Preface:

The “Interpretation of the Supreme People’s Court on Several Issues Concerning the Application of the General Provisions of the Contract Book of the Civil Code of the People’s Republic of China” (hereinafter referred to as the “General Provisions Interpretation”) came into effect on December 4, 2023. The General Provisions Interpretation includes provisions governing the trial of contract dispute cases as well as disputes over debts and obligations not arising from contracts, covering various aspects of social life and economic activities. Although the General Provisions Interpretation is not specifically applicable to financial institutions, it will have a significant impact on banking operations. Based on our work experience and the actual circumstances of banks, our attorneys elaborate on the potential impact of the General Provisions Interpretation on banking business.

I. Increased Accuracy Requirements for Third-Party Commitment Documents for Shortfall Coverage and Liquidity Support

Paragraph 3 of Article 1 of the General Provisions Interpretation: If a contractual clause has two or more interpretations that may affect the validity of the clause, the people’s court shall choose the interpretation that favors the validity of the clause; if it is a gratuitous contract, the interpretation that imposes a lighter burden on the debtor shall be chosen.

The provision of paragraph 3 of Article 1 of the General Provisions Interpretation stipulates that when there is a dispute over the understanding of a gratuitous contract, the interpretation that imposes a lighter burden on the debtor shall be chosen.

When a bank accepts commitment documents such as shortfall coverage or liquidity support provided by a third party other than the borrower as credit enhancement measures, if the bank cannot prove that the third party provided the credit enhancement for consideration, the court will usually deem it a gratuitous contract. In cases where the wording of the commitment document is ambiguous or subject to two or more interpretations, the court will, in accordance with paragraph 3 of Article 1 of the General Provisions Interpretation, interpret it as imposing a lighter obligation or liability on the third party. It is recommended to strictly review the wording of commitment documents such as shortfall coverage and liquidity support to avoid ambiguity.

II. The Content of a Cooperation Framework Agreement Determines the Nature of the Contract

Article 6 of the General Provisions Interpretation: If the parties agree in the form of a subscription agreement, order form, booking form, etc. to conclude a contract within a certain period in the future, or deliver a deposit to secure the conclusion of a contract within a certain period in the future, and the content such as the subject matter and object of the contract to be concluded in the future can be determined, the people’s court shall find that a preliminary contract has been established.

If the parties, by signing a letter of intent or memorandum or other means, merely express an intention to transact without agreeing to conclude a contract within a certain period in the future, or although there is such an agreement, it is difficult to determine the subject matter and object of the contract to be concluded in the future, and one party claims that a preliminary contract has been established, the people’s court shall not support such claim.

If the subscription agreement, order form, booking form, etc. concluded by the parties have reached a consensus on the main content such as the subject matter, quantity, price or remuneration, and satisfy the conditions for the establishment of a contract as provided in paragraph 1 of Article 3 of this Interpretation, and there is no explicit agreement to conclude another contract separately within a certain period in the future, or although there is such an agreement, one party has already performed and the other party has accepted such performance, the people’s court shall find that a formal contract has been established.

Article 7: After a preliminary contract becomes effective, if one party refuses to conclude the formal contract or, during negotiations for the formal contract, violates the principle of good faith, resulting in the failure to conclude the formal contract, the people’s court shall find that the party has failed to perform the obligations stipulated in the preliminary contract.

In determining whether one party has violated the principle of good faith during negotiations for the formal contract, the people’s court shall comprehensively consider factors such as whether the conditions proposed by that party during negotiations are clearly inconsistent with the content of the preliminary contract and whether it has made reasonable efforts to negotiate.

Article 8: After a preliminary contract becomes effective, if one party fails to perform its obligation to conclude the formal contract, and the other party requests compensation for losses caused thereby, the people’s court shall support such request in accordance with the law.

For the compensation for losses referred to in the preceding paragraph, if the parties have agreed upon it, such agreement shall prevail; if there is no agreement, the people’s court shall, taking into account factors such as the completeness of the content of the preliminary contract and the degree to which the conditions for concluding the formal contract have been satisfied, make a discretionary determination.

