Balancing Public Interest with Transactional Security: The Validity of Contracts Tainted with Corruption Under Chinese Law
© Springer International Publishing Switzerland 2015Michael Joachim Bonell and Olaf Meyer (eds.)The Impact of Corruption on International Commercial ContractsIus Comparatum – Global Studies in Comparative Law1110.1007/978-3-319-19054-9_3
3. Balancing Public Interest with Transactional Security: The Validity of Contracts Tainted with Corruption Under Chinese Law
Associate Professor, TC Beirne School of law, University of Queensland, Brisbane, Australia
School of Law, Xi’an Jiaotong University, Xianning West Road, No 28, 710049 Xi’an, Shaanxi, China
One of the civil law consequences of corruption currently prescribed under Chinese law is that a contract may be rendered void by virtue of its connection with corruption. By providing for five such circumstances, art 52 of China’s Contract Law reflects an absolutist approach that nullifies any contract that comes into contact with illegal conduct such as bribery. Unfortunately, invalidating a contract in most of those circumstances carries the cost of potentially harming a bona fide third party. On closer scrutiny, it may even do a disservice to the very purpose it is supposed to serve, such as the protection of state assets. It is thus submitted that, except where the contract itself is used as a vehicle to carry out the bribery, the contract is not void by reason of its connection with the bribery, at least where the parties have reached a genuine agreement.
This article is supported by the Chinese Social Science Fund (Project No 12XFX033).
Where a contract is in some way connected with the perpetration of corruption (such as the giving and taking of bribes), how should the law prescribe its validity in order to achieve a proper balance between the relevant competing ideologies, values and policies? As a point of legal principles, the answer must depend first on what the relevant ideologies, values and policies are and how they are being weighed relatively in a given jurisdiction. The answer may also vary according to factual considerations such as whether, and if so to what extent, one or both parties are involved in the corruption as well as the nature and strength of the connection between the corruption and the contract in question. For China, the law on this particular point is characterized by a constant tension between peremptory rigidity and unrefined opaqueness. In this socialist land, any illegality, or contravention with statutes, is taken extremely seriously. Yet, as an authoritarian state, China is riddled with corruption1 and this has unfortunately been tacitly accepted by many as part of mode de vie. Traditionally, a “private” contract, one that is made by different parties on an equal footing, is susceptible to a declaration that it is void, for any contradiction with an interest, policy or provision of a public character. However, the ruling class has come to realize that the protection or even encouragement of contract performance is vital to the success of a market economy. But the softening of the traditional stance has thus far been achieved by fairly blunt weapons. The characteristics of such an approach must be propounded and its weakness be exposed. To answer the above-posed question in a satisfactory way involves an evaluation of how far the competing ideologies, values and policies are implemented in practice during the current stage of China’s development in the history.
This article is concerned with legal rules providing for the civil law consequences of corruption, particularly the giving and taking of bribes. Corruption may have implications for different areas of private law. For example, a business who gives a bribe in order to obtain a favorable market status (such as an exclusive right to contract with a major supplier) may arguably have committed a tort infringing a competitor’s right to fair competition, thus giving rise to a liability in damages under arts 8(1) and 20 of the Law Against Unfair Competition.2 This article will not, however, deal with this or other similarly interesting matters about the civil law consequences of corruption. Rather, it is devoted to the issue concerning the validity or enforceability of a contract tainted, in one way or another, with corruption. Section 3.1 starts with a general discussion of the notion of “corruption” and its relevance in differing Chinese legal contexts. Section 3.2 then explores in some detail the effect of an act of corruption on contracts in light of the illegality brought about by it. Section 3.3 considers the application of the doctrine of apparent agency in this regard, particularly, the Chinese solution to contracts made with an unauthorized use of company seals and/or other certifying instruments. At the end of the article a conclusion draws the strings together by proposing an understanding of this area of Chinese contract law as a balancing exercise between, primarily, public interest and transactional security.
