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The Evolution of Contract Law in China
Introduction:The central theme is that while the black letter contract law has indicated a trend of convergence moving toward some basic norms which appear in other countries' contract laws and international conventions, the enforcement of contract law shows a visible trend of moving toward a hybrid regime combining features of both formal and informal enforcement mechanisms.
o This paradigm of evolution reveals the intricacies and complexities in China's contract law regime as well as the country's rule of law movement in general.
Legislative History and Structure of Contract Law
1. Legislative History
- Before the initiation of the reform and opening-up era in PRC there had been only contractual practices but no legislative activity in relation to contracts
- It was not until the early 1980s that China started to enact laws on contracts, beginning with the promulgation of the Law on Economic Contracts of 1981
- As a significant development, the Contract Law of 1999 replaced the three earlier statutes to unify the nation's contractual legislative framework which had been fragmented for almost two decades
The 1999 Contract Law achieved a degree of uniformity in China's contract law regime
The fact that the Contract Law abolishes the differential treatment of domestic and foreign parties and applies equally to them conforms to the national treatment principle, the core pillar principle under the General Agreement on Tariffs and Trade
(GATT) and its successor, the World Trade Organization (WTO)
- As the Contract Law is the centrepiece of China's legislative output in the field of commercial law, it is worthwhile recounting the historical background in which it was enacted, which offers a glimpse into the social and economic settings at earlier stages of China's transition to the market economy which was the context for the legislative efforts.
o As the fragmented structure of the contractual legislation at the time had increasingly been proven costly and outdated, there was a strong need for a unified contract law to remove discrepancies and inconsistencies among various contract codes.
o In 1993, the building of a socialist market economy was formally endorsed by the
China Communist Party with the goal of deepening economic reforms.
This heightened the agenda for legislative endeavours on contracts.
The draft statute was polished several times after heated discussion and debate in the circles of legislators and academics before being settled as a final text.
The NPC passed the law in 1999, which, signalling a high degree of legislative sophistication and foresight, has remained unchanged ever since
Importantly, there have been three subsequent judicial interpretations issued by the Supreme People's Court (SPC) in 1999, 2009, and 2012, respectively, that have helped substantiate the implementation of the
Contract Law.With regard to the enactment of the Contract Law, there were several important considerations underlining the meticulous drafting process (Hu 2010).
o First, under the then fragmented framework of contractual legislation, domestic economic contracts, foreign-related economic contracts, and technology transfer contracts were governed by different sets of legal rules.
The stratification was prone to gaps in application and enforcement,
reinforced by broad-brushed stipulations which lacked operative details.
o Second, there was a need for additional rules to combat increasing contractual fraud in market transactions which had infringed upon the interests of the state, collective units, and citizens.
o Third, previous legislation had left out multiple types of contracts, such as contracts on financial leasing, commission, and brokerage, calling for a significant expansion of the legislative coverage.
o Finally, as contents in the previous three statutes corresponding to the characteristics of a planned economy had become obsolete when the country was moving toward a market economy, a unified new contract law was expected to remove those out-of-date provisions.
In particular, the legislative purpose was clarified as upholding the lawful rights and interests of parties, not ensuring the execution of economic plans.
This goal was enshrined in the principles of freedom of contract, fairness, as well as honesty and good faith which were incorporated in the text of the
Contract Law, as opposed to emphasizing government oversight of contracting activity through administrative monitoring and sanctions under the previous statutes (Liang 1999a, pp. 26-27).
2. Legislative Style
- A widely shared consensus in academic circles is that China practices the fusion of civil law and commercial law (minshang heyi) in legislative activity, in the sense that there need not be a commercial code in addition to a civil code even though the enactment of a longawaited Civil Code has been protracted for many years.
o Instead, it is believed that the general principles and rules of civil law provide the foundation for commercial law, which builds on the basis of the more specialized principles and rules in the civil law applicable to the relationships and the activities among profitmaking business entities of equal legal status (Chen 2011, pp. 161,
As a result, in PRC there is no Commercial Code but only a quasi-civil code titled the General Principles of Civil Law (GPCL), as mentioned above.
