Contract formation

Good faith in negotiating

Is there an obligation to use good faith when negotiating a contract?

The good faith principle is recognised and embodied in the PRC Contract Law. It is expressly provided in the PRC Contract Law that the parties shall follow the principles of fairness and good faith in entering into and performing the contracts. In particular:

  • one party shall not, under the disguise of forming a contract, conduct negotiations with the other party with malicious intention to cause the other party to suffer loss;
  • one party shall not conceal important facts or make false statements in negotiating and entering into contracts; and
  • the parties shall keep confidential the information received during the negotiation and shall not use commercial information for any illegal or improper purposes.
‘Battle of the forms’ disputes

How are ‘battle of the forms’ disputes resolved in your jurisdiction?

The PRC Contract Law requires that the terms of the acceptance shall be identical to those of the offer. PRC law distinguishes between material and non-material alterations to the offer. The offeree must accept the terms of the offer in their entirety, and shall not add, qualify or modify any of those terms. If the acceptance of an offer has materially altered the terms of the offer, then such acceptance will be regarded as a counter-offer, rather than an acceptance of the original offer. Where the changes to the offer are not material, the acceptance is valid and recognised, and the terms of the acceptance will prevail, unless the offeror objects to such changes without delay, or if the offer indicated that no changes to the terms could be made in the acceptance. Changes concerning the subject matter, quantity, quality, price, time and place for the performance, liabilities for breach of contract and dispute resolution are considered material changes to the terms of the offer.

Language requirements

Is there a legal requirement to draft the contract in the local language?

There is no requirement under PRC law that contracts must be drafted and executed in the local language. In practice, it is not uncommon for contracts entered into in China to be drafted and signed in bilingual form with both Chinese and foreign language versions. But one important issue to note is that some contracts must be approved by, or filed with, Chinese government authorities. Generally speaking, the authorities and Chinese courts are reluctant to review documents drafted in a foreign language. Care must also be taken in preparing the bilingual version to maintain consistency of the language.

Online contracts

Is it possible to agree a B2B contract online?

‘Click-wrap’ contracts have full legal effect under the PRC Contract Law and the PRC Electronic Signatures Law. The National People’s Congress also released on 27 December 2016 the E-Commerce Law of the People’s Republic of China (draft) (Draft E-Commerce Law) for consultation. On 7 November 2017, the second draft of the E-Commerce Law of the People’s Republic of China (Second Draft E-Commerce Law) was released for consultation. On 1 January 2019, the E-Commerce Law of the People’s Republic of China (E-Commerce Law) came into force, and click-wrap contracts are now governed by it. Parties can freely agree whether to use a click-wrap contract and the legal validity of an online contract cannot be denied simply because the contract is entered into electronically.

However, certain conditions must be satisfied to determine whether an online contract is lawfully entered into. According to the Electronic Signatures Law, if a click-wrap contract can effectively show the content it carries and is readily available for retrieval and use, it will be deemed as being executed in a written form in compliance with Chinese law. In addition, under the E-Commerce Law, if goods or services published by an e-commerce operator meet the requirements of an offer and a customer places an order, a click-wrap contract is validly formed unless otherwise agreed between the parties. The e-commerce platform operator has the legal obligation to keep records of the transaction information for at least three years.

Disputes in relation to click-wrap contracts can be resolved by the following methods:

  • online dispute resolution mechanism established by e-commerce platform operator;
  • mediation by consumer organisations, industry associations, and other legally established mediation organisations;
  • arbitration or court proceedings.

In case of disputes where parties must prove the authenticity of an electronic contract, the court will consider the following factors:

  • whether the method of generating, storing and transmitting electronic data is reliable;
  • whether the method of maintaining the completeness of electronic data content is reliable; and
  • whether the method of ascertaining the sender of electronic data is reliable.

Statutory controls and implied terms

Controls on freedom to agree terms

Are there any statutory or other controls on parties’ freedom to agree terms in contracts between commercial parties in your jurisdiction?

Pursuant to the PRC Contract Law, parties cannot contract out of mandatory provisions. In particular, they shall not agree terms or enter into contract under any of the following circumstances:

  • either party enters into the contract by means of fraud or coercion to the detriment of the interests of the state;
  • there is malicious conspiracy causing damage to the interests of the state, of the collective or of a third party;
  • there is an attempt to conceal illegal goals under the guise of legitimate forms;
  • the contract terms are harmful to social and public interests; or
  • the contract violates mandatory provisions of laws and administrative regulations.
Standard form contracts

Are standard form contracts treated differently?

