PRC Court Admits Prior Negotiations in Contractual Construction
By Patrick Zheng | Charles Qin
English law excludes evidence of what was said or done during the course of negotiating an agreement for the purpose of drawing inferences about what the agreement means.[1] This exclusionary rule is endorsed by an Australian court, which recognizes that while the surrounding circumstances, including the commercial purpose, genesis, background, context, and the market, were always admissible as an aid in the construction of contract terms, evidence of negotiations and declarations of subjective intent were not.[2] Evidence of pre-contractual negotiations might be admissible as “safety nets”, in the words of Lord Hoffmann, for the purpose of proving estoppel, rectification of documents, ascertaining a meaning out of a “private dictionary”, genesis and object, and for constructing partly oral contracts, etc.[3]
Different from English law, Chinese law regards prior negotiations as part of the surrounding circumstances and allows them to be used as evidence when interpreting contracts. The guiding principles of contractual interpretation set out under Chinese law[4] include text, other clauses of relevance (whole text), context (surrounding circumstances), object and purpose, trade usages, good faith, etc. Although silent on whether prior negotiations are admissible, Chinese case law[5] makes clear that prior negotiations are part of the surrounding circumstances.
The case[6] below is a useful illustration of the admissibility of pre-contractual negotiations in interpreting a contract under Chinese law.
Background
The case concerns interpretation of the exact meaning of the word “assumption” of debt in a contract and whether similar wording used in pre-contractual negotiations is admissible to ascertain its meaning.
Jiangsu Staple Dangerous Goods Logistics Co., Ltd. (“STP Company”) and Quandong Electric Switch Co., Ltd. (“QD Company”) entered into a Share Transfer Agreement (“Share Transfer Agreement”), whereby QD Company sold its wholly-owned subsidiary Quandong (Nanjing) Solar PV Co., Ltd. (“QD Nanjing”) to STP Company at a price of RMB 32.8 million.
However, because QD Nanjing owed money to the local government, QD Company was unable to acquire the relevant approval and complete the transfer procedures as agreed. On 26 September 2013, STP Company remitted RMB 3 million into QD Company’s bank account. Later, STP Company and QD Company signed a Letter of Confirmation (“Letter of Confirmation”), which reads:
“The local government requires QD Nanjing to pay off RMB 3.8 million during the course of completing the formalities and approving of the share transfer…. In order to speed up the share transfer process, QD Company agrees to assume a payment of RMB 800,000, and STP Company agrees to assume a payment of RMB 3 million (not included in the purchase price of RMB 32.8 million). STP has remitted the above amount on 26 September 2013 into QD Company’s bank account.”
STP Company argued that according to the Letter of Confirmation, the payment of RMB 3 million had not been included in the share purchase price of RMB 32.8 million, and shall be an independent debt owed thereto. STP therefore claimed that QD Company was obligated to repay STP an amount of RMB 3 million, plus interest.
Decision
The trial court dismissed the claim. In the appeal, the Jiangsu High People’s Court (“High Court”) also dismissed STP’s claim that the RMB 3 million was a loan made to QD Company. When interpreting the Letter of Confirmation, the High Court relied on pre-contractual email exchanges which evidenced that STP was willing to voluntarily assume RMB 1 million to be paid to the government, and thereby concluded that “although the amount of ‘voluntary assumption’ by STP (RMB 1 million) is different from that of the Letter of Confirmation (RMB 3 million), the meaning of ‘assumption’ can be inferred from prior negotiations that it is meant to be ‘voluntary’, so the whole RMB 3 million need not be repaid by QD Company, and shall be borne by STP Company itself for the purpose of facilitating the share transfer process.”
Comment
There have been a number of significant English Supreme Court judgments[7] since Chartbrook Ltd v Persimmon Homes Ltd that have “softened” the more traditional English law approach to construction and interpretation of contracts. The trend in these judgments is to move away from the very strict “literalist” approach to interpretation of contracts towards a slightly more “contextual” approach.
This now means that in certain limited circumstances, the courts can now take into account pre-contractual negotiations and other pre-contractual materials (provided they were known to both parties) when construing and interpreting the contract. It is, however, true to say that English law still is slow to take into account pre-contractual materials and the approach remains that generally pre-contractual materials are excluded.
Further, even where English law permits pre-contractual materials to be considered, it only does so in a limited manner and for limited purposes. English law still remains predominately focused on the objective meaning of the words and language used in the contract document.
The underlying rationale of the rejection of prior negotiations and subjective intentions in contractual interpretation is the long-held English commitment to the view that there is a single moment when the intention of the parties crystalizes into a contract. There is no such notion under Chinese law. Since Chinese courts treat pre-contractual negotiations as surrounding circumstances admissible in contractual interpretation, it is advisable to clearly indicate the parties’ intent to exclude prior negotiations through an “entire agreement” or integration clause in the contract, although the entire agreement or integration clause itself may be subject to challenge or overridden by contrary evidence in prior negotiations.
【Endnote】
[1] See the comments of Lord Hoffman in Chartbrook Ltd v Persimmon Homes Ltd, [2009] 1 AC 1101 (HL) at [28-31], “The rule that pre-contractual negotiations are inadmissible was clearly reaffirmed by this House in Prenn v Simmonds [1971] 1 WLR 1381... In Prenn v Simmonds [1971] 1 WLR 1381, 1384 Lord Wilberforce said by way of justification of the rule: ‘The reason for not admitting evidence of these exchanges is not a technical one or even mainly one of convenience (though the attempt to admit it did greatly prolong the case and add to its expense). It is simply that such evidence is unhelpful. By the nature of things, where negotiations are difficult, the parties’ positions, with each passing letter, are changing and until the final agreement, though converging, still divergent. It is only the final document which records a consensus....’ ”
[2] Franklins Pty Ltd v Metcash Trading Ltd [2009] NSWCA 407.
[3] Investors Compensation Scheme Ltd v West Bromwich Building Society [1997] UKHL 28.
[4] Article 125, Contract Law of the People’s Republic of China (1999), “In the event of disputes between the parties concerned over the understanding of a clause of their contract, the true meaning of the clause shall be determined on the basis of the wording used in the contract, related clauses of the contract, purposes of the contract, trade practices and the principle of good faith.”
[5] See in Beijing Aiqin Investment Co., Ltd. v Yudan, Beijing Intellectual Property Court (2017) 京73 民终740号, “Article 125 mainly establishes the rules of contract interpretation as below: … (3) To take into account the circumstances and materials formed in the conclusion of the agreement, e.g. negotiations and exchanges, drafts papers, etc. (teleological interpretation).”
[6] Jiangsu Staple Dangerous Goods Logistics Co., Ltd. v Quandong Electric Switch Co., Ltd., Jiangsu High People’s Court, (2015) 苏商外终字第00047号.
[7] See Arnold v Britton & others [2015] UKSC 36; Wood v Capita Insurance Services Ltd [2017] UKSC 24 and Wells v Devani [2019] UKSC 4 (which concerns interpretation of oral contracts and also the role of implied terms).
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