Contracts 101: A Q&A on Contract Conclusion and Validity

From the simplest to the most complex business transactions, robust contracts are essential. At Horizons, we encounter many foreign companies drafting contracts for their Chinese subsidiaries without the mandatory clauses or drafted in English. In such cases, without taking the reasonable steps to ensure contracts are drafted properly and accordingly to the Chinese Law, the contract may not provide significant protection during a contractual dispute.

Below, we provide a Q&A on the contract conclusion and validity to support businesses to better safeguard interests.

For more information on contracts in China, we penned the Do’s and Dont’ of Contracts in China.

Q: When is a contact effective?

A: In general, a contract comes into effect as soon as it is legally concluded, unless otherwise provided by law or agreed by the parties.

If laws or administrative regulations require that the effectiveness of a contract is subject to approval and registration procedures, such requirement shall be followed. Where the party obligated to complete application for approval or other procedures fails to do so, the other party may request the former party to bear the liability for breach of such obligation.

Q: Can parties conclude a short-term contract based on concluding specific conditions?

A: The contractual parties may agree that a contract is terminated upon the occurrence of specified conditions stipulated in the concluded contract. However, if the conditions are unfairly prevented by a party for its own interests, such conditions shall be recognized as fulfilled. Equally, if a party unfairly facilitates the satisfaction of the conditions, such conditions shall be regarded as unfulfilled.

Q: Who can conclude a contract?

A: Contracts must be concluded by legal persons and natural persons with full civil capacity. A contract entered into by a person without civil capacity is void.

A contract entered into by a person with limited civil capacity is valid only upon confirmation by that person’s legal representative (i.e., such person’s legal custodian).

A contract signed on behalf of a legal entity, by a legal representative or by a person in charge of a legal entity exceeding the scope of their authority will be valid, unless the other party either knows or should have known that the person has so exceeded their authority.

Similarly, where a contract is entered into by a person who has no agency authority, or by an agent who acts beyond the scope of their authority or whose authority has already been terminated, the contract will be only valid if the other contractual party reasonably believes that the person acting on behalf of the counterpart has the necessary authority of agency. In such cases, the principal is entitled to request the agent who has no such authorisation to compensate for all losses suffered as a result of the agent’s authorized conduct.

Q: When is a contract deemed invalid?

A: The Book III Contract of the Civil Code sets forth circumstances under which a contract shall be deemed invalid, in part or entirely. Apart from above specific stipulations in the Book III Contract, a contract is also invalid in case of any of the following circumstances:

  • If it is performed by a person and another person based on a false expression of intent;
  • If it is in violation of the mandatory provisions of laws or administrative regulations or offends the public order or good morals;
  • If it is conducted through malicious collusion between a person who performs the act and a counterparty thereof and thus harms the lawful rights and interests of another person.
Q: Can a contract be revoked?

A: The party concerned may request the court or an arbitration institution to revoke the contract if it is:

  • performed based on serious misunderstanding;
  • induced to be performed by fraudulent means against the party’s true intention; and
  • performed against the party’s true intention owing to duress by the other party or a third person;
  • performed in situations such as where one party takes advantage of the other party that is in a desperate situation or lacks the ability of making judgment, which is obviously unfair.

A party’s right to revoke a contract is extinguished under any of the following circumstances:

  • the party has failed to exercise the right to revocation within one year from the date when it knows or should have known of the cause for revocation, or within 90 days from the date when the party who has performed the act with serious misunderstanding knows or should have known of the cause for revocation;
  • the party acting under duress has failed to exercise the right to revocation within one year from the date when the duress ceases; or
  • the party who becomes aware of the cause for revocation waives the right to revocation expressly or through its own conduct.
  • The right to revocation is extinguished if the party fails to exercise it within five years from the date when the contract has been performed.

A contract that is void or has been legally revoked has no effect from the very beginning. Where a contract does not take effect, or is void, revoked, or terminated, the validity of a clause concerning dispute resolution shall not be affected.

If you would like to discuss more about contract drafting in China, please contact Horizons at country.partners@horizons-advisory.com and our Partner in charge will be in touch.