PRC law allows for the use of standard form contracts, but the parties must follow certain special requirements.

The party that provides the standard form contract shall abide by the principle of fairness when specifying the respective rights and obligations of the parties and notify, by way of reasonable means, the other party to the exclusion or limitation of liability clauses. The duty of notification requires the party providing the standard form to use words or symbols in a different font or size to attract the attention of the other party. This notification requirement applies even where the other party has expressly or implicitly consented to the use of the standard terms.

Standard form contracts are invalid and unenforceable if they are intended to:

  • exclude or limit the liability for personal injury or property damage due to wilful misconduct or gross negligence;
  • exclude the liabilities of the party providing the standard terms or increase the liabilities of the other party;
  • deprive the other party of the primary rights under the contract; or
  • circumvent the mandatory provisions under PRC laws and regulations.

In judicial practice, where the standard terms are not clear and may suggest different interpretations, the courts and arbitration tribunals tend to interpret the standard terms in favour of the party that receives the standard terms, rather than the party that prepares them.

Implied terms

What terms are implied by law into the contract? Is it possible to exclude these in a commercial relationship?

PRC law does not have the same legal principle of implied terms as common law. However, the PRC Contract Law contains certain provisions stating that where the quality standards are not stated or not clearly stated in the contract, the parties can reach a supplementary agreement or perform the contract by adopting industry standards or trade practices as appropriate for the nature and purpose of the contract.

Vienna Convention

Is your jurisdiction a signatory to the United Nations Convention on Contracts for the International Sale of Goods (the Vienna Convention)?

Yes, China is a signatory to the Vienna Convention. China makes a reservation under article 95 of the Vienna Convention in relation to the application of article 1(1)(b) of this Convention.

Good faith in entering and peforming

Is there an obligation to use good faith when entering and performing a contract?

The PRC Contract Law expressly provides for the principles of equality, fairness and good faith. With regard to equality, neither party may impose its will on the other party. With regard to fairness, the parties must abide by such principle of fairness when prescribing their respective rights and obligations under the contract. With regard to good faith, the parties shall abide by such principle of good faith when exercising their rights and performing their obligations under the contract. Although the law does not give further guidance on these principles, in judicial practice in China, the parties are expected to act in good faith when entering into and performing a contract. For example, the PRC Contract Law expressly provides that the parties shall observe the principles of honesty and good faith and shall perform their respective contractual obligations in strict accordance with the agreed contract. The parties are also required to abide by the obligations in terms of notice, assistance and confidentiality in line with the nature and objective of the contract and the relevant trade practices. Another example is that under the PRC Contract Law, if the contract for sale of goods or services is silent on quality specification for the goods or services, the seller shall not intentionally select and deliver goods or services that are of inferior quality.

In addition, under the E-Commerce Law, e-commerce platform operators shall clearly mark the competitive ranking commodities and service as advertisement. Where the e-commerce platform operator knew or should have known that the operator infringes legitimate rights and interests of consumers but fails to take any effective action, the e-commerce platform operator shall be jointly and severally liable for the operator’s infringement.

Limiting liability

Prohibition on exclusions and limitations

What liabilities cannot be excluded or limited by a supplier in a contract?

Under the PRC Contract Law, liabilities for personal injury or property damage owing to wilful misconduct or gross negligence cannot be excluded or limited by contractual terms.

Financial caps

Are there any statutory controls on using financial caps to limit liability for breach of contract?

Under PRC laws, if one party is in breach of contract and causes loss or damage to the other party, the breaching party shall compensate the other party for the loss it suffered, including expected loss of profit. However, the recoverable loss cannot exceed the loss the breaching party foresaw or should have foreseen at the time of contract signing.

There are no express restrictions on financial caps for liability for breach of contract. However, the PRC Contract Law provides that if the liquidated damages as agreed by the parties in the contract are excessively higher or excessively lower than the loss actually suffered by the aggrieved party, the breaching party can apply to the court or arbitration tribunal to make adjustment downward or upward appropriately.

Indemnities

Are there any statutory controls on indemnities used to cover liability risks in contracts?

PRC law does not have the same indemnity concept as in common law. Any claim for damages for breach of contract is subject to the tests of causation link and reasonableness.

Liquidated damages

Are liquidated damages clauses enforceable and commonly used in your jurisdiction?

