In the previous issue’s column we looked at the types and features of long-term supply contract disputes, and in this issue we will analyse relevant strategies for dealing with and preventing the same. Dealing with long-term supply contract disputes should be divided into macro decision-making and micro decision-making, each of which should be treated differently.
Probability of winning. The party that intends to terminate – “terminate” here should be broadly interpreted, and include rescission, invalidation, termination or other such strategic methods of avoiding performance of the contract – a long-term supply contract faces the greater risk of losing an action, mainly due to the fundamental principle of contract law theory: a “contract shall be performed”.
However, the author has noticed that in practice this principle can produce completely opposite emotional effects on the parties to a long-term supply contract. The party that intends to terminate the contract, often armed with the mindset of “it’s worth a shot”, will be more nimble in its adducement of evidence and counter-argument, while the party intent on maintaining the contract is contrarily crippled by the heavy psychological burden of “we can only win, not lose”.
Allocation of the burden of proof. Pursuant to China’s rules of evidence, the party that asserts that the contract is invalid/rescindable is required to present evidence in support of its assertion. Accordingly, the main burden of proof mainly falls on the party that wishes to terminate the contract. However, the party wishing to maintain the contract will, in fact, seldom voluntarily waive its right to present evidence, thereby in reality somewhat evening out the burden on both parties. It should be noted that the party wishing to maintain the contract, being in the defensive position, is often required to present evidence in support of such negative facts as “the contract does not violate mandatory laws”, “the contract does not involve a material misunderstanding, is not grossly unfair”, etc., making for greater difficulty.
Costs. If a party opts for a cause of action that has an overall effect on the contract, such as “termination of the contract”, “rescission of the contract”, “continued performance of the contract”, etc., the costs of the action (arbitration costs) will usually be calculated based on the overall subject matter of the contract (i.e. the total consideration to be paid for complete performance of the contract), making for a large sum. Considering that many such cases ultimately end in a settlement, and it is usually necessary to reach agreement on the bearing of the costs of the action (arbitration costs) in the course of the settlement process, we would recommend that the parties reasonably control expenses and expenditures with appropriate skill, e.g. only claiming termination or rescission of contract performance for part of the term.
Enforcement. In recent years, efforts to enforce civil judgments and rulings in China have been continuously strengthened, producing a major breakthrough. However, in practice there remain legislative blind spots when it comes to long-term supply contracts. For example, with respect to a long-term supply contract that is performed in stages (e.g. a supply fee charged on a monthly basis), if enforcement is applied for at each stage, not only would this be onerous and very costly, but making a request for continued performance may even be prohibited because the subject matter “is not an appropriate subject for enforced performance”. Accordingly, advance thought should be given at the outset of the dispute to future enforcement based on the actual circumstances of the case, and this should be treated as a major basis for decisions.
It may be difficult to discuss in a general manner the issues that need to be considered at the micro level due to the differences in the facts of cases, but the options available and calculation of losses are important matters that need to be considered in all cases.
Options available. Generally speaking, the options available if one wishes to avoid the outcome of the performance of a long-term supply contract mainly include rescission of the contract, termination of the contract and invalidation of the contract. The most commonly seen grounds for rescission of a contract are “material misunderstanding” and “gross unfairness”, whereas termination of a contract is usually based on such grounds as “force majeure”, “change in circumstances”, etc. Furthermore, a series of judgments by the Supreme People’s Court and local higher people’s courts recently have interpreted in a more flexible manner the grounds of “a lawful form camouflaging an illegal objective” in article 52 of the Contract Law that can lead to invalidation of a contract, greatly increasing the risk of a contract being declared invalid. Accordingly, parties to a contract should, in the course of their offence-defence, pay full attention to such risk.
Calculation of losses. Calculation of the losses is one of the difficult points in dealing with long-term supply contracts. On the one hand, current laws do not clearly define each type of loss; and on the other hand, the numerous concepts raised in the large volume of Supreme People’s Court cases, interpretations and explanations – such as “direct losses and indirect losses”, “incurred losses and future losses”, “losses from the portion already performed and losses from the portion not yet performed”, “compensatory damages and punitive damages” – require more detailed and in-depth study.
Prevention of disputes
With respect to the risk of breach of contract, no certain preventive measures exist. However, through rational planning and adjustment, it is possible to achieve the objective of enhancing one’s side’s chance of winning, and reducing the other side’s chance of winning to the greatest extent possible, thereby realising indirect risk control. In this respect, we put forward two recommendations:
First, the enterprise should endeavour to preserve, during the course of concluding the long-term supply contract, the minutes of discussions, contract negotiation records, each version of the contract, records of key meetings and other such written information so as to ensure that the background of the negotiation of the contract, the process of reaching agreement and other such important facts can be restored in future.
Second, given that the facts of a long-term supply contract case are complex and specialised, the parties should do their utmost to opt for arbitration as the dispute resolution mechanism. From our past experience in handling such cases, the major arbitration institutions have accumulated extensive experience in handling long-term supply contracts, and perform admirably in terms of efficiency and impartiality.
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