Once a contract is formed, the parties must strictly observe and comply with the contract. This doctrine is known as pacta sunt servanda (Latin) meaning that ‘agreements must be kept’. Article 8(1) of the Contract Law provides that a lawfully established contract shall be legally binding on the parties thereto, who shall each perform its own obligations in accordance with the terms of the contract, and no party shall unilaterally modify or terminate the contract.
The doctrine of pacta sunt servanda is linked together with the doctrine of freedom of contract. In ancient times, contracts were enforced in a harsh manner. When a debtor failed to perform his contractual obligations, he would become a slave of creditors, or would even be killed. In the Middle Ages, breach of contract was regarded as a religious offence that signified a major issue of conscience.
In modern times, a person will not assume liabilities that affect his personal liberty for failing to perform a contract; for example, a debtor is not imprisoned for default in repaying a debt.
The consequence for nonpayment is limited to monetary compensation. The basis for pacta sunt servanda is the social contract theory. The three natural laws advocated by David Hume are:
stability of private property; transfer of property only by consent; and pacta sunt servanda. Thomas Hobbes also believes
that every man, ought to endeavour Peace, as far
as he has hope in obtaining it; and when he cannot obtain it, that he may seek, and use, all helps, and advantages of Warre. A party is not liable for a failure to perform any of his
obligations if he proves that the failure was due to an impediment beyond his control and that he could not reasonably be expected to have taken the impediment into account at the time of the
conclusion of the contract or to have avoided or overcome it or its consequences.
In modern contract law, one significant principle that erodes the doctrine of pacta sunt servanda is the so-called clausula rebus sic stantibus, i.e. the doctrine of fundamental change of circumstances. The doctrine of fundamental change of circumstances refers to the situation where a contract, once validly established, is rendered incapable of performance by a party due to a unforeseen fundamental change in circumstances beyond his control that upsets the common basis for the transaction envisaged by the contract such that it becomes obviously unfair for that party to continue the contract. The party adversely affected by the fundamental change in circumstances may then apply to court or an arbitral body to vary or discharge the contract. The doctrine has gained international recognition. Article 79(1) of the United Nations Convention on Contracts for the International Sale of Goods (CISG) states:
A party is not liable for a failure to perform any of his obligations if he proves that the failure was due to an impediment beyond his control and that he could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences.
At common law, this is known as ‘frustration.’
The crucial rule for applying this doctrine is to judge the change of circumstances, including changes in political, economic or other circumstances. These may include changes in law, government policy, currency exchange, market conditions and so on. Only extraordinary and unforeseeable changes beyond the control of the parties are included. For example, when we refer to the issue of currency, normal fluctuation of the currency exchange rate is not regarded as changes of circumstances for such purposes.
The rationale for this doctrine is to avoid unfairness resulting from events beyond the parties’ control. The legal may include: (1) modification or renegotiation, also known as the ‘obligation to renegotiate,’ where the affected party has the right to request the other party to renegotiate the terms of the contract; and (2) discharge of contract. The former is the preferred option, because the law tries to maintain the parties’ existing legal relationship if possible.
At present, the Contract Law of the PRC does not incorporate the doctrine of fundamental change. Article 27(1) of the Economic Contract Law (1981, now repealed) included this doctrine, but it was repealed in the 1993 version. During the drafting stage of the Contract Law in the 1990s, the doctrine of fundamental change of circumstances was included in the first four versions of the bill, but was deleted from the final draft, on the ground that the ‘legal system’ (probably referring to the quality of the judiciary) was not mature enough to distinguish change of circumstances and commercial risk. However, there are cases where the people’s courts adopted the concept in judicial practice. See, for example, articles 4 and 7 of the Interpretations of the Supreme People’s Court on Some Issues Trial of Disputes Relating to Rural Household Contracts (《關於審理農村承包合同糾紛案件若干問題的意見》), where the concept was for the first time applied in China.
Application of the Doctrine of Fundamental Change of Circumstances
Supreme People’s Court’s Reply on Some Issues concerning the Application of Laws for the Trial of Disputes Arising the Gas Meter Assembly Line Detection Technology Transfer Contract and the Sale and Purchase of Gas Meter Parts Contract between Wuhan City Gas Company and Chongqing Gas Meter Factory (《最高人民法院關於武漢市煤氣公司訴重慶檢測儀錶廠煤氣表裝配線技術轉讓合同購銷煤氣表散件合同糾紛一案適用法律問題的函》) (March 1992)
This case involved two separate contracts. The Gas Meter Assembly Line Detection Technology Transfer Contract was entered into between Wuhan City Gas Company and Chongqing Gas Meter Factory. The unforeseeable event in this case was the unexpected rise of the state-set price (the price ranged stipulated by the government) of aluminium ingot (the major raw material production of gas metre parts) from 4400-4600 yuan per ton, to 6600 yuan per ton, and the corresponding price of aluminium shell from 23.085 yuan per set to 41 yuan per set. Under item (4) of article 27(1) of the Economic Contract Law (now repealed), it was held by the court that if Chongqing Factory were required to supply the contracted gas meter parts at the original contract price, it would result in ‘obvious unfairness.’ Hence, the Supreme People’s Court directed the lower court hearing the subject case that the trial judge should exercise discretionary power to alter the terms of the contract in a fair and reasonable manner.