I recently delivered some training in Beijing and Shanghai to lawyers and other interested members of the public. The topic of the training seminar, which was co-sponsored by Melbourne Law School, China Business Law Journal and Thomson Reuters, was Bridging the Divide: Drafting and Negotiating Contracts in Cross-border Deals.
The purpose of the training was to identify the challenges that arise when lawyers draft contracts in cross-border deals, and the strategies that they can adopt to overcome these challenges. In particular, the training considered the impact of the following three factors on these challenges: law; language; and attitudes towards the nature and purpose of contracts.
All of these factors are interrelated and are integral to the way in which contracts are drafted and negotiated.
In relation to the first two factors, I suggested that the way in which we draft and negotiate contracts is inevitably shaped by the law and the language in which contractual rights and obligations are expressed. Different legal systems have different ways of perceiving and expressing concepts, and the differences are particularly pronounced in the area of contract law.
Consider, for example, the differences between common law and civil law systems in terms of the ways in which contracts are interpreted, and also the length of contracts.
In common law jurisdictions, the traditional approach to interpreting a contract has been based on the notion that the legal relationship between the parties is governed by the “four sides” of the contract; in other words, the relationship is defined exclusively by what is written in the contract itself. This is reflected in the following:
- the use of an “entire agreement” clause, under which the parties confirm that the agreement constitutes the entire agreement between the parties and supersedes any previous written or oral agreements;
- the “parol evidence” rule, which prevents courts from looking at extrinsic evidence (particularly oral evidence) when interpreting a contract;
- the literal approach to the interpretation of contracts, under which courts prefer to interpret contracts by reference to the meaning of the written words rather than the purpose for which the contract was signed; and
- the principle that “a deal is a deal” (as reflected in the Latin phrase: pacta sunt servanda) and that the parties to a contract should perform their obligations strictly in accordance with the contract.
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In recent years the common law has adopted less of a hardline approach. For example, courts have been willing to consider the purpose of a contract when interpreting its terms. However, the primary question is still: “What does the contract say about the relationship between the parties and their intentions?” This reflects the traditional importance that the law places on freedom of contract; namely, the principle that the parties should be free to strike a lawful bargain without interference from any external factors. Although the principle has been qualified in the area of consumer contracts, where statutes in common law jurisdictions impose mandatory requirements in a similar way to codes in civil law jurisdictions, the principle of freedom of contract still applies to commercial contracts. Since the legal relationship between the parties is governed exclusively by contract, it is necessary to ensure that contracts contain comprehensive provisions governing the rights and obligations between the parties. This has resulted in a tendency for contracts to be longer rather than shorter.
In civil law jurisdictions, on the other hand, courts are guided by the civil and commercial law codes, which often plug the gaps in contracts, and also by the principle of “good faith”. This means that there is less of a need to express things in great detail. In fact, if things are spelled out in too much detail, it might be counter-productive, which is why lawyers in civil law jurisdictions are often less concerned about making provisions for all possibilities and contingencies and why civil law contracts tend to be shorter than in common law jurisdictions. In addition, the law in civil law jurisdictions accepts the possibility that the contractual relationship will need to be adjusted to accommodate any fundamental change in circumstances (as reflected in the Latin phrase: rebus sic stantibus).
As an example of one of the differences in this regard, I pointed to the following dispute resolution clause, which is typically found in contracts in China that are governed by PRC law (e.g. a joint venture contract):
The Parties shall strive to settle any dispute arising from or in connection with this contract in good faith through friendly negotiations. If no settlement can be reached within a period of 60 days commencing on the date of notification of a dispute by one Party to the other Party, such dispute will be resolved by arbitration in Singapore conducted in Chinese and English by three arbitrators pursuant to the Rules of the International Chamber of Commerce.
When I asked the participants at the seminar whether an obligation to negotiate in good faith was a legally binding obligation, there was a divergence of opinion. Some suggested that the obligation was binding; others suggested that it was too uncertain to be binding and that it was simply a statement of intention.
The discussion highlighted one of the fundamental differences between common law jurisdictions and civil law jurisdictions; namely, the legal effect of an obligation to negotiate in good faith.
Inspired by the approach in civil law jurisdictions, article 6 of the PRC Contract Law provides as follows:
The parties shall observe the principle of good faith in exercising their rights and performing their obligations.
The above suggests that an obligation to negotiate in good faith would be considered binding under PRC law. In fact, the principle of good faith applies generally to the performance of obligations under a contract.
Interestingly, the position in common law jurisdictions is somewhat unsettled and has generated some debate in recent years. The traditional approach, which is still maintained by courts in England, is that an obligation to negotiate in good faith is too uncertain to be binding and that it is inherently repugnant to the adversarial position of parties when they enter into negotiations. However, courts in other common law jurisdictions such as the United States and Australia have suggested that an obligation to negotiate in good faith may be binding in certain circumstances.
The difference between the common law approach and the approach adopted under PRC law is even starker in the context of pre-contractual negotiations. Traditionally, the common law has shied away from the recognition of a duty to negotiate in good faith before a contract is entered into. Although principles of equity may provide a remedy where one party has relied to its detriment on a promise by the other party that it would enter into a contract (known as estoppel), there is no positive duty in common law to observe good faith in the negotiation of a contract.
Once again, inspired by the approach in civil law jurisdictions, PRC law provides that a party may be liable if it does not observe the principle of good faith when negotiating a contract. Article 42 of the PRC Contract Law (entitled “Pre-contract Liabilities”) provides as follows:
Where during the process of concluding a contract, a party is involved in any of the following circumstances and causes loss to the other party, it will be liable for damages:
1. negotiating with malicious intent under the pretext of concluding a contract;
2. intentionally concealing a material fact relating to the conclusion of the contract or supplying false information;
3. any other conduct that violates the principle of good faith.
It is unlikely that the law would apply to foreign companies when they negotiate with PRC counterparties outside China, since they would be beyond the jurisdictional reach of the PRC Contract Law. However, it would apply to negotiations between companies that are incorporated in China, including negotiations between a foreign investment enterprise in China and a local company, and even negotiations involving foreign companies if those negotiations take place on Chinese territory.
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A former partner of Linklaters Shanghai, Andrew Godwin teaches law at Melbourne Law School in Australia, where he is an associate director of its Asian Law Centre. Andrew’s new book is a compilation of China Business Law Journal’s popular Lexicon series, entitled China Lexicon: Defining and translating legal terms. The book is published by Vantage Asia and available at www.vantageasia.com
