A large percentage of the world’s goods are manufactured and imported from China. Behind each of these items, there are one or more contracts with Chinese parties or involving China – from simple sale and purchase contracts to complex contracts creating multi-billion dollar Sino-foreign equity joint ventures.
Notwithstanding the rise of China as an economic power, however, little is known about Chinese law and, in particular, about Chinese contract law. This article hopes to give the reader an introduction to some of the key features (and differences) of Chinese contract law.
The People’s Republic of China is a civil law country, which means that statutes, regulations and interpretations of statutes form the body of Chinese laws. Unlike England, Chinese court judgments (no matter whether it is the Supreme Court or the lower courts) do not form part of the law and are not binding on subsequent courts.
One has to be mindful of the differences that are unique to China. Two major differences are:
First, not all China-related contracts automatically take effect upon fulfilling the contract formation rules in the common law world (that is, having ticked the boxes of having an intention to create legal relation, offer-acceptance and consideration). Certain types of contracts require government approval to gain validity.
Two important categories of such contracts are the joint-venture contract and the equity transfer contract for a foreign investment enterprise. These types of contracts are heavily regulated by the Chinese government because it enables the government to exercise a degree of control over foreign investment. When I advise foreign clients entering into such contracts, I always ask them to think of the PRC government as the invisible third party to the contract.
Secondly, in line with other civil law countries, Chinese contract law contains both general principles that apply to all contracts (in PRC Contract Law Articles 1 to 129) as well as specific rules established for specific types of contracts (in PRC Contract Law Articles 130 to 428).
The list of specific contracts range from contracts for supply and use of electricity, to loan agreements, to warehousing agreements and agency agreements. This categorisation of different types of contracts is very different from the common law tradition and it can be a pitfall if one only considers the general contractual principles but fails to take into account specific principles that may be relevant. For example, while general contractual principles may allow parties to agree the term of a contract, a specific provision on leases mandates that any lease agreement which exceeds 20 years is invalid (PRC Contract Law Article 214).
The code does not specify any language requirement for China-related contracts, but for contracts which require government approval, a Chinese translation must be provided for approval or filing purposes. Where two languages are drafted, it is advisable to specify the language that takes precedence in such circumstances.
In terms of execution of contracts, like many other jurisdictions, Chinese contract law does not specify a particular form of execution that is valid. However, the practice in China is still very much that parties will be expected to execute a contract by affixing the company seal (or company chop). The person with the strongest authority to enter into contracts on behalf of a Chinese company is the legal representative of that company (a company officer that is unique to Chinese companies). Ideally, therefore, you would have a contract that is executed with both the company seal and the legal representative’s signature.
Whereas the effectiveness of oral agreements has been questioned in the past, recently, China has notified the United Nations that it will be bound by Article 11 of the convention on contracts for the international sale of goods. This means that a contract of sale need not be concluded in or evidenced by writing and is not subject to any other requirements as to form; a contract may be proved by any means, including witness evidence. However, as oral contracts do not have a good track record in Chinese courts, it is still best to rely on executed written agreements where possible.
The remedies that are available for breach of contract under Chinese contract law, such as specific performance, compensation for losses, liquidated damages, are in broad terms similar to common law systems. However, there are particular Chinese nuances here as well. For example:
* Specific performance remedies are difficult to get because they require further policing from the courts, which Chinese courts are generally less willing to do.
* Liquidated damages can be re-assessed by the court (and adjusted up or down) according to the damage actually suffered by the innocent party.
* Damages awarded by Chinese courts tend to be more conservative, especially if the claim is for a more speculative loss of profits claim. Chinese courts tend to require very concrete evidence of actual loss, for example, by submitting related contracts that could not be fulfilled as a result of the original breach of contract.
When drafting any contract, it is important to state expressly which law will govern it. For certain China-related contracts, it is compulsory that the parties use Chinese law. The following are some of the main categories of contracts that must be governed by Chinese law if they are to be performed in mainland China:
* Sino-foreign joint-venture equity or co-operative contracts;
* Contracts for Sino-foreign co-operative exploration and exploitation of natural resources;
* Contracts transferring equity in Sino-foreign equity or co-operative joint-ventures and wholly foreign owned enterprises, referred to as WFOEs.
For all other contracts, it is still compulsory to use Chinese law if the contract is not a “foreign-related” contract. A contract is not foreign related if all of the parties are Chinese companies or nationals.
Choice of dispute resolution clauses for contracts:
There are two basic options for resolving disputes in China-related commercial contracts: court litigation (onshore in mainland China not including Hong Kong or offshore anywhere outside mainland China) and arbitration (again onshore or offshore).
Litigation, whether onshore or offshore, is usually not a good choice for the non-Chinese party in a contract. The quality of Chinese court litigation is improving but remains variable. The main problem with offshore litigation is enforcement. In particular, mainland China does not enforce foreign judgments unless there is a reciprocal enforcement treaty in place with the relevant jurisdiction. To date, there are relatively few such treaties.
Arbitration (whether onshore or offshore) is a better choice than litigation. In negotiations, Chinese parties will often try to insist that arbitration be onshore. Where it is available, offshore arbitration is generally preferred by many foreign parties. However, only foreign-related disputes can be arbitrated offshore (see above re “foreign-related”). If your dispute is not foreign-related, or if you do not succeed in negotiating offshore arbitration, you may have to agree to onshore arbitration as the next best option.
There is nothing scary or vastly unexpected in Chinese contract law. Nonetheless, there are certain key differences that one should be aware of before entering into a significant investment. The above represents a very quick summary of some important elements of Chinese law. When in doubt, of course, instruct local counsel to give more specific advice on the contractual terms you are considering.
May Tai is a partner of law firm Herbert Smith Freehills LLP Beijing
Background
The Chinese contract law statute came into force on 1 October 1999. This statute and two subsequent interpretations of the statute issued by the Supreme People’s Court in 1999 and 2009 form the body of China’s contract law. The contract law is a comprehensive statute that was designed to apply to all types of contracts that are subject to Chinese law.
China is one of 78 member states that have adopted the UN convention on the international sale of goods. Chinese contract law is heavily influenced by the convention and, as a result of its influence, many of the general contract principles in China tend to be similar to other jurisdictions. For example, the principle of offer and acceptance (PRC Contract Law Article 13) and the intent to create legal relations (PRC Contract Law Article 14) are common to China and common law jurisdictions such as England.
Key points
Outside Chine, little is known about Chinese law and, in particular, about Chinese contract law.
In terms of execution of contracts, like many other jurisdictions, Chinese contract law does not specify a particular form of execution that is valid.
Litigation, whether onshore or offshore, is usually not a good choice for the non-Chinese party in a contract.
