News

Made in China, ginger, and trading contracts

26.09.2007

Toy recalls, poisonous pet food, poor quality compliance and low labour standards have marred the reputation of Chinese products in the international market place. A recently reported Chinese court judgement about rotten ginger highlights the critical importance of sound contract dispute management procedures and prompt action when something “Made in China” is not as the buyer expected.

What was the case about?

In Sui Zhong Fa Min San Chu Zi No 297, a decision of the Guangzhou Intermediate People’s Court reported earlier this year, a US buyer sued its Chinese supplier for an alleged breach of the quality conformity provision in a contract for the supply of ginger. The court found that:

  • in November 2000, the Guangzhou-based trading company entered into a contract with the US buyer for the sale of a consignment of ginger;
  • the trading terms were “FOB Guangzhou” and the destination port was the City of New York;
  • under the contract, the Chinese seller promised that the delivered ginger would comply with US food standards; and
  • on arrival in the US the ginger was found to be wet and rotten, and did not accord with those standards.

In August 2003, the US buyer sent a letter of demand to the Chinese seller, notifying the seller of the quality inconformity, alleging that the seller had fundamentally breached the contract, and claiming compensation for the damages suffered by the buyer. The seller did not respond to the buyer’s demands. The US buyer commenced litigation against the seller in China’s Guangzhou Intermediate People’s Court in 2004.

What or whose law should be applied?

The ginger sale contract did not specify a governing law. The Guangzhou court found that the United Nations Convention on Contracts for the International Sale of Goods 1980 (CISG) and Chinese law should be applied in resolving the dispute. Each party had its place of business in a CISG contracting state, and they had not excluded the application of the CISG or varied the effect of any of its provisions. The court ruled that Chinese law had the closest connection with the ginger sale contract, on the basis of connecting factors such as the defendant’s nationality, its business domicile and the place of performance of the contractual obligations.

The application of the “closest connection” principle to determine the applicable law of a contract is internationally acknowledged and is promoted by Article 8(1) of the Hague Convention on the Law Applicable to Contracts for the International Sale of Goods 1986.

Contest between passing of risk and quality conformity

The Chinese seller argued that the damage to the goods should be entirely borne by the buyer. This argument was based on the proposition that the risk of damage to the goods passed to the buyer the moment the goods crossed the ship’s rail at the named port of shipment, in accordance with the agreed FOB terms under INCOTERMS 2000.

The court disagreed, saying that the risk allocation rule under INCOTERMS 2000 was not to be confused with the seller’s quality conformity obligation, “the most important contractual obligation that a seller must perform”.

Time limit to make a claim

The Chinese seller then argued that the US buyer had lost its entitlement to claim that there had been a lack of conformity of the goods with a required quality standard because the buyer had failed to give the seller notice within two years from the date on which the ginger was actually handed over to the buyer, as required by Article 39(2) of CISG. Delivery took place in December 2000, but no demand had been made until August 2003 and the case had not been commenced until 2004. The seller argued that the buyer should have notified the seller before December 2002.

The US buyer countered this by relying on Article 129 of China’s Contract Law 1999, which essentially incorporates Article 8 and Article 10(2) of the United Nations Convention on the Limitation Period in the International Sale of Goods 1974. The US buyer argued that the time limit to make a claim about the defect under Article 129 was four years from the date when the goods were handed over to the buyer.

The court found that the two year time limit under the CISG applied. Accordingly, the US buyer’s claim was dismissed on the ground of “undue delay”. The court acknowledged that the question of the time limit for claims under international sale of goods contracts was a highly controversial issue in the Chinese legal community. Here the court found it reasonable to interpret the two year time limit rule under the CISG as a “specific quality deficiency time limit”.

Lesson one – are your contracts properly drafted?

Many Australian businesses are well-experienced in their international contracting, and have developed contractual documents which are well attuned to choice of law and forum and arbitration issues, and which contain terms and conditions which they consider to be essential for their specific circumstances. However that is not uniformly the case. Contract review and updating should be continuous. New entrants to international business should get it right from the start, by seeking appropriate advice tailored to their needs.

Lesson two – China has a legal system, but it is different to ours

Under the influence of rapid modernisation and WTO membership, China’s legal system is developing at a fast pace. In many areas Western laws have become the basis for new Chinese laws. Furthermore, under the General Principles of Civil Law 1987, international conventions ratified by China will prevail over any national, provincial or local laws and regulations.

Nonetheless, the Australian and Chinese legal systems will continue to be fundamentally different. There are marked differences in commercial laws and procedures, and China often conditions its accession to international conventions. Unlike common law jurisdictions, judgements rendered by Chinese courts do not amount to “judicial precedent”, and technically have no binding effect at all. However, there is an increasing trend within the Chinese judiciary for later tribunals to carefully examine reported cases with similar factual scenarios. As a practical matter, a concept of “persuasive authority” is building within Chinese jurisprudence.

If a party to a contract insists that Chinese law should apply, certain due diligence must take place. For example, what is the contract about, and what Chinese laws might be relevant to its interpretation and enforcement? If a contractual problem arises, what are the time limits and other procedural requirements that will be applied? No contracting party can expect to be advised about the entirety of Chinese laws that might apply, however an experienced China lawyer will immediately be able to identify the critical features of the law which should be taken into account.

Lesson three – monitor contractual performance, and move quickly if you have a claim

In the Sui Zhong case, the court adopted the two year time limit under the CISG, instead of the four year time limit otherwise applicable under Chinese law. In the circumstances, that outcome favoured the Chinese seller over the US buyer. Western lawyers are accustomed to a liberal approach towards claims argued to be time-barred, consistent with principles of justice and equity. But it would not be fair to say that the Guangzhou court’s ruling was driven by a local bias: the judgement is well-reasoned and has been favourably commented upon. Despite the lack of any formal principle of precedent under Chinese law, traders should now recognise the likely application of the shorter time limit in similar cases in the future.

Managing and preparing a cross-border commercial dispute can be a lengthy process for Australian companies. First, the relevant breach and cause of action must be established, sometimes amongst multiple parties operating in different places and speaking different languages. Even when that has been achieved, lawyers need to be appointed, court procedures need to be identified, and documents intended to be used as evidence have to be translated and then notarised and certified at the Chinese Embassy or at Chinese Consulate-General offices.

These things emphasise the importance of the proper identification of commercial disputes with Chinese parties, and the need to respond quickly and assertively.

Recommendations

Australian companies without proper arbitration agreements might find that litigating sale of goods contract disputes in Chinese courts is the only practicable way to obtain compensation. Furthermore, China and Australia do not yet have any mechanisms for the reciprocal recognition and enforcement of court judgements. Given the recent international tension about “Made in China” products, Australian companies should review their China-sourcing contracts, take prompt action to address contractual risks, and implement mechanisms for the timely identification of sale of goods problems and for making claims against defaulting parties.

This memo presents an overview and commentary of the subject matter. It is not provided in the context of a solicitor-client relationship and no duty of care is assumed or accepted. It does not constitute legal advice.