April 2023

Lihui Jiang and Teresa Huang

On November 4, 2022, the Supreme People’s Court issued the Interpretation on the Application of the General Provisions of Contract Part in the Civil Code of the People’s Republic of China (Draft for Comments) (hereinafter referred to as the “Draft for Comments”) for soliciting public comments from the society.  The Draft for Comments aims to correctly try contract disputes and creditor-debtor relationship disputes not arising from contracts.  The period for receiving comments has now ended.

Upon the adoption of the Civil Code, the former Judicial Interpretation I of the Contract Law and Judicial Interpretation II of the Contract Law were repealed.  The Draft for Comments contains some innovative provisions, as well as some provisions inherited and absorbed from the aforementioned Judicial Interpretations, and reflects some provisions of normative documents such as the Minutes of the National Courts’ Civil and Commercial Trial Work Conference and the Minutes of the National Courts’ Conference on the Implementation of the Civil Code.  From a structural perspective, the Draft for Comments consists of nine parts with 73 articles, including “general provisions, execution of contracts, validity of contracts, performance of contracts, preservation of contracts, modification and assignment of contracts, termination of contractual rights and obligations, liability for breach of contract, and supplementary provisions”.  This article will focus on some innovative or controversial provisions for reference.

1. Liability for negligence of the third party in contracting

Article 6 of the Draft for Comments innovatively stipulates the liability for negligence of the third party in contracting, indicating that if a third party conducts fraud or coercion causing the parties to conclude a contract against their true intentions, the third party shall be liable for corresponding compensation.  This Article may be considered as an expanded interpretation of Article 149 and Article 150 of the Civil Code related to fraud or coercion of third parties.  Although it aims to improve the liability system of the Civil Code and responds to certain situations in trial practice, there are some different opinions.  In the previous Contract Law and the General Provisions of the Civil Law, the liability for a third party’s fraud shall be assumed by the counterparty of the party who is defrauded, but the liability for negligence of the third party in contracting breaks the principle of “privity of contract”.  As the right to hold a third party accountable is based on tort, it is a bit abrupt to put this content in the judicial interpretation of Contract Part, and at the same time, such content also has the risk of contradicting Article 500 of the Civil Code.

Moreover, the second paragraph of this Article also provides that if the conclusion of a contract is based on the special reliance on a third party or relies on the knowledge, experience, or information, etc. provided by the third party, the third party commits any act in violation of the principle of good faith, or is at fault for the fact that the contract is not formed, is invalid, is revoked, or is determined to be without effect, the third party shall be liable for compensation.  The expression “special reliance or rely on” is more inclined to the subjective feelings of the parties, and it is difficult to have an objective standard for judgment in trial practice, which may also create unpredictable risks for practitioners in the legal, accounting, financial and consulting industries, etc.  Therefore, some professionals have suggested deleting it.

2. Malicious collusion between a representative or agent and the counterparty

Article 24 of the Draft for Comments makes an explanation on the malicious collusion between an agent or representative of a legal person or unincorporated organization and the counterparty, indicating that in the case of malicious collusion and damage to the lawful rights and interests of a legal person or unincorporated organization, the contract shall be null and void and the person concerned shall be jointly and severally liable for damages, which is a specific application of Article 154 and Paragraph 2 of Article 164 of the Civil Code.

It is worth mentioning that this Article also states that when the people’s court believes that there is a high possibility of malicious collusion between the relevant persons, but cannot exclude reasonable doubt, it may ex officio or upon application order them to make statements or provide relevant evidence on the relevant facts.  If the counterparty refuses to make statements or submit relevant evidence without justifiable reasons, the court may determine that the fact of malicious collusion is established.  In other words, under certain circumstances, the court has the right to require a party to “prove their own innocence”.  However, in terms of the burden of proof in civil litigation cases, except for some special circumstances such as the “reversal of the burden of proof” in some tort cases, the principle of “burden of proof borne by claimant” shall apply.  This interpretation allows the court to increase the burden of proof of a party under certain circumstances, but also increases the potential obligations and risks for some subjects, especially corporate legal persons.  Since the various commercial acts of a company are performed by its agents or representatives, if a company fails to reach unanimous internally and remains absolutely unanimous on a transaction, any shareholder may challenge the validity of the contract, which may cause some unnecessary resistance to the normal operation of the company.

3. Jurisdiction of subrogation litigation

The jurisdiction of subrogation litigation shall, in principle, be under the jurisdiction of the people’s court where the defendant is domiciled, except that the provisions of exclusive jurisdiction shall apply according to law.  The current controversy in judicial practice is whether a creditor in a subrogation action is bound by any arbitration or jurisdiction agreement existed between the debtor and the counterparty?  Accordingly, the Draft for Comments proposes two different options in Article 38.

