Understanding and Clarification–China’s New Judicial Interpretation of Contract Law

By Xia Dongxia and Yang Ting King & Wood Mallesons’ Dispute Resolution Group
 

The Interpretation of the Supreme People’s Court on Issues Concerning the Application of Law for Hearing Cases of Sale and Purchase Contract Related Disputes (the “2012 Interpretation”) was promulgated on June 5, 2012, and came into effect on July 1, 2012. The 2012 Interpretation, which includes eight sections and forty-six articles, explicitly regulates the establishment and validity of sale and purchase contracts, delivery and transfer of title, risk allocation, inspection and acceptance of subject matter, liability for breach, retention of title, and special sale and purchase contracts. The 2012 Interpretation clarifies several ambiguous issues in judicial practice, and also supplements the PRC Contract Law^[i](the “Contract Law”).

This article summarizes the main content of the 2012 Interpretation.

I .Recognition of the Validity of a Pre-Contract

In negotiating a contract, it is a common practice, especially in the sale and purchase of housing, that the parties sign an ‘order to purchase’ or a ‘letter of intention’, by which the parties agree to conclude a final contract within a certain time period. Theoretically, such a purchase order or letter of intention can be considered the “pre-contract” and the formal contract of “the final agreement”. Prior to the 2012 Interpretation, the Contract Law was silent on the validity and consequences of the breach of a pre-contract, hence debates arose in judicial practice. Some courts have supported the independent validity of the pre-contract^[i]; however, others only recognize liability for fault in forming the final contract.

Whilst the Interpretation of the Supreme People’s Court on Issues concerning the Application of Law to the Hearing of Cases Involving Disputes over Contracts for the Sale and Purchase of Commodity Housing^[ii] (the”Commodity Housing Interpretation”) states that if a pre-contract, has been performed, the pre-contract could be considered a contract for the sale and purchase of the commodity housing. However, the Commodity Housing Interpretation does not explicitly recognize the independent validity of a pre-contract.

Now, Article 2 of the 2012 Interpretation explicitly acknowledges the independent contractual validity of a pre-contract, in the form of an order to buy, order to purchase, reservation book, letter of intention, or memorandum.  Accordingly, even if a formal contract is not established, a party has the right to claim against the other party on the basis of breach of contract.

Since the goal of signing a pre-contract is to conclude a formal contract, it is our view that liabilities for breach of a pre-contract should include monetary compensation, liquidated damages, and deposit retention. However, in theory and practice, it remains arguable whether the non-breaching party can demand specific performance of the pre-contract, i.e. forcing the breaching party to sign the formal contract. This issue is not explicitly stipulated by the 2012 Interpretation. According to the draft committee’s opinion, the 2012 Interpretation did not provide a clear position regarding this issue and it remains open to further academic analysis and judicial clarification.^[iii]

II .Confirming the Validity of an Unauthorized Disposition Contract

Article 51 of the Contract Law provides that “[w]here a person having no right of disposal of property disposes of properties of another person, and the principal ratifies the act afterwards or the person without power of disposal has obtained the power after concluding a contract, the contract shall be valid.” To protect the transaction order and the buyer’s interest, the 2012 Interpretation confirms the position provided in the Contract Law, i.e., constrains the circumstances in which a contract will be invalidated, and affirms the validity of an unauthorized disposition contract.

Article 3 of the 2012 Interpretation states that “[w]here any party claims that a contract is void because the seller has no right to own or dispose of the subject matter upon entering into the contract, the court shall not support such request. If the seller causes the title of the subject matter to be unable to be transferred due to not obtaining the ownership of or the right to dispose the subject matter, the buyer has a right to request the seller to bear the default liability or request to terminate the contract and claims for liquidated damages.”

III .Specifying the Delivery Means for Electronic Information Products

Sale and purchase contracts for electronic information products are becoming increasingly prevalent. Unlike the subject matter of a traditional contract, delivery of the electronic information might be delivered without a physical carrier. For an electronic information product that does not require a physical carrier for delivery, the associated delivery rule is novel.