Articles 6 to 8 of the General Provisions Interpretation respectively provide for the legal application of preliminary contracts from three aspects: the determination of a preliminary contract, the determination of a breach of a preliminary contract, and the remedies for breach of a preliminary contract. A preliminary contract is a type of contract and must naturally satisfy the general requirements for contract formation, i.e., the content is specific and definite, and indicates that the parties are bound by their expression of intent. If the subject matter and object of the contract to be concluded in the future can be determined, the content of the expression of intent can be deemed specific and definite. After a preliminary contract becomes effective, if one party refuses to conclude the formal contract or, during negotiations for the formal contract, violates the principle of good faith, resulting in the failure to conclude the formal contract, such party has breached the preliminary contract and shall bear liability for breach of contract. Regarding the amount of compensation for losses, the court will make a discretionary determination between the reliance interest and the expectation interest of the formal contract, based on the maturity of the transaction and the degree of proximity to concluding the formal contract.

It is common for banks to enter into cooperation framework agreements with important clients. If a framework agreement stipulates that a separate loan contract must be concluded and also includes detailed rights and obligations such as loan term, interest and compound interest, loan limit, security and guarantee, it is likely to be deemed as directly constituting a formal contract rather than a preliminary contract. If a bank intends to enter into an indicative or preliminary agreement, the content of the relevant clauses should be suggestive and should not include definitive contractual terms.

III. Duty to Explain Standard Terms in Contracts

Article 10 of the General Provisions Interpretation: If the party providing standard terms, upon the other party’s request, explains the concept, content, and legal consequences of abnormal terms that are significantly related to the other party’s interests in a written or oral manner that can be generally understood by the other party, the people’s court may find that it has fulfilled the duty of explanation as stipulated in paragraph 2 of Article 496 of the Civil Code.

The party providing standard terms bears the burden of proof that it has fulfilled its duty to draw attention or explain. For electronic contracts concluded through information networks such as the Internet, if the party providing standard terms merely claims to have fulfilled its duty to draw attention or explain by means such as setting checkboxes or pop-up windows, the people’s court shall not support such claim, unless its evidence meets the requirements of the preceding two paragraphs.

Specifically in the context of financial business, considering the “abnormal terms that are significantly related to the other party’s interests” referred to in Article 10 of the General Provisions Interpretation and the regulatory provisions of the “Implementation Measures for the Protection of Financial Consumer Rights and Interests of the People’s Bank of China,” the quantity, interest rate, fees, performance period and method, precautions, risk warnings, and dispute resolution of financial products/services are considered content significantly related to the financial consumer’s interests. If such content is abnormal as mentioned above, the bank should provide warnings with clear markings to the financial consumer in accordance with the law. For the above clauses, banks should fulfill their duty of explanation. The General Provisions Interpretation clarifies the factors for determining “lack of judgment ability,” including the age, intelligence, knowledge, experience of the party, and the complexity of the transaction. These factors are used to determine whether the party can recognize the risks involved in the contract. The “Minutes of the National Civil and Commercial Trial Work Conference (Nine Civil Minutes)” contains principles for the trial of cases involving financial consumer rights protection disputes, which align with the value orientation of giving priority protection to financial consumers in the “Judicial Interpretation of the General Provisions of the Contract Book of the Civil Code.” If the selling institution violates the suitability obligation and constitutes “taking advantage of the other party’s lack of judgment ability,” resulting in a manifestly unfair contract at the time of formation, the financial consumer has the right to exercise the right of revocation and claim compensation for the principal investment amount and interest losses.

The scope of the duty of explanation is not limited to the concept and content of the clause itself but should also include its legal consequences. Explanation can be given in writing or orally, but it should meet the standard of “generally understandable” i.e., plain and clear for the financial consumer. For bank sales personnel, meeting the above explanation standard may be challenging. It is recommended to prepare unified explanations for financial products or provide uniform training on the duty of explanation to sales personnel before product release. Specifically in financial business scenarios, financial institutions typically require financial consumers to hand-copy a passage of text, sign or seal relevant documents, or even make audio or video recordings to fulfill their duty to draw attention and explain. In the absence of contrary evidence, the court generally finds that the financial institution has fulfilled its duty to draw attention and explain. The General Provisions Interpretation requires “explanations that can be generally understood.” Therefore, for special groups, such as the elderly, explanations should be given in a way that they can understand.