- The GPCL consists of three central elements - subjects of civil law (including individuals and legal persons), ownership and "obligations" (zhaiquan),and supplementary elements concerning "legal acts," proprietary rights, agency, limitation periods, and compensation for loss (Chen 2011, pp. 161, 316, 318). 3. Type of Contracts
- In the Contract Law, 15 types of contracts are addressed separately, called "named contracts" (known as "typical contracts" in Taiwan; see Chapter 4), each occupying an individual chapter.
Influence of Foreign Law and International Conventions versus Local CharacteristicsThe Contract Law displays traits of a strong influence of foreign law and international conventions as well as of local characteristics reflecting peculiar domestic needs.
1. Influence of Foreign Law and International Conventions
- Legislative techniques and particular legal mechanisms from both civil law and common law systems were incorporated in the drafting of the Contract Law.
o For example, the law has instituted the mechanism of "unrest defense" traditionally used in the civil law system on the one hand (Articles 68 and 69), and the notion and practice of "anticipated repudiation" originating from the common law system on the other (Article94(2),Article108).
o Another example is the deviation in the Contract Law from the principle of liability at
(presumed) fault in attributing liability for breach of contract.
This principle has traditionally been used in civil codes across civil law jurisdictions, including France, Germany, Japan, and Switzerland.
China instead adopts the common law principle of strict liability to protect the interests of the innocent party via extended scope of liability for breaches, as emphasized below.
- Here, "international conventions" primarily refer to the United Nations Convention on
Contracts for the International Sale of Goods (CISG), which has been in effect in China since
1988. o First, the law has incorporated key contents in the CISG in relation to the formation of contract, such as definition of offer, definition of invitation for offer, validity of offer upon arrival, revocation of offer and its restrictions, expiration of offer,
definition of acceptance, validity of acceptance upon arrival, validity of late acceptance, revocation of acceptance, as well as validity of both written and oral contracts.
- It has generally been agreed that the CISG had a crucial influence on the development of
Chinese contract law (Blase 2000,p.95).
o However, it is not clear from the legislative documentation why the CISG was used as a template for drafting the Contract Law.
- The literature appears to suggest that the CISG was often viewed by Chinese scholars and government authorities, as a more advanced international convention on contract law rules
(Ding 1999, p. 25) as it represents a great success to harmonize the differences in contract law norms and principles among various legal families.
o Given the fact that China is one of the largest trading nations in the world, relying on a more harmonized contract law code helps generate lower transaction costs and reduce potential disputes. o
Modelling its Contract Law on the CISG also means that the transplant would be easier and less costly for China compared to other options. In this sense, China's borrowing of the CISG to unify and upgrade its Contract Law was an evolution toward efficiency.Second, as to the conditions triggering the termination of contract, the Contract Law has accepted the doctrine of "fundamental breach" prescribed in the CISG, although with minor variations in wording (Han 2011a, p. 11).
o The law also follows the CISG in recognizing the validity of amendments to, or termination of, contract by consensual agreement.
o There is also no difference in the prescriptions on consequences of termination of contract between the CISG and the Contract Law.Third, on liability for breach of contract and exemptions from liability, there are also signs of conjunction with the CISG.
o For example, while the CISG incorporates both notions of "anticipatory repudiation"
at common law and "unrest defense" (Unsicherheitseinrede) in the civil law tradition, the Contract Law recognizes both of these notions to the same effect.
o Under the Caste establishment of liability of the breaching party for compensating losses suffered by the other party does not require fault, but comes with possibilities of exemptions from liability.
Such a system is called "strict liability "and has been written into the
Contract Law as it is widely regarded as one of the overwhelming tendencies for contract law development around the world, although some civil law jurisdictions still adhere to the principle of liability at fault.
o In addition, in calculating losses as the basis of damage compensation, the Contract
Law follows the CISG in adopting the rule of foreseeability.
