What is a fundamental breach of contract in China?

Case:?

The Cotton Factory and Company A entered into a?Cotton Sale and Purchase Contract, providing that the Cotton Factory shall supply Company A with 1173 tons of cotton, of which 337 tons shall be first-class cotton and 836 tons shall be second-class cotton. The Cotton Factory guaranteed the quality of the cotton delivered shall meet the standard of the standard agreed in the contract. In the event that there was disagreement on whether the quality the cotton meet the agreed standard, both parties agreed to seek a third party to inspect the products. It is also agreed in the contract that "if one of the parties fails to perform its obligations under the contract, the other party shall have the right to unilaterally terminate the contract, and the defaulting party shall pay the other party liquidated damages at 10% of the purchase price." The Cotton Factory subsequently delivered the cotton and Company A paid 19.39 million RMB for the goods. The contract was entered at a time when the cotton price was high and Company planned to resell the cotton and made profits.

Within one and a half years, Company A resold the cotton purchased from the Cotton Factory. Due to the quality not meeting the agreed standards and the fall in the market price of cotton，?Company A had to sell the cotton at much lower prices compared to the original purchase price. During the dispute, a third party inspect the products, and the test report stated that the Cotton Factory delivered a total of approximately 1,111 tons of cotton to Company A, of which 1.6 tons were first-class cotton, 523.4 tons were third-class cotton, 564.5 tons were forth-class cotton and 21.6 tons were fifth-class cotton. Therefore, Company A filed a suit before the court in order to terminate the contract, and request the Cotton Factory to refund all the payment for purchasing the cotton.?

(This case is adapted from (2006) Supreme Law Civil Final Judgment No. 111)

Issue：

Did the cotton not meeting the agreed standard of the contract result in a fundamental breach of contract? And can Company A unilaterally terminate the contract based on such default?

Analysis：

In China, a breach of contract resulting in the failure to achieve the contractual purpose constitutes a fundamental breach.

Even though the quality and quantities of the cotton delivery not meeting the standard agreed in the contract, the price difference due to the decrease in quality and quantity was 1.5 million, only accounting for 8% of the total purchase price. The Cotton Factory indeed breach the contract by delivering the lower classes of cotton. However, the products delivered being inferior did not deprive Company A of its opportunity to resell the product, which is the contractual propose for Company A. In addition, the reason Company A suffered great losses for the reselling is not only because the cotton was inferior, but also because the cotton price was dropping rapidly after the entering of the contract, and the latter is a common market risk born by the buyer. The rapid fall in the cotton price was not foreseeable by both parties at the time of contracting and was not caused by Company A.

The losses suffered by Company A for Cotton Factory’s breach of contract can be easily remedied through monetary compensation instead of the termination of the contract.

In conclusion, the Cotton Factory performed its obligation by delivery of the cotton, and Company A sold all of the cotton. The Cotton Factory indeed breached the contract by delivering inferior cotton, but the contractual propose for Company had been achieved. The breach does not constitute a fundamental breach under laws in China, and thus Company A cannot unilaterally terminate the contract.

Suggestions：

In determining whether a breach of contract constitutes a fundamental breach, it is first necessary to identify the purpose of the contract and whether that purpose cannot be achieved as a result of the breach.?

The contractual purposes shall be clearly stipulated in the contract for parties. For example, "[T]his the flowers purchased from Party B hereunder are for Party A's sales activities on 14 February 2023". Therefore, if the flower was delivered after 14 February 2023, even just one day late, the breach (a late delivery) would constitute a fundamental breach of contract.

Author:??Peter Lee, 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.

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.