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.