The 2012 Interpretation specifies special rules regarding the delivery means of electronic information products. Article 5 of the 2012 Interpretation states that “[i]f the parties define the delivery means expressly, the agreements shall be followed; if there is no agreement, or the delivery terms are unclear, the parties may agree supplementary terms through consultation. If they fail to do so, the terms shall be determined from the context of the contract or by trading practices. If a delivery means cannot be determined through these rules, the delivery shall be deemed completed upon the buyer receiving the agreed electronic information product or the document of title.”

The draft committee of the 2012 Interpretation believes that two types of delivery means for electronic information products are mainly used in trading practice:

(1) delivery of document of title; and

(2) accepting or downloading such products through internet transmission, where the vendor provides access to the electronic information product and the buyer accepts access to the product.

Considering the advantageous position of the vendor in the sale and purchase process of electronic information products (especially in the producing and transmitting procedures), the 2012 Interpretation states that delivery is completed when the buyer receives the electronic information products.^[iv]

IV .Specifying the Rules on Ownership of a Property Sold to Multiple Parties

Multiple parties may claim interest in one property in case where the seller has sold such property to different buyers. The Interpretation of the Supreme People’s Court on Certain Issues Concerning the Application of Contract Law of the People’s Republic of China (Part Two)^[v] has established that each multiple sale contract is valid.^[vi]The new rules for determining ownership between multiple parties are based on principles of ‘good faith’. However, the law does not deal with the situation where two or more buyers request performance of a contract at the same time, an issue of much debate in practice. Regarding normal movable properties not requiring registration, Article 9 of the 2012 Interpretation determines ownership according to date of the delivery of the goods, the date of payment and the date of the contract, as follows:

(1) a buyer who receives delivery of the goods has the right to request the court confirmation of ownership;

(2) where the property is not delivered, the seller shall deliver the property to the buyer who first makes payment;

(3) where the property is not delivered and no payment has been made, the seller shall deliver the property to the buyer who first entered into the sales contract.

For special movable properties such as vessels, aircrafts or motor vehicles, for which ownership must be registered, Article 10 of the 2012 Interpretation determines ownership according to date of the delivery of the goods, the date of registration and the contract date, as follows:

(1) for delivered property, the seller shall undertake the necessary steps to register the property in the buyer’s name;

(2) where the property is registered under the name of one buyer, but not yet delivered, the seller shall deliver the property to that buyer;

(3) where the property is not delivered and no buyer registered, the seller shall deliver the property to and register the ownership under the name of the buyer who first entered into the sales contract;

(4) where the property is delivered to one buyer but registered under the name of another buyer, the buyer who received delivery is entitled to request the court to register the property under his or her name.

V .Improving the Rules on Risk Allocation

To address new issues arising from risk allocation in judicial practice, the 2012 Interpretation makes the following clarifications and supplements to the Contract Law:

1. “Where transportation of the goods is required”

Article 11 of the 2012 Interpretation now stipulates that “where transportation of the goods is required”,  pursuant to Article 141^[vii] of the Contract Law, the seller is responsible for the shipment of the goods and the carrier is not a party to the sales contract. “Transportation of the goods” is not required where the seller transports the goods himself or the buyer is responsible for transportation.

2. Risk allocation rules where goods are delivered to a carrier at a specific location

Where a seller must deliver goods to a carrier at a location designated by the buyer, the Contract Law does not contain risk allocation rules for such circumstances. Article 12 of the 2012 Interpretation now provides that unless otherwise agreed, the buyer bears the risk after the goods have been delivered to the carrier at the place designated by the buyer.