2. Reflections on Local Characteristics
- The Contract Law is heavily reflective of the transitional environment and dynamics during the period of economic and social reforms in the PRC.
o It shows clear signs of trying to deal with a distinct set of problems and conflicts faced by contracting parties in the country's gradual transition to a market economy.
- Examples of China-specific provisions, include the following (Liang 1999a, p.27):
o For example, the "right of subrogation"(Article 73) has in particular been instituted for mitigating the problem of "triangular chains of debts"(sanjiaozhai) in practice where the difficulty of collecting debts is coloured by multiple, intermingling contractual relationships
The "right of cancellation" targets debtors who tried to evade or repudiate debts by transferring properties to a third party (Article 74).
o The obligation of the seller to transfer ownership of the subject matter to the buyer is aimed at remedying previous mishandling of cases by authorities (courts or administrative agencies) where a sales contract was nullified due to lack of formal registration of ownership transfer (Article 135).
o Multiple assurances for overseeing the formation and performance of construction contracts triggered by the particular difficulty in ensuring high-quality projects in a business environment where honesty and professionalism are often overshadowed --
by a thirst for profit. The requirement of an open tender for the formation of construction contracts and the adoption of a compulsory supervision system are responses to the serious social problem of poor-quality constructionprojectsthathadresultedinpersonalinjuriesandproperty damages (Article 271 and Article 276).
o To address abuses of attribution of liability to third parties for breach of contract in adjudicative practice, the law enshrines the doctrine of "privity of contract" by holding the breaching party liable despite of a third party's culpability (Article 121).
Another of the unique mechanisms specific to the country's transforming social and economic settings is the set of rules for establishing the validity of contracting acts by "legal representatives" of legal persons and other organizations in the context of ultra vires
o Unless the counterparty knows or ought to have known that the legal representative had overstepped his or her authorized scope of powers, the contract so concluded shall be valid (Liang 1999a, p. 29).
Why should a legal convergence of this kind ever occur?
o The main reason is that interactions of different legal systems increase transaction costs in cross-border businesses, particularly in terms of collecting and understanding legal information and the uncertainty concerning national legal procedures.
o The main function of legal convergence on contracts is the reduction of both legal uncertainty and transaction costs in both international and domestic trade(Chapter2).
This applies equally to the PRC in its incorporation of foreign rules and international conventions into the Contract Law when the country in the late 1990s was starting to unify its previously fragmented domestic product market held up by local protectionism and to tap the global market of trade and investment.
In this process, unique problems of contractual difficulties arising from transitioning and still underdeveloped legal and business environments nevertheless required local solutions not attended by foreign law and international conventions.
o This is primarily why the PRC Contract Law has shown signs of both convergence toward international norms and persistence with local practices.
i. Public Policy
- As pointed out above, the recognition of international standards and norms has not led to the disregard for local conditions and particularities.
- Chinese Contract Law, at least on occasions, is reflective of strong local flavours albeit with the CISG's liberal imprint.
- One of the features of the Contract Law is its room for subjecting the party autonomy to public policy.
o Although no explicit expression of "public policies "is found in the Contract Law,
scholars nevertheless argue that the expression "public interests in society"
inArticle52(5), which shall not be violated by contracts, can be rephrased as "public policies, "which could be interpreted to include both public order and public morality (Wang 2011, p. 660).
Because contracts that violate public interests would be held null and void, by the same token, contracts that disrupt public policies shall also be invalidated. Public policies can enter the inner system of civil law through the so-called "transferring clauses" (Su 2005, p.
- In China's context, the situation has two dimensions.
o 1. First, the concept of public policy is deliberately undefined.
Judging from the General Principles of Civil Law, the public policy prevails over international conventions.
However, there is no specific interpretation of "public policy," and Chinese law is also silent on the standard by which the "social and public interest "is held superior to the "international conventions.