3.1 Defining Corruption in the Context of Chinese Law
In China, the word “corruption” is often used as a generic term denoting unscrupulous and politically negative conduct rather than a substantive concept in law. Usually, corruption arises from governmental officials’ rent-seeking activities, made possible by their protected status and unchecked powers. That this is the case is made plain by a series of recent incidents where serious allegations of bribe-giving were made against the Chinese branch of major multi-national companies (such as Wal-Mart, Siemens, IBM) according to Chinese law. In view of the damaging effect of corruption in the government, President Xi has made the strike on such corruption his primary agenda. However, corruption may take various forms and permeate a wide range of walks of life. It is not public power or privilege alone that is prone to abuse. A stronger market position of a company, for example, may be abused by one of its executives for his personal ends rather than to serve the interests of the company. It is, therefore, incorrect to view “corruption” as exclusively a public law phenomenon requiring one of the parties to hold a position in a public institution. This is duly reflected in the recognition of both corruption involving one or more governmental officials and corruption occurring between private parties as capable of constituting crimes under China’s Criminal Law.
Corruption amounting to crimes lies at the core of a loose notion of “corruption”. It is therefore necessary to understand such criminal corruption in the first place. Under China’s Criminal Law there are specific crimes including those of “embezzlement” and “bribery” which can be seen as typical legal forms of corruption. Chapter VIII of the Law is entitled “Crimes of Embezzlement and Bribery” and it contains arts 382 to 396. According to these articles, any state functionary, or any person authorized by state organs, state-owned companies, enterprises, institutions or people’s organizations to administer and manage state-owned property shall be guilty of embezzlement if he, by taking advantage of his office, appropriates, steals, swindles public money or property or by other means illegally takes it into his own possession3; any state functionary shall be guilty of bribe-taking if he, by taking advantage of his position, extorts money or property from another person, or illegally accepts another person’s money or property in return for providing benefits for that person4; any person who, for the purpose of obtaining improper benefits, offers or gives money or property to a state functionary shall be guilty of bribe-giving.5 Aside from the obvious case of public servants, a “state functionary” also comprises people sent by state institutions to non-state institutions to engage in “public business” (art 93).
China’s Criminal Law extends some of the above provisions on corruption (particularly those regarding bribery) to the private sector. In chapter III of the Criminal Law “an employee of a company, an enterprise or other unit may be subject to a sentence of fixed-term imprisonment if he, by taking advantage of his position, demands money or property from another person, or illegally accepts another person’s money or property in return for benefits sought for that person”.6 The person who offers or gives money or property to the employee for the purpose of “obtaining improper benefits” is guilty of a crime of bribe-giving.7 Such an employee may not have any managerial role in the private company or enterprise but to be convicted under that provision he must have demanded or accepted a “relatively large” sum, viz above 5000 RMBs.8 It should be noted that a “commercial bribe” is expressly stated to comprise not only cash and tangible property, but also other benefits measurable in monetary terms, such as house renovation, gift cards etc.9 One of the most famous cases for bribe-taking by a non-state functionary is State v Hu Shitai (Stern Hu) 10 in which Mr Hu, head of the Singaporean mining company Rio Tinto’s Shanghai office, and his three Chinese colleagues were sentenced to jail terms of from 7 to 14 years for accepting bribes as a non-state functionary (in conjunction with committing the crime of interfering with business secrets).
