How will the Civil Code Affect the Management of Commercial Contracts?

The Civil Code of the People’s Republic of China (hereinafter referred to as “Civil Code”) which will come into effect on January 1st, 2021, has made a variety of amendments and innovations to the section on contracts. As there are a large number of contract cases in judicial practice, in this article, we will compare the new and old laws and regulations and analyze how the amendments will affect the contract management for commercial contracts.

1. The Effect of Pre-Contract

• Before

Interpretations of the Supreme People’s Court on Issues Concerning the Application of Law for the Trial of Cases Involving Disputes over Sale and Purchase Contracts (2012)

Article 2 Where parties sign an order to buy, order to purchase, reservation book, letter of intention, memorandum or any other pre-contract specifying that the parties will enter into a sale and purchase contract in a certain period, but one party does not discharge the obligation on entering into the sale and purchase contract and the other party requests such party to bear the liability for breach of the pre-contract or requests to terminate the pre-contract and claims for liquidated damages, the people’s court shall uphold such claim.

• After

Civil Code of the People’s Republic of China (2021)

Article 495 If the parties agree to conclude a subscription contract, subscription order, reservation order, etc. within a certain period in the future, such contracts shall constitute pre-contracts.

Where one party fails to perform the obligation to conclude a pre-contract as agreed, the other party may request it to bear the breach of contract liability in relation to the pre-contract.

• Modification and its Significance to Companies

By comparison, it can be found that the terms of the pre-contract have been formally incorporated into the contract section of the Civil Code, the validity of which has been confirmed, and its scope of the effect has also been expanded.

For companies, during the process of investments, mergers and acquisition, equipment procurement, business cooperation and other commercial activities, signing letters of intent and framework agreements are deemed as common practice. Before a company signs relevant agreements, they shall first make clear whether they shall sign a non-binding negotiation document or a legally binding pre-contract, and then design the relevant terms accordingly. After signing the effective pre-contract, the company should then strengthen their awareness as to the performance of the contract as breach of obligations under the contract will bear the corresponding liability for breach of contract.

2. Principle of Change of Circumstances

• Before

Interpretation of the Supreme Court on Certain Issues Concerning the Application of the PRC Contract Law (II)（2009）

Article 26 Where a party to a contract petitions the court to modify or terminate the contract on the grounds that the continuous performance of the same is obviously unfair to the party or the purpose of the contract will not be realized due to occurrence of any material change of circumstances that is unforeseeable, not caused by force majeure, and not a commercial risk after the conclusion of the contract, the court shall decide whether the contract shall be modified or terminated according to the principle of fairness on a case-by-case basis.

• After

Civil Code of the People’s Republic of China (2021)

Article 533 After a contract has been concluded, and the basic conditions for the contract have undergone a major change which was unforeseeable by the parties at the time of conclusion and which does not belong to commercial risks, if it is obviously unfair to one party to continue to perform the contract, the party adversely affected may renegotiate with the other party; if the negotiation fails within a reasonable period, the parties may request a people’s court or an arbitration institution to modify or rescind the contract.

The people’s court or arbitration organization shall take into account the actual circumstances of the case and amend or rescind the contract pursuant to the principle of fairness.

• Modification and its Significance to Companies

The principle of change of circumstances has been formally established as a legal basis. The Civil Code has deleted the precondition of “not caused by force majeure” in the change of circumstances and made it clear that the principle of change of circumstances is applicable to the event of force majeure. At the same time, the Civil Code establishes the arbitration institution as one of the subjects that can confirm the change of circumstances as opposed to leaving such matters to the sole discretion of the people’s court as previously outlined.

In the context of this year’s COVID-19 epidemic situation, the issue of contract performance related to force majeure and change of circumstances has been a constant hot topic. The Civil Code no longer excludes force majeure from the cause of change of circumstances and weakens the boundary between force majeure and change of circumstances. Therefore, certain parties to the contract whose continued performance of the contract will be obviously unfair due to the COVID-19 epidemic can choose to apply the principle of change of circumstance to appeal to the court to change or terminate the contract when the party to the contract is unable to claim the principle of force majeure to resolve the contract caused by the epidemic. This amendment provides a clearer basis for companies to solve contract disputes caused by the epidemic situation.

In addition to the above-mentioned amendments, the Civil Code also emphasizes the obligation of the specification of standard format contracts and reorganizes several conditions of an invalid contract. To sum up, we suggest that:

1. When drafting a standard format contract (such as “MainService Framework Agreement”), production and service companies shall draw the other party’s attention to the price, performance terms, risk warning/s, after-sale and civil liability of their products or services by means of bold font and underlining sections.
2. Companies shallpay attention to confirm if the other party may be eligible as a civil subject before signing the contract.
3. If the contract cannot be performed continuously due to non-subjective factors, it is necessary to judge whether the situation isin fact a change of circumstances.
4. When signing relevant legal documents, pay attention to distinguish the nature of the signed documents and clarify their legal binding force on the company itself.

As the Civil Code is about to enter into force, we will continue to pay attention to and update on the relevant official interpretations and opinions. If you are interested and want to obtain more information, please feel free to contact us at info@dandreapartners.com.