178 Chinese Contract Law

3.2. Malicious Collusion to Damage the Interests of the State, a Collective or a Third Party

In China, a contract is void if it is concluded under a malicious collusion to cause harm to the State, a collective or a third party’s interests.52 The collusion refers to the deliberate collaboration of a party with the other. Under the Contract Law, if the collusion leads to a contract between the parties, which is purposed, or contains contents, to damage the interests of the State, a collective or a third party for the illegitimate benefits or gains of the parties in collusion, the collusion will be found malicious or in bad faith.53

Therefore, in the concept of the Contract Law, malicious collusion is a civil conspiracy through the form of contract to achieve illegitimate goals. For example, a malicious collusion will present if a bidder conspired with the bidding inviter to ensure that the bidder will get the contract by pushing out other competitors. Another example of malicious collusion is that a representative of State owned enterprise collaborates with the other party in a contract to sell the products of the enterprise at the unreasonably low price in exchange for certain benefits the other party has brought or may bring to the said representative.

Obviously, the key elements of malicious collusion are “collaboration” and “bad faith”. The collaboration has a two-layer meaning. At first layer, the parties involved have an agreement aimed at carrying on intended act with each other. The agreement may be in the form of either words or conduct. The second layer is that the parties collaboratively take action together to achieve the goal underlying the agreement. Whether the goal has actually been achieved does not affect the finding of the collaboration. The bad faith implicates the knowledge and deliberation of the parties who collaborates. If the parties know that their collaborative conduct is causing or will cause harm or damage to the State, a collective or a third party’s interest, and deliberately make it happen, they are in bad faith.

52It is interesting to note that that Contract Law differentiates the State and collective from third party, which is criticized to treat the equal civil actors unequally. The argument against such wording is that as opposed to contract parties, both State and collective are all third parties.

53As noted, in China, the public ownership is divided into two categories: State ownership and collective ownership. Article 6 of Chinese Constitution (as amended 2004) provides that the basis of the socialist economic system of the People’s Republic of China socialist public ownership of the means of production, namely ownership by the whole people and collective ownership by the working people”. Under Articles 73 and 74 of the 1986 Civil Code, State property shall be owned by the whole people and property of collective organizations of the working people shall be owned collectively by the working people. Most collectives are rural collectives, i.e. farmers production associations.

Chapter Six	179

Thus, under the Contract Law, where a recovery for malicious collusion is sought, both collaboration and bad faith must be proved. But as is the case in practice, it seems very difficult to obtain the evidence that the parties collaborated in bad faith because the collaboration between the parties might not be discernable. On the other hand, a contract made through malicious collusion will be void only if the contract is purposed to damage the interests of the State, a collective or a third party. And then the claiming party has the burden of proof for both the intended or actual damage to such interests.

3.3. Use of Contract for Illegal Purpose

A contact, though legally concluded, is also null and void if it is intended to serve an illegal purpose. The difference between the malicious collusion to damage the State, a collective or a third party’s interests and the use of contract for illegal purpose is that the former deals the means of making the contract and its consequences, while the latter involves the legitimacy of purpose that the contract is made for.

In the case where contract is entered for a concealed illegal purpose, the form of the contact and the contract itself on their face are valid or legally permissible, but the goal that the contract is actually to achieve is illegal or prohibited by the law. To illustrate, assume the parties make a contract to voluntarily transfer of a piece of property between them, the contract, if not prohibited by the law with regard to the transferred property, would be valid and effective. But if the transfer of property is aimed at evading tax or payment of debts, the contract will be deemed as having concealed an illegal purpose (tax evasion or cheating) and therefore is void.

Pursuant to the Contract Law, the essential factor to determine whether an illegal purpose is concealed under a contract is the intent of the parties because from the outside, there is nothing wrong with the contract. Thus, if the parties intend to evade law or legal obligations through a legitimate contract, it would be held that there exists a concealed illegal purpose. The intent could also be inferred from the actual consequences resulted from the contract, for example, the frustration of the debt payment as a result of contractual transfer of the property by the debtor.

However, a question would be raised in the finding of concealed illegal purpose when one contractual party has the intent to conceal and the other party has no knowledge about it. The question is whether the innocent party should be compensated if the contract is held void for its concealing illegal purpose. For instance, a thief entered into a contract with a student to sell a used bicycle to the student for RMB 200 Yuan. The purpose of the thief for making the contract was to transfer the stolen good – the used bicycle – to the student for money and the student knew nothing about it. Clearly, the contract itself was

180 Chinese Contract Law

fine but the illegal purpose – transfer of the stolen good – was concealed. Should the student be able to get his RMN 200 Yuan back if the contract was declared void when the stolen bicycle was discovered? What if the thief spent the RMB 200 Yuan already? There seems to have no readily answer in China to this question yet.

Another matter involves damages. Of course, the use of contract to serve illegal purpose may or may not cause actual damages to other party. Nevertheless, under the Contract Law, to determine whether an illegal purpose is concealed under the color of a contract, the presence of actual damages is not required. Therefore, to the finding of illegal purpose under the guise of a contract, the question whether there have been any damages is not a concern. However, when determination of the liabilities to be imposed becomes an issue, the actual damages have significant relevancy.

3.4. Harm to the Social Public Interest

As discussed in Chapter IV, the protection of social public interest is a stated contract principle in China that directly affects the validity of the contract. This is a typical contract area where the freedom of contract is interfered with by the government for the interest of the public. Simply speaking, under the Contract Law, a contract, though freely concluded by the parties, may not be enforced if it offends the social and public interests that the government intends to protect.