Generally speaking, liquidated damages clauses are valid and enforceable in China, provided that the agreed liquidated damages are caused by the breach, are reasonably foreseeable and do not contravene mandatory provisions under PRC laws and regulations. The agreed liquidated damages are subject to adjustment by courts or arbitration tribunals, as discussed in question 11.

Payment terms

Statutory time limits on payments

Are there statutory time limits for paying invoices? Is it possible to agree a different payment period?

Generally speaking, PRC law does not provide for mandatory time limits for payment. The parties are free to agree on the payment schedule in their contract. However, if the contract does not include any provisions about timing, the parties can reach a supplementary agreement in relation to the payment schedule. If the parties cannot reach agreement, the payment timeline can be determined by reference to relevant clauses of the contract or in accordance with trade practices.

Late payment interest

Is statutory interest charged on late payments? Is it possible to agree a different rate of interest?

There is no statutory interest charged on late payments under Chinese law. Generally speaking, the parties may determine the interest rate on late payments. If the interest rate on late payments is not stipulated in the contract, the court may decide a rate based on the benchmark interest rate issued by the People’s Bank of China for renminbi loans of the same type and same term.

The interest rate for late payments agreed by the parties shall be reasonable and shall not be excessively high, otherwise the party obliged to pay interest can apply to a court or arbitration tribunal to make a downward adjustment.

Civil penalties

What are the civil penalties for failing to comply with statutory interest rate or late payment of invoices?

In addition to a penalty for late performance, the claimant can ask for damages equal to the loss caused by the breach of contract, including the interest that it would be expected to obtain should the contract have been performed. The breaching party shall continue with the performance even if it has paid the interest rate and penalty for late performance.

Termination

Implied terms

Do special rules apply to termination of a supply contract that will be implied by law into a contract? Can these terms be excluded or limited by including appropriate language in the contract?

The parties to a contract can terminate the contract by mutual agreement or under agreed conditions as stipulated in the contract.

The PRC Contract Law grants the parties the legal right to terminate the contract in the following circumstances:

  • contract objective cannot be realised owing to force majeure;
  • prior to the expiry of the period for performance of the contract, one party makes it clear that it will not perform its major obligations;
  • one party delays the performance of its major obligations, and fails to rectify its default within the given reasonable period of time, after being requested to perform; and
  • the objective of the contract cannot be realised because of one party’s failure to perform its contractual obligations or any other breach of the contract.

PRC law itself is silent on whether the above legal rights to terminate the contract can be excluded or limited by agreed terms in the contract. In practice, the parties tend to adopt a flexible approach by including clear contractual provisions to define the grounds for termination. Care must be taken in drafting deviations from the above legal rights for termination, to ensure that any contracting-out provisions will not be regarded as circumventing the mandatory provisions under Chinese law.

Notice period

If a contract does not include a notice period to terminate a contract, how is it calculated?

The aggrieved party shall send a notice to the other party if deciding to terminate the contract. The contract will be terminated when the notice reaches the other party, unless the notice otherwise provides for a specific termination date. If the other party objects, it may apply to the court or arbitration institution to determine whether the contract termination is valid.

Automatic termination on insolvency

Will a commercial contract terminate automatically on insolvency of the other party?

A commercial contract will not be automatically terminated solely because of the insolvency of the other party. If the court accepts an application for insolvency and appoints an administrator, the administrator may decide whether the contract that was concluded between the parties prior to the insolvency application, but is still pending completion by the parties, shall be continued or rescinded.

Termination for financial distress

Are there restrictions on terminating a contract if the other party is in financial distress?

A party is entitled to suspend the performance of its own contractual obligations and request the other party to provide security if the other party is in financial distress. If the other party has failed to regain its capability to perform the contract and to provide a security within a reasonable period of time, the party can terminate the contract.

Force majeure

Is force majeure recognised in your jurisdiction? What are the consequences of a force majeure event?

Force majeure is recognised under Chinese law. The PRC Contract Law provides that where a contract could not be performed because of force majeure, the liability for breach shall be excused in part or wholly. Force majeure is defined as circumstances that are unforeseeable, unavoidable and insurmountable. Where a party is unable to perform the contract due to force majeure, it has the duty to mitigate the loss and shall give a notice to the other party about occurrence of the force majeure within a reasonable period of time.

Subcontracting, assignment and third-party rights

Subcontracting without consent

May a supplier subcontract its obligations under the contract without seeking consent from the other party?

