what we think

Foreign companies and their subsidiaries that source from or distribute to businesses or consumers in China are wise to confirm their transactions with Chinese counterparts in a detailed commercial contract. This will not only ensure there is clarity on the rights and obligations of the parties, but the more details are agreed upon on paper, the easier it will be to enforce the contract if one of the parties backs out or breaches the agreed provisions.

Chinese law sets relatively few restrictions to commercial relations: for the most part, parties can negotiate and agree to contract terms freely and on a commercial basis. There are however exceptions. One important principle in legal practice is that under Article 5 of the PRC Contract Law (1999), the principle of fairness must be considered when defining the rights and obligations of each party. This means that a judge, when consider a contract dispute, will not only test the parties’ (in-) actions against the terms of the contract, but may also consider whether such terms were fair in the first place.

Courts are not the only option to test the terms of a contract. Between 1995 and 2008, the State Administration for Industry and Commerce (SAIC) had the right to investigate and penalize parties that used contracts to fraudulently acquire property, illegally take possession of or damage state owned assets, or damage the interests of the state, the public or third parties. Under the more recent Rules on the Supervision and Handling of Unlawful Contractual Practices (the “Contract Rules”), effective as of 13 November 2010, the SAIC re-establishes its right to penalize contract-related violations, but with a new emphasis on unfair clauses in standard contracts. The Contract Rules will benefit consumers more than businesses, but in any case they serve to remind all of the influence that China’s administrative authorities still have in domestic economic practices.

Investigating Contract Violations

Where a contract is signed but one of the parties finds its counterpart has violated the law, it may file a complaint. The SAIC or its local counterpart should investigate any breaches of laws or regulations, but especially the acts specifically mentioned in the Contract Rules. Violations can be penalized at three times the illegitimate benefits obtained as a result of the fraud but capped at CNY 30,000, or at no more than CNY 10,000 if there are no illegitimate benefits. If the fraud constitutes a crime however, the case shall be transferred to the Public Security Bureau for investigation and prosecution. Moreover, parties retain the right to claim against a counterpart for compensation in a civil action.

Compared to the 1995 rules, the Contract Rules in Articles 9, 10 and 11 contain a number of new additions. Business operators are strictly prohibited from using standard clauses if these serve to:

1. Exempt the business operator from certain liabilities
towards a consumer, such as:

• liabilities for personal injury;
• liabilities for property loss caused deliberately or by
  gross negligence;
• guaranty liabilities legally assumed for good or services;
• or liabilities legally assumed for breach of contract.

2. Increase the liabilities of the consumer, including by:

• setting an amount of liquidated damages or
• compensatory damages which exceeds the statutory or
  reasonable amount
• equiring the consumer to assume any operational risk
  that should be assumed by the provider of the standard
  clauses; or
• by imposing on the consumer liabilities that are in
  conflict with laws and regulations.

3. Exclude certain rights of the consumer, including:

• the right to modify or rescind the contract in accordance
  with law;
• the right to claim for payment of liquidated damages;
• the right to claim for compensation for damages;
• the right to interpretation of the standard clauses; and
• the right to lodge a lawsuit for disputes over the
  standard clauses.

Despite the new emphasis on standard clauses, the Contract Rules also list a number of general fraudulent acts that are punishable:

1) falsifying a contract;
2) fabricating a contracting party, or concluding a contract in another party’s name without authorization or by impersonating another party;
3) fabricating the subject matter of a contract or fabricating the sources of goods or sales channels to persuade another party into concluding or performing a contract;
4) releasing or using false information to persuade another party into concluding a contract;
5) concealing any material fact to cheat the other party into making a wrong expression of intent to conclude a contract or trick the other party into performing a contract;
6) having no ability to actually perform a contract but cheating the other party into concluding or performing a contract by first performing a petty contract or partially performing a contract;
7) setting in bad faith any actually non-performableclause in a contract, which causes the other party’s failure to perform the contract;
8) fabricating a reason to suspend (or terminate) a contract to cheat another party of property;
9) providing false securities; and
10) concluding or performing a contract by any other fraudulent means.

Comments

While the terms of Article 6 may again offer those companies that are the victim of contractual fraud an additional option to put pressure on their counterparts, the restrictions on standard clauses undoubtedly have a deeper impact as they are clearly designed to protect consumers against business operators that have the power to insist on unfair provisions.

Companies that sell directly to consumers such as (life) insurers and travel agents may be particularly vulnerable to investigations and penalties if they attempt to take advantage of their position by using unfair standard clauses.