by Xia Dongxia  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 “Interpretation”) was ratified at the 1545th Meeting of the Judicial Committee of the Supreme People’s Court on March 31, 2012, and became effective on July 1, 2012. The Interpretation, which includes eight parts and forty-six articles, further clarifies the application of laws regarding the establishment and validity of sale and purchase contracts, delivery and transfer of title, risk allocation, inspection and acceptance of the subject matter, liabilities for breach and retention of title, as well as special sales transactions. It is believed that the Interpretation will function significantly in enhancing the practicability of the existing contract rules, providing instructions to the people’s courts of all levels for the fair trial over contract disputes, protecting relevant parties’ lawful rights and interests and regulating market transactions.

Article 31 of the Interpretation stipulates that “[w]here a party to the sale and purchase contract gains benefits from the breach by the other party, and the breaching party claims a deduction of such benefits from the compensation for losses, the people’s court shall uphold such claim.” This Article formally establishes the principle of balancing benefits and losses (the “Balance Principle”) in sale and purchase contracts in China and fills the gap of the PRC Contact Law[i](“Contract Law”).

Theoretically speaking, the Balance Principle refers to the situation where the obligee for the compensation both suffers losses and gains benefits due to a damaging incident and is therefore only entitled to claim compensations from the obligor with such benefits deducted. The damaging incidents stated above include breach of contract, tort and other damaging events. The Balance Principle is a rule governing the fair allocation of benefits generated from the damaging incident. Specifically, it directly defines the scope of compensable damage and allocates the benefits generated from the damaging incidents in a fair way. The primary function of the Balance Principle is to achieve the purpose of damage compensation system, that is, to compensate the damages suffered by the victim and restore the status of the victim to that before the damage occurs. The damage compensation system only provides compensations for the losses that have been actually incurred, that is, the gap between the victim’s property (interests) prior to and after the occurrence of the damaging incident. As such, an accurate calculation of the gap, which is the basis for restoring the status of the victim to that prior to the occurrence of the damaging incident, shall deduct the victim’s benefits gained from such incident. Either the situation of “a higher amount of damages than the compensations” or the situation of “a higher amount of compensations than damages” will jeopardize the fundamental purpose of the damage compensation system. This said, the Balance Principle is designed to prevent the latter situation mentioned above.

The Balance Principle plays an important role in damage compensation system, and has great significance under both the contract law and the tort law. Under the contract law, the Balance Principle serves to limit the amount of compensations to be paid by the breaching party. It is among the four major principles frequently exploited in calculating the losses of receivable benefits when a breach to the sale and purchase contract occurs. The rest three principles are the principles of contributory negligence, foreseeability and mitigation of damages. If we look back into the legislative history of the Contract law, we can find that the Balance Principle was stipulated in the Contract Law of PRC (Draft) (“Draft”) prepared by scholars and submitted to the Legislative Affairs Committee of National People’s Congress in January, 1995. Article 153 of Section 3 (“Damage Compensation Liability”), Chapter 8 (“Default Liability”) of the Draft provides that where “the obligee to compensation suffered losses, and gained benefits thereof at the same time, the benefits gained by the obligee shall be deducted from the amount of compensation.” However, this Article was not included in the promulgated Contract Law and there are no specific regulations regarding the Balance Principle under the existing civil laws.

On July 7th, 2009, the Supreme People’s Court (SPC) issued the Guiding Opinions on Several Issues Concerning Trials of Civil and Commercial Contract Disputes under Current Circumstances (the “Guiding Opinions”). The Guiding Opinions clarify that in the trial of civil and commercial contract disputes, “when computing and determining the losses, the people’s courts shall consider the following principles combined, that is, the principle of foreseeability, the principle of mitigation of damages, the principle of balancing benefits and losses and the principle of contributory negligence, and decide the amount of compensation by deducting the unforeseeable losses, the improperly expanded losses by the non-breaching party, and the benefits obtained by the non-breaching party due to the breach, the losses caused by the faults of the non-breaching party, and necessary transaction costs from the total amount of compensation for the receivable benefits as claimed by the non-breaching party.” The Guiding Opinions, for the first time, provide that the Balance Principle is applicable to disputes arising under the Contract Law. This provision can be regarded as an official establishment of the Balance Principle under the regime of the Contract Law.

Article 31 of the Interpretation explicitly stipulates the Balance Principle in an independent provision for the first time. According to the Article 31, where a party to a sale and purchase contract obtains benefits from the breach by the other party, the breaching party may claim to deduct such benefits from the amount of compensation when computing losses. Literally speaking, Article 31 of the Interpretation could be viewed as the formal establishment of the Balance Principle in the sale and purchase contracts realm.

The relevant person in charge from the Supreme People’s Court once expressed in a press conference that the verification of the losses of receivable benefits is a long-debated issue in dispute resolution under sale and purchase contracts. For many years, due to the ambiguity of trial rules, judges have been trying such cases on their own discretion. Some judges even overruled the concept of receivable benefits in their judgments. The Interpretation provides “practical guidance” for finding the receivable benefits. ”The practical guidance” mainly refers to the principle of contributory negligence in Article 30 and the Balance Principle in Article 31respectively.

The Interpretation confirms the applicability of the Balance Principle to sale and purchase contracts. With respect to the applicability of the Balance Principle to other types of contracts, Article 174 of the Contract Law shall be resorted to. This article stipulates “[w]here the law provides otherwise on the other non-gratuitous contracts, such provisions shall be followed; if there are no such provisions, reference shall be made to the relevant provisions regarding sale and purchase contracts.” Similarly, provided there are no other regulations on non-gratuitous contracts, the Balance Principle stated in Article 31 of the Interpretation can be applied when deciding the compensation liability of breach of contracts.

[i] The PRC Contract Law was adopted at the Second Session of the Ninth National People’s Congress on March 15, 1999, and became effective as of October 1, 1999.