Within what timeframe do defects need to be reported to the seller? PRC Supreme People’s Court answers several questions related to sales contracts
Sales contracts dominate daily business life. In China their legal basis is mainly the PRC Contract Law of 1999. To further clarify legal issues arising out of sales contracts, the Supreme People’s Court of the People’s Republic of China (“SPC”) has issued the Interpretations on the Application of Law in Disputed Sales Contract Cases (“Interpretations”), which became effective on 1 July 2012. Whereas former interpretations by the SPC covered various aspects of the PRC Contract Law, this is the first time that the SPC has focused exclusively on sales contracts. The Interpretations are comprehensive and cover six chapters and 45 articles. Due to the power of the SPC to issue generally binding regulations and interpretations, they are binding for all courts in China and will also influence application of the PRC Contract Law by domestic and international arbitration institutions.
The most significant updates outlined in the Interpretations are summarised below.
1. Within what timeframe do defects need to be reported?
A buyer must inspect the goods and notify the seller of any defects within the contractually agreed inspection period. If no such period has been agreed, the buyer must inspect the goods in a timely manner and notify the seller of any defects within a reasonable period after he has discovered or ought to have discovered them, at the latest within two years of receipt of the goods. A contractual quality guarantee period replaces the above two-year period.
The above are the statutory provisions in Articles 157 and 158 of the PRC Contract Law. However, they do not make clear which defects the buyer must notify the seller of within an agreed inspection period after receipt, and which defects the seller can be notified of later, within a reasonable period after their discovery. Further, no criteria for determining a reasonable period are stated in the law.
In Articles 15 and 18 of the Interpretations, the SPC now distinguishes between obvious defects and latent defects. If an inspection period after receipt of the goods is too short to discover all defects, the buyer must notify only obvious defects. The buyer can notify latent defects within a reasonable period after he has discovered or ought to have discovered them.
With regard to determining what constitutes a “reasonable” period, Article 17 of the Interpretations advises that the following be considered: form, purpose and mode of transaction, transaction practices, installation situation, usage, type, quantity and nature of the goods as well as the nature of the defects, the buyer’s duty of reasonable care, method and difficulty of inspection, specific environment and skills of the buyer or the inspector and the principle of good faith.
The above provides more clarity and relief for buyers as latent defects are often impossible to discover during the inspection period. However, in the seller’s favour, it also makes clear that obvious defects cannot be notified after the inspection period.
2. Sale of non-owned goods and several sales contracts for the same goods
If a seller concludes a sales contract for goods which he does not own and is not entitled to dispose of, the sales contract is nevertheless valid. The buyer is entitled to claim against the seller for damages due to the seller’s breach of contract. This should be clear according to the PRC Contract Law; however, the SPC deemed it worthwhile to explicitly stipulate this in Article 3 of the Interpretations.
If a seller concludes several sales contracts for the same movable goods with different buyers and more than one of those buyers claims for performance of the contract, the legal situation was unclear in the past. The SPC has now established the following criteria in Article 9 of the Interpretations:
- If a buyer to whom the goods have already been delivered requests confirmation of the transfer of ownership, the court must support such a request;
- If the goods have not been delivered and the buyer who paid the purchase price first requests delivery and transfer of ownership, the court must support such a request; and
- If the goods have not been delivered and the purchase price has not been paid and the buyer who concluded the contract first requests delivery and transfer of ownership, the court must support such a request.
The above establishes a quite clear priority, i.e. first possession over first payment over first signing. It means that taking possession of the goods quickly and making fast payment can be advantageous for a buyer. Further, according to Article 10 of the Interpretations, in the case of vehicles, vessels and aircraft, fast registration of title transfer is helpful to support a buyer’s performance request, at least until the item has been delivered to another buyer.
3. Retention of title
In regard to selling movable goods, retention of title until payment of the full purchase price is accepted by PRC law and business practice. This serves to protect the seller’s interests when goods are delivered before payment is received. However, the statutory law is silent on the rights of the seller with respect to these goods.
The Interpretations now state in Article 35 that a seller is entitled to claim for repossession of the goods in the event of the buyer’s
- failure to pay the purchase price according to the agreement;
- failure to fulfil specific conditions according to the agreement; or
- sale, pledge or otherwise improper disposition of the goods.
If after repossession the buyer eliminates the above reasons within a period agreed by the parties or designated by the seller, the buyer can again request delivery of the goods according to Article 37 of the Interpretations.
Further, the seller is entitled to ask the buyer for compensation for any significant decrease in value of the returned goods.
In Article 36 of the Interpretations, the SPC has established an interesting restriction on the seller’s claim for repossession: if the buyer has paid more than 75% of the purchase price of the goods and the seller claims for repossession, the court will not support such a request. In its reasoning, the SPC states that the above provision is designed to balance the seller’s and buyer’s interests. In practice, it is possible that such a restriction will be more in favour of the buyer. As long as he pays 75% of the purchase price, he can be certain he will not be forced to return the goods.
Finally, the SPC confirms that movable goods sold under retention of title can be acquired by a bona fide third party according to Article 106 of the PRC Property Law. This means if a third party does not know that movable goods are still under retention of title and buys them from a buyer, the third party becomes their new owner. Therefore, it is important for business operators who sell goods under retention of title to insist upon clearly marking the goods as their property.
4. Other matters
Apart from the above, the Interpretations contain detailed provisions on conclusion of contracts, burden of proof for delivery, risk transfer, calculation of damages for breach of contract, payment by instalments and sale by trial.
The Interpretations offer important guidance and clarity for Chinese law sales contracts. They should be taken into account by foreign-invested enterprises in their domestic sales contracts, and by all foreign companies that have chosen or intend to choose Chinese law for their international sales contracts. By issuing the Interpretations more than twelve years after the PRC Contract Law took effect, the SPC has taken a further step towards making the application of Chinese law more predictable, and thus more attractive for foreign companies.