Rules on contract validity under the People’s Republic of China Civil Code

Forest Li

King Pound Law Firm, Guangzhuo

lg@kingpound.com

Peter Lu

King Pound Law Firm, Guangzhuo

Introduction

The Civil Code of the People’s Republic of China (the ‘Civil Code’) took effect on 1 January 2021. It consolidates a number of civil laws, including the general principles of civil law, property law, contract law, guarantee law, family law, succession law, tort law and specific clauses in the judicial interpretations of the Supreme Court of the People’s Republic of China (SPC). Its purpose is to protect the lawful rights and interests of civil entities by establishing a comprehensive system of civil rights which encompasses property rights, contract rights and personal rights. At the same time, it intends to preserve social and economic order and core socialist values, with the principle that civil activities are conducted in accordance with the law and regulation and that the values of justice, integrity and fairness shall be respected in civil activities.

On 5 December 2023, the SPC promulgated the Interpretation on Several Issues Concerning the Application of the General Provisions of the Contract Part of the Civil Code of the People’s Republic of China (the ‘Interpretation’). The Interpretation entered into effect on the same day as its promulgation. Under the Interpretation, the SPC illustrated the concept and situations of Mandatory Provisions of Laws or Administrative Regulations and the Principle of Public Order and Good Morals.

This article will introduce the implications of the Interpretation which affect the rules of contract validity in regard to the violation of Mandatory Provisions of Laws or Administrative Regulations and Principle of Public Order and Good Morals.

Mandatory provisions of laws or administrative regulations

Mandatory provisions are legal provisions that use terms such as ‘must’, ‘should/shall’ and ‘cannot’, while legal provisions containing words such as ‘may’ or ‘have the right to’ do not fall within the category of mandatory provisions.

Before the Civil Code, ‘mandatory provisions’ referred exclusively to ‘mandatory provisions for validity’ and did not include ‘mandatory provisions for administration’, according to Article 14 of the Explanation by the Supreme Court on Certain Issues Concerning the Application of the Contract Law of the People’s Republic of China (No 2), which took effect on 13 May 2009. Generally, mandatory provisions are those related to financial security, market order and national macroeconomic policies; those prohibiting transactions involving human organs, drugs and guns; and those addressing violations related to the licensing of the specific activities, the transaction method and illegal trading venues.

As mentioned above, a contract that violates mandatory provisions is void. However, Article 16 of the Interpretation specifies that, if any of the following circumstances apply where the legislative purpose of the mandatory provisions can be achieved by holding the perpetrator administratively or criminally liable, the Court may, in accordance with the first paragraph of Article 153 of the Civil Code, can determine that the contract is not void even though it violates the mandatory provisions:

1. although such mandatory provisions aim to maintain public order, the actual performance of the contract has only an obviously minor impact on public order, and determining the contract invalid would lead to an unfair and unjust outcome;
2. such mandatory provisions are intended to protect the national interests such as taxes, land transfer fees and other national interests, or the legitimate interests of other civil subjects rather than the civil rights and interests of the contracting parties, and determining the contract valid will not hinder the achievement of the purpose of these provisions;
3. such mandatory provisions are aimed at requiring one of the parties to strengthen risk control, internal management, etc, while the other party lacks the ability or obligation to review whether the contract violates these mandatory provisions, and determining the contract invalid would unfairly burden the other party with adverse consequences;
4. although one party violates mandatory provisions at the time of contract formation and subsequently has the ability to rectify the violation, the party fails to do so, which contradicts the principle of good faith; and
5. other circumstances stipulated by laws and judicial interpretations.

Although Article 16 of the Interpretation provides an explanation and enumeration of circumstances where ‘violating the mandatory provision does not invalidate a contract’ in the Civil Code, these examples remain relatively broad. Judges still have significant discretion when adjudicating cases.

To help readers understand mandatory provisions better, the following are some examples of mandatory provisions that explicitly announce the invalidity of some civil activities for references:

1. Article 1007 of the Civil Code prohibits the sale or purchase of human cells, tissues, organs or bodies in any form. Any sale or purchase in violation of the preceding paragraph shall be invalid;
2. Article 39 of the Urban and Rural Planning Law of the People’s Republic of China stipulates that if zoning requirements are not incorporated into a contract for state-owned land use right, the contract for the use of state-owned land use rights shall be invalid; and
3. Article 31 of the Insurance Law of the People’s Republic of China stipulates that an insurance contract is void if the policyholder does not have an insurable interest in the insured.

In the case of Shanghai Zhuoshi Energy Technology Co Ltd v Quanzhou Lanrun Energy Technology Co Ltd for Franchise Contract Dispute,[1] the plaintiff, Lanrun Company, and the defendant, Zhuoshi Company, entered into the ‘Easy Fuelling Agreement’ on 28 May 2021. The agreement was aimed at utilising an internet information platform to provide smart delivery services to a large number of diesel users.

