Tuesday, June 5, 2007

Freedom of Contract in China: Not So Fast Yet

Freedom of contract plays a crucial rule in most commercial activities, and the basic idea is that both parties get the benefit of their bargain in exchange for the imposed contractual duties. Simply put, you “pay” for what you bargained for in the contract. In order for this basic form of commercial tool to work effectively and efficiently, the parties to the contract must have the freedom to decide what is good and bad for itself, free of other interferences and influences.

However, things do not work 100% well in reality. In the United States, courts sometime step in to declare certain terms and provisions null and void because the enforcement of which violates equity, fairness, or public policy in general. A detailed discussion of this topic is beyond the scope of this post.

In the same vein, contracts can be under scrutiny in China, thus being subject to governmental, administrative interference under the umbrella of consumer rights protection.

For example, the City of Shanghai enacted a municipal statute on July 13, 2000. (ordinance)—Regulations on the Supervision of Contract Terms and Provisions. (上海市合同格式条款监督条例) Similarly in Beijing, the Municipal Administration of Industry and Commerce issued an administrative order, which was blessed by the city government. Titled Circular Regarding Intensifying the Supervision of Contract Terms and Provisions, the order resembles the Shanghai statute. (关于加强北京市合同监督管理若干意见的通知) Hereafter, I refer to the above-mentioned municipal rules as “orders.”

According to the Orders, the following terms and provisions are per se illegal:

A. Terms and provisions that shield the drafting party from the following liability:

1. Liability arising out of personal injury to consumers;
2. Liability arising out of damages to consumer’s property due to intentional tort or gross negligence;
3. Warranty liability provided to consumers along with sale of products or services;
4. Liability due to the drafting party’s breach of contract;
5. Other liabilities under the law due to the drafting party’s breach of contract

B. Terms and provisions that increase consumers’ liability:

1. Unreasonable amount of liquidated damages or contractual damages;
2. Responsibility of operational risks that rightfully belong to the drafting party;
3. Other terms or provisions that unlawfully increase consumers’ liability

C. Terms and provisions that extinguish the following consumers’ rights:

1. The right to lawfully amend or rescind the contract;
2. The right to demand liquidated damages or actual damages;
3. To exercise the right of contract interpretation;
4. The right to litigate in the event of a dispute.
5. Any other consumers’ rights guaranteed under the law.

As a consumer, I am not against the protection of consumer rights. But the pervasive hand-on, in-you-face type of governmental interference in the contractual process, in my humble opinion, is an affront to the basic idea of freedom of contract. Even if there are instances of fraud, unfair contractual practices, governmental interference, like the Orders, is arguably not the most efficient means of correction, and I’d argue that the market itself is in the long term, which includes the consumers at large in a burgeoning market economy.

As a lawyer friend always says:"A litigation lawyer would die for a good argument." However true that might be, the reality of doing deals in China, especially in two of China's largest and important cities Beijing & Shanghai, demands foreign and domestic companies alike to draft contracts carefully so as to avoid the contracts being deemed void.


JG said...

A very interesting post. I am left wondering, though, whether the Chinese government is really doing anything out of the ordinary here.

Even in a classically liberal common law jurisdiction such as England, immense restrictions on parties' freedom to agree contractual terms between themselves arise from the common law itself (for example, the prohibition on punitive liquidated damages clauses). Add to that the Unfair Contractual Terms Act (prohibition on certain exclusions of liability), and specific regulations designed to prevent parties contracting on their own standard terms & conditions abusing their bargaining strength (such as the slew of consumer protection legislation) and many of the terms prohibited by the Orders are off-limits to an entity contracting with consumers here as well.

I should be very interested to know the position in other jurisdictions - how free are parties really to agree terms between themselves in, say, the various US states, in France, in Australia, in India?

One final question - can illegal provisions be severed in China, or would these forbidden terms contaminate the entire contract they appear in?

Brad Luo said...


First,if your alias gives away anything factual, I LOVE beef too, may be too much for my heart doctor to stomach.

Second, I hope my 06/06/07 post answers your "final question" in the comment.

Your point about "whether the Chnese government is doing anything out of the ordinary here" is well taken. The Contract Law of P.R.China is fairly clear, limiting the scope of state intrusions into private contracts. However, the local rules are what really concerns me. I will blog about some pretty intrusive municipal executive actions targeting contractual freedeem on 06/07/07.

Third, I hope to continue the discussion about freedom of contract in other jurisdictions. Cntract law is largely state law in the United States, so the state courts and federal courts applying federal law in accordance with the Eerie doctrine are all over the map. Very often courts look to equity for a fair outcome. A thorough analysis of this will take some time, but I am definitely interested furthering my research into this area.

Thanks for visiting and commenting!

Stay tuned.