Clearing up the Law: China's New Judicial Interpretation on the Sale of Commercial Premises

According to relevant PRC laws on legislation and law construction, judicial interpretations issued by the Supreme People's Court (the SPC) function to clarify specific issues relating to the application of law in the trial process.¹ The new Interpretation is no exception. As indicated above, the current legal framework on real estate is composed of hundreds of central and local statutes. In addition to the PRC Civil Law General Principles, the PRC Contract Law(中华人民共和国合同法), the PRC Security Law(中华人民共和国担保法), and the Administration of Urban Real Property Law (城市房地产管理法)that are mentioned in the Interpretation as its basis, many other rules and regulations have to be referred to in trials of real estate disputes, which include (but are not limited to) the following:

¡P Administration of the Assignment of Urban Real Property Provisions, issued by the Ministry of Construction on August 7 1995 and amended on August 15 2001. This regulation governs real estate deals in which a transfer of property title occurs, but does not apply to the sale of commercial real estate by real estate developers.

¡P Administration of the Leasing of Urban Premises Procedures, issued by the Ministry of Construction and effective June 1 1995. This law stipulates the basic issues regarding real estate leases.

¡P Administration of Registration of Ownership of Rights in Urban Buildings Procedures, issued by the Ministry of Construction on October 27 1997 and amended on August 15 2001.

¡P Administration of Urban Real Property Mortgage Procedures, issued by the Ministry of Construction on May 9 1997 and revised on August 15 2001. This law was formulated pursuant to the Security Law, but provides more specific and detailed implementation guidelines related to the mortgaging of real estate.

¡P Administration of the Pre-sale of Urban Commodity Premises Procedures, issued by the Ministry of Construction on November 15 1994 and amended on August 15 2001.

¡P Real Estate Advertising Tentative Provisions, issued by the State Administration of Industry and Commerce on December 30 1996 and amended on December 3 1998. These rules provide quite detailed requirements for advertising in real estate sales, but do not cover the effectiveness and legal consequences of misrepresentation and false statements in advertisements.

¡P Administration of Urban Real Property Development and Business Procedures, promulgated by the State Council on July 20 1998. They provide for general statutory requirements on the qualification of real estate developers and general principles of real estate development and business operation.

¡P Urban Real Property Resettlement Administrative Procedures, promulgated by the State Council on June 6 2001. They set forth procedures and requirements for the application and approval of resettlement for real estate development purposes, and provide general principles to regulate the rights and obligations of parties involved in resettlement.

¡P Administration of Sale of Commodity Premises Procedures, issued by the Ministry of Construction on April 4 2001. These Administrative Procedures set forth stipulations governing basic issues in the sales activities of commercial real estate, including the statutory requirements for sale, advertisement, sales contract, area calculation, resolution to area discrepancy, brokerage, payment, quality guarantee and warranty, and basic rights and obligations of real estate developers and purchasers, among other things. As a matter of fact, as the first regulation specifically aimed at regulating purchase and sale of commercial real estate, the Administrative Procedures have provided basic rules of the game for sellers and purchasers to follow, although some of the rules are somewhat sketchy and lack practicability.

THE INTERPRETATION

The purpose of the Interpretation is to address the most prominent problems arising from the application of these laws and regulations, so as to provide useful guidance to the resolution of real estate disputes. In particular, the Interpretation has clarified ambiguities in several areas of long-standing controversy, which constitute the most common causes of disputes arising from real estate purchase contracts.

Advertisements and Promotional Materials

Real estate developers in China rely heavily on advertising. It is a common practice to use seemingly impressive but sometimes untrue descriptions and pictures in advertisements to promote projects. It is also typical of sales people to make all kinds of verbal promises or outright falsehoods about the quality, facilities or neighbourhood of the premises to induce prospective purchasers to enter into purchase contracts. Since the Contract Law generally treats commercial advertisements as invitations for offer rather than offers in themselves, what is described, represented, or promised in advertisements does not constitute binding obligations. However, the Contract Law also prescribes that "where the contents of a commercial advertisement satisfy the terms of an offer, it may be regarded as an offer".² The main problem here is that no specific standard has been given as to how a commercial advertisement satisfies the terms of an offer, and as a result, this provision has hardly been used to sue for damages caused by reliance on misrepresentation or false promises made in advertisements or promotional materials.

