China’s first Civil Code took effect on 1 January 2021. The Civil Code consists of 1,260 articles in seven parts: (1) General Provisions, (2) Property Rights, (3) Contracts, (4) Personality Rights, (5) Marriage and Family, (6) Inheritance, and (7) Torts, as well as Supplementary Provisions.
This article covers some of the key issues of the new Civil Code for foreigners regarding their Chinese investments and operations.
Set up a proper entity before doing business
Foreign investors should properly set up an entity in the People’s Republic of China before doing business to limit their liability. According to Articles 103 and 104 of the Civil Code, unincorporated organizations shall be registered in accordance with the law, and where an unincorporated organization becomes insolvent, its capital contributors or promotors shall assume unlimited liability for the debts of the organization, unless otherwise provided by law.
Be more careful with documents
Foreign investors need to be much more careful before signing a PRC related letter of intent, or memorandum of understanding. According to Article 495, a letter of subscription, letter of order, letter of reservation and the like, in which the parties agree to conclude a contract within a certain period of time, constitutes a preliminary contract, and is legally binding.
Be familiar with administrative and approval procedure
Foreign investors shall either recruit a good PRC lawyer, or let the local party do the administrative and approval procedures, for example, in a joint venture set-up. As per Article 502, where the party of a contract obligated to complete an application for approval or other procedures fails to do so, the other party may request the former party to bear the liability for breach of such obligation.
Avoid usurious loans
It is now clearly stipulated in Article 680 that it is forbidden to lend money at a high interest rate. The court will support interest rate of four times the Loan Prime Rate (2021 figures, LPR is 3.85%, resulting in 15.4%), and according to interpretations, anything over 36% is unlikely to be valid.
Be aware of new typical contracts
Contract Law in the PRC previously governed 15 “typical contracts” in areas such as sales, construction and technology. This has now been increased to 19. The four new types of typical contracts are: guarantee contracts, factoring contracts, property contracts and partnership contracts. Provisions have also been added to regulate electronic contracts.
In terms of guarantee contracts, foreign investors should not overlook the changes to the guarantee liability and the guarantee period to enhance the protection of guarantors.
A choice of law is not always allowed
One does not always have a choice of law. For example, Article 467 highlights that the laws of the PRC shall apply to the contracts of Sino-foreign equity joint ventures, Sino-foreign contractual joint venture, and Sino-foreign cooperation in the exploration and exploitation of natural resources to be performed within the territory of the PRC.
Be aware of provisions related to unfair contract terms
In terms of contract protection, foreign investors should be aware of new articles added to strengthen the protection of the weaker contracting parties. For instance, Article 496 stipulates that where standard terms are adopted in concluding a contract, the party supplying the standard terms shall observe the principle of fairness in defining the rights and obligations of the parties, and to remind the other party in a reasonable way of the provisions that greatly affect the other party.
Where the party with standard clause fails to perform the aforementioned obligation of drawing attention or giving explanations, and consequently leads the other party to overlook or misunderstand any clause concerning its interest, the affected party may claim such clause is not part of the contract.
Be aware of provisions related to the third party’s right
The third party’s rights in a contract are now recognized by the law. According to Article 522, where the parties agree that the debtor shall perform the obligation to a third person, if the debtor fails to perform this obligation, or the performance does not conform to the agreement, the debtor shall bear default liability to the creditor.
Where it is provided by law or agreed by the parties that a third person may directly request the debtor to perform the obligation to him, and the third person does not explicitly reject it within a reasonable period of time, if the debtor fails to perform the obligation to the third person or the performance does not conform to the agreement, the third person may request the debtor to bear default liability. The defenses that the debtor has against the creditor may be asserted against the third person.
The court’s power to modify a contract
A contract can be modified or rescinded even without a force majeure clause. According to Article 533, after a contract is formed, where a fundamental condition upon which the contract is concluded is significantly changed, which is unforeseeable by the parties upon conclusion of the contract and which is not one of the commercial risks, if continuing performance of the contract is obviously unfair to one of the parties, the party that is adversely affected may re-negotiate with the other party. Where such an agreement cannot be reached within a reasonable period of time, the parties may request the people’s court or an arbitration institution to rectify or rescind the contract.
Service providers’ obligation to protect personal rights
Articles 1194-1197 introduce internet-related tort liabilities and obligations for network users and network service providers.
According to Article 1195, if a network user commits a tortious act through using the network service, the right holder is entitled to notify the network service provider to take measures such as deletion, blocking or disconnection. This provision may also apply to operators which are located in Hong Kong and offshore serving the PRC market.
The Civil Code also enhances foreign investors’ right to privacy and protection of personal information by introducing new provisions (Articles 1032-1039) that define personal information, prescribe the requirement to handle personal information, and designate certain prohibited acts in relation to personal information.
Employer’s obligation to protect personal rights
Foreign investors shall review their PRC office’s policies in response to the additional provision in protection of personal rights and sexual harassment (Article 1010).
Punitive damages for IP infringement
Michael Jordan is now better protected! According to Article 1185, in the case of an intentional infringement of another person’s intellectual property rights, where the circumstances are serious, the infringed person has the right to request corresponding “punitive” damages.
Proactive response requirement with manufacturer and seller
According to Article 1206, where a defect is discovered after a product is put into circulation, the manufacturer or seller shall take remedial measures such as stopping sales, providing warnings, or recalling the product in a timely manner. The manufacturer or seller shall be liable for the aggravated part of damage if they either fail to take remedial measures in a timely manner or take ineffective measures that cause the damage to be aggravated.
Environmental protection awareness is a must
There are new provisions in the Civil Code to punish those who cause damage to the environment during the operation of their business. According to Article 346, the right to use a lot of land for construction purposes shall be created in conformity with the requirements for conservation of resources and protection of the ecological environment.
As per Article 1232, where a tortfeasor intentionally pollutes the environment or harms the ecological system in violation of the provisions of law, resulting in serious consequences, the infringed person has the right to request corresponding “punitive” damages.
As a major consolidated piece of legislation, the Civil Code makes it easier for foreign investors to understand their rights and obligations when doing business in China. Given the aforementioned non-exhaustive changes to the law on contracts and torts from various perspectives, foreign investors who are interested in or currently conducting business in China are reminded to review their business operations and contracts to make sure they are in compliance with the new Civil Code.
Dr Dennis CW Tang, Registered Foreign Lawyer, Tung, Ng, Tse & Lam Solicitor