According to Article 7 of the Contract Law, when a contract is concluded or performed, no social public interest may be damaged. In addition, it is mandated in Articles 55 of the Civil Code that a civil conduct shall not violate social public interest. Further, Article 58 of the Civil Code provides that a civil conduct is null and void if it violates the social public interest. In China, the term of social public interest and the term of public policy are often interchangeably used in contract cases. But as we have indicated, the social public interest in China is regarded to connote both public order and social virtues.

To speak fairly, social public interest is a very broad concept and is difficult to be precisely defined. A tough question is perhaps the one as to what would constitute a social public interest. There are several efforts that have been made in China by the scholars who try to (a) offer a scholarly guidance on the list of conducts that would violate the social public interest and (b) make a distinction between public social interest and State and private interest. For example, as one view argued, the social public interest mainly refers to the interest of all members of the society. In contrast, the State interest is the interest that the State as a governing body enjoys, and the private interest is the interest of particular member of the society.54

54 See Wang Liming, supra note 7 at pp. 652–653.

Chapter Six	181

In many cases, the social public interest is being reflected in statutes. As a result, the social public interest is often intertwined with the issue of legality of the contact. If a statute clearly prohibits the parties from making certain contract that would be in violation of a particular social public interest, there will then be a case that combines both social public interest and legality. The unfair competition law may serve as a good example in this regard. The very purpose of the unfair competition law is to create an environment in which the business operators will deal with each other fairly. Hence, if a contract is purposed to impose unreasonable restriction on competition, the contract not only may violate unfair competition law itself but also would be contrary to the social public interest of fair competition embodied in the law to promote the welfare of the general public.

In addition, a contract may be deemed null and void for damaging social public interest even if it violates no provision of the existing laws or regulations. It is particularly true when the social virtues are involved, over which the laws may have limited coverage. On the other hand, due to the wide range of the social and public interest, not every violation of such interest would render the contract void. Under the Contract Law, a contract would be void for violation of social public interest only if such violation would damage the public order and important social virtues.

3.5. Violation of Compulsory Provisions of Law or Regulations

A contract that violates the compulsory provisions of law is a matter of illegality. If a contract is found to have violated the law, the contract is void and has no effect from beginning. In China, the violation of compulsory provisions is separated from the use of contract for illegal purpose because it is believed that the issue of illegality differs from that of the use of contract for illegal purpose. The major difference is described to be that the illegality directly involves the subject matter or the contents rather than the underlying objective of the contract. A few contract scholars in China also argue that the illegality under the Contract Law shall in addition include violation of the formality mandated by the law or regulations. In their view, for example, if a contract is required to be approved under the law, without such approval the contract will be void because violation of the approval requirement will make the contract illegal in its formality.

With regard to the scope of illegality, the Contract Law takes a narrower or more restrictive approach than the 1986 Civil Code. Under Article 58 of the Civil Code, a civil conduct will be invalid if it violates the law. The Contract Law, however, limits the law to the compulsory provisions of the law. In other words, a contract will be null and void only if it violates the provision of the law that is imperative. In terms of their effect, the provisions of the law could

182 Chinese Contract Law

be divided into two categories: mandatory provisions and non-mandatory provisions. A provision of law is mandatory if it is denoted by the word such as “should”, “must”, “shall”, or “prohibited”. If the provision is phrased with the word “may”, “could” or “allowed”, the provision is deemed non-mandatory.

Thus, under the Contract Law, to make a contract void for illegality, it must be proved that the contract violates the mandatory provision of the law. A both debatable and practical issue, however, is what would be the “law” for purposes of making a contract void. The very center of the issue is whether the local law should be included as the “law”. Many argue that the law shall mean the statute passed by the national legislature and the administrative regulations adopted by the national government, excluding any local law or regulations because the Contract Law makes no indication about application of any local law or regulation in this regard.55 But some point out that despite the disputes over the “law”, if a contract contradicts the local law or regulations, it may be deemed void on the ground of harm on social public interest. Obviously, the issue whether the violation of the local law or regulations would make the contract void remains unsolved.56

As described in the introduction of this book, China has a unified legal system with an exception to Hong Kong and Macao because of the historical status of these two regions. Under the Chinese Constitution (as amended 2004), the primary legislative power rests with the National People’s Congress. The National People’s Congress (and its Standing Committee) is responsible for adopting and amending national laws. The executive branch, namely the State Council and its ministries, is empowered to stipulate regulations and rules of administrative nature at the national level. In addition, the people’s congresses the provincial level (including municipalities directly under the central government) and their standing committees have the power to make local law and rules that do not contravene the Constitution, national laws or administrative regulations.

Given the strong likelihood of local government to protect the local interests, one should not underestimate the possible influence of local law and regulations on the validity of contract. Since the local courts are all required to report to the local people’s congress and the courts budgets are provided by the local government, it is not uncommon to see that the court decisions are more

55See Wang Liming & Cui Jianyuan, supra note 43 at pp. 278–279; Jiang Ping et al, A Detailed Explanation of the Contract Law of Law, 43 (China University of Political Science and Law Press, 1999); Yang Lixin et al, Implementation and Application of the Contract Law of China, 87–88 (Jilin People’s Publishing House, 1999).

56See Su Haopeng, supra note 13 at 285.