Five FAQs when 'sealing the deal' in China

18 March 2019

Cross-border transactions, while bringing new and exciting opportunities for your business, can be challenging. When you have got to grips with the cultural nuances of negotiating tactics, there comes the matter of drafting your agreement; making sure you have taken into consideration laws and regulations of an often unfamiliar jurisdiction. Nevertheless, "dotting the i's and crossing the t's" with a party in China (or if you are a Chinese party, with an overseas party) does not need to be cumbersome. Ensure you are one step ahead by understanding the following five FAQs, dissected and de-mystified by our team of experts in our Guangzhou Representative Office.

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1. Does China have a concept of contractual "indemnity"?

No, in the People's Republic of China (PRC) there is no such thing as the concept of a contractual "indemnity". Including such a term in a contract can therefore be misleading both to Chinese parties and foreign parties who may expect different outcomes.

In simple terms, in English law, an indemnity clause is a provision whereby Party A is required, on the happening of a specified event (the 'trigger' event, which does not need to be a breach of contract), to pay money (either all losses caused by the trigger event or an agreed sum) to Party B. However, the precise operation of an indemnity clause depends on the terms of the contract.

For the receiving party, it can be preferable to include an indemnification clause in a contract, rather than relying on an award of damages for a breach of contract, because there is no requirement:

  1. to prove the fact or amount of loss;
  2. to show that the loss was caused by a breach - it is sufficient to show that loss was caused by the trigger event;
  3. to show that the receiving party took steps to mitigate its loss; or
  4. to consider remoteness of loss - indemnity clauses can be drafted so that even losses that are too remote to be recoverable as damages must be paid.

Effectively, the benefit for the party that is contractually indemnified is that an indemnity should increase the level of quantum recoverable. However, the actual level of recoverability will ultimately depend on the terms of the contract as indemnity clauses can be contractually limited.

If you are a Chinese party, you should note that the concept of an indemnity also exists in other jurisdictions, for example, in US, Canadian, Australian and Hong Kong law, but these jurisdictions may interpret the clause differently, so it is recommended to speak to an advisor in the relevant jurisdiction.

2. How does compensation in China work?

In China, compensation is paid when there has been a breach of contract. The innocent party is only required to prove loss if the amount of compensation has not been agreed in advance (i.e. liquidated damages). If the amount has been agreed in advance, there is no requirement to prove loss but the court, if asked to by either party, has the discretion to decide whether or not to reduce or increase this amount of compensation, taking into account a comprehensive list of factors, including the actual loss suffered. This is underpinned by the Chinese concept of contractual "fairness" i.e. that the contractual terms must be "fair" for all parties. If minimal loss is suffered, it would be unfair for the wrongdoer to pay an excessive amount and for the innocent party to profit from the breach of contract, so the court ultimately aims to strike a balance.

The court will adjust the final amount of payment based on a comparison between the agreed damages and the actual loss suffered by the innocent party. On this principle, if there is a breach of contract but no loss is suffered the Chinese court will make an assessment in the context of fairness to the parties. Therefore, even if there are liquidated damages agreed, a Chinese court has the discretion to override the language in the contract if it is deemed that the liquidated damages are too high when compared with the actual loss suffered.

In English law, where a contract has no contractual indemnity clause and does not expressly state a specified sum to be paid in the event of a breach of contract, the innocent party will need to rely on an award of damages for a breach of contract at common law. The underlying principle is similar to PRC law, with the purpose of an award of damages being to compensate the injured party for loss, rather than to punish the wrongdoer. Damages should place the innocent party in the same position they would have been in, or expected to be in, had the contract been performed.

3. What is direct/indirect loss in China?

Under English law, all damages for breach of contract are either direct or indirect (consequential).

  1. Direct loss means losses arising naturally as a result of the breach in the usual course of events. Direct loss is always recoverable as damages for breach of contract.
  2. Indirect loss (or consequential loss) means losses that do not arise naturally as a result of the breach in the usual course of events, but are likely to arise in special circumstances. These are only recoverable as damages for breach of contract if the paying party knew or should have known of the special circumstances at the time of entering into the contract. Otherwise, they are considered to be too remote.

PRC law does not have quite as distinct a concept when it comes to measuring remoteness of loss. Put simply, it is first necessary to determine the loss suffered. The wrongdoer shall compensate the innocent party for all losses suffered, including the benefits that the innocent party expected to receive had the contract been properly performed. However, the calculation of loss will never go beyond what the wrongdoer foresaw or should have foreseen at the time the wrongdoer signs the relevant contract.

4. What is meant by the term 'jurisdiction' in China?

In English law, the choice of jurisdiction in a contract can be exclusive or non-exclusive. It is important to understand the differences between these concepts. A non-exclusive jurisdiction clause expressly provides for disputes to be heard in the courts of a specific jurisdiction, but if it is appropriate, the parties may take a dispute to the courts of any other jurisdiction. An advantage of a non-exclusive jurisdiction clause is that there is an element of certainty as to the jurisdiction, but if the circumstances of the case mean it would be more suitable for the dispute to be heard elsewhere, this is still possible. A significant disadvantage is the increased risk of parallel proceedings.

It is important to remember that if you are entering into a contract where China is stated to have jurisdiction, you will need to be mindful that there is a further consideration when deciding jurisdiction. It means not only choosing which country's laws to submit to (territorial jurisdiction), but also deciding the appropriate location of the court within China itself.

In China, the parties have a choice of five courts where they can file an action in the event of a contractual dispute. However, selection of the court is limited by conditions, for example, the court must be at the appropriate level and the location must be either the defendant's domicile, the place of performance of the contract, the place of execution of the contract, the address of the claimant, the location of the subject matter, or a venue which is otherwise connected to the dispute.

In terms of applicable law, parties in a foreign-related contract may choose the applicable laws for their contracts. However, if there are mandatory rules that require it must be Chinese law to govern the application of foreign-related civil relations, for example, protection of employee rights or public health and safety, Chinese law shall be the only applicable law.

5. Does the contract have to be in Chinese?

No. In PRC law, there is no mandatory provision that a contract should only be written in Chinese. Further, PRC contract law stipulates that if a contract is formed in two or more languages and it is agreed that all versions will be equally effective, the courts will uphold this agreement.

If a contract is bilingual and there is no clause that either stipulates which language shall prevail, or that all versions have the same meaning, the Chinese version does not automatically prevail. If there are inconsistencies, the parties may submit the contract to a court or an arbitration tribunal to settle the issue and the contract will be interpreted based on the purpose of the contract.

Other than in rare cases where litigation is carried out in an autonomous region with its own language and where Chinese people are the minority, courts use Chinese as the language of litigation procedures. Readers must also note that there are several local authorities requesting documents purely in Chinese and they disregard English versions entirely.

In arbitration proceedings, parties enjoy more discretion than in litigation proceedings, for example, they are entitled to agree what language can be used in the arbitration process (compared with litigation whereby Chinese is the only language used in the proceedings, whether orally or written). If there is no such agreement on the language, the tribunal will decide on the language in which to proceed and this varies from one arbitration centre to another.


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