Chinese Supreme Court Rules on Letter of Intent
By Patrick Zheng | Charles Qin
Under English law, the general presumption is that a letter of intent does not give rise to bilateral contractual liability. Even if all terms of a contract are agreed and identifiable with the necessary certainty, by using the words “subject to contract” or some synonym the parties may prevent contractual relations arising until that restriction is mutually lifted,[1] although English courts have tried to find various ways to get around this issue by interpreting the contract in such a way that the contract does not concern the so-called “agreement to agree” issue.[2]
Under Chinese law, the general proposition is that a letter of intent is a legally binding contract creating contractual obligations. The Supreme People’s Court adopted the German notion of preliminary contract,[3] using the nomenclature “Yu Yue He Tong” (预约合同) in Chinese,[4] which refers to a preliminary document that is purported to be crystalized into a formal contract some time later.
Since a letter of intent is binding, but only preliminary in nature, the vast majority of disputes concerning letters of intent in China are focused on whether the parties are obliged to perform the letter of intent to enter into a formal contract and an aggrieved party could claim remedies based on the formal contract yet to be concluded.
The case below is a useful illustration of the legal effect of letter of intent under Chinese law.[5]
Background
Zaihe Investment Co. Ltd. (“Zaihe Investment”) and Landing Group Co. Ltd. (“Landing Group”) (collectively “the Parties”) signed a letter of intent (“Letter of Intent”), under which Zaihe Investment agreed to transfer a certain number of shares of a company to Landing Group, and Landing Group in turn agreed to make payment as consideration (“First Installment”). Shortly after executing the Letter of Intent, the Parties signed a memorandum (“First Memorandum”), which reads:
“The Letter of Intent merely reflects the Parties’ willingness and interest in cooperation, which shall be subject to the formal Share Transfer Agreement to be signed later. In the event of any discrepancy between the two instruments, the formal Share Transfer Agreement prevails.” (Emphasis added)
Pursuant to the Letter of Intent, Landing Group paid part of the consideration to Zaihe Investment, and later, the Parties entered into the formal Share Transfer Agreement following the terms of the letter of intent. The Share Transfer Agreement also confirmed that the First Installment had already been paid.
However, sometime later, the Parties signed another memorandum (“Second Memorandum”) which stated that the formal Share Transfer Agreement was no longer binding.
A dispute arose over restitution sought by Landing Group concerning return of the consideration paid to Zaihe Investment in performing the Letter of Intent. The issue before the competent court, therefore, was whether the Letter of Intent gives rise to an enforceable contractual relationship, and whether it survives after the Parties have entered into a formal contract contemplated by the Letter of Intent.
Decision
The trial court examined the terms of the First Memorandum and held that the Letter of Intent was not binding upon the Parties because it was subject to the formal Share Transfer Agreement to be signed later.
In the appeal, the Supreme People’s Court held that the trial court erred in ruling on the nature of the Letter of Intent. The court observed:
“The Letter of Intent herein is a preliminary contract. Its legal effect is to bind and secure that the parties would enter into a formal contract by virtue of the principle of good faith, which shall be subject to the PRC Contract Law. In the present case, the Parties performed the obligations set out under the Letter of Intent by signing the formal Share Transfer Agreement, thus the rights and obligations under the Letter of Intent have been discharged pursuant to Article 91(1) of the PRC Contract Law.”
On the basis of the foregoing conclusion, the court held that the Letter of Intent, while legally binding on the Parties, had ceased to have any legal effect after the Parties finalized and executed the formal Share Transfer Agreement. Therefore, Zaihe Investment had no contractual basis to keep the consideration paid by the Landing Group.
Comment
Chinese judges will take a holistic approach in construing a letter of intent, taking into account all of the circumstances surrounding the transaction as well as business common sense and usages, to decide whether it has been crystalized into a formal contract or should be regarded itself as a formal contract. This case is a welcome clarification from the Supreme People’s Court on the nature of letter of intent, but a lot of issues are yet to be answered by further judicial interpretation.
