Terminating a contract, even under arguably clear circumstances, is notoriously difficult, and presents numerous risks that can potentially give rise to unforeseen disputes. In this article, we discuss some recent developments and clarifications regarding contract termination under the PRC Civil Code.
Multiple approach to termination
There are three primary approaches for contract termination under PRC law:
1. Exercising a statutory right of termination;
2. Exercising a contractual right of termination;
3. Reaching a mutual agreement on termination.
Each approach differs significantly from the others. Mutual termination requires consent by all parties to the contract and is usually described as “terminating an agreement by agreement”. With respect to statutory or contractual rights of termination, parties entitled to those rights may terminate the contract unilaterally, under prescribed circumstances. The difference between those two rights is that the statutory right of termination is provided by law while the circumstances for the contractual right of termination is agreed upon by the parties.
Exercising Termination rights
Under the Civil Code, unilateral termination must be exercised with notice, and becomes effective upon the arrival of such termination notice. Additionally, the Civil Code adopts a more flexible attitude towards alternative ways of serving termination notice which are widely used in daily practice.
For example, the non-breaching party may issue a notice to the breaching party requesting correction or performance within a reasonable period, while at the same time stressing that the contract will be terminated if no correction is made within such period. In addition, parties may also file a lawsuit or arbitration application directly for termination without giving any notice.
In certain situations, unilateral termination may only be done through court or arbitration proceedings. This includes ‘change of circumstance’ under Article 533 of the Civil Code and ‘claim for termination by breaching parties’ under Article 580 of Civil Code.
One of the most impactful changes is the introduction of a time limit for exercising a right of termination. According to Article 564 of the PRC Civil Code, parties may agree on the time limit for termination. However, without an agreement, the right of termination must be exercised within one year, commencing when the terminating party knew or should have known the cause(s) for termination, or within the reasonable time after the other party requests the termination of contract.
Moreover, such time limit applies to contracts concluded prior to the Civil Code, retroactively. So, for example, if a party knew or should have known about the cause(s) for termination before the Civil Code became effective on January 1, 2021, the expiration date would be December 31, 2021.
Terminating contracts is always tricky, and wrongful termination can subject parties to potentially huge liabilities. DaWo has assisted numerous clients in contract termination disputes. If you have any questions, please do not hesitate to contact us.