Regarding electronic contracts, the “Judicial Interpretation of the General Provisions of the Contract Book of the Civil Code” stipulates that setting checkboxes or pop-up windows alone will be deemed insufficient to fulfill the corresponding duty to draw attention and explain. Attorneys believe that measures such as pop-up windows with separate explanation pages and separate electronic signatures for those pages; requiring separate clicks to confirm special terms; setting a minimum reading time; providing question-and-answer options, with manual or automatic responses to queries, can more fully demonstrate that the duty to explain the electronic contract has been fulfilled. The above procedures should be retained in the system in an appropriate manner to preserve evidence.

IV. Determination of Contract Validity in Criminal-Civil Intersection Scenarios

Article 16 of the General Provisions Interpretation: If a contract violates a mandatory provision of a law or administrative regulation, and under any of the following circumstances, the imposition of administrative or criminal liability on the person responsible can achieve the legislative purpose of the mandatory provision, the people’s court may, in accordance with the proviso of paragraph 1 of Article 153 of the Civil Code that “unless the mandatory provision does not result in the invalidity of the civil juristic act,” find that the contract is not invalid due to violating the mandatory provision:

(1) Although the mandatory provision is intended to maintain social public order, the actual performance of the contract has a significantly minor impact on social public order, and finding the contract invalid would lead to an unfair or inequitable outcome in the case;

(2) The mandatory provision is intended to protect the state’s interests such as tax revenue, land transfer fees, or the legitimate interests of other civil subjects rather than the civil rights and interests of the contracting parties, and finding the contract valid will not affect the realization of such normative purpose;

(3) The mandatory provision is intended to require one party to strengthen risk control, internal management, etc., and the other party is unable or has no obligation to review whether the contract violates the mandatory provision, and finding the contract invalid would cause it to bear adverse consequences;

(4) Although one party violated a mandatory provision at the time of concluding the contract, after the conclusion of the contract, it has the conditions to remedy the violation of the mandatory provision but, contrary to the principle of good faith, fails to do so;

(5) Other circumstances provided by laws or judicial interpretations.

If a mandatory provision of a law or administrative regulation is intended to regulate the performance conduct after the conclusion of a contract, and a party requests a finding of invalidity on the ground that the contract violates the mandatory provision, the people’s court shall not support such request, unless the performance of the contract inevitably leads to a violation of the mandatory provision or otherwise provided by laws or judicial interpretations.

Article 16 of the General Provisions Interpretation clarifies the circumstances under which a violation of a mandatory provision does not render a contract invalid. If the imposition of criminal liability on the person responsible can achieve the legislative purpose of the mandatory provision, simply declaring the contract invalid would not be conducive to protecting the interests of the contracting parties, especially the innocent party. It also requires that the counterparty was unaware and could not have been expected to be aware that the contract violated the mandatory provision, and that finding the contract valid would not harm social public interests. In loan business, banks often play the role of the innocent party. For example, in factoring or pledge loan transactions where the creditor and debtor maliciously collude to fabricate claims, banks are often unaware that the borrower’s conduct constitutes a criminal offense. This provision plays an important role in protecting bank rights and interests in criminal-civil intersection scenarios.

V. Avoiding Unauthorized Agency and Ultra Vires Agency During Contract Signing

Article 20 of the General Provisions Interpretation: If a law or administrative regulation, in order to restrict the representative authority of the legal representative of a legal person or the responsible person of an unincorporated organization, stipulates that the matters involved in the contract should be resolved by the authority or decision-making body of the legal person or unincorporated organization, or should be decided by the executive body of the legal person or unincorporated organization, and the legal representative or responsible person enters into the contract in the name of the legal person or unincorporated organization without authorization, and the counterparty who has not exercised reasonable review duty claims that the contract is effective against the legal person or unincorporated organization and that it bears liability for breach of contract, the people’s court shall not support such claim. However, if the legal person or unincorporated organization is at fault, the court may, by reference to Article 157 of the Civil Code, order it to bear corresponding compensation liability. If the counterparty has exercised reasonable review duty and constitutes apparent representation, the people’s court shall handle the matter in accordance with Article 504 of the Civil Code.

If the matters involved in the contract do not exceed the representative authority of the legal representative or responsible person as stipulated by laws or administrative regulations, but exceed the limitations on representative authority set by the articles of association or authority body of the legal person or unincorporated organization, and the counterparty claims that the contract is effective against the legal person or unincorporated organization and that it bears liability for breach of contract, the people’s court shall support such claim, unless the legal person or unincorporated organization proves that the counterparty knew or should have known of such limitations.

