312 Chinese Contract Law

and earnest money, but the aggrieved party may only claim one of them when the other party breaches the contract.

There is a writing requirement for an agreement on the earnest money. According to Article 90 of the Guaranty Law, the earnest money agreement shall be made in writing. With regard to the delivery of the earnest money, the parties are required to specify in their agreement the time for the delivery, and the agreement will not take effect until the day when the earnest money is actually delivered. Because of the security function of the earnest money, the agreement of the earnest money is normally regarded as a side contract, although such an agreement is often seen as a contract clause or article. The existence of such agreement is totally dependent on the underlying contract.

An issue that recurs with high frequency is perhaps the amount of the earnest money. The parties, of course, have the right to decide through their negotiations how much the earnest money should be on the basis of the contract price. But in order to prevent abuse of the right, there is a cap that is imposed by the law. In accordance with the Guaranty Law, the maximum amount of the earnest money as agreed upon by the parties shall not exceed 20 percent of the contract price. In practice, if the agreed earnest money is over the 20 percent cap, the agreement will not necessarily be void, but the agreed amount will be reduced to the 20 percent.

5. Mitigation Duty

Mitigation, also called “avoidable consequence”, is the rule to preclude the recovery of the damages that could have been avoided with reasonable efforts and without undue risk, burden or humiliation.47 The duty to mitigate is recognized in the Contract Law and applies to the aggrieved party. The idea is that in case of breach the aggrieved party shall not sit idly and allow the damages to accumulate. In China, the mitigation duty is viewed as a fault-based duty, under which the aggrieved party will be found at fault if it fails to take reasonable action to avoid further damages that could be avoided.

The mitigation duty is provided in Article 119 of the Contract Law. It is required that the non-breaching party take proper measures to prevent the aggravation of loss. If the non-breaching party fails to take proper measures so that the loss is aggravated, it may not claim any compensation as to aggravated part of the loss.48 In addition, the party in breach will be held responsible for the reasonable expenses incurred to the other party for making efforts

47See Goetz & Scott, The Mitigation Principle: Toward a General Theory of Contractual Obligation, 69 Va. L. Rev. 967 (1983).

48See the Contract Law, art. 119.

Chapter Ten	313

to prevent the loss aggravation. But according to the people’s courts, the reasonable expenses should not include the salaries or other remuneration for the services of the party.49

Under the Contract Law, the mitigation duty also arises in the situation where the contract could not be performed due to force majeure. Article 118 provides that a party who is unable to perform the contract on the ground of force majeure shall give the other party a prompt notice in order to reduce the probable loss to the other party, and shall provide evidence in this regard within a reasonable period of time.50 To simplify, the duty of mitigation, as applied in Article 118, is about the duty of prompt notice.

6. Exemption of Liability

Once again, based on the traditional doctrine of pacta sunt servanda (agreement must be kept), a party who fails to perform a contract shall be held liable for breach. But such liability may be excused in certain circumstances that are either agreed by the parties or provided by the law. If a party is exculpated from the liability for breach under the agreed circumstances, the exculpation is called contractual exemption. When the liability for breach is excused under the provision of law, the exculpation is termed as legal exemption. If the breach falls within the legal exemption, the liability of the party in breach will be excused as the operation of law without reference to the agreement of the parties or the terms of the contract.

The only legal exemption of the contractual liability in the Contract Law is the exemption on the ground of force majeure. Under Article 117 of the Contract Law, in case where a contract could not be performed because of force majeure, the liability for breach shall be excused in part or wholly in light of the effects of the force majeure. Recall that in Article 94 of the Contract Law, the force majeure is a legal ground on which a contract may be dissolved. Here upon occurrence of force majeure, a party’s obligation to perform the contract will be excused and the liability for breach will consequently be exempted.

In the meantime, Article 117 provides two exceptions to the legal exemption, namely exemption from the liability due to force majeure, under the Contract Law. The first exception is where “the law otherwise provides”. For example, under Article 34 of the Post Law, force majeure may not exempt the liability of the post office for the loss of money remittance or insured postal articles. The second exception involves delayed performance. It is provided in

49See Li Guoguang, supra note 5 at p. 497.

50See the Contract Law, art. 118.

