Guiding Opinion on Several Issues Concerning the Trial of Civil and Commercial Contract Disputes under Current Circumstances

(Issued by the Supreme People's Court on July 7 2009.)

Higher people's courts of the provinces, autonomous regions and municipalities directly under the central government, military courts of the People's Liberation Army, and the Production and Construction Corp Branch Court of the Higher People's Court of the Xinjiang Uyghur Autonomous Region:

We hereby issue to you the Supreme People's Court, Guiding Opinion on Several Issues Concerning the Trial of Civil and Commercial Contract Disputes under Current Circumstances and ask that you duly and thoroughly implement the same while taking into account local realities.

At present, as the conflicts and disputes engendered by the spread of the global financial crisis have been clearly reflected in the judicial sector, civil and commercial cases, particularly civil and commercial contract disputes relating to the operations of enterprises, have shown a marked increase in number; additionally, numerous new trial practice issues caused by changes in the macroeconomic situation have arisen. If people's courts, while referring to the state's economic development strategy and the requirements of “maintaining growth, protecting people's livelihoods and maintaining stability”, adhere to the guiding principles of “basis in trials, embracing the overall situation, helping others who are in the same boat and jointly overcoming current difficulties”, firmly instil the philosophy of rendering service for the overall situation and administering justice for the people, earnestly study and resolve in a timely manner universal issues and key issues that immediately relate to changes in the macroeconomic situation encountered in the course of civil and commercial trial practice and effectively settle conflicts and disputes, it is not only an important task of civil and commercial trial authorities in countering the economic crisis but is also of great significance in safeguarding the good faith market trading order, ensuring an investment environment characterised by a fair legal regime, fairly resolving disputes, shoring up market confidence, etc. We hereby set forth the following opinions on several issues concerning the trial of civil and commercial contract disputes by people's courts under current circumstances.

I. Prudent application of the principle of changed circumstances and rational adjustment of the relationship of the parties' interests

1. Where a large volume of disputes arise over the trading of products and the flow of funds between market entities at present due to the impact of factors such as severe fluctuations in the price of raw materials, changes in market supply and demand, and insufficiency of working capital, and certain parties, in the course of legal actions, petition for application of the principle of changed circumstances in order to amend or terminate their contracts, people's courts shall conduct a strict examination in line with the principle of fairness and the principle of changed circumstances.

2. When a people's court is to apply the principle of changed circumstances, it shall fully note that the global financial crisis and the change in the domestic macroeconomic circumstances is not a sudden change process that catches every market entity off guard, but is rather a gradually evolving process. During the evolving process, market entities should, to a certain degree, be able to foresee and judge market risks. People's courts shall grasp in accordance with the law the conditions for applying the principle of changed circumstances, stringently examine claims of “unforeseeability” by parties and apply with even greater prudence the principle of changed circumstances to contracts involving subject matters that are large volume commodities, such as oil, coking coal and non-ferrous metals, whose market nature is volatile and that have consistently been marked by relatively large fluctuations in price or contracts the subject matter of which is risk investment financial products, such as stocks and futures.

3. People's courts shall rationally distinguish changed circumstances and commercial risk. Commercial risks are risks inherent to the engagement in business activities, e.g. changes in supply and demand, increases and decreases in prices, etc. that have not reached the level of an exceptional change. A changed circumstance is a risk that is not inherent in the market system and was unforeseeable by the parties at the time they entered into their contract. A people's court, when determining whether a certain material objective change constitutes a changed circumstance, shall pay attention to weighing whether the type of risk is one that is generally accepted as being unforeseeable, whether the degree of the risk far exceeds the reasonable anticipation of a normal person, whether the risk could have been guarded against and controlled, whether the nature of the transaction falls within the usual “high risk, high return” category, and other such factors, and, taking into account the specific circumstances of the market, distinguish between changed circumstances and commercial risk in individual cases.

4. For the grasp of the value orientation of the adjustment standards, people's courts shall nevertheless abide by the principle of favouring protection of non-breaching parties. Application of the principle of changed circumstances does not involve a straightforward exemption of the debtor from its obligations and the creditor bearing the adverse consequences, but rather, attention needs to be fully paid to balancing interests and fairly and reasonably adjusting the relationship of the parties' interests. In the course of a legal action, a people's court shall actively steer the parties toward conducting new negotiations and amending their contract. If the new negotiations are unsuccessful, it shall endeavour to achieve a resolution through mediation. With a view to preventing abuse of the principle of changed circumstances and thereby affecting the normal trading order in the market, when a people's court decides to apply the principle of changed circumstances to render a judgment, it shall, in accordance with the requirements of the Supreme People's Court, Circular on Correct Application of the Interpretation on Several Issues Concerning the Application of the <PRC Contract Law> (2) in Serving for the Overall Work Situation of the Party and the State (Fa [2009] No.165), stringently carry out the relevant review procedure for applying changed circumstances.