Article 21: If the matters involved in a contract fall under any of the following circumstances, the people’s court shall find that the staff member of the legal person or unincorporated organization has exceeded the scope of their authority when concluding the contract:

(1) Matters that should be resolved by the authority or decision-making body of the legal person or unincorporated organization in accordance with the law;

(2) Matters that should be decided by the executive body of the legal person or unincorporated organization in accordance with the law;

(3) Matters that should be handled by the legal representative or responsible person on behalf of the legal person or unincorporated organization in accordance with the law;

(4) Matters that are not ordinarily within the scope of their authority to handle.

If the matters involved in the contract do not exceed the scope of authority determined in accordance with the preceding paragraph, but exceed the limitations on the staff member’s scope of authority set by the legal person or unincorporated organization, and the counterparty claims that the contract is effective against the legal person or unincorporated organization and that it bears liability for breach of contract, the people’s court shall support such claim, unless the legal person or unincorporated organization proves that the counterparty knew or should have known of such limitations.

Article 22: If the legal representative, responsible person, or staff member enters into a contract in the name of the legal person or unincorporated organization without exceeding their authority, and the legal person or unincorporated organization merely claims that the contract is not effective against it on the ground that the seal affixed to the contract is not the registered seal or is a forged seal, the people’s court shall not support such claim.

If the contract is concluded in the name of the legal person or unincorporated organization, but only bears the signature or fingerprint of the legal representative, responsible person, or staff member without affixing the seal of the legal person or unincorporated organization, and the counterparty can prove that the legal representative, responsible person, or staff member did not exceed their authority when concluding the contract, the people’s court shall find that the contract is effective against the legal person or unincorporated organization, unless the parties agreed that affixing a seal is a condition for the contract to be established.

If the contract only bears the seal of the legal person or unincorporated organization without the signature or fingerprint of any person, and the counterparty can prove that the contract was concluded by the legal representative, responsible person, or staff member within their scope of authority, the people’s court shall find that the contract is effective against the legal person or unincorporated organization.

Articles 20 to 22 of the General Provisions Interpretation clarify that when signing a contract, not only must the seal be affixed, but the identity and authority of the handler must also be verified. When signing contracts, banks must ensure that the expression of intent of the counterparty is genuine. In corporate business, the previous practice focused on the authenticity of the counterparty’s seal. After the issuance of the General Provisions Interpretation, the importance of the handler’s signature has increased, and the requirements for verifying the handler’s identity are higher. Therefore, in subsequent bank operations, not only must the authenticity of the official seal on the contract be ensured, but also, as much as possible, the handler should be required to sign in person. If in-person signing is not possible, at least evidence materials proving the handler’s identity and authority, such as a power of attorney, company resolution, or other documents, should be retained.

VI. Prevention of Bank Employee “Fly-Order” and Ultra Vires Conduct

Articles 20 to 22 of the General Provisions Interpretation: The phrase “the counterparty can prove that the legal representative, responsible person, or staff member did not exceed their authority when concluding the contract” determines whether the legal consequences are borne by the bank. “Fly-order” refers to a bank staff member engaging in sales conduct unrelated to their position during working hours, most commonly the unauthorized sale of wealth management products, which may even constitute the criminal offense of illegally absorbing public deposits. There have been numerous court decisions holding banks proportionally liable due to employee “fly-order” incidents. According to the General Provisions Interpretation, restrictions on the work authority of bank employees and external explanations play a decisive role in determining whether the bank bears liability in litigation. It is recommended that banks clearly define the authority of their staff in internal authorization documents or issue specific authorization provisions. It would be even more effective if such restrictions are stated in special clauses in contracts or posted in the workplace as reminders.

VII. Special Agreements Regarding Invoices

Article 26 of the General Provisions Interpretation: If one party fails to perform non-primary debts such as issuing an invoice or providing supporting documents as required by law or contract, and the other party requests continued performance of such debt and compensation for losses caused by the delay in performance, the people’s court shall support such request in accordance with the law; if the other party requests rescission of the contract, the people’s court shall not support such request, unless the failure to perform such debt makes the purpose of the contract unattainable or the parties have otherwise agreed.

