1 January 2021 was a significant date in the development of the Chinese legal system, as on that day the Civil Code of the People’s Republic of China came into effect and various laws including the Contract Law (for a discussion of the Civil Code and the recognition of customs, see China Business Law Journal, Volume 8, Issue 6: Custom and Law). In accordance with the principle that the law must not have retroactive effect, contract law continues to regulate legal acts that were taken before January 1, 2021. This is provided for in Articles 1 and 20 of the Certain Provisions of the Supreme People’s Court regarding the validity of the application of the Civil Code of the People’s Republic of China (adopted at the 1,821th session of the Supreme People’s Court Legal Committee on December 14, 2020).
Two topics are discussed in this column: the continued application of contract law in relation to contracts and contractual disputes; and the aforementioned provisions of the Civil Code relating to the interpretation of contracts.
Continuous application of contract law
According to the regulations, matters relating to the conclusion of contracts entered into before January 1, 2021 are governed by the Contracts Act. This applies subject to the exception in Article 8 of the provisions that in cases where the application of the Contract Act would invalidate the contract, but the application of the Civil Code would result in the validity of the contract, the Civil Code will apply.
Article 20 of the provisions provides that in cases where the performance of a contract concluded before January 1, 2021 is continued after January 1, 2021, disputes relating to the performance of the contract before January 1, 2021 are subject to contract law and the judicial interpretations of contract law and disputes about the fulfillment of the contract after January 1, 2021 are based on the relevant provisions of the German Civil Code.
Contract interpretation according to BGB
Articles 142 and 466 of the Civil Code regulate the interpretation of contracts and apply to the interpretation of all contracts subject to PRC law, regardless of whether they were concluded before or after January 1, 2021 Contract law. In order to understand how the new provisions on the interpretation of contracts clarify the previous position, it is necessary to compare the previous position under Article 125 of the Contracts Act with the new position under Articles 466 and 142 of the Civil Code.
Article 125 of the Treaty Law read as follows:
Article 125
In the event of a dispute between the parties about the understanding of a contractual clause, the true meaning of the clause is determined by the words and phrases used in the contract, the relevant contractual provisions, the purpose of the contract, business practices and the principle of good faith.
Articles 466 and 142 of the Civil Code have changed the position of Article 125 of the Contract Law as follows:
Article 466
In the event of a dispute between the parties about the understanding of a contractual clause, the meaning of the disputed clause is determined by the provisions of Article 142, paragraph 1 of this Act.
Article 142
If an expression of will is made towards another person, the true meaning of the clause, the meaning of the expressed will, is determined by the words and sentences used in the contract with reference to the relevant provisions of the contract, the nature and purpose of the civil law system, the business habit and the principle of good faith.
Some PRC legal scholars believe that Article 125 of the Treaty Law and the position under Articles 466 and 142 of the Civil Code are essentially the same. Others argue convincingly that the new position in the Civil Code includes substantive clarifications. The following three clarifications are relevant:
(1) First, the “meaning of the clause at issue” in Article 466 and the “meaning of the intention expressed” in Article 142 have replaced the “true meaning of the clause” in Article 125 of the Law on Treaties as the purpose of the interpretation of the treaty. While Article 125 of the Contract Law was primarily subjective in nature, emphasizing that the purpose of the contract interpretation was to determine the true will of the contracting parties at the time of the conclusion of the contract, the new provisions of the Civil Code are primarily objective and clarify that the The purpose of the contract interpretation is to determine the meaning of the disputed clause in terms of the “expressed intention”.
(2) Second, Art. 125 did not expressly prioritize the five methods of interpretation mentioned in the provision – namely the literal method (the words and phrases used in the treaty); the contextual method (“the relevant provisions in the contract”); the earmarked method (“contractual purpose”); the custom method (“Transaction Custom”); and the method of good faith (“Principle of Good Faith”). However, scholars have found that Article 125 sets the literal method as the starting point and have suggested that the order of priority be: first, the literal interpretation of the disputed clause; second, the contextual approach to the other relevant contractual clauses; and third, the purpose of the contract, business practices and the principle of good faith.
Art. 142 of the Civil Code, however, suggests that literal interpretation should take precedence and that other methods should be used if the literal interpretation cannot determine the meaning.
(3) Thirdly, Article 142 of the Civil Code also contains a reference to the “nature” of the contract in addition to the purpose of the contract. It follows that the disputed clause must be interpreted in relation to both the purpose and the nature (or nature) of the contract in order to bring the disputed clause into line with the basic nature of the contract.
Scientists have also suggested that the purpose of the Civil Code clarifications is to “protect and promote market transactions, limit judicial discretion and standardize the rules of judicial determination”. [This and the following quotes are taken from Tian Ye “The Amendment and Judicial Application of Contract Interpretation Rule in the Civil Code” (2020)]. The need to limit the judges’ discretion is particularly relevant when interpreting contracts in good faith. The following is an overview of each of the five methods of contract interpretation.
Literal method of interpretation
This method has been defined as “interpreting the words in the contract on the basis of the common understanding of the average person and in accordance with common elements such as grammar, syntax and meaning of words”.
Contextual method of interpretation
This method has been defined as “interpreting the disputed clause by incorporating it into the contract as a whole, linking it with the context and with reference to the other related clauses”.
The reference to “the context” – also referred to as “surrounding circumstances” – is generally understood to mean that it allows courts to consider extrinsic evidence such as pre-contractual correspondence and negotiation. Chinese law does not recognize the “probation” rule as it applies in common law jurisdictions. Instead, Chinese law follows the principle of “seeking the truth from facts,” which makes all relevant evidence admissible with regard to the will of the parties.
A recent Chinese case accepted the assumption that prior negotiations are part of the surrounding circumstances.
Targeted method of interpretation
This method has been defined as “interpreting the disputed clause in a way that aims to achieve the purpose of the contract”.
Tailored interpretation method
This method has been defined as “interpreting the disputed clause in accordance with factors such as business and transactional practices that were locally adopted by both parties at the time”.
Method of interpretation in good faith
This method has been defined as “requiring that the parties be honest and trustworthy in their transactions, emphasizing that the rights and obligations between the parties [should be] are broadly equivalent, fair and reasonable and require that the parties not harm the state, the public good or the interests of others ”. It seems to require an interpretation of the contract that is consistent with the interpretation of the contract by a person of good faith. The principle of good faith was enshrined in Article 6 of the Law on Contracts:
Article 6
The parties should respect the principle of good faith in the exercise of their rights and the performance of their obligations.
It is now reflected in Article 7 of the Civil Code:
Article 7
In carrying out any civil law activity, a civil law corporation should act in good faith, maintain honesty and honor obligations.
It has been recognized that the principle or duty of good faith is very broad. Given its wide scope, it has been argued that the principle of good faith should be used as a last resort in the interpretation of a contract.
It will be interesting to watch Chinese cases as they apply the provisions of the Civil Code regarding contract interpretation.
Andrew Godwin
A former partner of Linklaters Shanghai, Andrew Godwin teaches law at Melbourne Law School, Australia, where he is Associate Director of the Asian Law Center. Andrew is currently on secondment as Special Counsel to the ALRC to assist with its investigation into corporate and financial services regulation. Andrew’s new book is a compilation of the popular China Business Law Journal encyclopedia series titled China Lexicon: Defining and translation legal terms. The book is published by Vantage Asia and is available at www.vantageasia.com
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