The processing mechanism of default party suing for dissolution of contract in China during Covid-19

Chenyu Zhang
AllBright, Shanghai
zhangchenyu@allbrightlaw.com

The people's Court of Yuecheng District, Shaoxing City, Zhejiang Province, recently tried a case concerning a leasing contract dispute that occurred during the pandemic of Covid-19. This case reflects the negative impact of the pandemic on social life and China’s response mechanism to it.

The plaintiff, Pan, signed a house leasing contract with the defendant, Tang, in April 2019, and agreed in the contract that Pan rented the house from Tang for selling daily necessities and cosmetics. The leasing period was from April 2019 to April 2022. After the establishment of the contract, Pan paid the rent fee from April 2019 to April 2020 and obtained the business licence. On 20 March 2020, Pan sued for termination of the house leasing contract (from 2 March 2020) between the two parties. The main reason was that the pandemic was too serious to continue the business operation. According to Article 94 of the Contract of Law of the People’s Republic of China, one of the parties may dissolve the contract prior to the expiration of the period of performance if the other party expressly states, or indicates through its conduct, that it will not perform its major obligation. The court finally rejected the plaintiff’s claim. The reason for the judgment is as follows: although Covid-19 constitutes a kind of force majeure and caused the plaintiff’s business to stagnate for a period of time, all industries have resumed work and production in current stage and so could the plaintiff. This pandemic did not reach the point where the plaintiff’s contractual purpose could not be achieved, and he could still use the house involved to run the business. Therefore, it did not comply with Article 94 of the Contract Law to dissolve the contract.

In the above case, what the plaintiff (Pan) faced is a common dilemma encountered by business operators not only in China but also worldwide; that is, tenants do face the objective fact of running a business with difficulty under the impact of Covid-19. At this time, the request of a tenant, namely the party in breach, to terminate the leasing contract has become a difficult problem in judicial practice worldwide. China, as one of the first countries affected by Covid-19, has already explored a set of coping mechanisms.

In fact, before Covid-19, this kind of case had already appeared sporadically in Chinese judicial practice. As the careless handling of these cases is very likely to cause contract deadlock, which is unfavourable to both parties’ rights and interests, the request of the defaulting party to terminate the leasing contract has become a sensitive issue in justice. In the past, Chinese law did not have clear regulations on this issue, which led to the fact that the judicial practice could only proceed from legal principles to balance the interests of the parties. However, the lack of specific clauses in the Contract Law as a basis makes the judgment unconvincing. The Minutes of the National Courts' Civil and Commercial Trial Work Conference and Civil Code have filled this gap. These two regulations both recognise that the breaching party has the right to judicially terminate the contract to avoid the deadlock. At the same time, the recognition of the right of the defaulting party to terminate the contract does not mean ignoring the protection of lawful rights of the observant party. The breaching party shall compensate the observant party in strict accordance with the liability for breach of contract stipulated in the contract.

The emergence of the Minutes of the National Courts Civil and Commercial Trial Work Conference and Civil Code provides a certain legal basis for the request of the default party to terminate the contract. However, it is not fully applicable to the actual condition in which China strives to resume work and production as well as restore economic construction under Covid-19. To this end, the Supreme People’s Court proposed new guidelines:

1. Notice of the Supreme People's Court on Promulgation of the Guiding Opinions on Several Issues Concerning the Proper Hearing of Civil Cases Involving the Covid-19 Epidemic (I):

If the epidemic situation or the epidemic prevention and control measures only lead to difficulties in the performance of the contract, the parties concerned may renegotiate; if continuous performance is possible, the people's court shall effectively strengthen mediation and actively guide the parties concerned to continue the performance. Where a party requests rescission of a contract citing difficulty in performance of the contract, the people's court shall not support the request. Where the continued performance of a contract is evidently unfair to a party concerned, and the party concerned requests for change of contract performance period, performance method, price amount, etc, the people’s court shall decide whether to support the request, taking into account the actual conditions of the case. Upon amendment of a contract pursuant to the law, where a party concerned still asserts partial or full waiver of liability, the people's court shall not support the assertion. In the case that the objectives of a contract cannot be achieved due to epidemics or the epidemic prevention and control measures, and a party concerned requests for rescission of the contract, the people's court shall support the request.

