Key Points:

  • New guideline seeks to create strict standards and procedures to address public concerns about the abuse of the change-in-circumstances principle
  • In applying the principle, courts must reasonably differentiate between commercial risk and change in circumstances

In a May 2009 Squire Sanders China Alert, we analyzed a judicial interpretation (Interpretation II on Several Issues Concerning the Application of the PRC Contract Law, February 9, 2009 [Interpretation II]) published by the PRC Supreme Court allowing courts in China to amend or terminate contracts based on the principle of changes in circumstance. This principle concerns significant changes that occur after a contract has been signed that are unforeseeable at the time of entering into the contract but not attributable to force majeure and not considered commercial risks. It was the first time that the PRC Supreme Court officially acknowledged and interpreted the principle of changes in circumstance.

Interpretation II is a response to the global financial crisis, and there are concerns as to whether the principle will be abused by China’s courts as a way to protect China-based companies. On April 27 the Supreme Court issued a Circular requiring local courts to report any change or termination based on the principle of change in circumstance to the High Court for approval, and how to interpret “significant change,” “commercial risks” and “change in circumstances” is still ambiguous and controversial. Under such circumstances, the Supreme Court issued the Guideline on Several Issues on Hearing Civil and Commercial Contract Disputes Cases on July 7, 2009 (the Guideline) to clarify the questions.  

According to the Guideline, the Supreme Court requires all lower courts to apply the principle of changes in circumstance while reviewing the following aspects:

  1. The current world financial crisis was not a sudden change or completely unavoidable. The global economy has gone through a process of gradual changes, during which time the parties involved should have foreseen the market risk to some extent. Therefore, the courts must strictly review the allegation of “unforeseeable,” especially in cases involving products whose markets fluctuate geatly by nature, such as oil, metal and financial products.
  2. Courts must differentiate between “commercial risk” and “change in circumstances.” Commercial risk is an inherent risk existing in transactions, such as price fluctuation, that is not abnormal. In judging whether a change is a “change in circumstances,” the court must consider (i) whether the risk is significantly beyond reasonable anticipation, (ii) whether such risk can be prevented or controlled and (iii) whether the nature of the transaction is “high risk, high profit.”
  3. Courts should try to pursue justice de facto, instead of a mere exemption of obligation, by guiding the parties to renegotiate the agreement or reach a settlement. If a court decides to apply the principle of change in circumstances, the decision must be reported to and approved by the High Court.

Thus, to address the public’s concerns about the abuse of the principle of change in circumstances as well as provide guidance to lower courts in the principle’s application, the Supreme Court tried to create strict standards and procedures under the Guideline.

In addition to the principle of change in circumstances, the Guideline clarifies other important issues. One is the 30-percent line drawn by Interpretation II for adjustment of liquidated damages. The Guideline provides that courts should not apply the 30-percent standard as a fixed rate, but must evaluate the actual situation and balance the interests among the parties to accomplish “true fairness” and prevent “fairness on the surface.”