Introduction

As early as 1987, energy service companies began to operate in Beijing Municipality and Shandong and Liaoning Provinces. This marked the first appearance of such companies and the concept of energy performance contracting (EPC) in China. EPC business developed rapidly from the outset, although it subsequently experienced ups and downs in relation to the need for increased energy savings. However, the market potential for the development of EPC business in China remains highly favourable.

EPC business is fairly competitive and must be supported with well-developed laws and regulations. The government realised this from the beginning and has made great efforts to promote domestic EPC business through legislation as well as judicial support – both of which are indispensable to the resolution of EPC-related disputes.

Legislation

Although China's first energy service companies appeared in 1987, legislation governing EPC business was not formally adopted until 2000, when the government enacted a number of regulations and fiscal and tax incentive policies in order to promote it. In particular, the former National Economic and Trade Commission,(1) together with two other ministries, issued the Proposals on Further Promotion of China's Green Lighting Projects. In this document the government highlighted the necessity of establishing energy service companies and adopting the EPC mechanism.

In 2007 the government promulgated the Energy Conservation Law, which set out the EPC mechanism. In 2010 the National Development and Reform Commission (NDRC), the Ministry of Finance and several other departments jointly issued the Proposals on Acceleration of the Promotion of Energy Performance Contracting and Development of the Energy Efficiency Service Industry.(2) This document sets out qualitative targets and guidelines for the development of EPC business and various financial and tax incentives for EPCs.

Also in 2010, the Ministry of Finance and the NDRC issued the Temporary Measures on the Administration of Energy Performance Contracting Project Finance Award Funds, which provided fiscal incentives for energy service companies that engage in shared savings projects. The government also ramped up its support for energy service companies through tax policies. In particular, the tax authorities issued the Notice on Policy Issues of Value Added Tax, Business Tax and Corporate Income Tax in Promoting the Development of the Energy-Saving Industry, which gave energy service companies a temporary exemption from value added tax and business tax, an exemption from corporate tax for the first three years, a 50% tax levy for the next three years and other tax incentives.

In order to standardise the EPC business, on January 1 2011 the government promulgated the General Technical Rules for Energy Management Company Business. These rules:

  • explicitly defined the terms 'EPC', 'EPC project', 'energy service company', 'project energy savings' and 'energy consumption standard';
  • stipulated technical requirements for energy condition diagnosis, the energy consumption standard, determination of the energy-saving rate and other technical problems relating to EPC projects; and
  • offered a template for energy performance shared savings contracts.(3)

The government recently revised the Measures on Administration of Energy Efficiency Labelling, which apply to all energy-saving products provided by service providers in EPC projects. The revised measures will enter into force on June 1 2016. However, the general view is that China still lacks sophisticated legislation with detailed provisions on the development of EPC business. What is even more problematic is that breaches of EPC contracts are not uncommon and the judicial system is not rigorous enough to protect the expectation interests of EPC service providers.

Recent court case

Despite the aforementioned problems, one recent court judgment shows signs of a positive change in judges' attitudes in relation to breaches of EPC contracts. In Chongqing Chuanran Energy-Saving Technology Ltd v Chongqing Zongshen Power Machinery Co Ltd, decided by the Chongqing Municipal Superior People's Court in June 2015,(4) the judge was noticeably more supportive of the EPC service provider, granting damages against the breaching party based on the expectation interests of the EPC service provider under the EPC contract.

Facts

On May 20 2010 Chongqing Chuanran Energy-Saving Technology Ltd (Chuanran) entered into a supply contract with Chongqing Zongshen Power Machinery Co Ltd (Zongshen) for a waste heat utilisation project for Zongshen's power die-casting factory. The contract was based on a model EMC contract and provided that Chuanran was responsible for the design, production and installation of the project's energy-saving facility. The fiscal stipulation was that the two parties would share the funds derived from the energy savings for six years in accordance with the following sliding scale:

  • first year – 25% for Zongshen and 75% for Chuanran;
  • second year – 40% for Zongshen and 60% for Chuanran; and
  • from third year onwards – 50% for Zongshen and 50% for Chuanran.

Chuanran's share of the funds saved were to be paid by Zongshen.