The following extra-judicial expositions made by Hua Zhang, justice of the Supreme People’s Court and others, may provide helpful guidance.[6]
1. If the parties have expressly denied the contractual nature of the letter of intent, it shall not be regarded as a preliminary contract, hence no enforceable contractual obligations exist.
2. Provisions in the letter of intent such as confidentiality, exclusivity, governing law, and dispute resolution are generally held to be binding no matter the intention and whether or not the terms of an “agreement to agree” are sufficiently certain.
3. If the intention of the parties, objectively construed, is certain enough that the parties are obliged to enter into a formal contract subject to some conditions precedent, and if the condition is found to have been satisfied, then the non-breaching party can ask the court to order the breaching party to enter into the formal contract, or it can ask the court for damages including expectation damages arising out of the contemplated formal contract.
4. In case some key terms are left for further “best endeavor” discussions, if one of the parties breaches its “best endeavor” obligations, the remedy for the aggrieved party shall be limited to its reliance interest and does not include its expectation interest.
5. If the parties have entered into a formal contract in accordance with the letter of intent, in writing or by conduct, the letter of intent shall cease to have effect and a party cannot claim damages or other remedies under the letter of intent.
Although the starting point with a letter of intent under Chinese law is strikingly different from that of English law, the pragmatic approaches adopted by Chinese judges are to some extent similar to those approaches encapsulated by Rix LJ in the Mamidoi-Jetiol case,[7] which set out principles for dealing with letters of intent under English law which in some circumstances preserves the bargains of the parties under a letter of intent on the basis of sufficient certainty.
To sum up, for a foreign party who enters into a letter of intent under Chinese law, it is advisable to make it clear on the face of the letter of intent that it does not have any contractual effect to avoid ambiguity which might lead to an unwanted contractual dispute.
【Endnote】
[1] Gerard McMeel, McMeel on The Construction of Contracts Interpretation, Implication, and Rectification (3rd edn, Oxford 2017), 431.
[2] Richard Calnan, Principles of Contractual Interpretation (2nd edn, Oxford 2017), pr 16.
[3] Astrid Stadler & Bernd Rüthers, Allgemeiner Teil des BGB (18th edn, CH Beck Publishing 2014), 120.
[4] Article 2, Interpretation of the Supreme People’s Court on Issues Concerning the Application of Law in the Trial of Cases of Disputes over Sales and Purchase Contracts, Fa Shi [2012] No.8.
[5] Landing Group Co. Ltd. v Zaihe Investment Co. Ltd., Supreme People’s Court, (2015)民二终字第143号.
[6] Hua Zhang, Remedies for Breach of Preliminary Contract, Journal of Law Application (2019) Issue 2; See also Chao Sun, The Nature and Validity of Preliminary Contract, People’s Judicature (2016) Issue 11.
[7] Mamidoil-Jetoil Greek Refinery Co SA v Okta Crude Oil Refinery AD [2001] EWCA Civ 604, [2001] 2 Lloyd’s Rep 76.
Authors:
往期分享
PRC Court Rules on Sham ArbitrationService of Process by Contractually Agreed Method under PRC Law
Chinese Court Decides on Method of Service in Arbitration
Chinese Court Rules on the Effect of Shareholders’ Agreement
Chinese Court Upholds Pathological Singapore Arbitration Clause
Chinese Court Decides on Res Judicata of Arbitration Award
长按下图识别二维码关注我们
© 通力律师事务所
本微信所刊登的文章仅代表作者本人观点, 不代表通力律师事务所的法律意见或建议。我们明示不对任何依赖该等文章的任何内容而采取或不采取行动所导致的后果承担责任。如需转载或引用该等文章的任何内容, 请注明出处。
点击“阅读原文”，直达通力官网了解更多资讯！