Should Chinese Contract Law Stipulate the Doctrine of Changed Circumstances

2012-02-24 21:36:19

                                                                                                               By Linchang Shen

 

ⅠIntroduction

In 1999, the top legislature of China merged the previous three contract laws and enacted an integrated contract law code—the Contract Law; the Contract Law does not stipulate the doctrine of discharge by changed circumstances. However, such a doctrine had been included in the 3^rd, 4^th and 5^th draft of the bill of the Contract Law. Even though after the promulgation of the Contract Law, there exist heated debates among Chinese legal scholars and judiciary about whether Chinese contract law should include the doctrine. It is well known that the law has several values, such as fairness, stability, and so on. Nonetheless, each value of the law are not always compatible with the others, for example, in the issue in question, the certainty and sanctity of contract is one of the most important values of contract law, whereas in some special situations, for example, due to changed circumstances, if sticking to the principle of abiding by the contract the value of fairness of the law could be undermined, the two values of law are in contradiction, the law has to pick up only one value. In fact, the core of the disputes between the proponents and opponents is how to balance the two different values: the certainty and sanctity of contract and the substantial fairness in an individual case, namely, which value should be preferred. Therefore, in the issue in question, which opinion about changed circumstances is right is judged by how to properly balance the two conflicting values in the context of Chinese current situation. Undoubtedly, it is quite helpful to study the judicial practices in other jurisdictions, especially in developed countries as well as the international instruments about commercial contract. In this essay, I will research how developed market economies (industrial countries) deal with the conflict of the two values of law----certainty and individual fairness; and then I will study CISG and PICC to find out how they handle the issues arising from supervening events in international level. Combining with analyzing the status quo of both the development of market economy and the quality of the judiciary in China, I will conclude that it is proper for the Contract Law to exclude the doctrine of discharge by changed circumstances.

 

Ⅱ.The doctrine and the Chinese contract law legislations

Since 1978, China has been witnessing the great transition from plan economy to market economy. Needless to say, contract law is one of the most important laws to regulate the market economy. The Economic Contract Law, the Economic Contract Containing Foreign Elements Law, and the Technology Transfer Law were enacted respectively in 1981,1985, and 1987. In 1993, the Amendment of the Constitution of People’s Republic of China officially declared that China implements socialist market economy system. From 1993, the People’s Congress began considering to enact an integrated contract law code to substitute for three separate and conflicting contract laws in order to adapt the development of the market economy. In 1999, the Congress consolidated the previous three contract laws in a new contract law code—the Contract Law. Besides contract laws, the General Principles of Civil Law enacted in 1986 deals with the contract relationship. Both the General Principles of Civil Law and the contract laws do not include the doctrine of discharge by changed circumstances. However, there have existed some judgments applying this doctrine to adapt the contract to the changed economic circumstances, especially due to the sharp currency inflation in the early 1990s.

During the legislation of the Contract Law, some legal scholars and judicial officials suggested new contract law should follow the international trend to incorporate the doctrine of changed circumstances. Actually, from 3^rd to 5^th draft of the bill of the Contract Law the doctrine had been included. In the third draft, article 55, chapter 4 states that (Zhaodong, 2001),

After the contract becomes effective, if the changed circumstances not caused by both parties make the performance of the contract become apparently unfair to one party, the party is entitled to request the other party to renegotiate the contract, if the both parties cannot achieve an new agreement through renegotiation, the party may ask the court or arbitrator to alter or avoid the contract.

The fourth draft revised the provision in third draft. In the fourth draft, article 52, chapter 4 stipulates (Zhaodong, 2001),

Except force majeure, if due to unanticipatable, unavoidable materially changed circumstances, the performance becomes apparently unfair, the party is entitled to ask the court or arbitrator to alter or avoid the contract.

The 5^th and also the last draft of the bill of the Contract Lawrevised again the relevant provision in 3^rd draft. Article 77,chapter 4 reads (Zhaodong, 2001),

        If due to significant changes of state economical policy, social economy and other objective circumstances, the performance of the contract becomes meaningless or entail enormous loss to one party, such change cannot be anticipated when entering into contract and solved by a party, the disadvantaged party is entitled to the other party renegotiate the contract; upon the failure of renegotiation, the disadvantaged party may ask the court or the arbitrator to adapt or terminate the contract.