The abovementioned April 4 2001 Administrative Procedures aim to regulate advertising in the real estate market by prescribing that the contents in an advertisement must be true, legitimate, scientific and accurate, and that contracting parties should include contents expressly stated in advertisements or promotional materials in the purchase contract.³ The implication of the above provision, however, is that the contents of an advertisement or promotional material will not be binding unless expressly contained in the contract.

Since purchasers in most cases do not have equal bargaining power with developers, it is a rare case that a purchaser can succeed in having the sweet and enticing words of a sales girl included in the formal contract. As a result, it is quite impossible to claim against a seller for false statements presented in advertisements or promotional materials.

The much-applauded provision in Article 3 of the Interpretation is made to address the problem:

Advertisements and promotional materials of commercial premises are invitations for offer. Nevertheless, if the representations and promises made by the seller with respect to the structure and relevant facilities within development zoning boundaries of the building are specific and definite, and have significant impact on the formation of the purchase contract and the purchase price of the premises, then such representations and promises shall be regarded as offers. In such event, even if the said representations and promises are not set forth in the contract, they shall nevertheless be regarded as part of the contract, and the parties shall take breach liabilities for breaking such representations and promises.

The clarification is significant in that it sets out the scope and standard by which the contents of advertisements and promotional materials can be regarded as part of the purchase contract. Although some people have concerns about the ability of Chinese judges to exercise discretion in deciding what kind of representations and promises can be qualified as having significant impact on the formation of the purchase contract and the purchase price, real estate sellers now have to be more prudent before making unfounded claims in advertisements or promotional materials, otherwise they may be faced with liabilities for breach of contract. One note, however, has to be made. According to the above Article 3, the scope of advertisements and promotional materials that may be regarded as part of the contract is limited only to those making references to things within the development zoning boundaries. False statements about the existence of a beautiful lake or lush green park outside the zoning boundaries approved for the project will not be regarded as part of the contract even if they may have a significant impact on the formation of the purchase contract and the purchase price. Purchasers will still need to exercise due care of investigation on their own part to find out what exactly they are getting for their potential purchase.

Punitive Damages as Additional Remedy to Purchasers against Sellers' Fraud

Another significant clarification of law brought about by the Interpretation is to allow purchasers of real estate to claim for punitive damages from developers in certain circumstances.

Concealment or Withholding of Information

Per Article 9, a purchaser can seek legal recourse if the seller intentionally conceals or withholds the following information from the purchaser:

(i) the fact that the seller has not obtained a Pre-Sale Permit Certificate for Commercial Real Estate (Pre-Sale Permit);⁴

(ii) the fact that the premises for sale have already been mortgaged as security; or

(iii) the fact that the premises for sale have already been sold to a third party or arranged as compensation for resettled residents.⁵

If the seller had not concealed or withheld the above information, no contract would have been formed, or even if entered into, would have been void according to law,⁶ or would have been rescinded or altered by the court.⁷ The Interpretation allows the purchaser to claim damages from the seller when the contract becomes void, rescinded or terminated owing to the seller's fraudulent conduct as mentioned above. Remedies available to the purchaser include refund of payment already made by the purchaser plus interest, compensation for losses incurred to the purchaser, and punitive damages from the seller not exceeding the amount already paid.

Material Breach of Contract

According to Article 8, a purchaser can also seek damages when the seller commits a material breach of contract that makes it impossible to realize the purpose of the contract, as follows:

(i) by mortgaging the premises to a third party as security without informing the purchaser after the purchase contract has been entered into between the seller and the purchaser; or

(ii) by selling the premises again to a third party after the purchase contract has been entered into between the seller and the purchaser.

Again, remedies granted by the Interpretation to a purchaser under the above circumstances include termination of contract, refund of payment already made by the purchaser plus interest, compensation for losses incurred to the purchaser, and punitive damages from the seller not exceeding the amount already paid by the purchaser.