3. Risk allocation rules for goods in transit

According to Article 144 of the Contract Law, the buyer of goods in transit shall bear the risk since the establishment of the contract. But in practice, it is unfair to have the buyer bear the risk, in the event that at the time of the contract establishment, the seller knows or should have known the damage of the goods but fails to inform the buyer about the damage. To address the unfairness, Article 13 of the 2012 Interpretation now provides that, if at the time of the establishment of the sales contract, the seller knows or should have known the goods were lost or damaged, and the seller fails to inform the buyer as such, the seller bears the risk of this loss or damage. This is consistent with Article 68 ^[viii] of the United Nations Convention on Contracts for the International Sale of Goods.

4. Risk allocation rules for non-specified goods

The Contract Law is silent on risk allocation rules for non-specified goods.Article 14 of the 2012 Interpretation now provides that the seller bears the risk where parties have no agreement on risk bearing, if the goods are non-specified, and the seller does not specify the goods, which should correspond to the contract, by recognizable means such as shipping documents, or other forms of notification to the buyer.

VI .Rules on the Loss of Benefits Receivable from Performance of the Contract

The rules about compensation for the loss of benefits receivable from performance of a contract is a difficult issue in the field of contract law. Although theContract law^[ix] generally provides compensation for such losses, it does not provide detailed standards on the calculation of such losses. Hence, there is no uniform standard in judicial practice and some courts decline to support claims for these losses.

The 2012 Interpretation provides practical regulations on compensation for the loss of benefits receivable from performance of the contract. Pursuant to theContract Law and Articles 29, 30 and 31 of the 2012 Interpretation, such losses are calculated according to the principles of “foreseeability”, “mitigation”, “contributory negligence”, and “balance of gains and losses”. The principles of contributory negligence and balancing gains and losses have the greatest influence in this part of the 2012 Interpretation.

A Guiding Opinion has also been issued by the Supreme People’s Court in respect to the burden of proof for establishing loss of benefits receivable from performance of a contract.^[x]This Guiding Opinion provides that, in general, the breaching party will be responsible for proving that the losses claimed are higher due to the non-breaching party’s failure to mitigate damages, i.e. take steps to minimize its loss, where the non-breaching party benefits from the breach, or where the non-breaching party is also at fault. The non-breaching party must prove loss of receivable benefits under the contract and the associated transaction costs.

Foreseeability might be addressed by either the non-breaching party or the court, which may make judgments at its discretion.

VII .Specifying the Regulations on Retention of Title

While theContract Law only provides general regulations on retention of title^[xi], the 2012 Interpretation set forth detailed regulations on this matter. The new regulations, set out below, seek to balance the interests of seller and buyer,

1. Retention of title rule does not apply to sales of real estate

Article 34 of the 2012 Interpretation explicitly stipulates that the retention of title rule does not apply to sales of real estate.

2. Seller’s rights to retrieve

According to Article 35 of the 2012 Interpretation, the seller has the right to retrieve possession of the subject matter when:

• the buyer has or is not paying the purchase price as agreed;
• the buyer is not fulfilling conditions as agreed; or
• the buyer is selling, pledging or making other improper disposal of the subject matter.

 However, a seller’s right to retrieve possession is restricted:

•  where the buyer has paid 75% or more of the purchase price; or
•  the property has been sold to a bona fide third party.

3. Buyer’s right to re-gain possession

Under Article 37 of the 2012 Interpretation, a buyer may regain possession of the subject matter by eliminating the basis of the seller’s retrieval. Where the buyer does not re-gain possession, the seller may re-sell the subject matter. Where the seller re-sells the subject matter, any profit from the re-sale after deducting the expenses including, the re-transaction expenses, interests, and any unpaid purchase price, shall be refunded to the original buyer. If the selling price is insufficient to cover the seller’s costs, the seller may request the original buyer to pay the additional amount.

The 2012 Interpretation in this case has taken into account interests of both the seller and the buyer.

VIII .Conclusion

The 2012 Interpretation has coordinated the provisions of the Contract law and associated regulations, enhanced the usability of rules for sale and purchase contracts, and refined rules concerning unforeseen issues which had arisen in judicial practice. Please contact us for further assistance in understanding and applying the 2012 Interpretation, so that we might help reduce legal risks and resolve disputes in an efficient way.