Welcome help for foreign companies

Section I of the Guiding Opinion further clarifies the distinction between:

• mere “commercial risks”, which are inherent in business activities; and
• a genuine material change of circumstances, which is unforeseeable and not inherent in the market system.

It is clear that the SPC seeks to impose a more disciplined regime and will strictly examine any claim that a change is unforeseeable. On balance, therefore, although concerns remain over how courts and tribunals will apply this doctrine, the Guiding Opinion is a much welcomed first step in providing further guidance on this doctrine.

Upholding liquidated damage clauses
The Contract Law allows courts to adjust the amount of liquidated damages agreed upon by the parties, where such an amount is considered to be “excessively higher” or lower than the actual loss suffered by the innocent party.

This power has long been the subject of controversy among foreign parties, not least because of the difficulty in predicting when the courts would intervene and what benchmark would be used to determine the appropriate level of liquidated damages.

In the Interpretation, the SPC sought to clarify the situation by listing a few factors which courts will take into account and setting out the general principle that where the agreed liquidated damages are more than 30% higher than the actual loss, it will be regarded as being “excessively high”. There has been concern over whether the 30% benchmark was unduly rigid, however.

Section II of the Guiding Opinion addresses this concern by clarifying that the indiscriminate adoption of a fixed percentage or other one size fits all approach should be avoided. It elaborates on the factors which courts will take into account in deciding whether to interfere with the agreed liquidated damages, such as the relative market power of the parties and whether standard form contracts have been used.

The Guiding Opinion, like the Interpretation, focuses only on when excessively high liquidated damages will be reduced. It does not clearly deal with the converse situation, which is when the SPC intervenes to increase the amount of liquidated damages, if it is lower than the actual loss suffered by the innocent party.

Guidance on recovering loss of profits
The Contract Law recognises that if a party breaches a contract, the innocent party can recover damages equal to the loss arising from the breach, including the loss of anticipated profits suffered by the innocent party. Damages may not exceed the loss which the defaulting party foresaw or ought to have foreseen as a possible consequence of breach, at the time it entered into the contract. The Contract Law provides limited guidance on how such profits are calculated, however.

Section III of the Guiding Opinion addresses in greater detail how anticipated profits are calculated. It stipulates that the courts should consider all relevant factors and exclude losses which are “inappropriately expanded” by the innocent party, benefits that the innocent party obtained due to the breach, and losses caused by the negligence of the innocent party.

Agency and apparent authority
In the PRC, it is fairly common for there to be disputes over whether and when an agent is authorised to act on behalf of its principal. The Guiding Opinion provides helpful clarification on the principle of “agency by estoppel” (or apparent authority). Under the Contract Law, where an agent enters into a contract without authority from its principal, and the counterparty reasonably believes that the agent is authorised to do so, the resulting contract is deemed to be valid.

Section IV of the Guiding Opinion elaborates on this, clarifying that for a contract to be binding on the principal, the agent must:

• (objectively) appear to have the authority for its actions; and
• the counterparty, when entering into the contract, has to act in good faith and has to (subjectively) believe that the agent was authorised.

Courts need to consider all relevant factors surrounding the formation and performance of the contract and decide whether the counterparty has taken due care in entering into it. This guidance should give parties greater certainty over when they may rely on an agent as having been authorised by its principal.

Mandatory rules of law
The Contract Law stipulates that a contract is void if it violates mandatory rules of law or regulations. On its face, the effect of this provision is very broad, potentially striking down a wide range of contracts for violation of any mandatory rule. In developing jurisdictions such as the PRC, this is of some concern since parties sometimes inadvertently fall foul of mandatory rules, with no intention of doing so.

The Interpretation and the Guiding Opinion provide useful guidance on the true scope of this provision. The position is that not all mandatory rules, if violated, will render a contract void. Where the rule specifically provides that this is the case, then a contract that violates such a rule will be invalid. If a mandatory rule is silent on this, the court has a discretion to decide whether a contract is thereby rendered void.

Section V of the Guiding Opinion further distinguishes between:

• mandatory rules that impact on the formation of a contract; and
• mandatory rules that merely regulate the capacity of a party to enter into a contract or the manner of performance of a contract.

In the former case, if the performance of the contract would harm state or public interests, the contract is void. In the latter case, the contract is not void per se but courts have discretion to decide on its validity. In these circumstances, courts are to exercise their discretion with caution, and should seek the views of the legislative authorities or a superior court where necessary.

The SPC's recognition that not all breaches of a mandatory rule will render a contract void is in line with accepted international practice, and indicates the importance the court places upon contractual certainty.

Anticipatory breach
In order to protect the interests of parties who have performed their contractual obligations, Section VI of the Guiding Opinion provides that where a party has fulfilled all its obligations, and there is strong evidence suggesting that its counterparty will fail or refuse to perform its payment obligation, the court may bring forward the deadline for payment, or order that payment be due immediately.

Examples of such situations include where the payee has expressly indicated that it will not perform its payment obligation, has diverted property or spirited funds away to evade debts, or has forfeited its goodwill.

While this provides some helpful guidance to the parties, it remains to be seen how effective the guidance will be in practice, and whether it will offer a meaningful remedy to the innocent party before the contractual due date for performance.

Valuable assistance
The Guiding Opinion is likely to be particularly helpful for foreign parties. First, it provides guidance on PRC legal concepts, some of which are novel under their own legal systems. Secondly, it has been common practice for foreign parties in the PRC to use precedents prepared under a different legal system (typically, under a common law system such as Hong Kong, England or the US) and to adapt these for use in the PRC without carefully tailoring them to the local legal and regulatory system, even where the contracts are governed by PRC law. By providing relatively clear guidelines, the Guiding Opinion will encourage foreign parties to take them into account in how they draft and structure their contracts, to anticipate disputes which may arise in the future.

Although gaps remain, the Guiding Opinion provides useful insights as to how PRC law deals with a number of fundamental concepts, even as it also suggests an increasing desire and confidence by mainland China to develop its own indigenous legal system.

Peter Yuen and John Choong, Freshfields Bruckhaus Deringer