Lease contract disputes due to change of usage

By Kevin Shao, City Development Law Firm
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Plant lease contracts have their peculiarities, to a certain extent. The contract term is generally long, and change of usage, or reconstruction, or even illegal construction, can always happen during the contract term. But most plant lease contracts are not as rigorous as, for example, contracts for the lease of offices and shopping malls, and there is no contractual agreement to be referred to for some of the disputes. This article will analyze disputes over plant lease contracts arising from the change of housing purposes, based on the author’s practical experience.

KEVIN SHAO Senior Partner City Development Law Firm
KEVIN SHAO
Senior Partner
City Development Law Firm

Company A leased 10 plant buildings with a gross floor area of 15,000 square metres to Company B for office and commercial purposes in 2005, with a lease term of 20 years and the rent to be paid in advance, quarterly. Company B renovated and decorated the plants (without relevant application and approval formalities) during the lease term, and demolished a part of the plants, and built some houses. Company B began to delay paying the rent from 2014. Company A repeatedly demanded payment but to no avail, so Company A notified Company B in writing to terminate the lease contract, and brought an action in court for Company B to pay the rent arrears and liquidated damages. Company B filed a counterclaim alleging that the contract was invalid, and requested Company A to compensate losses of renovation and reconstruction as well as anticipated profit.

The focus of this dispute is: (1) Does the contract become invalid due to the change of the purpose of the plant?; (2) Does Company A need to compensate for the renovation and reconstruction?; and (3) If the contract is null and void, does Company B have the right to claim the anticipated profit?

Contractual effect. Company B alleged that changing the purpose of the plant to office and commercial use violates article 140 of the Property Law, article 56 of the Land Administration Law and article 18 of the Urban Real Estate Administration Law, making the lease contract null and void.

The author believes that, first, the construction entity (the land use right holder) must be the regulatory object of the provisions under the above-mentioned three laws that regulate behaviour of changing the purpose of land use by construction entities during development and construction process after obtaining a land use right, instead of use, lease and disposal of the houses after completion of construction.

Second, the Land Administration Law classifies land as farm land, land for construction and unutilized land. Even in accordance with the relevant provisions of the Land Administration Law, change of land use refers to the change among the above three purposes of use, which excludes the change of industrial plant into office and commercial purpose.

Third, articles 2, 3 and 15 of the Interpretation of the Supreme People’s Court (SPC) on Several Issues Concerning Specific Application of Law in the Trial of Cases on Disputes over Contracts for Lease of Urban Houses specify that lease contracts must be invalid under the following circumstances: lease contracts with regard to houses that have not obtained planning permit of construction engineering or have not been built in accordance with the planning permit of construction engineering; lease contracts with regard to temporary buildings that have not been approved, or have not been constructed according to the approval contents; lease contracts with regard to temporary buildings that overrun the approved term of use; contracts where the sublease period exceeds the remaining lease term of the lessee; and sub-lease contracts without consent of the lessor. Changing the usage of the house is not included in the circumstances of invalid contracts.

Compensation for decoration. According to provisions of articles 10 and 11 of the SPC interpretation, where the lessor disagrees to make use of the attached decoration or renovation, the lessee may claim relevant losses of decoration or renovation in the following four circumstances:
(1) decoration or renovation is undertaken by the lessee with the consent of the lessor, while the lease contract is invalid (both parties must bear responsibilities according to their respective fault); (2) the contract is terminated due to breach of contract by the lessor; (3) the contract is terminated due to breach of contract by both parties (responsibilities shall be borne by both parties according to their respective fault); and (4) the contract is terminated due to reasons not attributable to either party (responsibilities shall be borne by both parties based on the principle of fairness).

Therefore, in this case, when the contract is valid, if the contract is terminated due to breach of contract by the lessee, the lessee will have no right to claim against the lessor for relevant losses of decoration or renovation according to article 11 of the SPC interpretation. Even if the contract is held to be invalid, both parties will bear the losses of the residual value of the decoration, as it is specified in the contract that the houses are industrial plants, and both parties are aware of the situation.

Anticipated profit. Company B seeks to obtain anticipated profit based on article 113 of the Contract Law. However, article 113 specifies damages for breach of contract and only applies to breach of contract by either party when the contract is valid. If the contract is null and void, article 58 of the Contract Law applies: “The property acquired as a result of a contract shall be returned after the contract is confirmed to be null and void or has been revoked; where the property cannot be returned or the return is unnecessary, it shall be reimbursed at its estimated price. The party at fault shall compensate the other party for losses incurred as a result. If both parties are at fault, each party shall respectively be liable.”

When comparing article 58 with article 113, article 113 has one more provision, i.e. “including the interests receivable after the performance of the contract”. Therefore, in the case of an invalid contract, compensation for damage does not involve anticipated profit. Moreover, according to article 56 of the Contract Law, a contract that is null and void must have no legally binding force from the very beginning, so the interests receivable after the performance of the contract must not be protected by law.

Kevin Shao is a senior partner at City Development Law Firm

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