As long as a state functionary, or a person authorized by State organs or State-owned companies, or an employee of a private company, taking advantage of his position, demands money or property from another person, or illegally accepts another person’s money or property in return for benefits sought for that person, he shall be guilty of bribe-taking under China’s Criminal Law, no matter whether the crime was committed or the consequences of the crime occurred inside or outside China (so is the case with the crime of embezzlement). Therefore, a cross-border embezzlement or bribery will constitute a crime under China’s Criminal Law. A crime is a cross-border crime if it is not committed wholly within the jurisdiction in which a charge is brought for it. Accordingly, an embezzlement or bribery committed in Hong Kong, Macao or Taiwan is a cross-border crime. An embezzlement or bribery committed by a Chinese national in a foreign country is convictable under art 7 of the Criminal law as it is either committed by a state functionary or serviceman or, when committed by a citizen, with a maximum punishment more severe than a fixed-term imprisonment of 3 years. Since 1980s, people’s courts in mainland China have decided cases involving an embezzlement or bribery committed in Hong Kong.11 In practice, a person of a foreign nationality may also be convicted for an embezzlement or bribery committed in China. In the above Rio Tinto case,12 Stern Hu is an Australian citizen.
However, it should not be thought that the notion of “corruption” is confined to criminal law. Commercial bribery comprises all kinds of bribery existing in commercial practices, including, for example, kickbacks or rebates given contrary to state policy.13 It follows that an act of bribery falling short of a crime may none the less give rise to liabilities under civil law (such as damages) or administrative law (usually in the form of fines). The Law Against Unfair Competition, and a departmental regulation issued in accordance with it,14 makes detailed provisions for various forms of commercial bribery that may arise in practice. Art 8 of the Law Against Unfair Competition contains a general prohibition against a “business operator” (viz, a person, legal or natural, or an economic entity who engages in profit-making transactions on goods or services) perpetrating bribery, “by offering money or goods or by any other means”, to accomplish a sale or purchase of commodities (including both goods and services, art 2). The “bribe” under art 8 is further stipulated to consist of cash or tangible property, including gifts except “small advertising gifts” (Interim Provisions, art 8), no matter in what name it is offered or received; and “other means” refer to offering benefits other than cash or tangible property, such as opportunities to go on a domestic or international trip (Interim Provisions art 2). Art 8 draws a distinction between “kickback” (huikou) on the one hand, and “discount” (zhekou) or “commission” (yongjin) on the other. Offering or accepting a kickback is treated as bribe-giving or bribe-taking if done “off-the-book” and “in secrecy”, whilst offering or accepting a discount or commission is openly legitimatized if done “in an explicit way” and “truthfully recorded in accounting books”. Both a kickback and a discount involve a refund or deduction of a proportion of the price of the commodity sold (arts 5 and 6). A commission is remuneration for the service provided by a qualified middleman in market transactions (art 7). The critical distinction between a kickback and a discount or commission lies in whether the payment or transfer is clearly and accurately recorded in financial books in accordance with the general accounting rules.
In the event of a contravention, the Law Against Unfair Competition makes the guilty business operator liable to compensate for the damage caused to an injured business operator, including any reasonable expense incurred by the latter to investigate the contravention, or to disgorge profits made out of the contravention during the period of its subsistence where such damage is unquantifiable (art 20). This provision appears to enunciate or at least evidence a general principle that allows damages to be recovered for a contravention of any provision of the Law, including the prohibition against corruption under art 8. However, it must be borne in mind that art 8 is not a prohibition against corruption per se. Rather, it targets solely corruption that results in unfair competition, namely, acts that not only “infringe upon the lawful rights and interests of another business operator” but also “disturb the socio-economic order” (art 2). This excludes some acts of corruption which do not fall within the scope of the Law. In addition, a business operator who contravenes art 8 is subject to a fine of from 10,000 to 200,000 RMBs, depending on the circumstances of the case, and may face a confiscation of all illegal gains obtained, where the contravention does not constitute a crime (art 22).