These provisions allowing the imposition of punitive damages are widely seen as a breakthrough. The Contract Law itself does not provide for punitive damages as a remedy to an innocent party in an event of breach, except by pointing out that where a business operator has defrauded a consumer, the Protection of the Rights and Interests of Consumers Law (中华人民共和国消费者权益保护法)(the Consumer Protection Law⁸) shall apply.⁹ Article 49 of the Consumer Protection Law provides that:

A business operator that conducts an act of fraud in providing a commodity or a service to a consumer must, upon the request of such consumer, increase the amount of compensation for losses incurred to such consumer. The increased amount shall be equal to the price or fee paid by the consumer for purchasing the commodity or service from the business operator.

According to the above provision, a fraudulent seller of goods or services should, in order to compensate for the losses incurred by a consumer, refund the price paid by the latter for receiving the goods or services, and pay extra damages in an amount equal to the price that the consumer has paid, disregarding the actual losses incurred to the consumer by the seller's fraudulent acts.

There have been years of debate over whether the same doctrine should be applied to the purchase of real estate. The key issue is whether real property can be regarded as a commodity as envisioned in the Consumer Protection Law. A common consideration against the application of such doctrine in real estate disputes is based on the concern that, given the fact that the purchase price of real estate is usually very high, punitive damages equal to the purchase price may entitle the purchaser to an unreasonable enrichment, which is contrary to the principle of fairness inherent in contract law.

Obviously, when formulating the Interpretation, the SPC tried to strike a balance. By allowing punitive damages in fraud cases in real estate sales, the court seems to have recognized commercial premises as commodities. By giving discretion to judges in awarding punitive damages up to an amount equal to the purchase price, the court has tried to avoid unreasonable enrichment of the purchaser that may result from a rigid application of Article 49 of the Consumer Protection Law. Although some people have again expressed concern about the impartiality of judges in exercising their discretion to decide how large a punitive damage to impose on fraudulent developers, the right to claim punitive damages as confirmed by the Interpretation has given a powerful weapon to purchasers against blatantly fraudulent practices by developers.

Ownership Certificates

In many parts of China, purchasers sometimes have to wait for three years or longer to receive the ownership certificates for the premises they buy. There are different reasons for this, but the delay caused by the developer is usually an important factor. There have been many disputes in this regard, but the liability of the developer or seller has never been clearly defined. The SPC has this time tried to solve the problem by clearly setting out a time limit for obtaining Ownership Certificates. Article 18 of the Interpretation provides that the seller shall bear the liability of breach and pay damages to the purchaser if, for reasons attributable to the seller, the purchaser fails to obtain the ownership certificate of the premises at the time agreed in the purchase contract or 90 days after delivery of the premises if they are sold before completion, or 90 days after signing of the contract if the premises are sold after completion.

Relationship with the Mortgage Loan Contract

Commercial premises have been bought on mortgage loans for many years in China, but there has been no clear legal stipulation as to what will happen to a mortgage loan agreement if the purchase contract for the premises is terminated or rescinded. It is generally believed that if the purchase contract no longer exists, there is no reason that the loan agreement should be effective. In reality, however, many disputes arise simply because of the absence of clear legal provisions. In Article 24, the Interpretation makes it clear that if the real estate purchase contract is terminated or rescinded, it is no longer possible to fulfil the purpose of the mortgage loan contract, which should also be terminated upon request from the parties.

Nature of a Deposit

When the Interpretation was promulgated, most observers in the Chinese media hailed it as providing more protection to real estate purchasers. A close look at its articles shows that not all are favourable to purchasers. Clarifications of sundry legal uncertainties serve the interest of all parties involved. Article 4 on the nature of deposits is an example.

It is a customary practice in the sale of commercial real estate in China to ask the purchaser to pay a small amount of money to "secure" their right to purchase the premises that they intend to buy. In most cases, buyers are asked to pay this deposit before the parties agree on the terms of the contract. Naturally some buyers change their mind later. Prior to the promulgation of the Interpretation, it was unclear whether such a deposit should be regarded as a security deposit subject to the provisions of the Security Law. In Article 4 it is made clear that when a deposit is received by the seller from the buyer as security for the conclusion of a purchase contract by way of subscription, offer to purchase or pre-booking, such deposit shall be disposed of in accordance with legal provisions on security deposit if the purchase agreement is not concluded for reasons attributable to one of the parties. In other words, if the seller is responsible for the failure to enter into the purchase contract, he should return the deposit at two times of the amount received; if the buyer is responsible for the failure, he should have no right to claim refund of the deposit paid.

