The application of law to foreign-related contracts

By Craig Zhou, Martin Hu & Partners
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As China’s economy gains steam, its global trade activities are increasing and business contracts between Chinese and foreign companies are on the rise, often making it a contentious issue for the two sides to agree on governing law when they ink a contract.

Craig ZhouAssociateMartin Hu & Partners
Craig Zhou
Associate
Martin Hu & Partners

Whether a contract is signed between two domestic parties or between a domestic party and a foreign party, autonomy of the will is generally considered a fundamental principle to conclude a contract. The parties can draft the contract terms at their will as long as the terms are not against the law.

According to the Law of the Application of Law for Foreign-related Civil Relations, the parties to a contract may explicitly choose the laws applicable to foreign-related civil relations in accordance with the principle of autonomy of the will, as long as the application of foreign laws will not damage the social and public interests of China.

According to the Interpretation of the Supreme People’s Court on Several Issues Concerning the Law of the Application of Law for Foreign-related Civil Relations, a party arguing that the law it agreed to govern its contract with the other party is not applicable, because the law has no practical relations with foreign-related civil relations, and the argument will not be supported by the court. When both parties agree or choose to change the application of law before debates in the court of first instance are concluded, the court must allow this change.

China’s laws have also imposed restrictions on the parties when they choose the law of application. First of all, when the law deprives the parties of the right to agree on the application of law for a foreign-related contract, they cannot choose a law to govern their contract. For instance, a labour contract between Chinese workers and a foreign employer must apply the law of the place where the workers are based; if it’s difficult to determine their workplace, the labour contract must apply the law where the employer’s main business operations are carried out.

Second, the parties must explicitly choose a law applicable to their contract. However, if the parties cite the laws of the same country and do not raise an objection to the application of law, the court can conclude that the parties have made a choice on the application of law for foreign-related civil relations, and acknowledge the legal effect of their choice on the application of law.

Third, when the parties agree to adopt foreign laws to govern their contract, the foreign country’s law of application of law must not be cited to govern the contract. That rule is meant to prevent the parties from circumventing China’s mandatory provisions or breaching China’s social and public interest.

Finally, where any Chinese law has mandatory provisions in relation to a foreign-related contract, the mandatory provisions must apply. For instance, for a Sino-foreign joint venture enterprise contract, Sino-foreign co-operative operation contract, or a contract for Sino-foreign joint exploration and development of natural resources that is performed within the territory of China, the law of China applies.

The rule on the application of law when there is no agreement

In addition to the principle of the autonomy of the will, China’s laws have additional provisions in relation to foreign-related contracts when the contractual parties do not make any agreement on the application of law. According to article 145 of the General Principles of The Civil Law, the parties to a contract involving foreign interests may choose the law applicable to settlement of their contractual disputes, except as otherwise stipulated by law. If the parties to a contract involving foreign interests have not made a choice, the law of the country to which the contract is most closely connected must be applied.

According to article 126 of the Contract Law, parties to a foreign-related contract may select the applicable law for resolution of a contractual dispute, except otherwise provided by law. Where parties to the foreign-related contract failed to select the applicable law, the contract must be governed by the law of the country with the closest connection. As stipulated by the Law of the Application of Law for Foreign-related Civil Relations, parties may choose the applicable law to govern a contract. If the parties do not choose, the laws at the habitual residence of the party whose fulfilment of obligations can best reflect the characteristics of this contract, or other laws that have the closest relation with this contract, must apply.

Based on practical experience, the author finds that characteristics of a foreign-related contract include the place where the contract is negotiated, signed, established and performed, where the subject matter of the contract is located, as well as the parties’ residence, nationality, where they are founded and where they operate their business.

In judicial practice, however, the adoption of legal terms such as “the most characteristic features of a contract” and “laws that have the closest relation with this contract” has been plagued by a high level of uncertainty. Since legal disputes surrounding a foreign-related contract may involve several countries that have different legal systems, languages and cultural backgrounds, it’s unrealistic to expect China’s judges to be familiar with other countries’ legislation policies and relevant legal provisions, let alone make comparison and analysis.

As a result, when the parties do not make any agreement on the application of law for a foreign-related contract, the judges are baffled as to how to rule their disputes. Most such cases were eventually ruled according to China’s laws, instead of foreign laws as they are supposed to be due to their close relations with foreign-related contracts.

For instance, a contractual dispute between a company in Xiamen and a chemical company in Indonesia, and another contractual dispute between two Chinese companies and a company in Hong Kong, were tried according to Chinese laws because their contracts were signed and performed within the territory of China. But in the former case the Chinese company was a buyer and in the latter case the Chinese companies were suppliers, suggesting the application of law appears to lack pertinence.

In conclusion, there are three primary rules regarding the law of application that governs foreign-related contracts. First, mandatory provisions must apply when they are in place. Second, parties to a contract must agree on the law of application when there are no mandatory provisions. Third, when there is no agreement on the law of application, the court must decide according to the “closest relations” principle, and it’s more likely to rule that Chinese laws should be applicable to address their contractual disputes.

Author: Craig Zhou is an associate at Martin Hu & Partners

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