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In a typical court judgment or arbitration award, the validity of contract is the first item to be examined in a civil or commercial case if the applicable law is PRC Law. An invalid contract shall be void ab initio (see article 56 of the Contract Law).

The general rules for handling invalid contracts are: return of property, compensation through conversion of the property into money, and compensation for losses by the faulty party (article 58 of the Contract Law). Parties may expect that the invalidity of a contract will result in non-performance of all contents of the contract (except for dispute resolution clauses), as many judgments and awards have ruled.

It is such an expectation that makes certain parties believe that their claim of invalidity would benefit them by avoiding adverse performance or consequences. It is also the reason why the claim of invalidity is commonly seen as a defence of the party that fails to perform its contractual obligations. The claim of invalidity is particularly frequent in financial and construction cases.

Two arbitration cases that the author encountered recently are given as examples. The first case is the disputes over an equity transfer and entrusted shareholding contract. In this case, the claimant purchased shares from the respondent. The target company was to be listed at the moment of transaction and has been listed subsequently.

The respondent was entrusted by the claimant as a registered shareholder of the target company and was asked to make registration change and transfer the dividends after the public offering. The respondent claims that the contract violates certain laws and regulations that prohibit such entrusted shareholding. The contract therefore violates the public policy and shall be deem invalid. As a result, the applicant has no ground for claiming registration change and transfer of the dividends.

The second case involves disputes over a construction contract. In this case, the claimant, as the subcontractor, requested the respondent, as the general contractor, for workload compensation and liquidated damages for arrears. The respondent, however, alleged the invalidity of its own general contract since the company itself failed to conform with the contractors’ qualification requirements. Therefore, the subcontract is also invalid, and the liquidated damages clauses in the subcontract shall not apply.

Similar scenarios are not rare, either in arbitration or litigation. A similarity is witnessed with the two cases, as the claiming parties were aware, or should have been aware, of the risk of invalidity when entering the contract. But they kept their silence before the dispute arose. When other parties file a case against the claiming parties, the invalidity defence may become an excuse to turn down the contract and avoid performance.

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