II. Reasonably adjusting the amount of liquidated damages in accordance with the law and fairly resolving the issue of liability for breach of contract

5. At present, due to the change in, and effect of, the domestic macroeconomic environment, breaches of contract arising in the performance of civil and commercial contracts have become quite marked. With respect to provisions on liquidated damages specified in contracts by parties that are grossly in excess of the losses incurred as a result of a breach or that are highly punitive in nature, people's courts shall reasonably adjust the amount of liquidated damages and fairly resolve the issue of liability for breach of contract in keeping with the letter and the spirit of the second paragraph of Article 114 of the Contract Law and Article 29 of the Supreme People's Court, Interpretation on Several Issues Concerning the Application of the <PRC Contract Law> (2) (Contract Law Interpretation (2)) on the adjustment of excessive liquidated damages.

6. Under current circumstances where enterprises experiencing difficulties in their operations is a generalised phenomenon, with respect to the amount of liquidated damages that grossly exceeds the loss incurred as a result of a breach, the scope of discretion shall be reasonably adjusted in keeping with the principles of good faith and fairness specified in the Contract Law and by adhering to the nature of liquidated damages as being compensatory first and punitive second, and efforts shall be duly made to prevent the use of autonomy of the will as grounds to completely excuse the setting of excessive liquidated damages by parties.

7. When a people's court is to adjust excessive liquidated damages in accordance with the second paragraph of Article 114 of the Contract Law, it shall consider the specific circumstances of the case, take the losses incurred as a result of the breach as the benchmark, comprehensively weigh factors such as the extent to which the contract was performed, the fault of the parties, the anticipated benefits, the strength or weakness of the position of the parties in entering into the contract and whether a standard contract or standard clauses were used, comprehensively balance factors based on the principles of fairness and good faith and avoid perfunctorily using a fixed percentage or other such “one size fits all” method so as to avoid actual unfairness that may arise from the mechanical administration of justice.

8. With a view to reducing the litigation burdens of parties and duly resolving liquidated damages disputes, where the party in breach mounts its defence for exemption from liability on the grounds that the contract was not formed, the contract did not enter into effect, the contract is invalid or that it did not commit a breach of contract but does not petition for adjustment of liquidated damages, the people's court may give an explanation as to whether the concerned party should assert that the liquidated damages are excessive. The people's court shall correctly determine on whom the burden of proof lies. If the party in breach asserts that the specified liquidated damages are excessive, it shall bear the burden of proof in respect thereof, and if the non-breaching party asserts that the liquidated damages are reasonable, it shall also provide the pertinent evidence. If a party asserts that the provisions on liquidated damages survive the termination of the contract, the people's court may handle the matter in accordance with Article 98 of the Contract Law.

III. Distinguishing the types of loss of anticipated benefits and duly determining loss of anticipated benefits

9. Under current circumstances where breach of contract by market entities is quite marked, a breach of contract generally results in a loss of anticipated benefits. Based on factors such as the nature of the transaction and the objectives of the contract, loss of anticipated benefits can mainly be divided into loss of production profits, loss of operating profits, loss of resale profits and other types of losses. In a breach of a sales and purchase contract for production equipment and raw materials, etc., the loss of anticipated benefits incurred by the buyer due to breach by the seller usually falls within the category of loss of production profits. In the case of a contracted operation contract, leased operation contract or contract for the provision of services, the loss of anticipated benefits arising due to a breach by a party usually falls within the category of loss of operating profits. In the case of a pair of sales and purchase contracts, the loss of anticipated benefits incurred by the seller under the resale contract down the line due to a breach of contract by the seller under the first contract usually falls within the category of loss of resale profits.

10. When a people's court calculates and determines loss of anticipated benefits, it shall comprehensively apply the foreseeability rule, the mitigation rule, the benefits rule, the contributory negligence rule and other such rules, and deduct from the total damages for anticipated benefits claimed by the non-breaching party the unforeseeable loss of the party in breach, the loss inappropriately expanded by the non-breaching party, benefits obtained by the non-breaching party due to the breach, loss caused by the non-breaching party also being negligent and the necessary transaction costs. If fraudulent operations as specified in the second paragraph of Article 113 of the Contract Law exist, or if the parties have agreed on the method of calculating liquidated damages as specified in the first paragraph of Article 114 of the Contract Law or if the breach results in personal injury or death or psychological damage, etc., the rule for the compensation of loss of anticipated benefits shall not be applied.

