Can a defaulting party unilaterally terminate the contract in China?

1. Case:?

Company A rented an office owned by Company B. The parties entered into an Office Lease Contract. The term of the lease is two years, from June 2017 to June 2019, and the monthly rent is RMB 40,000 with a deposit of one month’s rent. During the lease period, due to the deterioration of Company A's business conditions, Company A defaulted on its rent for a month.

The lease contract did not stipulate any situation in that Company A, as the tenant, could unilaterally terminate the lease contract. However, Company A took the initiative to send a?Notice of Termination of Lease Contract?to Company B on 30 August 2018. Company A requested the lease contract to be terminated and the deposit to be deducted against the rent for the month in which the notice was sent. Company A also promised to vacate the premises by the end of that month.

After receiving the notice, Company B refused to terminate the lease contract and demanded Company A continue to pay the rent until the end of the lease period. Company A, as the defaulting party, then filed a lawsuit and claims to terminate the lease contract.

(This case is adapted from (2019) Beijing Civil Final Judgment No. 5827.)

2. Issues：

Does a tenant, as a defaulting party, have the right to terminate the contract by law?

3. Analysis：

In the?Minutes of the National Courts' Civil and Commercial Trial Work Conference, the Supreme Court holds the opinion that the breaching party does not have the right to terminate the contract unilaterally. However, the Supreme Court further demonstrated that, in the performance of some long-term contracts, such as housing leases, the parties have formed a contractual logjam. It is sometimes disadvantageous to both parties if the breaching party is not allowed to terminate the contract by way of a lawsuit. Therefore, a court may uphold the defaulting party's claim to sue for termination of the contract when certain conditions are met, and the conditions are as follows:

(a) The breaching party is not in bad faith for breach of contract; (b) It is unconscionable for the breaching party to continue to perform the contract; (c) The non-breaching party's refusal to rescind the contract contravenes the principle of good faith.

In this case, Company A, as the tenant, could not afford to continue to pay rent due to its significant business deterioration and it was not in bad faith for failing to pay rent in time. If the contract was not terminated, the liability for default of rent would increase and Company A would be certainly in deeper financial trouble. At that point, Company B, as the office owner, turned a blind eye to the tenant's plight and insisted that the lease contract could not be terminated and Company A should keep paying rent. This case was the situation stipulated in the?Minutes of the National Courts' Civil and Commercial Trial Work Conference. Although Company A is the defaulting party and no unilateral right of termination has been agreed in the contract, Company A can still claim to terminate the lease by way of litigation. However, it should be stressed that even if the contract was terminated, Company A would still be liable for the breach of contract and pay liquidated damages agreed in the contract.

4. Suggestions：

The Supreme Court held that in certain circumstances the defaulting party has the right to terminate the contract, but such right is strictly limited so that courts will not easily apply it in cases. In addition, the right for a defaulting party to terminate a contract must be exercised by way of litigation, which means that the defaulting party cannot terminate a contract by simply giving notice to the other party. This also makes it more difficult to exercise the right of termination.

Companies are reminded that when entering into a contract, they should pay attention to whether they have the right of termination provided in the contract and the means to get themselves out of the deal in some severe adverse circumstances.?

Author:??

Peter Lee (Jianchao Li), who graduated from Fudan University, currently works at the Sunivers Law Firm based in Shenzhen, as Senior Legal Counsel and Director of CSR and also leads a team focusing on?dispute resolution?and?corporate compliance.

??????He has considerable experience in dispute resolution both in China and cross-border. He has worked as an in-house counsel in?a well-known?FORTUNE 500 tech company. During that period, he joined the disputes management team and handled major disputes for business. He has also spent a year working in South America, as a legal Manager in charge of?legal compliance?for a subsidiary including?employment, export control, and data protection.

??????He also has accumulated extensive knowledge and experience in?Charity Law, Non-Profit Organization Law,?and?ESG-related Issues.

Many thanks to?Chen Yaqi?(Intern) for her contribution to this article.

This article is for general information only and does not constitute any legal opinion of the author or his firm on a particular matter, nor should it be used for taking or not taking any action. For advice on your specific matters, please contact the author by phone (86-14776255163), or by email ([email protected]).

Copyright 2023 Jianchao Li (Peter Lee). No reproduction, copying, or translation of materials without prior permission of the author.