In March 15^th, 1999; the bill of the Contract Law was passed on in the second session of 9^th People’s Congress. However, the doctrine of changed circumstances was excluded from the law. The reason is quite simple: the legislators just worried about that the negative effect of inclusion such a doctrine maybe overweighs the positive effect. The Report about the Review of the Draft of the Contract Law presented by the Law Committee of People’s Congress stated clearly[2],

…3. About the doctrine of changed circumstances. This is very complicated issue, and during the drafting process, there existed different views. Many representatives argue that it is very difficult to define the doctrine properly, and is very difficult to differentiate from the force majeure, and the application of this doctrine is very sophisticated. In fact, only in some extremely special situations can this doctrine be applied, it is premature to include such a doctrine. The Law Committee, basing on thorough study, suggests that such a doctrine should be excluded from the contract law…

Indeed, why the legislators refused the doctrine of changed circumstances, just as professor Liang Huixing commented[3], lies in that the legislature distrust the judiciary in China. Are the legislators proper to exclude the popular doctrine in almost every jurisdiction?

 

Ⅲ. How changed circumstances are dealt with in other countries and in CISG and PICC

A. Civil law jurisdictions

To China, the doctrine of changed circumstances is an extraneous rule of law, and it is said the theory and the terminology of the doctrine were imported from Germany. Therefore, it is necessary to study how German law handles the effects of the changed circumstances. The legislators of the German BGB (the civil code) initially contemplated but then rejected the idea of a general rule that every contract contains an implied condition that it only remains effective so long as the essential circumstances existing at the time the parties entered into the contract have not fundamentally changed (Wolfgang Kotzur , 1998). The commission, which revised the draft BGB stated that ‘ this doctrine endangers the security of commerce’ and that ‘it might obscure the distinction between condition and motive and induce lawyers to give mistaken weight to the effect of a motive not incorporated in the contract’ (Konrad Aweigert & Hein Kotz, 1998). However, the unforeseen effects of the First World War and the following hyperinflation demonstrated the inadequacy of traditional impossibility provisions in dealing with the multitude of problem cases that did arise where performance was not impossible but ensnared by so many difficulties that it seemed unjust to require the parties to continue to perform their obligation (Wolfgang Kotzur, 1998). In addition, the  courts had been left in the lurch by the legislature, they had to work out equitable solution on their own (Konrad Aweigert & Hein Kotz; 1998, p.520).The courts responded at first with commendable creativity by extending the BGB's impossibility provisions(§275) to situations where performance is so fraught with difficulties that members of the relevant business circle would consider it equal to impossibility (economic impossibility) (Wolfgang Kotzur; 1998, p.345-347). After the First World War, the courts adopted a new doctrine called ‘disappearance of the foundation of the contract’. This is concerned with the parties' expectations in respect of certain circumstances existing at the time of execution. if their will to enter into the contract depends upon some circumstances, a subsequent major change in those circumstances might then cause the contract's foundation to disappear (Wolfgang Kotzur;1998, p.345-347). The doctrine is based on § 242 BGB, which stipulate that a party must perform its obligations in good faith (Wolfgang Kotzur;1998, p.345-347). The Germany Supreme Court stressed that in the last resort the critical thing was ‘applying the standard of good faith to the circumstances of the individual case. The defense applies only…if and in so far as the result flowing from strict adherence to the contract would be intolerable for the debtor in view of the new situation’ (Konrad Aweigert & Hein Kotz, 1998; 524).

Just as discussed above, the doctrine ‘disappearance of foundation of the contract’ is not a provision of German civil law code BGB; The doctrine was just developed by the judicial sector through broad interpretation of § 242 BGB good faith provision to deal with special situation in Germany especially due to the two world wars. Additionally, in the view of the German Supreme Court, only ‘the result flowing from strict adherence to the contract would be intolerable for the debtor in view of new situation’ can the disadvantaged parties adapt or terminate the contract. Therefore, it is quite difficult to succeed to discharge the obligation of the contract by the doctrine due to changed circumstances.

The French courts are extremely chary of the defense that changed circumstances have rendered performance much more difficult, and treat an obstacle to performance as releasing a party only if it is an unforeseeable event, not attributable to the debtor, which causes it quite impossible to perform the contract for the duration. Only where the impediment, of itself, constitutes force majeure can it discharge the disadvantaged party (Konrad Aweigert & Hein Kotz;1998,p.525).

