China: China's Supreme People's Court Issues Clarification and Interpretation of the Contract Law

Last Updated: 29 March 2010

On April 24, 2009, the Supreme People's Court of the People's Republic of China (the "SPC") issued the "Interpretation II of the Supreme People's Court on Several Issues concerning the Application of the Contract Law of the People's Republic of China" ("Interpretation II"), which came into force on May 13, 2009.

The release of Interpretation II was driven by two major factors. First, it was felt that the "Interpretation I of the Supreme People's Court on Several Issues concerning the Application of the Contract Law of the People's Republic of China" ("Interpretation I") issued by the SPC in 1999 did not adequately deal with many of the issues arising out of the changed social circumstances in the 10 years since its release.

Secondly, the ongoing global financial crisis led to an increase in the number of contract disputes since the second half of 2008. By way of example, in the first quarter of 2009, first instance courts in China heard more than 790,000 cases concerning contractual disputes, an increase of 13.75 percent compared to the number for the same period in 2008. These contractual disputes accounted for 53.46 percent of all civil and commercial cases at first instance in 2009.

The Scope of Interpretation II

Interpretation II has 30 articles divided into six parts. The six parts are: (1) conclusion of contract; (2) validity of contract; (3) performance of contract; (4) termination of contractual rights and obligations; (5) liabilities for breach of contract; and (6) supplementary provisions. In this Commentary, we will concentrate on five specific issues:

  • Commercial impossibility
  • Standard form clauses
  • Registration of contracts
  • Set-off of debts
  • Liquidated damages

Commercial Impossibility. Interpretation II enshrines the legal principle of rebus sic stantibus in Article 26. The legal doctrine of rebus sic stantibus allows for contracts to become inapplicable because of a fundamental change in circumstances. This is akin to the English legal concept of frustration or impossibility. Article 26 provides that parties can modify or terminate a contract where:

  1. A substantial change of circumstances occurs after the contract is concluded;
  2. The change of circumstances is unforeseeable when the contract is concluded;
  3. The change of circumstances is not caused by force majeure;
  4. The change of circumstances is not a commercial or business risk; and
  5. It is obviously unfair to a party, or the purpose of the contract would be frustrated, if the parties continued to perform the contract.

In such circumstances, a party can file a request for the modification or rescission of the contract, and the court shall decide whether to modify or rescind the contract under the principle of fairness and in light of the facts of the case.

The doctrine of frustration or impossibility is designed to solve the problem of obvious unfairness after conclusion of a contract. Even if the contract was fair at the time of its conclusion, if there is a fundamental change afterward that would impose substantial losses on one party or would make the contract deviate from its original purpose, the contract can be modified or rescinded.

Two things need to be emphasized for the application of Article 26. First, the changed circumstances cannot have been caused by a force majeure event, and secondly, the court must strictly differentiate between a situation of frustration and normal market risks.

Standard Clauses. Interpretation II admits the validity of certain standard form clauses if, at the time of concluding a contract, the party providing the standard form clauses adopted special characters, symbols, fonts, and/or other signs sufficient to arouse the other party's attention to the content of the standard form clauses regarding liability exemptions or restrictions in favor of the party providing the standard form clauses. The same applies if the first party made an explanation of the standard form clauses according to the requirements of the other party.

However, the SPC is aware of the disadvantages of standard form clauses, in particular their negative impact on customers. Accordingly, Interpretation II requires that the party providing the standard form clauses must bear the burden to prove that it has fulfilled the obligation to make reasonable prompting and explanation. The court will revoke or invalidate such clauses if the party relying on the clauses fails to perform these obligations.

Registration of Contracts. Although contracts that need to be approved or registered under a relevant law or administrative regulation for their effective conclusion in China are fewer than before, there are still some types of contract, particularly in the construction field, that require registration. If these contracts have not been approved or registered, there will be no contract existing, and thus the innocent party cannot request the other party to assume liability for breach of contract.

Interpretation II provides that after the formation of a contract that does not become effective until it is approved or registered under a relevant law or administrative regulation, if the party that has the obligation to apply for the approval or registration (the "registration party") fails to do so, such a failure shall fall within the scope of "any other act in violation of the principle of good faith" provided in Article 42(3) of the Contract Law. The court may rule that the other party could go through the relevant formalities by itself, and the registration party shall be liable for compensating the other party for the expenses incurred and the losses actually caused to the other party as a result of the registration party's failure.

Set-off of Debts. Interpretation II stipulates for the first time the order of debts that can be set off. In other words, where the debtor's repayment is not enough to pay off all debts of the same type owed to the same creditor, the repayment should follow the following waterfall scheme: (1) the agreement concerning the order of debts to be set off between the debtor and creditor shall be firstly obeyed; (2) a due debt shall be set off; (3) a debt for which no guaranty is provided to the creditor or the guaranty provided to the creditor is in the smallest amount shall be set off; (4) a debt with a heavier debt burden, in the event that the guaranty amounts are equal, shall be set off; (5) debts shall be set off in the order of the dates of maturity of the debts; and (6) debts with same due date shall be set off in proportion to each other.

If the repayment is not enough to pay off all debts, and if there is no agreement between the parties, the debtor shall pay interest and expenses besides the primary debt in the following order: (1) expenses incurred for realizing the creditor's rights; (2) interest; and (3) the primary debt.

Liquidated Damages. If a party requests the court to increase the liquidated damages under paragraph 2 of Article 114 of the Contract Law, the amount after the increase shall not exceed the amount of the actual losses suffered by that party; after the increase, the court shall reject further requests for compensation for losses by the innocent party.

On the other hand, if a party requests a proper reduction of the liquidated damages under paragraph 2 of Article 114 of the Contract Law, the court shall make a ruling on the basis of the facts of the case and under the principle of fairness and good faith. If the liquidated damages agreed upon by the parties exceed the losses actually incurred by 30 percent, they shall be generally deemed as "significantly higher than the losses incurred," and the parties could then request the court to decrease the liquidated damages.

The SPC has now clarified that "significantly higher" in effect means 30 percent higher than actual losses. Accordingly, provided that an owner's liquidated damages are less than 30 percent higher than its actual losses, such liquidated damages should stand, even though they are greater than the actual losses suffered.

Conclusion

Overall, these interpretations by the SPC are a welcome clarification of the law as it affects contracts in China. In many ways the SPC is taking a very practical and pragmatic approach to contractual disputes, which is consistent with approaches adopted in many foreign jurisdictions.

The frustration or impossibility doctrine is now enshrined in Chinese law, and this helpfully expands on the existing good faith and force majeure provisions under Articles 8 and 117 respectively of the Contract Law. In effect, Interpretation II recognizes what amounts to an economic force majeure, or even commercial impossibility situation.

With regard to the 30 percent threshold for excessive liquidated damages, the SPC is following its previous interpretation concerning commercial real estate sale and purchase contracts, effective on June 1, 2003, which provided that significantly higher liquidated damages could be reduced to 30 percent above the actual losses.

The author wishes to thank Jiang Zhou and Cao Shu in the Beijing Office for their assistance in the preparation of this Commentary.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions