Introduction:

A commercial lease contract is a continuing contract, which is clearly distinct from a one-time contract. The Civil Code largely follows the provisions of the Contract Law, constructing its main regulatory framework around one-time contracts, and pays limited attention to continuing contracts. However, in judicial practice, such cases often involve complex facts and numerous disputes, leading to considerable controversy in judicial adjudication and inevitably resulting in inconsistencies in the application of law.

In this article, the authors, drawing on case studies, discuss the remedy paths for the lessor after the lessee breaches the lease by early termination and vacates the premises, as well as the current judicial practice determinations, aiming to provide meaningful insights for handling such cases.

1

A Commercial Lease is a Continuing Contract, Distinctly Different from a One-Time Contract

A continuing contract is one where the content of the contract cannot be fulfilled by a single performance but requires continuous realization. Its fundamental characteristic is that the time factor plays a crucial role in the performance of the obligation, and the total content of the performance depends on the length of the performance period.[1] Article 563 of the Civil Code[2] refers to this as a “contract with continuous performance obligations.” Examples of continuing contracts in practice include leases, mandate contracts, partnership agreements, and sales agency contracts with a fixed duration that have the nature of a sales contract. The commercial lease discussed in this article is a typical continuing contract. As a continuing contract, a commercial lease differs from a one-time contract in the following ways:

(I) Both the Lessor and the Lessee of an Indefinite-Term Commercial Lease Have the Right to Arbitrarily Rescind the Contract

Regarding the rules on statutory rescission, Article 563 of the Civil Code adopts a combination of general and special provisions. Article 563(1) establishes the circumstances for general statutory rescission. Article 563(2) provides that “for an indefinite-term contract with continuous performance obligations, either party may rescind the contract at any time, provided that it gives the other party reasonable notice in advance.” This provision establishes the statutory rescission rule for continuing contracts, granting parties to an indefinite-term continuing contract a statutory right of arbitrary rescission, which is distinctly different from one-time contracts.[3] Based on Article 563(2) of the Civil Code, either party to an indefinite-term commercial lease may exercise the right to rescind at any time, but must notify the other party in advance and allow a reasonable period for preparation.

(II) When a Fixed-Term Commercial Lease Reaches an Impasse Due to the Lessee’s Early Breach and Vacating, the Lessor’s Claim for Specific Performance is Difficult to Sustain

In fact, Article 580[4] of the Civil Code, concerning the construction of an impasse, takes non-monetary obligations as its regulatory object. Although there is still debate in judicial practice as to whether the lessee’s obligations under a commercial lease are “non-monetary obligations,” it is generally accepted that “a situation where the lessee is unwilling to continue performing the lease agreement, rendering actual performance impossible” constitutes a typical contractual impasse. Regardless of whether the lessee’s subsequent obligation is a “monetary payment obligation,” it has a continuing nature; it is a continuous performance obligation, contingent upon the lessee’s continued possession and use of the leased premises, and requires mutual cooperation between the parties. The authors tend to believe that the lessee’s obligations under the lease are “continuous monetary payment obligations.”

Therefore, Article 48 of the Minutes of the National Conference on Civil and Commercial Trial Work clarifies: “A breaching party does not have the right to unilaterally rescind the contract. However, during the performance of certain long-term contracts, such as house lease contracts, if a contractual impasse arises between the parties, absolutely prohibiting the breaching party from seeking contract rescission through litigation may be disadvantageous to both parties. Under this premise, if the following conditions are met, the people’s court shall support the breaching party’s claim for rescission of the contract upon its filing of a lawsuit.”[5] Thus, from a judicial practice perspective, the scope of application of judicial termination does not exclude continuous monetary payment obligations.

(III) In the Event of a Contractual Impasse, the Civil Code Grants the Breaching Lessee a Statutory Right of Rescission and Clarifies the Method of Exercising It

Article 580 of the Civil Code provides that in a contractual impasse, the breaching party may file a lawsuit for rescission in court. This means the law confirms the breaching party’s statutory right of rescission during an impasse. However, this right can only be realized by petitioning a court or arbitration institution, and its application conditions are narrowed (applying only to situations of contractual impasse) to ensure it does not disrupt the logical continuity of the general rules on the right of rescission in Article 563 of the Civil Code.[6] In other words, strict adherence to the contract is the principle; granting the breaching party the right to rescind in an impasse is an exception and a breakthrough to the principle of strict adherence.

