The Payment by Installment Provisions in the Contract Law Do Not Apply to Contracts for Payment by Installments on Share Transfer(Mainland China)

James Cheng
On September 19, 2016, the Supreme People’s Court issued Guidance Case No. 67 (dispute over share transfer between Changlong Tang and Shihai Zhou; hereinafter the “Case”). Since a contract for payment by installments on share transfer is different from any other payment by installment transactions in terms of the purpose of the agreement, the object of the transaction, and the assumption of risk between the parties, it was held in this Case that if a transferee’s breach by delay or refusal of payment in a payment by installments on share transfer, and the transferor seeks to terminate the contract, Article 167 of the Contract Law of the People’s Republic of China does not apply.
1. Case background
Shihai Zhou and Changlong Tang entered into a Share Transfer Agreement and a Share Transfer by Installments Agreement on April 3, 2013. Zhou transferred his 6.35% holdings of Chengdu Double Star Electrical Device Co., Ltd. under the Qingdao Transfer Group to Tang for a total share price of RMB7.1 million to be paid in four installments. Tang, the transferee, failed to make the second installment payment, and Zhou sought to terminate the Share Transfer by Installments Agreement on grounds of Tang’s breach. Tang then filed suit at the PeopleÕs Court for a declaratory action to invalidate such termination and order Zhou to continue performance.
2. The result and reasoning
The Chengdu Intermediate People’s Court in Sichuan Province ruled against Tang in the first instance. The Sichuan High People’s Court reversed and agreed with Tang’s claims. Zhou then appealed to the Supreme People’s Court, which was finally rejected.
The court’s decision held that the key issue is whether Zhou has the right to terminate per Article 167, and for the following reasons, the transferor of a share transfer agreement does not have the right to terminate under that provision:
(1) Differences between a share transfer by installments contract and a sales by installments contract
Pursuant to Article 167 of the Contract Law and Article 38 of the Interpretation on Issues Concerning the Application of Law in the Adjudication of Disputes Involving Sales Contracts, a transaction by installments contract may be summarized as (1) buyer to pay the total price to the seller over more than three installments, or buyer makes more than two installments to the seller after seller’s delivery of the transacted subject; (2) sales by installments are commonly seen for consumers to meet daily livelihood expense requirements; and (3) Article 167 of the Contract Law grants the seller with a specific right to terminate the contract primarily to protect the seller’s recovery of the remaining payment so that he or she does not need to assume excessive credit risks.
Although the transfer in this Case also uses installments, a share transfer is still different from the ordinary transactions in the following aspects: (1) The primary purpose for Tang’s receipt of the shares was for participating in the management and operation of the company and generate economic benefits, not to meet his livelihood; (2) since the shares will always exist with the target company, the credit risk to be assumed by the seller is different from those assumed by a seller in a typical transaction by installments; and (3) after the parties terminate the share transfer contract, the transferor would not require the transferee to pay for use of the transacted subject. In conclusion, the court held that it is inappropriate to simply apply the right to terminate under Article 167 of the Contract Law to a share transfer by installments contract.
(2) No impact on the realization of contractual objectives
After considering Tang’s breach, the people’s court held that he was willing to continue performance and only delayed in the second installment payment while having paid the other three installments in compliance with the contract. Therefore, the objectives of Zhou’s contract could be realized.
(3) Good-faith principle for the agreement between the parties
Since it was specifically stipulated in the share transfer contract between the parties that “this Agreement shall be executed in duplicate and become effective upon signatures of the parties without regret forever,” even if Zhou wished to follow Article 167 of the Contract Law, he should have first requested Tang to pay the full price before seeking to terminate the contract.
(4) Considerations for maintaining transaction security
In this case, after Tang received the shares, he started participating in the management and e operation of the company, and he has already made the share registration with the industry and commerce authority. Unless a material breach has occurred, a direct move to terminate the contract would actually result in a negative impact on the stability of the management and operation of the company.