It is in a series of decisions around the middle of the 19^th century that the views of the Court of Cassation were established (Konrad Aweigert & Hein Kotz; 1998, p.525).In the case (Civ.9 Jan.1856, DP 1856.Ⅰ.35), the Court of Cassation tersely observed that ‘ this was not a case of absolute impossibility of performance’ and quashed the decisions of lower courts which had rescinded the contracts due to changed circumstances (Konrad Aweigert & Hein Kotz;1998, p.525-526) . Later, the Court quashed a decision delivered by the Court of Appeal at Aix (Civ.6 March.1876, DP 1876.Ⅰ.197); in this case the Court of Cassation once again encapsulated its views in the formula ‘that, however equitable their decision might seem, tribunals must never use lapse of time or other circumstances in order to modify the agreements of parties and substitute new clauses for those which were freely accepted by the parties themselves’ (Konrad Aweigert & Hein Kotz; 1998,p. 526) .

After the first world war the inflexibility of the courts induced French legal scholars to make all manner of attempts to render a change of circumstances legally relevant one way or another, under the comprehensive heading of ‘imprevision’, and the lower courts in France occasionally followed those theories conceived by the legal scholars, however, the Court of Cassation held rigidly to its previous view (Konrad Aweigert & Hein Kotz;1998, p.525) .

Nonetheless, the highest administrative court in France, by contrast, proved readier to adapt contracts to changed circumstances (Konrad Aweigert & Hein Kotz; 1998, p.526). The reason for such decisions is the public interest in the continuance of contracts, which are essential to the orderly conduct of public life. (Konrad Aweigert & Hein Kotz;1998,

p. 526). However, the civil courts were quite unmoved by the decisions of the highest administrative court. Apart from a few lower courts decisions the view has remained intact that even catastrophic effects on contracts only justify rescission if the very strict conditions of force majeure are satisfied (Konrad Aweigert & Hein Kotz; 1998, p.527)

French businessmen have reacted in their own way to the restrictive attitude of the courts. They allocate the risks due to future war, strikes or currency fluctuations by express clauses in their contracts, or else have recourse to arbitration and empower the arbitrators to adapt the contract to the changed circumstances in the light of what is fair and reasonable (Konrad Aweigert & Hein Kotz;1998, p.527). However, in civil law jurisdictions, with the exception of Belgium, all other nations have declined to follow the French model (Konrad Aweigert & Hein Kotz;1998, p.527)

B. Common law jurisdictions

In common law system, the rules of law which deal with the supervening events are the doctrine of impossibility/impracticability and the doctrine of frustration of purpose.

In Britain, even in 17^th century the common law established the doctrine of absolute contract through the case Paradine v Jane (Sir Guenter Treeitel; 2004, p.19)The case was frequently cited in later decisions in which the court held that supervening events had not discharged a party from the contractual obligation, even after Taylor v Caldwell[4], which is now generally considered to have established the doctrine of discharge by impossibility (Sir Guenter Treeitel;2004,p. 19). What is more, many of the actual decisions in which Paradine v Jane was applied are still regarded as good law (Sir Guenter Treeitel; 2004, p.19). The common law abandoned the doctrine of absolute obligation by the case Taylor v Caldwell, the legal systems provide for the discharge of one or both parties when a contract has become impossible to perform ( C.M.Bianca, M.J.Bonell; 1987, p.573).Taylor v Caldwell is generally regarded as the turning point in this branch of law, as the case in which the law moved away from the doctrine of absolute contracts to the modern doctrine of discharge by supervening events (Sir Guenter Treeitel; 2004, p.42).

Compared to the United Kingdom, the United States adopted a more flexible doctrine to terminate the contract—the doctrine of discharge by impracticability. The doctrine has also been referred to as one of ‘commercial impracticability’.[5] §2-615 of the Uniform Commercial Code[6]provides for ‘excuse by failure of presupposed conditions’ where the agreed performance has been ‘made impracticable by the occurrence of a condition, the non-occurrence of which was a basic assumption on which the contract was made’. General statements of the doctrine of discharge by impracticability can be found in some passages from the Restatement 2d and in the Comments to §2-615 of the Uniform Commercial Code. Comment 4 to §2-615 of the Uniform Commercial Code explains the doctrine by saying that,

 Increased cost alone does not excuse performance unless the rise in cost is due to some unforeseen contingency, which alters the essential nature of the performance. Neither is a rise or collapse in the market in itself a justification, for that is exactly the type of business risk which business contracts made at fixed prices are intended to cover.