It is particularly important to note that for continuing contracts, whether it is an arbitrary right of rescission or a right of rescission in an impasse, the breaching party must bear liability for breach of contract to the non-breaching party when exercising the right. This is the reasonable consideration for the breaching party to be released from the contract’s binding and the price for redeeming contractual freedom.

2

From the Lessor’s Perspective: Paths for Remedy When a Commercial Lease Reaches an Impasse

Consider the following case:

The property rights of the building involved were held by several hundred owners (hereinafter “all owners”) on a per-area basis. All owners leased the entire building to Company A. Lease agreements were signed individually between Company A and the owners for their respective shops, with rent increasing by 4% annually.

Subsequently, due to the pandemic and other reasons, Company A’s business failed, and it could not bear the high rental costs. Company A repeatedly negotiated rent reductions with the owners but failed to reach an agreement. Company A then proposed a plan for early termination, but the parties could not reach an agreement. The owners demanded strict performance of the contract. Faced with this situation, Company A defaulted on rent from March 1, 2021, and unilaterally vacated the premises on April 1, 2021, without completing the formal handover procedures to the lessor. Furthermore, Company A vacated other floors but continued operating on the first floor. Additionally, the leased building is a single structure with interconnected internal layouts; all access routes, including elevators to all floors, passed through the first-floor shops still operated by Company A. This fact created an objective situation where all shops on floors other than the first floor could not be normally re-leased or used.

This is a group commercial lease dispute handled by the authors in 2023, where we represented the lessor. When handling this group case, we encountered a practical issue: while most of the numerous owners sought damages for breach of contract from Company A, some individual owners still demanded specific performance of the lease agreements. The different claims of the owners meant that in terms of the lessor’s remedy, there was a path selection issue.

(I) The Lessor’s Choice of Remedy for Breach of Contract by the Lessee in a Contractual Impasse

Article 577 of the Civil Code[7] stipulates: “If a party fails to perform its contractual obligations or fails to perform them in accordance with the agreement, it shall bear liability for breach of contract, including specific performance, taking remedial measures, or compensating for losses.” This article establishes the basic principles of liability for breach of contract, defining the nature, imputation principles, and forms of liability. According to this provision, when a party breaches, the other party may choose to claim specific performance of the contractual obligations. Therefore, it is understandable why some individual owners in the aforementioned case demanded that Company A continue performing the lease agreements to realize the expected benefits contemplated in the future lease term.

Thus, at both the factual and legal levels, the lessor appears to have a basis for claiming specific performance. However, as discussed in Part I, a commercial lease is a continuing contract. When a contractual impasse has formed, the lessor cannot choose to demand specific performance from the lessee. Therefore, the issue is to determine whether the circumstances of the case constitute a contractual impasse, i.e., whether the necessary elements for forming a contractual impasse are met.

Wang Liming defines a contractual impasse as a situation where, in the event of a fundamental breach by one party, the non-breaching party refuses to rescind the contract, and the breaching party does not have the right to rescind, leading to a dilemma in contract performance. Based on this, the law grants the breaching party the right to rescind the contract through litigation or arbitration in an impasse. Article 48 of the Minutes of the National Conference on Civil and Commercial Trial Work summarizes three elements for a contractual impasse:

First, the breaching party is not maliciously in breach. This is the key point in determining whether a contractual impasse exists. The breaching party is an honest but unfortunate party; its breach arises from objective economic difficulties, not from a pursuit of higher economic benefits.

Second, continuing performance would cause an imbalance of power between the parties, allowing one party to enjoy all the benefits while subjecting the other party to significant losses, which would obviously be unfair to the breaching party. Although specific performance by the lessee conforms to the principle of strict adherence to the contract and protects the lessor’s performance interest, it may cause the lessee to fall into hardship or even bankruptcy due to the heavy economic burden. Considering that continuing contracts are long-term, the risks faced during performance are often difficult to assess or are underestimated at the time of contracting.