11. When a people's court determines loss of anticipated benefits, it shall reasonably allot the burden of proof. In general, the party in breach shall bear the burden of proving that expanded losses were due to failure by the non-breaching party to take reasonable mitigation measures, that the non-breaching party benefitted from the breach and that the non-breaching party was also negligent. The non-breaching party shall bear the burden of proof in respect of the total amount of the loss of anticipated benefits that it incurred, and the necessary transaction costs. With respect to foreseeable losses, either the non-breaching party may adduce evidence in support thereof, or the people's court may determine the same at its discretion based on the actual circumstances.

IV. Correctly grasping the constitutive elements of law and reliably determining agency by estoppel

12. In major state projects and sectors and fields such as contracting and leasing where, at present, the shock of the global financial crisis and the effects of the change in the domestic microeconomic situation are felt quite sharply, the execution of contracts in the name of, and actual performance thereof by, departments of work units, project managers and even individuals and disputes involving agency by estoppel arising from the problem of determining contract entities and the validity of contracts have become quite common due to parties to contracts transferring contracts, subcontracting or subleasing. In this respect, people's courts shall correctly apply the provisions of Article 49 of the Contract Law on the system of agency by estoppel and stringently determine acts of agency by estoppel.

13. The system of agency by estoppel set forth in Article 49 of the Contract Law does not only require that the act of agency by a person with no such power seem objectively to be one carried out with such power, but also requires that the counterparty subjectively act in good faith and that it believe, without fault on its part, that the actor has the power of agency. If the counterparty claims that agency by estoppel is constituted, it shall bear the burden of proof in respect thereof, and shall not only be required to present evidence substantiating the agency act, e.g. contract, official seal, seal and other such forms of required items objectively manifesting the power of agency, but shall also provide evidence of its having acted in good faith and of its belief, without fault on its part, that the actor had the power of agency.

14. When a people's court is determining whether a counterparty subjectively acted in good faith and was without fault, it shall take into consideration the various factors in the course of conclusion and performance of the contract to comprehensively determine whether the counterparty fulfilled its obligation of reasonable care. Additionally it shall consider such factors as the time the contract was concluded, in whose name it was signed, whether it bears the relevant seals and whether the seals are genuine, the method and place of delivery of the subject matter, the materials purchased, the apparatus leased, the purpose of the borrowed amount, whether the project owner was aware of the act of the project manager, whether it participated in the performance of the contract, etc. to render a comprehensive analysis and judgement.

V. Correctly applying mandatory provisions and reliably determining the validity of civil and commercial contracts

15. Correct understanding, identification and application of “violates mandatory provisions of laws or administrative regulations” in Item (5) of Article 52 of the Contract Law are crucial to safeguarding the validity of civil and commercial contracts and to the security and stability of market transactions. People's courts shall, pursuant to Article 14 of the Contract Law Interpretation (2), pay attention to distinguishing mandatory provisions that affect validity and mandatory provisions of an administrative nature. If a mandatory provision that affects validity is violated, the people's court shall hold the contract to be invalid. If a mandatory provision of an administrative nature is violated, the people's court shall determine the contract's validity based on the actual circumstances.

16. People's courts shall comprehensively consider the intent of laws and regulations and weigh mutually conflicting rights and interests, e.g. the types of rights and interests, the security of transactions and the objects regulated thereby, etc. in comprehensively determining the type of the mandatory provision. If what is regulated by a mandatory provision is a contract act itself and the interests of the state or the public interest would be harmed absolutely should such contract act occur, the people's court shall hold the contract to be invalid. If what is regulated by the mandatory provision is the “market entry” qualifications of a concerned party and not a certain type of contract act, or what is regulated is an act of performance of a contract and not a certain type of contract act, the people's court shall determine the validity of such contract with prudence and, where necessary, it shall seek the opinion of the relevant legislative authority or seek instructions from the people's court immediately above.

VI. Reasonable application of the rule of the right of plea of unease and safeguarding the lawful rights and interests of rights holders

17. Under the present circumstances, with a view to procuring timely preservation of evidence by contracting parties that act in good faith and the effective protection of the legitimate and lawful rights and interests of rights holders, where a party has performed all of its delivery obligations and petitions for payment by the payee of an amount not yet due, despite the fact that the specified term for the payment thereof has not expired, but there is incontrovertible evidence showing that the payee has expressly indicated that it will not perform its payment obligation, or that the payee has had its business licence revoked or cancelled, has been closed down by the relevant authority or has ceased operations, or that the payee has diverted property or spirited funds away in order to avoid debts, or that the payee has forfeited its business reputation or that the payee has otherwise indicated by its behaviour that it will not perform its payment obligation, the people's court may, in keeping with the spirit of the first paragraph of Article 68, Article 69, Item (2) of Article 94, Article 108, Article 167, etc. of the Contract Law issue an order declaring the payment term expired or accelerating its expiration, unless the payee has provided appropriate security.