Preface

Affiliated operation is common in industries such as construction engineering and transportation. Usually, individuals or entities without corresponding qualifications engage in business activities by borrowing the name of the affiliated party. In such a complex legal relationship, when a counterparty conducts transactions with the affiliated person and a dispute arises, whether the counterparty can claim liability from both the affiliated person and the affiliated party largely depends on whether the counterparty knew about the affiliated relationship. Today, we will delve into this legal issue.

I. Liability Bearing When the Counterparty is Unaware of the Affiliated Relationship

When a counterparty conducts a transaction with an affiliated person in the name of the affiliated party without knowledge of the affiliated relationship, in accordance with the principle of contract relativity, the contractual relationship shall be established between the counterparty and the affiliated party. This is because the counterparty signs the contract based on trust in the qualifications, reputation and other aspects of the affiliated party, and the affiliated party, as the nominal subject of the contract, shall naturally assume the contractual obligations. At the same time, in judicial practice, to protect the legitimate rights and interests of bona fide counterparties, many courts will rule that the affiliated person and the affiliated party bear joint and several liability. This is based on the principle of fairness and the consideration of protecting transaction security. The affiliated party obtains benefits by allowing the affiliated person to use its name, so it shall be responsible for the risks arising therefrom; and the affiliated person, as the actual subject performing the contract, cannot shirk its responsibilities either.

Case Support:

In the case of (2019) Supreme Court Civil Application No. 5928, Jiang Shengxue signed the "Project Contract Economic Contract" with Zhang Honggang in the name of Jiang Shengxue Project Department of the Second Branch of Sijian Company, under which Zhang Honggang subcontracted the hydropower installation project of the Phase V project. There is no evidence to show that Zhang Honggang, the counterparty to the contract, knew about the affiliated relationship between Jiang Shengxue and Sijian Company when signing the contract. The court ruled that in such circumstances, the original judgment determined that Jiang Shengxue (the affiliated person) and Sijian Company (the affiliated party) should bear joint and several liability for the project payment and interest involved in the case to Zhang Honggang. This is because the counterparty was unaware of the affiliated relationship and signed the contract based on trust in the name of the affiliated party. To protect the counterparty's reasonable trust, the affiliated person and the affiliated party shall bear joint and several liability.

II. Liability Bearing When the Counterparty is Aware of the Affiliated Relationship

The situation is different when the counterparty, knowing the existence of the affiliated relationship, still chooses to conduct transactions with the affiliated person in the name of the affiliated party. In such circumstances, in accordance with Article 13 of the Guiding Opinions (Trial) of Nantong Intermediate People's Court on the Determination of Liability for Disputes Arising from Commercial Activities Conducted by Actual Constructors of Construction Projects in Their Own Capacity (Tong Zhong Fa (2010) No. 130), if the counterparty knows or ought to know the fact of affiliation, subcontracting in violation of regulations, or illegal subcontracting, but still agrees to the actual constructor conducting transactions in the name of the construction entity, the actual constructor shall bear the liability. This means that the counterparty cannot claim liability from the affiliated party.

From a legal principle perspective, when a counterparty conducts a transaction with knowledge of the affiliation, its act is an act of assumption of risk. At this time, the counterparty is no longer a bona fide contractual counterparty, and it has a certain understanding and prediction of the contractual risks. Therefore, the law no longer provides it with the same protection as when it is unaware, but mainly attributes the liability to the actual constructor, i.e., the affiliated person.

Case Support:

In the case of (2022) Supreme Court Civil Application No. 388 - Anhui Huali Construction Group Co., Ltd., Anhui Huali Holding Co., Ltd. v. Xuancheng Times Real Estate Development Co., Ltd. Construction Engineering Contract Dispute Case, Anhui Huali Construction Group Co., Ltd. signed the "Construction Engineering Contract" with Xuancheng Times Real Estate Development Co., Ltd. Later, it was found that the actual constructor was Anhui Huali Holding Co., Ltd., and there was an affiliated relationship between Anhui Huali Construction Group Co., Ltd. and Anhui Huali Holding Co., Ltd., of which Xuancheng Times Real Estate Development Co., Ltd. was aware. During the construction of the project, Anhui Huali Holding Co., Ltd. actually organized the construction, managed it, and settled the project payment with Xuancheng Times Real Estate Development Co., Ltd., etc.

The Supreme People's Court held that the "Construction Engineering Contract" involved in the case should be deemed invalid due to the existence of an affiliated relationship. Anhui Huali Construction Group Co., Ltd. was only the nominal contractor, and the actual constructor was Anhui Huali Holding Co., Ltd. Moreover, Xuancheng Times Real Estate Development Co., Ltd. was aware of the affiliated relationship. Therefore, Xuancheng Times Real Estate Development Co., Ltd. should not claim contractual rights against Anhui Huali Construction Group Co., Ltd., nor was Anhui Huali Construction Group Co., Ltd. entitled to claim project payment and other rights against Xuancheng Times Real Estate Development Co., Ltd. in accordance with the contract.

This case once again clarifies that when the counterparty is aware of the existence of the affiliated relationship, the affiliated party usually does not need to bear the rights and obligations arising from the contract. A de facto relationship of rights and obligations is formed between the counterparty and the affiliated person. This is of important guiding significance for maintaining the transaction order in the construction engineering field and determining the liability of all parties fairly and reasonably. It also reminds all parties to carefully examine the identity and qualifications of the other party when signing a contract to avoid disputes caused by affiliation and other issues.

III. Summary and Outlook

The determination of liability in affiliated relationships is a complex legal issue. Counterparties must act with caution when conducting transactions with affiliated persons. Understanding the legal consequences corresponding to their knowledge of the affiliated relationship can help counterparties make correct decisions when disputes arise.

• For the affiliated party, lending qualifications entails huge legal risks, and they shall strictly comply with laws and regulations and put an end to affiliated behaviors.
• For the affiliated person, obtaining qualifications through legal channels and operating in a standardized manner is the long-term solution.
• For the counterparty, before signing a contract, they should fully examine the identity and qualifications of the other party and clarify whether there is an affiliated relationship to accurately predict transaction risks.

The continuous improvement of laws and the accumulation of experience in judicial practice will provide clearer and more reasonable standards for the determination of liability in affiliated relationships.