Third, the non-breaching party refuses to exercise the right to rescind.

It should be noted that “malicious breach” here is not identical to ordinary subjective intent. “Malicious” here means acting to pursue higher economic benefits, as opposed to facing objective economic difficulties. As stated in the Shanghai No. 1 Intermediate People’s Court’s micro-course “Application of the Rules on Judicial Termination of Contractual Impasse,” the purpose of the contractual impasse system is to protect the interests of an honest but unfortunate party and effectively resolve the impasse to avoid an imbalance of rights and waste of social resources.[8]

Thus, the situation in the aforementioned case clearly constitutes a contractual impasse, and a claim for specific performance is neither theoretically nor practically possible or feasible. Specifically:

1. Company A’s business objectively failed; there was no malicious breach.
2. Continuing performance would impose an insurmountable financial pressure on Company A, potentially leading to bankruptcy. Moreover, Company A subjectively was unwilling to continue and had already vacated.
3. The lessor was unwilling to rescind the contract and insisted on specific performance.

(II) Scope of Claims for Remedy Available to the Lessor in a Contractual Impasse

As discussed, given that a claim for specific performance in a contractual impasse is neither theoretically nor practically possible, we persuaded the clients to abandon this claim and instead maximize claims for economic losses against Company A. Generally, in such commercial lease disputes, the claims a lessor can assert in an impasse typically include the following:

1. Claim for rescission of the contract – proactively exercising the statutory right of rescission. However, if the breaching lessee has already filed a lawsuit for rescission, this claim may be unnecessary. (The lessor’s proactive acceptance of the premises and mitigation of losses will be discussed further below.)
2. Claim for overdue rent and late payment penalties or interest. Typically, the rent deposit or security deposit can be set off first. It is recommended to handle the deposit in the same case.
3. Claim for compensation for use and occupation of the premises. If the lessor cannot re-lease the premises due to the lessee’s defective delivery (e.g., failing to vacate and restore the premises properly), the court generally considers this a delivery defect and holds the lessee liable for the occupation fees during the resulting period.
4. Claim for damages to the premises, such as for damage beyond normal wear and tear.
5. Claim for liquidated damages for breach of contract. Even if the lessee has a statutory right to rescind, this does not exempt it from liability for damages arising from the breach.
6. Claim for delivery of the premises in a conforming condition, such as restoration to the original state or removal of obstructions.
7. Other claims (if any).

(III) Scope of Claims and Judicial Determination in the Foregoing Case

Through the above analysis, we can see the complexity and intricacy of lease disputes. The aforementioned case essentially covers all the claims a lessor can assert in a lease dispute. The specific claims in the case were as follows:

1. Request a judgment that the “Lease Agreement” between the plaintiff and defendant was rescinded on March 31, 2021;
2. Request a judgment ordering the defendant to pay the plaintiff rent from March 1, 2021, to March 31, 2021;
3. Request a judgment ordering the defendant to pay the plaintiff late payment penalties from February 25, 2021, to the date of actual payment;
4. Request a judgment ordering the defendant to pay the plaintiff compensation for use and occupation of the premises from April 1, 2021, to the date of actual delivery;
5. Request the court to order the defendant to pay the plaintiff liquidated damages (equivalent to six months’ rent);
6. Request the court to order the defendant to restore the shop to its original condition and deliver the shop to the plaintiff in a conforming condition.

During the litigation, the court consolidated the group of cases. We observed that in other lawyers’ cases, there were claims demanding Company A continue performance. Those lawyers, upon the court’s clarification during the hearing, changed their claims from specific performance to damages for breach. Of course, this case had its particularities: it was a group case requiring consistent judgments for all parties; and the leased building was a single integrated structure, making it practically infeasible to deal with individual shops separately. The court ultimately ruled:

1. The contract was rescinded on April 1, 2021;
2. Supported the claim for rent for March 2021;
3. Supported the claim for compensation for use and occupation of the leased shops from April 1, 2021, to March 31, 2022, i.e., 12 months’ rent;
4. Supported liquidated damages equivalent to 3 months’ rent (the contract stipulated 6 months).