314 Chinese Contract Law

Article 117 of the Contract Law that if the force majeure occurs after one party has delayed in performance, the liability shall not be exempted. The underlying reason is that delay in performance is a breach for which the nonperforming party should be held liable, and force majeure should not exempt the liability of the party who is already in breach.

Quite often, parties to a contract prefer to negotiate in their contract a force majeure clause in order to better protect their respective interests. Note that in China, absence of the force majeure clause does not deprive a party of the right to claim exemption upon occurrence of force majeure because of the availability of Article 117 legal exemption. But, if there is a force majeure clause in the contract, the clause will be regarded as a supplement to the legal exemption and may be used to help allocate risks and ascertain the scope or coverage of the force majeure.

Chapter XI

Third Parties

Third parties are those who are not the parties but related to the contract or have the interests in the contract. A broader coverage of the third parties also includes those who have impacts on the performance of the contract. There is a dictum in the contract literature that a contract has the effect or produces consequences only to the parties themselves and does not externally affect others.1 But third parties theory penetrates the internality of the contract affairs and brings the non-party’s interests into the center of discussion by looking at external effects created by the contract.

In China, an interesting phenomenon is that the matter on third parties seems to have not received as much attention as it should. Firstly, the Contract Law contains no special chapter dealing with third parties and the law of third parties can only be seen from the scattered provisions of the Contract Law. Secondly, almost none of the published contract books makes the third parties a separate issue and discusses them in a specific way. Thirdly, there is a lack of systematical rules that govern the relations between the parties and non-parties. The reasons for this phenomenon may be many, but the most important one appears to be rooted in traditional belief that a contract only involves the parties.2

1 See Robert Scott & Jody Kraus, Contract Law and Theory (3rd ed), 1127 (LexisNexis, 2002).

2A predominant doctrine in China that precludes non-parties from the contract is the relativism of contract. Under this doctrine, only the parties may each other claim the rights and bear obligations arising from the contract. In this sense, relativism may actually mean or bear a great resemblance to “privity”, though the term “privity” is not commonly used in China.

316 Chinese Contract Law

Before the Contract Law was adopted, the matters of third parties in China only appeared in conjunction with the assignment. At that time, a popular notion was that the contract was the matter of parties, and the only possible non-party who may affect the contract was government authority. Therefore, the concerns about non-party were all centered on the authority coming from the government, and there were certain legal provisions that applied in this respect. An illustrative example is Article 116 of the 1986 Civil Code. It provides that if a party fails to fulfill its contractual obligations on account of the higher authority, the party shall first compensate the other party for damages or take other remedial measures as agreed upon in the contract, and then the higher authority shall be responsible for settling the loss the party suffered.

The Contract Law expands the third parties to include those to or by whom a contract is performed. In addition, the Contract Law replaces the term “government authority” with the term “third parties” to cover in a more general sense the situation where the non-performance is caused externally by a non-party (including government authority). However, it must be noted that the Contract Law contains no such concepts as intended or incidental beneficiary nor does it differentiate donee beneficiary from creditor one. In other words, the Contract Law makes no further efforts in the identification of the third parties.

Nevertheless, compared with previous laws, the Contract Law has made certain progress in regulating third parties. In addition to assignment, the Contract Law specifies several situations in which a third party is involved. The first situation is the contract whereby the parties agree to make performance to a third party. The second situation concerns the contract under which the performance is to be made by a third party. The third situation deals with the breach that is caused by a third party. In addition, the Contract Law has several provisions that are aimed particularly at protecting the interests of the third parties. For instance, according to Article 106 of the Contract Law, the rights and obligations of a contract may not be terminated as a result of the assumption of the rights and obligations by the same person if the interests of a third party are involved. But still, the matter of the third parties is an unfinished business of the Contract Law.

It is true that the issues concerning the third parties could not be fully addressed without discussing assignment and delegation because an assignment or delegation involves a transfer of contractual right or obligations from a party to a non-party. But is should be pointed out that in China, assignment and delegation normally come up with the modification of contracts. A common belief in China is that assignment and delegation are more closely related to the modification than to the third parties. This belief, as we have seen, is also reflected in the Contract Law where the contract assignment (including delegation) is provided in the chapter together with the contract modification.