Bribery is defined strikingly similarly under both of the above two laws. It involves an abuse of one’s special position or influence in exchange of money, property or other personal benefits. It is a representative form of “corruption” which gives specific meaning to that notion. The Criminal Law and the Law Against Unfair Competition are, of course, two most important pieces of legislation in the regulation of bribery. But the illegality of bribery and the State’s disapproving attitude towards it are also attested by hundreds of anti-corruption laws and regulations enacted in China since the commencement of reform and the opening of door to the world in late 1970s. This arena of domestic law deals not only with bribery meeting the thresholds of crimes or unfair competition conduct, but also other less severe bribe-giving and bribe-taking acts. China has also ratified the United Nations Convention Against Corruption.15 However, it was declared that China would not be bound by Paragraph 2 of art 66 (submission of dispute to arbitration and then to the International Court of Justice) of the Convention.16 Besides, China has participated in a series of APEC Anti-Corruption Conferences,17 signed treaties on extradition with more than 30 countries,18 and signed almost 100 agreements relating to judicial assistance. China is also a member of the International Criminal Police Organization. All these domestic law-making and international engagements reflect a state policy that any form of bribery is illegal and should be discouraged as far as possible. It is against this background that the Chinese legal rules prescribing the illegality and invalidity of contracts is to be understood and assessed.
3.2 Contracts Tainted with Corruption and Illegality
As shown in the last section, none of the existing statutory provisions specifically devoted to or explicitly embracing corruption addresses, in generic terms, the civil law consequences of corruption. There is certainly no provision for the effect of corruption on the validity or enforceability of a contract connected with it. The more helpful guide is to be found in some general provisions of the 1999 Contract Law. The key provisions in this regard are those concerning void contracts. These provisions resemble the equivalent provisions under the 1986 General Principles of Civil Law (“GPCL”) which deal with legal acts generally instead of contracts. The central provision is contained in art 52 of the Contract Law:
Although each of the five sections of art 52 may potentially be invoked in a corruption case, none of them is necessarily predicated on the presence of corruption. Of the five circumstances that render a contract void, only three, that is, sections (3)–(5), may be established by showing an act of corruption per se. However, the other two circumstances (sections (1) and (2)), which hinge on proof of, respectively, fraud or coercion and malicious collusion, are no less important as these two kinds of misconduct are often entangled with corruption. It is proper to analyze each section as a separate rule and to consider how they might be applied to resolve a dispute involving a contract connected with some form of corruption.
Art 52 A contract is void under any of the following circumstances:
either party enters into the contract by means of fraud or coercion, thereby impairing the interests of the State;
the parties collude maliciously, thereby causing damage to the interests of the State, of the collective or of a third party;
the parties attempt to conceal illegal goals under the disguise of legitimate forms;
the parties cause harm to the public interests of the society; or
the parties contravene mandatory provisions of laws or administrative regulations.
Like many other provisions, art 52 was drafted in rather broad terms. In analyzing the application of the rules contained therein, it thus becomes particularly important to resort to court decisions and arbitral awards in China to ascertain the status of the law. This exercise is currently plagued with difficulties. Although there are a number of court decisions or arbitral awards sanctioning civil law relief for various acts of corruption, they do not constitute a formal legal source in China. Such decisions and awards are mostly concerned with penalties, confiscation, restitution of misappropriated properties and damages, and only a handful of them touch upon the issue as to the validity of contracts as a consequence of corruption. Courts and tribunals in China are not accustomed to discussing or laying down general principles of law, with the consequence that their position on many points of law is not made clear and legal reasoning in such decisions or awards is usually inadequate. Worse still, owing to the absence of a unified system of precedents, it is impossible to tell whether, and if so how far, a given decision, even of the Supreme People’s Court (“SPC”), will be adhered to by other courts in future like cases. Nevertheless, the SPC has been working towards building a body of precedent-like cases expected to be an instructive source for courts of all levels, through the publication of the Gazette of the Supreme People’s Court (“GSPC”) and the implementation of a Guiding Case system. It remains that much gap is left in even those cases for the inventive mind of a commentator. Below a number of representative cases selected by reference to their analytical or expository value will be used to illuminate the pertaining principles of Chinese law.