"According to the General Principles of Civil Law as well as the Civil
Procedure Law, China's "social public interest" may be locked in the objective criterion, that is, whether there is any contradiction to the PRC
o 2. Owing to the ambiguous scope of public policy, the second problem is that the courts often make expansive use of public policy considerations in adjudicating commercial disputes, which creates uncertainty, thereby increasing transaction costs.
For example, public policy is expansively used by Chinese courts to practice local protectionism (Long and Wang 2015, pp. 48-59).
ii. Government intervention
- The principle of party autonomy is often compromised by government intervention.
- It has been widely recognized that the state always plays a prominent role in steering the direction of foreign investment and also of national economic development.
- The extent of state control is best evidenced by the approval regime in the admission of foreign investment. The government authorities are involved in all stages of a foreign investment project, from its formation, through its operation and on to its termination.
o The approval and/or registration procedures are a prerequisite to foreign investment at almost all stages of a project.
- For instance, a contract which needs to be approved by the government authority comes into effect only after the grant of the approval.
- The continuing modernization of the Chinese legal system, institutional infrastructure and institutional designs is moving towards a hybrid configuration involving a strengthening of the state's managerial role and the transformation of a closed society into a liberal and open society.
- The licensing and approval procedures may take much longer than would be expected.
o Many foreign investors may have to devote significant amounts of managerial time and resources to handling approvals and licensing issues (US-China Business Council 2007).
o While the Communist Party has recently shown a determination to allow the market to play a decisive role, removing excessive government intervention from the commercial arena has a long way to go.
iii. Default Rules versus Mandatory Rules
- The distinction between default and mandatory rules in contract law is that:
o default rules can be opted out by party autonomy -o whereas mandatory rules are not subject to exclusion by party autonomy
Generally speaking, under the principle of freedom of contract, contract law around the world is commonly characterized by the dominance of default rules, as is the case with the
Generally, It was suggested that it may be efficient for courts and legislatures to choose default rules that a majority of people actually objectto(penaltydefaults)andtointentionallyincreasethetransaction costs of contracting around these rules in order to encourage information disclosure by the more informed party to her counter party and to the court (Ayres and Gertner 1989,
The rationale behind this is that it is less costly for the parties to contract around this default rule by including a quantity term in ex ante contracting than for the courts to decide on what quantity the parties "would have desired" in ex post litigation (Ayres and Gertner 1989, p. 96).
o This distinction, however, does not seem to find a similar application under the PRC
Under the Contract Law, the parties need to specify a quantity term ex ante
When the parties failed to specify a quantity term, the statute is not clear as to whether or not the contract would continue to be enforceable (Contract
Law, Article 62).
The SPC judicial interpretation, nevertheless, fills in that gap by indicating that if the court can decide on the quantity, the contract should be deemed valid (Judicial Interpretation on Several Questions Regarding Application of the Contract Law (Part II),2009,Article 1).
Otherwise, the court may view the contract as being invalid.
o On balance, this judicial stance is less rigid than that suggested by the UCC.
The difference lies in the discretion given by the statute to the court to explore what the parties "would have wanted" when the quantity clause is not specified.
Under the UCC, the court can simply leave the matter aside and refuse to enforce the contract (i.e., refuse to calculate on what the parties "would have wanted").
In the PRC, by comparison, the court may come up with a quantity term by exploring what the parties "would have desired" of their contractual dealing,
and would only refuse to enforce the contract when it could not decide on the quantity term by interpreting the contract.
The judicial position in the PRC contract law regime on the quantity term,
therefore, can be understood as adopting a tailored default rule, instead of a penalty default rule.
An even trickier task is to judge (adjudicate) what rules should be characterized as
o Normally, a primary judgment can be made on the basis of the literal wording of the rules where commands like "shall not," "shall," and "must" appear
When it is not crystal clear whether a provision is mandatory or not, the Supreme
People's Court has instructed lower courts to make decisions with a comprehensive
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