Banks have strict financial systems and often require invoices as a precondition for initiating payment procedures. Without obtaining an invoice, it is usually difficult to start the payment process. The General Provisions Interpretation clarifies that the obligation to pay is a primary contractual obligation, while issuing an invoice is generally considered an ancillary obligation. Therefore, if it is not explicitly agreed that issuing an invoice is a condition for payment, it cannot be used as a reason to refuse payment. In such a case, if the bank delays payment accordingly, it will bear liability for breach of contract. It is recommended to explicitly agree in the contract that the issuance of an invoice is a condition for payment.

VIII. Bank’s Right of Choice in Debt-for-Asset Swap Agreements

Article 27 of the General Provisions Interpretation: If the debtor or a third party fails to perform the debt-for-asset swap agreement as agreed, and after a reminder, still fails to perform within a reasonable period, and the creditor chooses to request performance of the original debt or the debt-for-asset swap agreement, the people’s court shall support such request, unless otherwise provided by law or agreed by the parties.

After a bank enters into a debt-for-asset swap agreement with the debtor, if the debtor fails to perform the debt-for-asset swap agreement as agreed, the bank may, after a reminder, choose to request performance of the original debt or the debt-for-asset swap agreement. The bank has autonomous discretion in choosing the direction for realizing its claims, making operations more flexible and increasing the possibility of the bank realizing its claims.

IX. Debt-For-Asset Mediation Documents Do Not Have Real Rights Effects

Article 27 of the General Provisions Interpretation: If a debt-for-asset swap agreement is confirmed by the people’s court or if the people’s court issues a mediation document based on a debt-for-asset swap agreement reached by the parties, and the creditor claims that property rights were transferred or have effect against bona fide third parties as of the effective date of the confirmation document or mediation document, the people’s court shall not support such claim.

The General Provisions Interpretation clarifies that a “debt-for-asset mediation document” does not have real rights effects and cannot be used to oppose bona fide third parties. After obtaining a “debt-for-asset mediation document,” the bank should complete real rights registration as soon as possible to achieve the transfer of property rights.

X. Exclusion of Jurisdiction and Arbitration Clauses in Subrogation and Revocation Actions

Article 36 of the General Provisions Interpretation: After the creditor initiates a subrogation action, if the debtor or the counterparty raises an objection to the court’s jurisdiction on the ground that the debt-obligation relationship between them is subject to an arbitration agreement, the people’s court shall not support such objection. However, if the debtor or the counterparty applies for arbitration regarding the debt-obligation relationship between the debtor and the counterparty before the first court session, the people’s court may suspend the subrogation action in accordance with the law.

First, the judicial interpretation does not recognize that the arbitration agreement between the debtor and the counterparty automatically binds the creditor. That is, an agreement between the debtor and the counterparty that the creditor should exercise subrogation rights through arbitration does not automatically bind the creditor. At the same time, Article 535 of the Civil Code, when stipulating the creditor’s right of subrogation, uses the phrase “may request the people’s court,” without mentioning an arbitration institution. Based on the legislative intent, the creditor can only exercise the right of subrogation through litigation.

Second, even if the debtor and the counterparty have agreed on an arbitration clause, if the debtor is not diligent in exercising its rights and the creditor exercises subrogation, the people’s court has the authority to accept the case. However, if the debtor’s counterparty has already applied for arbitration before the conclusion of the first-instance debate, the subrogation action should be suspended. This provision facilitates banks in exercising their subrogation rights.

XI. Criteria for Determining “Obviously Unreasonable Price” in Subrogation and Revocation Actions

Article 42 of the General Provisions Interpretation: If the transfer price is less than 70% of the market transaction price or the guidance price at the place and time of the transaction, it may generally be deemed as an “obviously unreasonably low price”; if the purchase price is more than 30% above the market transaction price or the guidance price at the place and time of the transaction, it may generally be deemed as an “obviously unreasonably high price.” If the debtor and the counterparty are related by family or affiliation, the restrictions of 70% and 30% in the preceding paragraph shall not apply.

The above provision establishes the criteria for determining an “obviously unreasonably low price” when exercising subrogation and revocation rights. Where there is a “family relationship” or “affiliated relationship,” the deviation range is not subject to the restrictions. This provision is beneficial for banks in exercising subrogation and revocation rights.