Article 4 of the Interpretation came as a surprise to ordinary purchasers of real estate and to consumer protection organizations. It also seems to contradict Article 22 of the Administrative Procedures, which provides that any amount received by the seller for the purpose of booking premises should not be regarded as a security deposit and should be returned to the purchaser if the parties fail to enter into a formal purchase contract.

Delivery of Premises

Another clarification that may not be so friendly to purchasers is contained in Article 11. Here delivery is expressly defined as the handover of the occupation of the premises. Risks related to the premises transfer with delivery, which means that a purchaser shall bear all the risks of the premises once they are handed over to him. It is further provided in this article that if the purchaser, with no valid reason, refuses to take possession of the premises upon receipt of written notice of delivery from the seller, the risks of damages of the premises shall be transferred to the purchaser on the date of delivery specified in such written notice.

CONCLUSION

The Interpretation contains specific provisions for resolving the most common disputes arising from real estate purchase and sale contracts, including those relating to advertisements, deposits, delivery, area calculation, quality and warranty responsibilities, loans and mortgages, title transfer, and conflicts with third party rights, among others.

It should be noted that the Interpretation only applies to commercial real estate developed for sale to the general public and does not apply to other types of real estate such as second-hand, publicly owned and economy premises (Article 1).

Also worth noting is that the Interpretation applies to all cases under trial after June 1 2003, either in the first instance or second instance (Article 28). This gives it a kind of retrospective force to govern pending trials of disputes that happened before the promulgation of the Interpretation. Some questions have been raised on this point, but it is widely welcomed and perhaps can be justified on the fact that it is mainly meant to make laws clearer, not to create new laws.

Even though we should not view the Interpretation as a panacea, it is anticipated that it will help bring about more unified court practices and enhance the efficiency, fairness and predictability in the trial of real estate cases. The rules contained in the Interpretation and the values pursued therein will not only guide China's courts at different levels and in different places to work in a more uniform manner in judging real estate disputes, but also help to create better market behaviour in the real estate industry and facilitate fairer competition based on good faith.

ENDNOTES

1 See the PRC Legislation Law(中华人民共和国立法法), effective July 1 2000; the National People's Congress Standing Committee Resolution on Strengthening Law Construction Work, adopted on June 1 1981; the PRC Organization of People's Courts Law, amended on September 2 1983; and the Supreme People's Court Provisions on Judicial Interpretation, issued on June 23 1997.

2 See Article 15 of the PRC Contract Law(中华人民共和国合同法), effective October 1 1999.

3 See Articles 14 and 15 of the Administration of Sale of Commodity Premises Procedures.

4 Pursuant to the Interpretation, the provision by the seller of a false Pre-sale Permit will be treated as concealing the fact of not having obtained the Pre-Sale Permit.

5 Resettled residents refer to residents originally living on a land plot that is later used by the developer for real estate development. A resettled resident may elect to be compensated for the loss of a previous residential unit by entering into a resettlement agreement with the developer under which the resettled resident is entitled to certain premises on a fee-free or discounted-fee basis, or a mixture of both.

6 Pre-sale of commercial real estates refers to the sale of real estate that is under construction or is to be constructed. According to the Administration of Urban Real Property Law, pre-sale of commercial real estate is subject to approval and registration at real estate administrative agencies. The Administration of the Pre-sale of Urban Commodity Premises Procedures, promulgated by the Ministry of Construction and amended in August 2001, prescribe that a developer must not conduct pre-sale before obtaining the Pre-sale Permit from the administrative authority. Article 2 of the Interpretation provides that the absence of the Pre-sale Permit will render a pre-sale contract void.

7 See the Contract Law, Articles 42, 52 and 54.

8 The Consumer Protection Law was promulgated on October 31 1993 and effective January 1 1994.

9 See the Contract Law, Article 113.