The Restatement 2d,§261,Comment d states,

Impracticability means more than impracticality. A mere change in the degree of difficulty or expense due to such causes as increased wages, prices of raw materials or cost of construction, unless well beyond the normal range, does not amount to impracticability.

It is said ‘that common law courts set so high a burden before hardship is conceded that it is tantamount to economic impossibility, with levels of increase ranging from 200% to 1000%’. ( Alexei G. Doudko,2000)

In England, support for the view that impracticability or commercial impossibility can, of themselves, be grounds of discharge is, however, confined to dicta and to extra-judicial statements (Sir Guenter Treeitel, 2004;283).The English cases do not provide a single clear illustration of discharge on such a ground alone; and the possibility of such discharge appears to have been denied on a number of occasions in the House of Lords (Sir Guenter Treeitel; 2004,283). What is more, the hostility to impracticability or mere commercial impossibility as a ground of discharge is expressed in a number of other cases, such as Tenants Ltd v CS Wilson &Co Ltd, Blackburn Bobbin Co Ltd V TW Allen &Co (Sir Guenter Treeitel; 2004,283-284).evidently, in England, the doctrine of impossibility is quite strict, and is much close to the principle of impossibility in civil law code in Germany and the doctrine of force majeure in France civil law code.

The doctrine of discharge by frustration of purpose is accepted both in England and America, however, courts in both countries are aware of the danger that doctrine could undermine the principle of the sanctity of contracts(Sir Guenter Treeitel; 2004, p.346).In America, just due to the danger, it was argued that the doctrine of discharge by frustration of purpose had not been, or ought not to be, accepted in America(Sir Guenter Treeitel; 2004, p.346). In England, although the doctrine was originated in the coronation cases, it has seldom been applied in England since the case was decided (Sir Guenter Treeitel; 2004, p.346).

C.CISG and PICC

The United Nations Convention of International Sale of Goods (CISG) is one of the most important treaties dealing with the international trade, and almost all trade powers are the member of the Convention. Undoubtedly, it is definitely necessary to study CISG when talking about how to handle supervening events. The relevant stipulation of CISG is Article 79(impediment excusing a party from damages) [7]. The Convention picks up the terminology ‘impediment’ to refer to the supervening events, which is different not only from the impossibility or force majeure in continental law countries but frustration and impracticability/impossibility in common law countries. As a universally accepted convention, the CISG establish its own unique doctrine to deal with the effect of supervening events, A literal analysis of article 79 (1) reveals a four-part definition: (1) an impediment(2)reasonably unforeseeable at the time of the conclusion of the contract(3) reasonably impossible to overcome(4) having induced the non-performance of the contract. These elements constitute the traditional components of force majeure ( C.M.Bianca, M.J.Bonell; 1987.p.573).The Convention lays great importance on the sanctity of contracts in international trade, and therefore the disadvantaged parties is quite difficult to be relieved from the obligation of contracts due to supervening events. According to article 79(1), the Convention does reject the doctrine of changed circumstances; in addition, the CISG refuses to terminate or adapt the contract just because of frustration of purpose. Generally speaking, as far as the requirement of relieving the disadvantaged party is concerned, article 79(1) is as strict as the doctrine of impossibility in Britain and the doctrine of force majeure in France.

The Principles of International Commercial Contract (PICC) is so-called soft law, without binding effect, however, the importance of the principle should not be underestimated. After PICC1994 was published, it achieved enormous success, not only has it been applied to administrate the international contract through autonomy in international commercial businesses, but also some countries regard the PICC as the guide for their law reform. The immediate success of the UNIDROIT Principles worldwide prompted UNIDROIT as early as 1997 to resume work “with a view to the publication of an enlarged second edition of the Principles.”( Michael Joachim Bonell ; 2004, p.5-40). Exactly ten years after the appearance of the first edition of the UNIDROIT Principles, the new edition principles 2004 was unanimously approved by the Governing Council in April 2004 (Michael Joachim Bonell ; 2004, p.5-40). Therefore, it is important to study the concerned stipulations in the PICC for the study of this essay.