The parties performed the contract smoothly until March 2013, when Zongshen stopped using the energy-saving facility installed by Chuanran and failed to pay Chuanran its share of the funds saved from the project. Chuanran then brought an action against Zongshen before the Chongqing Fifth Intermediate Court for termination of the contract and claiming the unpaid energy-saving funds. The court supported Chuanran's claims. In September 2014 Chuanran filed a new claim, requesting that Zongshen pay – aside from the funds derived from the energy savings for the previous period – the funds that could have been saved in the remaining 53 months' expectation interest (calculated from April 2013 to August 2017). Zongshen rejected Chuanran's claims, contending that they had no factual or legal basis.

The court supported Chuanran's claims for the funds saved from the previous period, but dismissed its claim for compensation based on expectation interest loss. Both parties appealed to the Chongqing Municipal Superior People's Court. The second-instance court hearing was held on March 9 2015.

Decision

The court found that the case involved several major issues, the most important of which was whether Chuanran was entitled to the funds that could have been saved for the remaining period of the contract based on expectation interest loss (ie, had the contract been fully performed by the defendant, thereby generating the energy-saving benefits).

It was noted that Article 113 of the Contract Law provides that:

"Where a party has failed to perform or rendered non-conforming performance, thereby causing loss to the other party, the amount of damages payable shall be equivalent to the other party's loss resulting from the breach, including any benefit that may be accrued from performance of the contract."

The court found that in this case, Chuanran – as the energy-saving service provider – was entitled to enjoy the energy-saving benefits attributable to the operation of the facility for the entire period of contract, and that had the defendant fully performed the contract, Chuanran would have continued to enjoy its share of the energy-saving benefits until expiration of the contract. The court also found that in March 2013 Zongshen stopped using the facility on no reasonable grounds. The court held that Chuanran was entitled to compensation for the loss of its expectation interest for the remaining period of contract. Therefore, Zongshen was ordered to pay Chuanran's share of the funds saved from the operation of the facility for the remaining period of contract.

The court then addressed the issue of how to determine the amount of damages for the plaintiff based on its loss of expectation interest. The supply contract included provisions relating to the method of calculation of damages based on expectation interest. The court held that the damages should actually be calculated based on Chuanran's potential gains from the energy-saving benefits attributable to the facility for the remaining period of contract, with the deduction of capital expenditures that Chuanran was obliged to pay for removal of the facility on termination of the contract. In the second-instance claim, Chuanran claimed a total sum of Rmb1,626,538 (with the support of Article 19(4) of the supply contract), based on the funds that could have been saved for the remaining period of the contract and the interest of liquidated damages. The court accepted the concept of expectation interest claims and considered several other factors, such as the remaining period of the contract, the percentage of energy-saving funds attributable to the remaining period and necessary maintenance costs for the regular operation of the facility. The court ultimately held that Chuanran was entitled to Rmb400,000 in compensation from Zongshen based on loss of expectation interest. The court dismissed Chuanran's other claims.

This case centred on a dispute that often arises between parties to shared energy-saving EPC contracts, in which the party receiving the energy-saving facility or solution breaches the contract and the EPC service provider consequently loses all future expectation interests. The appellate court decision in this case was correct in protecting the EPC service provider's expectation interests following the other party's breach of the EPC contract. It is hoped that this case will set a positive example for Chinese EPC dispute resolution in future. With an increasing number of judgments similar to the one in this case, the interests of energy service companies will hopefully be sufficiently protected, which would thus create a healthier environment for the development of China's EPC sector.

Comment

China's EPC industry has a big potential for substantial development in future; however, the industry is still not large enough to meet the needs of the domestic energy conservation market.(5) In order to promote such development and achieve the energy-saving and carbon emission reduction goals set by the government, more legislation should be put forward and increased judicial support should be provided.

Thus far, the legal system has not played a sufficient role in protecting energy service companies' interests and ensuring fair play in the EPC sector. Most of the existing legislation relating to EPC business is of a lower legal status; the only high-level national legislation in this regard is the Energy Conservation Law, while most other EPC rules are set out in administrative regulations, ministerial orders and certain regulatory documents with limited scope of application. EPC regulations issued by local governments are also lacking, especially with respect to financial management, tax incentives and subsidies.

Due to the relative dearth of EPC legislation in China, performance rates of EPC contracts are low and disputes often arise. The judicial system's failure to rigorously protect energy service companies' expectation interests will ultimately inhibit further development of the EPC sector. The government therefore must redouble its legislative and judicial efforts to support the sector's growth.

For further information on this topic please contact Libin Zhang or Yanbin Zhao at Broad & Bright by telephone (+86 10 8513 1818) or email (libin_zhang@broadbright.com or yanbin_zhao@broadbright.com). The Broad & Bright website can be accessed at www.broadbright.com.

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