[China Intellectual Property News] Obligations Borne by Contract Signer Who Set up Company to Perform Contract

— Analysis of Infringement Dispute over Franchise Contract Among Shanghai Yiju, Wu and Pizhou Motel

January 23, 2019   China Intellectual Property News   Page 13

Chen Luyang

[Case Number]

(2015) XuMinSan (Zhi) ChuZi No. 619

(2016) Hu73MinZhong No. 312

[Judging Principle]

　　When the actual performer of a franchise contract hasn't been established before the contract is signed, and the actual performer is established only to perform the contract, and when a dispute arises over the contract and the counterparty or the third party wantsto claim damages,the doctrine of privity of contract shall be overcome to give the counterparty the right of choice, that is, the counterparty may choose either the signer or the actual performer to bear the liability.

[Case Review]

On July 1, 2009, Party A (the franchisor) Shanghai Yiju signed a franchise contract with Party B (the franchisee) Wu and the outsider Zhang. The contract stated clearly the privileges and obligations of Party A, Party B and the franchised outlet. On September 3, 2009, Wu applied and registered Pizhou Motel Hotel Co., Ltd. (hereinafter referred to as Pizhou Motel) and began to do business in the name of the company. On January 5, 2011, Zhang quit the franchise contract. Later, Shanghai Yiju sued Wu and Pizhou Motel for failing to pay the due debt andresolve the follow-up issues.

After hearing the case, the court of first instance held that thefocus of the dispute lied inwho should bear the civil liability of the franchisee. In this case, the franchise contract was signed between the franchisor Shanghai Yiju and the franchisee Wu and Zhang. Pizhou Motel was not a contracting party of the involved franchise contract. Although Pizhou Motel paid Shanghai Yiju according to the involved franchise contract as soon as the company was established, it could only be regarded as the company performing the contract on behalf of Wu. As a party to the involved franchise contract, Wu should enjoythe privileges and perform the obligations in accordance with the contract. The court of first instance ruled that Wu should stop the infringement and paid for the damages, and Pizhou Motel was liable for giving Wu assistance.

After the ruling of the first instance was announced, Wu refused to accept it and appealed to Shanghai Intellectual PropertyCourt (hereinafter referred to as SIPC).

After hearing the case, SIPC held that the case was special in that the signer and the actual performer of the contract were not the same, that is, the contract was signed by Wu, while the principal of the actual performer was Pizhou Motel established by Wu for the performance of the contract. Under the circumstance, when damages are generated during the performance of a contract, if no sufficient evidence can prove the coexistence of debt between the signer and the actual performer, and if the signer signs the contract only to make the company he/she establishes later perform the contract, the counterparty may choose either the signer or the actual performer to bear the liability. In this case, since Shanghai Yiju had already required Wu to bear the contractual liability based on the privity of contract, it shouldn't require Pizhou Motel to bear it as well. So the liability generated when Pizhou Motel performed the contract should be borne by Wu.

SIPC determined that the ruling of the first-instance court was correct and should be upheld in accordance with the law.

[Judge's Comment]

The case is about a dispute over a franchise contract. Thefocus of the dispute is how to determine the principal to bear the liability when the signer and the actual performer of the contract are inconsistent, and when a party wantsto claim damages in accordance with the contract. One view is that the doctrine of privity of contract should be strictly observed when a dispute arises during the performance of the contract, that is, the signer shall bear the liability in accordance with the contract. Another view is that the doctrine of privity of contract could be overcome to make the actual performer bear the liability when a dispute arises during the performance of the contract since the actual performer and the signer are inconsistent. A third view is that if the signer signs the contract only to make the company he/she establishes later or some other principal perform the contract, the doctrine of privity of contract could be overcome to give the counterparty the right of choice, that is, the counterparty may choose either the signer or the actual performer to bear the liability.The second-instance court adopted the third view.

A franchise contract is signed between a franchisor and a franchisee. The purpose of the franchise contract signed between the franchisor and the franchisee is to carry out franchise business. But the principal of the business is often not the signer, since the franchisee needs to carry out the business according to a unified operation mode, for example, in the form of a franchised outlet. In most cases, the contracting principal cannot meet the requirements of the franchisor or carry the franchised operation resources. So the franchisee needs to set up another principal that meets the requirements to perform the obligations stipulated in the franchise contract, such as “Pizhou Motel Hotel Co., Ltd.” in this case. During the performance of a franchise contract, the actual performer and the signer are often closely related, that is, the actual performer does not exist before the franchise contract is signed, but is established by the franchisee to perform the obligations stipulated in the contract. Once a dispute arises during the performance of the contract and the counterparty files a lawsuit in court, the court usually regards the signer as the principal to bear legal liability according to the doctrine of privity of contract. The privity of contract is undoubtedly one of the basic principles of the law of contract. However, with the continuous economic development and the increasing frequency and complexity of transactions, the existing doctrine of privity of contract can no longer meet the needs of social development. In this case, if the doctrine of privity of contract is still observed strictly, it may damage the legitimate rights and interests of the counterparty or the third party, resulting in substantial unfairness, and thus the balance of interests cannot be achieved.

Who is to bear the legal liability when the signer and the actual performer of a contract are not the same, and the actual performer is established after the contract is signed for the only purpose of performing the contract, and when a dispute arises during the performance of the contract and the counterparty or the third party wantsto claim damages? So far, there has been no straightforward stipulation regarding this issue in any law or regulation. The Article 2 of the Third Judicial Interpretation of the Company Law stipulates that, when an initiator signs a contract in his or her own name to establish a company and the counterparty of the contract requires the initiator to bear the contractual liability, the people's courts shall uphold the counterparty's claim; when the company has affirmed the contract mentioned above after the establishment, or has actually enjoyed the contractual rights or performed the contractual obligations, and when the counterparty of the contract requires the company to bear the contractual liability, the people's court shall uphold the counterparty's claim. In order to appropriately reduce the counterparty's obligation of verification and enhance the protection of the counterparty's interests, the Article determines the principal to bear the contractual liability according to the theory of Rechtsschein. If the initiator signs a contract during the establishment of the company, the principal specified is actually the company being established, and in principle, the established company shall bear the liability. So the Article has overcome the bound of the privity of contract. The Article 75 of China's General Provisions of Civil Law stipulates that, when a founder engages in civil activities in his or her name to found a legal person, the third person has the right to choose either the legal person or the founder to bear the liability that arises. This Article gives the third person the right to choose either the founder or the legal person after its establishment to bear civil liability under certain circumstances. It shows that, after the General Provisions of Civil Law overcame the privity of contract, it has provided more ideas and solutions on how to better protect the third person's rights and interests. This case is a typical example of such circumstances, and the third person is actually the counterparty of the franchise contract. When the civil liability arising from the performance of a contract is being defined, it is necessary to give the third person or the counterparty the right to choose the principal to bear the liability, so as to provide a more adequate and effective way to remedy the third person's rights. If no sufficient evidence can prove the coexistence of debt between the signer and the actual performer, and if the signer signs the contract only to make the company he/she establishes later perform the contract, the counterparty may choose either the signer or the actual performer to bear the liability.

How shall the court respond if the counterparty of a contract requires both the signer and the performer to bear the contractual liability? The court of second instance holds that, since the signer and the actual performer are not jointly and severally liable for the contract, the signer alone shall bear the contractual liability according to the doctrine of privity of contract. In this case, since Shanghai Yiju had already required Wu to bear the contractual liability based on the privity of contract, it shouldn't require Pizhou Motel to bear it as well. So the liability generated when Pizhou Motel performed the contract should be borne by Wu.

(The author is from Shanghai Intellectual Property Court.)