Proposal 1: If the counterparty objects to the subrogation action filed by the creditor due to the existence of an arbitration or jurisdiction agreement between the counterparty and the debtor, the court shall not uphold it, but if the counterparty files another lawsuit or arbitration against the debtor and claims a suspension of the subrogation action before the end of the court debate in the first-instance procedure, the court shall grant permission.  This proposal respects the autonomy of parties and reflects the equal status of arbitration and litigation in dispute resolution^[1].  However, there is a risk that the debtor and the counterparty are more likely to take measures afterwards to damage the interests of creditor, such as backdating the arbitration agreement to exclude subrogation right.  Option 2: If the creditor files a subrogation action and then the counterparty objects it on the ground of the existence of an arbitration or jurisdictional agreement, the court shall dismiss the action or inform the creditor to file a lawsuit with a court of competent jurisdiction.  As the object of the creditor’s subrogation is the debtor’s rights against the counterparty, the creditor shall not enjoy a superior position to the debtor.  Therefore, if an arbitration agreement can be excluded by the creditor’s subrogation rights, what is the significance of the arbitration agreement?  At present, all walks of life have different views on these two options, and we are waiting for the final version.

4. Notice of credits assignment and multiple assignments of credits

The Draft for Comments adds a new interpretation on the notice of credits assignment in Article 50, specifying that whether the debtor fulfills its obligations to the assignee is subject to whether it receives a valid notice.  The notifiers shall not be limited to the assignor, but also the assignee, but it is necessary to provide effective legal documents confirming the fact of credits assignment, the notarized credits assignment contract and other evidence that can confirm the fact of the credits assignment.  In other words, if the assignee conveys the fact of credits assignment to the debtor in a general manner without attaching supporting documents, it cannot be regarded as a valid notice.

In addition, paragraph 3 of Article 50 stipulates that if the assignee claims by way of litigation that the notice of credits assignment shall take effect when a copy of the complaint is served, the court shall uphold it, i.e. it recognizes the “litigation in lieu of notification”.  This paragraph clarifies that the assignee may file a lawsuit directly without giving a notice as a prerequisite, which may put the debtor in a disadvantageous position that it has to bear the corresponding litigation costs and attorney’s fees if it loses the case.  If a notice is required as a prerequisite, some debtors will fulfill its obligations upon receipt of the notice, thus avoiding the burden of litigation and saving certain judicial resources.  Although this paragraph provides that the litigation costs shall be borne by the assignee, there are still some opposing views that “litigation in lieu of notification” shall not be recognized.  As notice and litigation are different concepts, and there is no direct and necessary relationship between litigation itself and the occurrence of the assignment, while the notice will be accompanied by evidence of the credits assignment, it is more in line with the procedure and more logical to notify first and then file a lawsuit.  Perhaps the Supreme Court has also considered these controversies, and there is another option in this paragraph, that is, not to make any provision thereon.

In addition, considering the frequent occurrence of multiple credits assignments, the Draft for Comments clarifies that the “order of arrival of notices” shall be the criterion for determining to whom to perform.  The assignee whose credits has not been fulfilled may claim liability for breach of contract against the creditor.  From the debtor’s perspective, it is reasonable to judge to whom to perform in chronological order, but this Article does not take into account the fact that there may be a specific order of fulfillment among the assignees according to the different nature of the credits.

5. Compensation and calculation of acquirable interests

From Article 63 to Article 65, the Draft for Comments has made detailed provisions on the compensation of acquirable interests, including the calculation thereof, the reasonable period of time for alternative transactions and the compensation when the acquirable interests cannot be determined.  It should be noted that Article 65 provides that in certain circumstances, compensation for breach of contract are no longer calculated on the basis of the losses suffered by the non-breaching party, but on the basis of the benefits gained by the breaching party as a result of the breach.  The victim’s losses and the victimizer’s gains are two different concepts, and the latter is generally applied in the case of infringement.  For example, a case of infringement of intellectual property rights may use the victimizer’s gains as the basis of compensation for losses.  For the first time, there is such a provision on the compensation for breach of contract.

The above is an overview of the Draft for Comments and the highlights of some articles.   In general, the Draft for Comments is rich in content, with both innovative rules and inheritance of the old law, and also responds to some divided and difficult issues in trial practice.  Thus, it will become a very important judicial interpretation of the Civil Code after the issuance of its official version.

[1] Cheng Xiao: Several Opinions on the Interpretation of the Supreme People’s Court on the Application of the General Provisions of Contract Part in the Civil Code of the People’s Republic of China (Draft for Comments)丨Frontier http://www.changchunkc.jcy.gov.cn/gzlc/202211/t20221115_3876388.shtml 

The contents of all newsletters of Shanghai Lee, Tsai & Partners (Content) available on the webpage belong to and remain with Shanghai Lee, Tsai & Partners. All rights are reserved by Shanghai Lee, Tsai & Partners, and the Content may not be reproduced, downloaded, disseminated, published, or transferred in any form or by any means, except with the prior permission of Shanghai Lee, Tsai & Partners.

The Content is for informational purposes only and is not offered as legal or professional advice on any particular issue or case. The Content may not reflect the most current legal and regulatory developments. Shanghai Lee, Tsai & Partners and the editors do not guarantee the accuracy of the Content and expressly disclaim any and all liability to any person in respect of the consequences of anything done or permitted to be done or omitted to be done wholly or partly in reliance upon the whole or any part of the Content. The contributing authors’ opinions do not represent the position of Shanghai Lee, Tsai & Partners. If the reader has any suggestions or questions, please do not hesitate to contact Shanghai Lee, Tsai & Partners.