of the PRC Contract Law so that a creditor may now seek invalidation of a wider range of malicious transactions or disposal acts of its debtor that impairs its ability to pay.

6. Termination right - Objection

Where one party seeks to raise an objection to the termination right exercised by the other party, Article 24 of the Second Judicial Explanation clarifies that a time period agreed by the parties shall apply. If not agreed, the objection must be raised within three months of the party's receipt of the termination notice.

7. Major change of objective circumstance

Article 26 of the Second Judicial Explanation offers a new legal basis for a contract party to require amendment or rescission of a contract, when a major change of objective circumstances occurs after contract conclusion, not being a commercial risk, but none-foreseeable at contract conclusion, and also not caused through a force majeure event.

8. Liquidated damages

Articles 28 and 29 of the Second Judicial Explanation aim to bring compensation for liquidated damages in line with actual losses. Although the court should also consider loss of anticipated profits when reviewing liquidated damages alleged to be excessively high, the court's decision shall be mainly based on actual losses. It has been further clarified that liquidated damages that exceed the losses by 30% may be generally considered as "excessively high".

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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