Contract termination in the Civil Code - CWG

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Myles Seto
Deacons, Hong Kong
myles.seto@deacons.com

Hayley Li
Deacons, Hong Kong
hayley.li@deacons.com

 

On 28 May 2020, the National People’s Congress of the People’s Republic of China approved The Civil Code of the People’s Republic of China (the 'Civil Code'). The Civil Code will come into force on 1 January 2021. From the basis of the Contract Law of the People’s Republic of China (the 'Contract Law'), the ‘contract section of the Civil Code’ makes various modification in the law regarding contract termination. This article focuses primarily on: (1) the peremption period for exercising the right of termination; (2) the time of termination of a contract through litigation or arbitration; and (3) the right to terminate by a defaulting party.

The peremption for exercising the right of termination

According to Article 199 of the Civil Code:

‘ […] the duration of such rights as the right of revocation or termination, etc stipulated by law or agreed to by the parties shall be calculated from the date when a party entitled to such right knows or ought to have known that such right has accrued […] Upon the expiration of the duration, the right of revocation, the right of termination and other rights shall be extinguished.’

Article 95 of the Contract Law stipulates that in case of a failure by a party to exercise the right to terminate a contract at the end of the period prescribed by the contract for doing so, the said right shall be extinguished. However, it does not specifically prescribe for the peremption of the right of termination, which therefore, results in the absence of uniform rules governing peremption in contract termination in judicial practice.

In previous contract disputes, judges would usually cite Article 15 of the Interpretation of the Supreme People’s Court on Several Issues Concerning the Application of Law in the Hearing of Cases Regarding Disputes over Contracts of Commercial House Transaction as references:

‘If the other party fails to demand, the right of termination shall be exercisable within one year from the date of accrual of the right to terminate, and the right of termination shall be extinguished if it is not exercised within the time limit.’

By the same analogy, the peremption period of one year applies. Nevertheless, due to the differences between different types of contract, there are many cases where judges could not directly apply the one-year peremption applicable to real estate transaction contracts, resulting in a major difference in judgments on this issue.

To solve the problem, Article 564 of the Civil Code stipulates that:

‘[…] where the law does not stipulate or the parties have not agreed upon the time limit for exercising the right to terminate a contract, the right shall be extinguished if no party exercises such right within one year from the date on which the party is entitled to terminate knows or ought to have known the cause for termination, or fails to exercise such right within a reasonable period of time after being demanded to do so by the other party.’

Therefore, it is clear that the peremption period applicable to the right of contract termination is one year, which amalgamates the adjudication rules, provides clear legal guidance for judicial practice, and avoids differentiating treatments between different types of contracts on the issue.

The time of termination when the contract is terminated by litigation or arbitration

Among other methods, a contract can be terminated by notice, commencement of litigation or application for arbitration. In terms of termination by notice, the time of termination is when the notice reaches the other party, whereas in the case of termination, by commencement of litigation or application for arbitration, the time of termination was not stipulated before the Civil Code was issued. In judicial practice, there are two ways for identifying the time of termination: when a copy of the complaint or arbitration application is served on the other party; and, the date on which the judgment or arbitration award takes effect. The Civil Code adopts the first method of identification, which is the same as that stipulated in Article 48 of the Ninth Civil Conference Minutes (the 'Consultation Draft'). This method emphasises that the right to terminate is, by nature, a right exercised by the party, and clarifies that the court or arbitration institution’s examination of a party’s termination action is ‘confirmation’ rather than ‘adjudication’. Therefore, when a contract is terminated by commencement of litigation or application for arbitration, the time of termination is ‘when a copy of the complaint or a copy of the arbitration application is served on the other party’, thereby clarifying the controversies in judicial practice.

The defaulting party’s right to terminate the contract

Article 110 of the Contract Law provides for situations where a defaulting contractual party will not be required to continue to perform its non-monetary obligations under the contract, and therefore, it is a defence for a defaulting party but not a right to terminate a contract. In judicial practice, a non-defaulting party often requests the continual performance of the non-monetary obligations, but the defaulting party invokes the said defence, rendering the non-monetary obligations unperformed – the contract could not be terminated, and the parties end up in a deadlock. To avoid this scenario from happening, the Consultation Draft proposed a concept of the right of a defaulting party to terminate the contract, but without mentioning the responsibility for its breach of contract. Article 580, of the Civil Code stipulates that ‘the parties’ can request termination of the contract which term should properly be understood to include a defaulting party, thereby conferring the right to terminate on the defaulting party, while upholding its liability for breach of contract. It should be noted that such a termination right for a defaulting party shall only apply for non-performance of non-monetary obligations, and the right must be exercised through the court or arbitration institutions, and cannot be brought about by statutory means or by agreement. This new provision of the Civil Code is conducive to resolving the contractual deadlock based on the principle of good faith, facilitating a ‘win-win’ situation for the parties.

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