Following the analysis of the five sections of art 52, there will be further discussion of the legal consequences of declaring a contract void and the proper role this might be playing to curtail corruption. Under the standard model, there are two contracts up for analysis: a bribery contract by which a bribe is given and a main contract procured by the bribe. As will be seen, they are, and ought to be, treated rather differently under the provisions of art 52.
3.2.1 Art 52(1): The Interest of the State
This section applies to the main contract only. Corruption may accompany or be a cause of fraud or coercion. Where fraud or coercion is shown to have been used as a means to attain the conclusion of a contract, it is in principle odd to say that this will lead to the contract being void. If the law is minded to protect the defrauded or coerced party, who presumably does not consent voluntarily to the terms of the contract, then the better option appears to be to render the contract voidable by that party. Adopting this option avoids inflexible injustice to the innocent contracting party and any third party who deals with it in reliance on the validity of the contract, hence promoting the security or certainty of transactions on the market. The key to understanding art 52(1) is its additional requirement that the conclusion of the contract by means of fraud or coercion must impair “the interests of the State”. How should this phrase be interpreted? Will the fact that the State has a general interest in preventing corruption suffice to satisfy the criterion under that section? Or does it require the defrauded or coerced party to be a state-owned company or in possession of state assets? It appears that “the interests of the State” have been restrictively interpreted by the courts, referring only to such particular interests as the State might have in the performance of the contract in question. The section does not extend beyond the interests of the State, as a party to the contract, in its performance. Accordingly, such interests of the State are not impaired under section (1) simply because the conclusion of the contract involves bribery which endangers the integrity of the government, thus weakening the authority of the State, or defies a clean market morality, thus disrupting a good market order. The relevant test comes down to an evaluation of the substantive terms of the contract to see if they are sufficiently disadvantageous to the party who represents the interests of the State.
The application of this test is illustrated by two cases. The first case concerns one particular dispute in the high-profile legal battle between Guangzhou Pharmaceutical Holdings Ltd (GPH), the legal owner of a famous soft drink brand “Wong Lo Kat/Wanglaoji”, and Jiaduobao (JDB) Beverage Co Ltd, a licensee contracted to develop a market for the brand. The parties executed an extension of the license but GPH alleged that the new contract was void as JDB procured the extension by bribing an executive of GPH.19 The dispute was referred to arbitration and the China International Economic and Trade Arbitration Commission (“CIETAC”) held that the contract was void under art 52(1) of the Contract Law. Subsequently, the Beijing First Intermediate Court rejected JDB’s application to set the award aside. In this case GPH was a state-owned company and the extension of the license was clearly disadvantageous to GPH in view of the fact that the two companies were battling over the right to use the brand. Therefore the decision conformed to the legislative purpose of art 52(1), namely, to safeguard state assets and to prevent their loss, and applied that section appositely to the facts of the case. However, this special protection may contradict the fundamental logic of market economy since, once it enters the market, the State should compete with other parties on a level field. In addition, it must not be assumed that, where the contract is disadvantageous to the party representing the interests of the State, the best way to protect such interests is necessarily to declare the contract void. To declare a contract void is a drastic measure which does not differentiate between the parties. It may be inappropriate in cases where, for example, the party representing the interests of the State has rendered all or part of its performance under the contract whereas the other party’s performance is still outstanding. The second case is an unreported case where a tenderer for the lease of an office tower bribed some officers of the owner/lessor (a government agency) and subsequently won the bid. The conclusion of the lease contract would not harm the interests of the State since the contract price was not lower than the fair market rate and the winning bid was, viewed objectively, the most suitable bid. In the case, the lessee has invested substantially in the renovation of the offices in reliance on the contract, therefore to declare the contract void would injure innocent shareholders of the lessee company and lead to a waste of social resources. Therefore, this is a case where the value of contractual certainty, and the interests of those who have in good faith relied upon the contract, should be prioritized over the interests of the State. For the latter to trump the former, there must be particularly strong facts necessitating the protection of state assets, something not present in the second case but perhaps discernible in the first.