The court supported the compensation for use and occupation for such an extended period because Company A’s selective vacating of the building created a substantive obstacle to the owners’ ability to re-lease the entire building. During negotiations, Company A had promised to vacate the first floor if the owners found a new tenant for the whole building, but subsequently reneged on this promise. Based on this, the judge ordered Company A to pay occupation fees until it vacated the first floor. Additionally, the judge, considering the overall circumstances, adjusted the amount of liquidated damages.

(IV) Insights and Reflections from the Foregoing Case

1. The Timing of Contract Rescission

For the parties, the time at which the rights and obligations under the contract terminate as determined by the court is crucial. In continuous monetary payment obligations, the timing directly determines the amount of debt owed. Although Article 565(2)[9] of the Civil Code provides that a contract is rescinded when the copy of the complaint or arbitration application is served on the other party, Article 59 of the Judicial Interpretation of the Contract Law Book[10] clarifies that the service time is the basic principle. However, it allows the judge reasonable discretion to consider dynamic factors, meaning the judge is not strictly bound by Article 565(2) and can reasonably adjust the rescission time based on the specific circumstances of the case. In this specific case, the judge did not accept the rescission date claimed by the lessor but instead determined the rescission date as April 1, 2021, which effectively recognized the date of the breaching lessee’s unilateral vacation. Notably, the lessee did not exercise its judicial right of rescission in this case. It is important to note that generally, vacating the premises is considered a form of return or delivery. However, in this case, the lessee’s return was defective as it did not involve a complete return of the entire building.

2. The Issue of Returning the Shop Premises

In the aforementioned case, because the lessee failed to return the entire leased premises, creating obstacles for the lessor to re-lease the property as a whole, the court ordered the lessee to bear the compensation for use and occupation for the period during which the premises were not fully returned. Thus, in practice, if a defective return affects the lessor’s ability to re-lease, the lessor may claim compensation for use and occupation for the period the premises cannot be re-let due to the defect. This period of compensation does not necessarily align with the date of contract rescission; such situations are specific to individual cases.

3. The Burden of Liquidated Damages

Undoubtedly, a breaching party must bear liability for breach of contract to the non-breaching party. However, the amount of liquidated damages is a topic frequently revisited in judicial practice. Theoretically, liquidated damages generally apply the principle of compensating for losses, taking into account foreseeable losses based on the actual losses suffered by the non-breaching party. Therefore, the judge has significant discretion in adjusting the amount of liquidated damages. If the contract stipulates excessively high liquidated damages, the judge has the authority to adjust them to a reasonable amount. Specifically for commercial leases, the prevailing judicial approach is to award liquidated damages equivalent to approximately 3 to 6 months’ rent. Within this range, the judge comprehensively applies the rules of foreseeability, mitigation, and offsetting benefits to determine the amount of foreseeable interest loss. The law naturally expects the lessor to fulfill its duty to mitigate losses in a timely manner; the lessor cannot claim compensation from the lessee for losses that could have been avoided.

4. Carefully Consider the Specific Circumstances of the Individual Case

The foregoing case involved special circumstances: first, the building was leased as a whole, comprising over 400 small owners, with historical and practical reasons for such a collective lease arrangement that was difficult to partition; second, when Company A breached and vacated, it deviated from the principle of terminating the whole lease wholly, and adopted a vacating plan beneficial to itself but detrimental to the owners of floors 2-5. This ultimately led the court to find that although the contracts for floors 2-5 were rescinded, it effectively prevented those owners from being able to re-lease their shops, resulting in a judgment ordering Company A to pay one year’s compensation for use and occupation. From this judgment, Company A’s selective vacating strategy was clearly unadvisable, and the severe consequences of its breach were likely beyond its anticipation. Therefore, the specific circumstances in individual cases vary widely, and these differences can significantly impact the final judicial decision. This underscores the need, when applying general rules, to also consider the specific circumstances of each case for careful handling and response.