2. Notice of the Supreme People's Court on Promulgation of the Guiding Opinions on Several Issues Concerning the Lawful and Proper Trial of Civil Cases Involving the Covid-19 Epidemic (II):

Where the epidemic situation or epidemic prevention and control measures result in failure of a party to perform the sales contract within the agreed time limit or increase in performance costs, and the continued performance will not affect the realisation of the purpose of the contract, if the party requests for rescission of the contract, the people's court shall not uphold such request.

Given the judgement of the People’s Court of Yuecheng District, it is not difficult to find that in Chinese judicial practice it is, indeed, aimed at the resumption of work and production of the whole society and it takes the continuous performance of contract as principle. Only when the purposes of the contract cannot be realised will the court support the termination of a contract. Among the reasons of judgment of the People’s Court of Yuecheng District, another issue worth noticing is the determination of force majeure. In reality, many parties in breach claim the pandemic to be force majeure when suing, and they request to terminate the contract grounded on Article 94 of the Contract Law (‘it is rendered impossible to achieve the purpose of contract due to an event of force majeure’). This leads to two problems in judicial practice: one is whether the pandemic could be deemed as force majeure and the other is whether this force majeure makes the purposes of contract impossible to realise.

Force majeure refers to unforeseeable, unavoidable and insurmountable objective circumstances.^[1] Covid-19 and its precaution and control measures are sudden and hard to foresee for ordinary people, which meet the general characteristics of force majeure. Therefore, the pandemic of Covid-19 and its precaution and control measures should be classified as force majeure. In judicial practice, the courts also identify the pandemic as force majeure. However, even if the courts do deem the pandemic as force majeure, it does not mean that the party in breach could terminate the leasing contract according to Article 94 of the Contract Law. It is only when the pandemic has an actual impact on the performance of a contract, that is, there is causal relationship between the pandemic and the inability to perform a contract and thus the purposes of contract cannot be realised that the contract may be terminated. This is also the reason why the court tried the party in breach to lose the lawsuit in the above case. Although the pandemic makes the breaching party run its business with difficulty, it is far from the point where the purposes of the contract cannot be realised.

In the handling mechanism of the breaching party’s request to terminate the contract during the period of a pandemic, another highlight is to balance the interests of both parties while maintaining the validity of the contract as much as possible. For example, in the above case, the defendant’s counterclaim to ask the plaintiff for the overdue payment was rejected by the court. The Supreme People’s Court requires the court to strengthen the mediation role, ‘if the tenant’s request for rent reduction or exemption, extension of the lease term or postponement of rent payment, the People’s Court may guide the parties concerned to mediate by reference to the policies regarding rent reduction and exemption; if the mediation fails, the contract shall be modified based on the principle of fairness, in line with the actual situation of the case’.^[2] It is also the same way in judicial practice. Taking commercial housing as an example, if the tenant is unable to use the house because of the pandemic and requests to reduce rents, the court would also support this request. This reflects the implementation of the principle of fairness in Chinese judicial practice. The courts shall avoid unnecessary losses of the interests of parties while persisting on the resumption of work and production.

Considering the Covid-19 pandemic is still ongoing, the restoration of economic order has become a top priority. In China’s judicial practice, it is very prudent to deal with the request of the party in breach to terminate the leasing contract. To maintain the validity of contract and making the contracts continue to perform if possible is the court’s primary operation in practice. But when the pandemic makes it impossible to realise the purposes of a contract, the court will also support the termination of a contract as well as strengthen the mediation function and taking the interests of the parties into account, which reflects the principle and flexibility of Chinese justice in practice, reaching the unity of legal and social effects.