The Court held that Lanrun Company entered into the contract with the intention of using Zhuoshi Company’s network platform to acquire customer sales in the market; subsequently using its own refuelling trucks to provide diesel refuelling services to these customers. The refuelling trucks’ associated metering software would measure and charge for the fuel dispensed. Lanrun Company was engaged in the retail sale of petroleum products.

Article 183 of the Catalog of Administrative Approval Items for Administrative Licensing of Administrative Approval Items that Need to be Retained promulgated by the State Council stipulates that the approval of qualifications for the wholesale, storage and retail of petroleum products is required. Lanrun Company’s activities without obtaining the required approval and licence, disrupted the market order for the sale of petroleum products and posed safety hazards. Therefore, the court determined that Lanrun Company’s activities violated the mandatory provisions of the administrative regulations so that the contract was void.

Principle of public order and good morals

Article 17 of the Interpretation clarifies that a contract, although not violating mandatory provisions, shall be deemed void if it falls under any of the following circumstances that constitute a violation of the principle of public order and good morals:

1. contracts that have an impact on national security such as political security, economic security and military security;
2. contracts that affect social stability, fair competition or harm the public interests or disrupt the public order; and
3. contracts that deviate from social morality or family ethics, destroy personal dignity or otherwise violate customs.

The Interpretation further states that, when determining whether a contract violates public order and good morals, the Court shall uphold the core socialist values, take into account the motive and transaction purpose of the parties, the intensity of regulation by government departments, the frequency of similar transactions by the parties within a specified period, the social consequences of their acts, in addition to other factors and provide sufficient reasons in the adjudicative document. If, to suit their daily needs, the parties conduct a transaction that neither has a significant impact on the public order, nor affects national security, nor violates good morals, the Court shall not determine the contract to be invalid.

Just as the application of mandatory provisions, the definition of public order and good morals is still extremely vague and uncertain, giving the Court nearly unlimited discretion in how to determine the case. This necessitates further guidance from the SPC in future published cases.

In the case of Tunyan (Shanghai) Network Technology Co Ltd v Shanghai Huoyi Network Technology Co Ltd for Service Contract Dispute,[2] the plaintiff, Tunyan Company, sought payment of RMB 89,201.60 for services rendered in February 2021. The defendant, Huoyi Company, countered that Tunyan Company was an enterprise engaged in ‘faking’ online data, a practice of artificially inflating app rankings by fabricating download numbers. The promoted downloads did not originate from genuine users, leading to the removal of its game software from the Apple App Store’s rankings. Huoyi Company filed a counterclaim, demanding the return of its service fee of RMB 100,000 and compensation for damages of RMB 100,000.

The Court held that public order and good morals serve to balance individual and public interests, acting as a restriction on the freedom of contract principle and delineating the boundaries of party autonomy. Genuine network data plays a crucial role in the ecological environment of online operations and development, impacting consumer rights protection, the online operational environment, data and information security, and market order. These aspects are all intertwined with public order and good morals. The Court determined that the service contract which focused on ‘faking’ app rankings was void as it violated public order and the good morals principle. Consequently, all claims for the anticipated contractual benefits based on the agreement were turned down by the Court.

Conclusion

As mentioned above, the Civil Code aims to promote economic development and pursue social stability and upholds the fundamental principles of respecting freedom of contract. It will not arbitrarily interfere with the effectiveness of the contract or invalidate the contracts between parties. In special circumstances, to balance the interests of the parties, one party is granted by the Civil Code with the right to revoke a contract which does not serve his/her best interest. Furthermore, when the party without the capacity, with false intent or enters into a contract in violation of the mandatory provision of laws and regulations, or offending the public order and good morals, the validity of the contract will be destroyed.

As a lawyer, I recommend that my clients and staff keep in mind the following when drafting, reviewing and commenting on a contract in China:

1. they use the comprehensive template for drafting a contract in commercial projects, which includes the clauses stipulated by the Civil Code and the clauses of definition, breach of contract, dispute settlement, governing law, notice, language and validity. The comprehensive clauses will be critical the dispute settlement;
2. the contract must provide for the rights and obligations of each party in a fair and equal manner. It cannot exempt one party from liability, exclude the rights of the other party, or impose unreasonable restrictions. Standard form contracts, especially the exemption clauses and special clauses, must be strictly reviewed and must be given particular notice to the other party; and 
3. the main clause of the contract shall not violate mandatory provisions of laws and regulations. A professional lawyer is required to search for the mandatory provisions of laws and regulations and review the main clause of the contract to determine whether it violates the mandatory provisions of laws and regulations or violates the rules of public order and good morals.

When we follow these tips in drafting and reviewing a contract, we can provide with comprehensive protection to interests in China.[3]