As a general rule under Chinese law, a supplier cannot subcontract obligations under the contract without first obtaining consent from the other party, who will not otherwise be bound by the subcontract.

Statutory rules

Are there any statutory rules that apply to subcontracting in your jurisdiction?

If the subcontracting is subject to approval from the regulator that originally approved the contract, such subcontract of obligations must go through the required approval. If the subcontractor is required to have a specific qualification, the main contractor cannot subcontract to a party that does not have the required qualification. Further, in a contract for construction projects, generally speaking, a contractor is prohibited from subcontracting the entire contract to a third party and a subcontractor cannot further subcontract.

Assignment of rights and obligations

May a party assign its rights and obligations under the contract without seeking the other party’s consent?

Where the creditor to a contract assigns its contractual rights to a third party, it should notify the debtor of the assignment but does not need to seek the consent from the debtor.

However, where the debtor intends to transfer its obligations under a contract in whole or in part to a third party, consent shall be obtained from the creditor.

A party to the contract cannot assign rights to a third party if the nature of the contract does not permit the assignment, or if the parties have previously agreed that the rights cannot be assigned or if the law prohibits the assignment. If the assignment is subject to approval and registration procedure with relevant government authorities, the assignment becomes effective only after the completion of such approval and registration procedure.

What statutory controls apply to the assignment of rights or obligations under a supply contract?

With respect to the assignment of receivables, after receiving the assignment notice, the debtor reserves a right of set-off against the assignee. If there is a pledge over the accounts receivable, it must be registered through the Registration Announcement System run by the Credit Centre under the People’s Bank of China.

Enforcement by third party

How may a third party enforce a term of the contract?

Generally, a person cannot acquire and enforce rights under a contract to which he or she is not a party. However, as an exception, the PRC Contract Law admits in very limited situations that a contract may have an effect on a third party. The right of subrogation and the right of rescission are the main instances of this issue.

Disputes

Limitation periods

What are the limitation periods for breach of contract claims? Is it possible to agree a shorter limitation period?

Generally, the time limit for breach of contract claims is three years pursuant to the General Principles of the Civil Law of the People’s Republic of China (effective from 1 October 2017) (Civil Law General Principles), calculating from the date on which the party concerned knew or should have known of the infringement of its rights. Special time limit provisions are set out under relevant PRC rules for special contracts. For example, the time limit for disputes with respect to contracts of international sale of goods is four years. Pursuant to the Supreme People’s Court’s Provisions on Applicable Time Limitation in Civil Cases, such time limits are statutory limits and it is not possible for the parties to agree on a shorter limitation period in contravention of the judicial interpretation.

Choice-of-law clauses

Do your courts recognise and respect choice-of-law clauses stipulating a foreign law?

Under PRC laws, parties to a contract with foreign elements are permitted to choose a foreign law as the governing law for their contract. The following factors are considered in determining whether a contract has foreign elements:

  • whether any party is a foreign party or resides in a foreign country;
  • whether the object of the contract is located in a foreign country;
  • whether the contract is signed, performed, revised or transferred in a foreign country; or
  • whether factors that affect the rights and obligations of the parties take place in a foreign country.

For some special contracts, such as Sino-foreign equity joint venture contracts, Sino-foreign cooperative joint venture contracts and Sino-foreign cooperative contracts for exploitation and development of natural resources in China, must be governed by PRC law. Choice of a non-PRC law for these contracts is not valid.

Do your courts recognise and respect choice-of-jurisdiction clauses stipulating a foreign jurisdiction?

Parties to a contract with foreign elements can choose a foreign jurisdiction. However, China has only signed mutual legal assistance treaties with a small number of countries, and enforcement of court rulings given by foreign courts will prove difficult in China. Parties to a transaction with no foreign elements can only choose local jurisdiction in China.

It is important to note that under the Arrangements for Reciprocal Recognition and Enforcement of Judgments in Civil and Commercial Cases by Courts of the Mainland China and the Hong Kong Special Administrative Region, which came into force on 18 January 2019, court rulings given by Hong Kong courts can be recognised and enforced directly in China without going through further court procedure in China. This will provide a great convenience if parties to a contract want to choose HK court proceedings for resolving their contractual disputes.

Efficiency of local legal system

How efficient and cost-effective is the local legal system in dealing with commercial disputes?

