Within what timeframe do defects need to be reported to the seller? PRC Supreme People's Court answers several questions related to sales contracts
Sales contracts dominate daily business life. In China their
legal basis is mainly the PRC Contract Law of 1999. To further
clarify legal issues arising out of sales contracts, the Supreme
People's Court of the People's Republic of China
("SPC") has issued the Interpretations on the Application
of Law in Disputed Sales Contract Cases
("Interpretations"), which became effective on 1 July
2012. Whereas former interpretations by the SPC covered various
aspects of the PRC Contract Law, this is the first time that the
SPC has focused exclusively on sales contracts. The Interpretations
are comprehensive and cover six chapters and 45 articles. Due to
the power of the SPC to issue generally binding regulations and
interpretations, they are binding for all courts in China and will
also influence application of the PRC Contract Law by domestic and
international arbitration institutions.
The most significant updates outlined in the Interpretations are
summarised below.
1. Within what timeframe do defects need to be reported?
A buyer must inspect the goods and notify the seller of any
defects within the contractually agreed inspection period. If no
such period has been agreed, the buyer must inspect the goods in a
timely manner and notify the seller of any defects within a
reasonable period after he has discovered or ought to have
discovered them, at the latest within two years of receipt of the
goods. A contractual quality guarantee period replaces the above
two-year period.
The above are the statutory provisions in Articles 157 and 158 of
the PRC Contract Law. However, they do not make clear which defects
the buyer must notify the seller of within an agreed inspection
period after receipt, and which defects the seller can be notified
of later, within a reasonable period after their discovery.
Further, no criteria for determining a reasonable period are stated
in the law.
In Articles 15 and 18 of the Interpretations, the SPC now
distinguishes between obvious defects and
latent defects. If an inspection period after
receipt of the goods is too short to discover all defects, the
buyer must notify only obvious defects. The buyer can notify latent
defects within a reasonable period after he has discovered or ought
to have discovered them.
With regard to determining what constitutes a
"reasonable" period, Article 17 of the Interpretations
advises that the following be considered: form, purpose and mode of
transaction, transaction practices, installation situation, usage,
type, quantity and nature of the goods as well as the nature of the
defects, the buyer's duty of reasonable care, method and
difficulty of inspection, specific environment and skills of the
buyer or the inspector and the principle of good faith.
The above provides more clarity and relief for buyers as latent
defects are often impossible to discover during the inspection
period. However, in the seller's favour, it also makes clear
that obvious defects cannot be notified after the inspection
period.
2. Sale of non-owned goods and several sales contracts for the
same goods
If a seller concludes a sales contract for goods which he does not
own and is not entitled to dispose of, the sales contract is
nevertheless valid. The buyer is entitled to claim against the
seller for damages due to the seller's breach of contract. This
should be clear according to the PRC Contract Law; however, the SPC
deemed it worthwhile to explicitly stipulate this in Article 3 of
the Interpretations.
If a seller concludes several sales contracts for the same movable
goods with different buyers and more than one of those buyers
claims for performance of the contract, the legal situation was
unclear in the past. The SPC has now established the following
criteria in Article 9 of the Interpretations:
(1) If a buyer to whom the goods have already been delivered
requests confirmation of the transfer of ownership, the court must
support such a request;
(2) If the goods have not been delivered and the buyer who paid
the purchase price first requests delivery and transfer of
ownership, the court must support such a request; and
(3) If the goods have not been delivered and the purchase price
has not been paid and the buyer who concluded the contract first
requests delivery and transfer of ownership, the court must support
such a request.
The above establishes a quite clear priority, i.e. first
possession over first payment over first signing. It means
that taking possession of the goods quickly and making fast payment
can be advantageous for a buyer. Further, according to Article 10
of the Interpretations, in the case of vehicles, vessels and
aircraft, fast registration of title transfer is helpful to support
a buyer's performance request, at least until the item has been
delivered to another buyer.
3. Retention of title
In regard to selling movable goods, retention of title until
payment of the full purchase price is accepted by PRC law and
business practice. This serves to protect the seller's
interests when goods are delivered before payment is received.
However, the statutory law is silent on the rights of the seller
with respect to these goods.
The Interpretations now state in Article 35 that a seller is
entitled to claim for repossession of the goods in the event of the
buyer's
(1) failure to pay the purchase price according to the
agreement;
(2) failure to fulfil specific conditions according to the
agreement; or
(3) sale, pledge or otherwise improper disposition of the
goods.
If after repossession the buyer eliminates the above reasons
within a period agreed by the parties or designated by the seller,
the buyer can again request delivery of the goods according to
Article 37 of the Interpretations.
Further, the seller is entitled to ask the buyer for compensation
for any significant decrease in value of the returned
goods.
In Article 36 of the Interpretations, the SPC has established an
interesting restriction on the seller's claim for repossession:
if the buyer has paid more than 75% of the purchase price of the
goods and the seller claims for repossession, the court will not
support such a request. In its reasoning, the SPC states that the
above provision is designed to balance the seller's and
buyer's interests. In practice, it is possible that such a
restriction will be more in favour of the buyer. As long as he pays
75% of the purchase price, he can be certain he will not be forced
to return the goods.
Finally, the SPC confirms that movable goods sold under retention
of title can be acquired by a bona fide third party according to
Article 106 of the PRC Property Law. This means if a third party
does not know that movable goods are still under retention of title
and buys them from a buyer, the third party becomes their new
owner. Therefore, it is important for business operators who sell
goods under retention of title to insist upon clearly marking the
goods as their property.
4. Other matters
Apart from the above, the Interpretations contain detailed
provisions on conclusion of contracts, burden of proof for
delivery, risk transfer, calculation of damages for breach of
contract, payment by instalments and sale by trial.
The Interpretations offer important guidance and clarity for
Chinese law sales contracts. They should be taken into account by
foreign-invested enterprises in their domestic sales contracts, and
by all foreign companies that have chosen or intend to choose
Chinese law for their international sales contracts. By issuing the
Interpretations more than twelve years after the PRC Contract Law
took effect, the SPC has taken a further step towards making the
application of Chinese law more predictable, and thus more
attractive for foreign companies.
This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq
Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.
The original publication date for this article was 06/09/2012.