3

The Lessor’s Predicament and Choices in Commercial Lease Disputes

In summary, during the performance of a fixed-term lease, the lessor, under the existing legal framework, finds it difficult to effectively prevent the lessee’s unilateral breach and vacating. This is determined by the unique characteristics of a continuing contract. Consequently, the lessor’s available methods for asserting rights upon the lessee’s breach and early termination are limited, primarily to claims for damages for breach of contract. Theoretically and practically, the possibility of demanding specific performance from the lessee is almost non-existent. Therefore, in commercial lease disputes, the following recommendations are offered for the lessor’s rights remedy:

1. When the lessee requests rent reduction, partial vacating, or full vacating, the lessor should assess the situation and respond with reasonable negotiation, rather than rigidly insisting on strict contractual performance.

In practice, lessees often request partial vacating or rent reduction due to business difficulties. If the lessor rigidly refuses, the lessee may unilaterally vacate the premises. Under such circumstances, it is very difficult for the lessor to legally compel the lessee to continue performance. In difficult economic times, re-leasing the premises is not easy, and the new rent may be significantly lower. Therefore, before a lease dispute erupts, the lessor must make a commercial judgment and choose the correct course of action to avoid unnecessary losses.

2. After the lessee vacates the premises, the lessor should promptly take control of the premises and quickly re-lease them to reduce unnecessary expanded losses.

Article 63(3) of the Supreme People’s Court Interpretation on Several Issues Concerning the Application of the General Provisions of the Civil Code’s Contract Book provides: “When determining the amount of damages for breach of contract, if the breaching party argues for a deduction of losses resulting from the non-breaching party’s failure to take appropriate measures to mitigate, losses correspondingly caused by the non-breaching party’s own fault, any additional benefits obtained or necessary expenses reduced by the non-breaching party due to the breach, the people’s court shall support such deduction in accordance with the law.” This provision clarifies that the lessor cannot claim damages for losses that could have been avoided through mitigation. Thus, after the lessee vacates, the lessor should promptly take back and manage the premises to reduce unnecessary losses, rather than holding out and claiming rent for an empty property. Judicial practice generally holds the lessor to have a duty to mitigate losses; otherwise, it cannot recover the avoidable portion of the loss.

3. During negotiations with the lessee regarding termination, the lessor must not only assess the situation but also proactively preserve evidence and document losses to prepare for potential litigation.

Key points for the lessor to focus on include: First, whether the lessee’s breach was malicious, i.e., to pursue higher economic benefits. This is a critical factor in determining whether a contractual impasse exists. Second, documents from the negotiation process (not limited to written materials). For example, if the lessee informed the lessor in advance of objective economic difficulties and made diligent efforts to mitigate the lessor’s losses (e.g., finding replacement tenants, subletting) to create a win-win situation, this may be viewed favorably. Conversely, if the lessee abruptly vacates without negotiation, causing greater losses to the lessor, the nature and degree of the lessee’s liability for breach will likely be higher. These factors will influence the judge’s assessment of the lessee’s liability. Third, document and preserve evidence of all resulting losses to meet future contingencies.

Notes (scroll up and down for more):

[1] See Wang Zejian, Principles of Obligations, Peking University Press, 2009, p. 132.

[2] Civil Code, Article 563: Under any of the following circumstances, a party may rescind the contract: (1) Where the purpose of the contract cannot be achieved due to force majeure; (2) Where, before the expiration of the performance period, one party expressly states or indicates through its conduct that it will not perform its main obligations; (3) Where one party delays performing its main obligations and still fails to perform them within a reasonable period after being demanded; (4) Where one party delays performing its obligations or commits other breaches of contract, thereby making it impossible to achieve the purpose of the contract; (5) Other circumstances provided by law. For an indefinite-term contract with continuous performance obligations, either party may rescind the contract at any time, provided that it gives the other party reasonable notice in advance.

[3] See Mao Ronghua, Application of the Civil Code and Judicial Practice, Law Press, 1st ed., p. 387.

[4] Civil Code, Article 580: Where a party fails to perform a non-monetary obligation or performs a non-monetary obligation in a manner inconsistent with the agreement, the other party may request specific performance, except in any of the following circumstances: (1) Where the performance is legally or factually impossible; (2) Where the subject matter of the obligation is unsuitable for compulsory performance or the cost of performance is excessively high; (3) Where the creditor fails to request performance within a reasonable period. If any of the excepted circumstances specified in the preceding paragraph exists, making it impossible to achieve the purpose of the contract, the people’s court or arbitration institution may terminate the contractual rights and obligations upon the request of a party, without affecting the liability for breach of contract.