Compared to both domestic laws and other international instruments, the PICC1994 is more readily to relieve the disadvantaged party from the obligation of contract or adapt the contract to the new situation due to changed circumstances (hardship). The PICC not only incorporates a rule of force majeure (article.7.1.7)[8] but also stipulates a doctrine of hardship (Article6.2.1 to article 6.2.3)[9]. Interestingly, like the CISG, the PICC does not borrow the conception dealing with supervening events from either common law system or civil law system; the PICC employs the terminology ‘hardship’.  The term ‘hardship’ was chosen because it is widely known in international trade practice as confirmed by the inclusion in many international contracts of so-called ‘hardship clauses’ (Michael Joachim Bonell; 2002, p.245).

6.2.1 make it clear that as a consequence of the principle of the binding character of the contract performance must be rendered as long as it is possible and regardless of the burden it may impose on the performing party ( Michael Joachim Bonell; 2002, p.245).

In article 6.2.2, the PICC defines hardship as a situation where the occurrence of events fundamentally alters the equilibrium of the contract, provided that those events meet the requirements, which are laid down in sub-paragraphs (a) to (b). In the light of the Comment to article 6.2.2, whether the alteration of the equilibrium is ‘fundamental’ in a given case will of course depend upon the circumstances. If, however, the performance is capable of precise measurement in monetary terms, an alteration amounting to 50% or more of the cost or the value of the performance is likely to amount to a ‘fundamental’ alteration’ (Michael Joachim Bonell; 2002, p.247).

The Comment provides an illustration to article 6.2.2,

In September 1989 A, a dealer in electronic goods situated in the former German democratic republic, purchases stocks from B, situated in country X, also a former socialist country. The goods are to be delivered by B in December 1990.in November 1990, A informed B that the goods are no longer of any use to it, claiming that after the unification of the German democratic republic and the federal republic of Germany there is no longer any market for such goods imported from country X. Unless the circumstances indicate otherwise, A is entitled to invoke hardship.

The illustration is a typical circumstance in which the purpose of the contract is frustrated. However, supposing that the case happens in the United Kingdom, the court will in all refuse A to discharge the contract.

Therefore, the PICC is quite lenient to the disadvantaged party to terminate or adapt the contract due to the changed circumstances. Naturally, article 6.2.1 – 6.2.3 on hardship has occasionally been criticized as a possible source of abuse. However, in fact, article 6.2.1 – 6.2.3 on hardship has not entailed such a negative effect. Not only did they not induce frivolous litigation but in the relatively rare cases where they were invoked by a party to have it terminated or revised for supervening hardship, they more often than not served to confirm the validity of the contract or to impose performance according to the originally agreed terms ( Michael Joachim Bonell, 2004).

Ⅳ.The Status Quo of Development of Market Economy and the Judiciary in China

It is well known that the certainty and predictability of transactions is essential to the development of market economy, easy repudiation or termination of contracts inevitably destroy the market safety and discourage commercial deals, and consequently, hinder the economy from developing. Actually, the United Kingdom, the oldest capitalist economy, has been paying enormous attention to the sanctity of contracts and always extremely reluctant to avoid a contract. China is a traditional agricultural country, and the market economy has never been developed sufficiently in Chinese history. After 1949, the market economy has just begun to be established since 1992, and now it is far from mature and the conception of the sanctity has far from been embedded in market participants. Therefore enough emphasis should be laid on the sanctity of contracts and the order of transaction in current China. Even though the doctrine of discharge by changed circumstances can achieve the equity in an individual case, however the doctrine can harm the order and the certainty of the market. When balancing the two conflicting values of law, the importance of sanctity and safety of contract should be much more emphasized.

In addition, it is the case that the quality of the judges in China is not high enough. Although in recent years, with the construction and development of market economy, more and more legal graduates have been recruited into judiciary, a substantial number of judges without systematic legal education lack of essential judicial expertise, not to mention the necessary knowledge of economics. On the other hand, just like the comment of Law Committee of the Congress, the doctrine of changed circumstances is a very complex and subtle legal mechanism, obviously, the proper application of this subtle legal device is quite beyond the capacity of some judges. The great discretion empowered by this doctrine probably lead to abuse. Not only the positive effect of this doctrine cannot be achieved, but also the safety of transaction could destroy.