Generally speaking, the Chinese local legal system is efficient and cost-effective in handling commercial disputes. If the parties choose court proceedings, each commercial dispute can go through up to two rounds of proceedings, each of which will last normally up to six months. The Provisions issued by the Supreme Court on Limiting Trial Extension and Trial Delay for Civil and Commercial Cases were amended and have been effective since 27 March 2019 with a view to improving the efficiency of court proceedings in China. But the competency and capability of local judges vary from city to city and sometimes, local protectionism may present an issue, especially litigating against a party at the local court where that party is based.

For better expertise, professionalism and confidentiality, it is not uncommon that parties seek to resolve their disputes by way of arbitration. There are several reputable arbitration institutions in China, among which the China International Economic and Trade Arbitration Committee (CIETAC) is well regarded. Over the years, CIETAC has developed a good reputation for handling China-related commercial disputes.

New York Convention

Is your jurisdiction a signatory to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards? Which arbitration rules are commonly used in your jurisdiction?

China acceded to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards on 22 January 1987, its accession becoming effective on 22 April 1987. Under China’s accession commitments, the New York Convention only applies to disputes arising from contractual and non-contractual commercial legal relationships, and China makes reservation in relation to disputes between foreign investors and the governments of host countries.

In China, the leading arbitration institution handling foreign-related disputes is CIETAC and CIETAC procedural rules are the most commonly used arbitration rules in China. The most recent version of CIETAC arbitration rules came into effect on 1 January 2015.

Remedies

Available remedies

What remedies may a court or other adjudicator grant? Are punitive damages awarded for a breach of contract claim in your jurisdiction?

The forms of remedies under the PRC Contract Law include specific performance, rectification measures and compensation for loss suffered by the aggrieved party. The liquidated damages with punitive nature can be awarded by courts or arbitration tribunals, provided that the liquidated damages are reasonably foreseeable and the aggrieved party has taken reasonable actions to mitigate the loss. The courts or arbitration tribunals may adjust the liquidated damages upward or downward if the actual loss suffered by the aggrieved party is excessively higher or lower than the actual loss.

Update and trends

Recent developments

Are there any other current developments or emerging trends that should be noted?

Current developments33 Are there any other current developments or emerging trends that should be noted?Development of E-Commerce Law in China

In recent years, an increasing number of enterprises and consumers have been using electronic means to conclude contracts. Both the PRC Contract Law and the Electronic Signatures Law explicitly recognise electronic contract as a legal form of concluding contracts. In practice, electronic contracts might have several potential drawbacks:

  • an electronic offer cannot be revoked due to the instantaneity of electronic transmission;
  • most of electronic contracts are standard form contracts, and consumer cannot negotiate with operators to modify the contract; and
  • consumers cannot see the real items due to the nature of online shopping, which might lead to major misunderstanding of the contract.

On 1 January 2019, the E-Commerce Law came into force to further recognise the legal effect of electronic contracts. Traditionally, whenever there is a dispute, the consumer is required to provide the court with the original and intact electronic contract that can be retrieved at any time. However, under the E-Commerce Law, the e-commerce platform operator has the legal obligation of keeping records of the transactional information for at least three years. If the platform operator is unable to provide the court with the original contract or transactional record, they should undertake the corresponding legal responsibility. The E-Commerce Law also requires platform operators to establish online dispute resolution mechanisms that tend to be more consumer-friendly. This mechanism greatly reduces the negative effect of the drawbacks mentioned above.

Development of the Civil Code in China, replacing the Contract Law and other major Chinese laws

The General Principles of the Civil Law came into force on 1 October 2017, which marks the first step for compiling the PRC Civil Code. On 5 September 2018, the draft version of the Separate Parts of the Civil Code was issued by the Standing Committee of the National People’s Congress for public consultation. This draft version includes Contract Law, Property Law, Law of Personality Rights, Marriage and Family Law, Inheritance Law and Tort Liability Law and has been scheduled for second reading at the People’s National Congress sessions in March 2020.

In the Contract Law section of the Draft Civil Code, several important modifications are made to the current Contract Law. These are:

  • specific provisions are provided for conclusion and performance of electronic contracts;
  • relevant rules for contract preservation, loan contracts, and financial leasing contracts have been improved, and a special chapter has been added to stipulate the guarantee contract; and
  • in addition to the good faith principle, the parties also have the obligation of saving natural resources, reducing pollution and increase recycling.

After the Civil Code becomes effective, it will repeal and replace the prevailing effective Contract Law, Property Law, Securities Law, Marriage Law, Adoption Law, Inheritance Law and Tort Liability Law.