[5] Article 48 of the Minutes of the National Conference on Civil and Commercial Trial Work: “[Rescission by the breaching party upon filing a lawsuit] The breaching party does not have the right to unilaterally rescind the contract. However, during the performance of certain long-term contracts, such as house lease contracts, if a contractual impasse arises between the parties, absolutely prohibiting the breaching party from seeking contract rescission through litigation may be disadvantageous to both parties. Under this premise, if the following conditions are met, the people’s court shall support the breaching party’s claim for rescission of the contract upon its filing of a lawsuit: (1) the breaching party is not maliciously in breach; (2) continuing performance of the contract would be manifestly unfair to the breaching party; (3) the non-breaching party’s refusal to rescind the contract violates the principle of good faith. If the people’s court renders a judgment to rescind the contract, the liability for breach of contract that the breaching party should bear shall not be reduced or exempted due to the rescission.”

[6] See Mao Ronghua, Application of the Civil Code and Judicial Practice, Law Press, 1st ed., p. 435.

[7] Civil Code, Article 577: If a party fails to perform its contractual obligations or fails to perform them in accordance with the agreement, it shall bear liability for breach of contract, including specific performance, taking remedial measures, or compensating for losses.

[8] Shanghai No. 1 Intermediate People’s Court, Application of the Rules on Judicial Termination of Contractual Impasse.

[9] Civil Code, Article 565: Where a party claims rescission of a contract in accordance with the law, it shall notify the other party. The contract is rescinded when the notice reaches the other party. If the notice states that the contract will be automatically rescinded if the debtor fails to perform its obligations within a specified period, and the debtor fails to perform within that period, the contract is rescinded upon the expiration of the specified period. If the other party objects to the rescission, either party may request the people’s court or an arbitration institution to confirm the validity of the rescission. Where a party directly claims rescission of a contract by filing a lawsuit or applying for arbitration without notifying the other party, and the people’s court or arbitration institution confirms the claim, the contract is rescinded when the copy of the complaint or the copy of the arbitration application is served on the other party.

[10] Article 59 of the Supreme People’s Court Interpretation on Several Issues Concerning the Application of the General Provisions of the Civil Code’s Contract Book: Where a party requests termination of contractual rights and obligations in accordance with Article 580(2) of the Civil Code, the people’s court shall generally take the time when the copy of the complaint is served on the other party as the time of termination. If, based on the specific circumstances of the case, taking another time as the time of termination would better comply with the principles of fairness and good faith, the people’s court may take that other time as the time of termination, provided that it fully explains its reasons in the judgment.

[11] Article 63 of the Supreme People’s Court Interpretation on Several Issues Concerning the Application of the General Provisions of the Civil Code’s Contract Book: When determining the “loss that the breaching party foresaw or ought to have foreseen at the time of entering into the contract as a possible consequence of the breach” as specified in Article 584 of the Civil Code, the people’s court shall, based on the purpose for which the parties entered into the contract, comprehensively consider factors such as the parties’ identities, the contract content, the type of transaction, trade customs, and negotiation process, and determine the loss according to what a civil subject in a similar or identical situation to the breaching party would have foreseen or ought to have foreseen at the time of entering into the contract. In addition to the benefits obtainable after the performance of the contract, the non-breaching party claims that there are additional expenses, such as those incurred for bearing liability for breach of contract to a third party, and other losses caused by the breach, and requests the breaching party to compensate for them. Upon trial, if the court finds that such losses were foreseen or ought to have been foreseen by the breaching party at the time of entering into the contract, the people’s court shall support such a claim. When determining the amount of damages for breach of contract, if the breaching party argues for a deduction of losses resulting from the non-breaching party’s failure to take appropriate measures to mitigate, losses correspondingly caused by the non-breaching party’s own fault, any additional benefits obtained or necessary expenses reduced by the non-breaching party due to the breach, the people’s court shall support such deduction in accordance with the law.