What is more, due to the current judicial system, it is impossible to eradicate the local protectionism. Currently, the local governments control the finance and other important resources of local courts, inevitably, the local courts have to be subject to the will of local governments. Such a doctrine, which empowers the judges with great discretion, will naturally become a tool to fulfill the local interest. The consequence is disastrous, the national market will be broken into a lot of pieces, and the establishment of an integrated national market will becomes only a dream.

 

Ⅴ.The unfairness in individual cases can be solved through alternative way

It is the case that the commercial transactions, especially the international trade, have a lot of risks, such as suprtinflation, strike, government injunction natural disasters and so on. It is impossible for parties to anticipate all potential risks ahead when they negotiate and enter into contracts, some unexpected change could fundamentally break the equilibrium of the contract and bring some fatal result to the parties. The exclusion of the doctrine of changed circumstances does not mean the parties cannot do anything to prevent the unfairness in the performance of the contract. The merchant can avoid and control the unexpected risk by incorporating the force majeure or/and the hardship clauses in their contracts. When the supervening events happen, they could adapt the contract to the changed situation or even terminate the contract to keep the equilibrium of their contract. Actually, in France and Belgium, where the doctrine of changed circumstances is refused by the law, the commercial contracts usually contain such a force majeure or/and hardship clauses.

Some people argue that, with the integration into world economy, the Chinese economy will inevitably be affected more frequently and severely by external elements, such as sharp increase in oil price, war, and natural disasters, therefore, a good number of contracts could be influenced and lose equilibrium, such as the situations in Germany after world wars. They suggest strongly enacting the doctrine of changed circumstances. Nonetheless, if in extreme situations, common unfairness can be adjusted by special legislation.

 

Conclusion

Although the doctrine of changed circumstances can fulfill the equity in individual cases and soften the rigidity of law, the negative effect of this doctrine to undermine the sanctity of contract and the safety of transactions should not be ignored. Most jurisdictions recognize that the changed circumstances entitle the parties to adapt or terminate the contract, however, either the common law system or the civil law system, judges are all quite prudent to terminate the contract just due to the supervening events, actually, only in a few cases which were of extreme exception the contracts were terminated. In China, in light of the need of developing market economy, the sanctity of contract and safety of the transaction is much more needed; due to the quality of judiciary as a whole is not ideal, the doctrine of changed circumstances could entail disastrous result to the market economy, therefore the exclusion of the doctrine from the Contract Law is proper. However, the adoption of the doctrine of changed circumstances is the international tendency, China should adopt the doctrine to overcome the rigidity of law in the long run when the problems mentioned above have been resolved.

 

Bibliography:

1.Alexei G. Doudko, Hardship in Contract: the Approach of the UNIDROIT Principles and Legal Developments in Russia, Rev.dr.unif. 2000-3.

2.C.M.Bianca, M.J.Bonell, (1987) Commentary on the International Sales Law the 1980 Vienna Sales Convention.

3. Evan Mckendrick, (1995) Force Majeure and Frustration of Contract, second edition, Lloyd’s of London Press Limited.

4. Herbert Berstein, Joseph Lookofsky, (2003)Understanding the CISG in Europe, second edition, Kluwer Law International.

4.Konrad Aweigert & Hein Kotz ,(1998)An Introduction to Comparative Law, third edition, translated by Tony Weir, Clarendon Press. Oxford.

5.Michael Joachim Bonell, UNIDROIT Principles 2004 – The New Edition of the Principles of International Commercial Contracts adopted by the International Institute for the Unification of Private Law, UNIFORM LAW REVIEW 2004.

6.Michael Joachim Bonell, (2002) the UNIDROIT Principles in Practice.

7 Sir Guenter Treeitel, (2004) Frustration and Force Majeure, second edition, Sweet & Maxwell.

8.Wolfgang Kotzur, Termination of Contracts – Frustrated Parties, Journal of International Banking Law, J.I.B.L. 1998, 13(11).

9.Zhang zhaodong, the Contract Law and the Doctrine of the Changed Circumstances, the Collections the Civil and Commercial Law Dissertations, volume20, 2001.