Navigating CISG Compliance in China: Analysis of IP Warranties & Fundamental Breach in Cross-Border Supply Chains

Lessons from the “Southern Truck v. Aggeus” Appeal & the Supreme People’s Court’s Guiding Precedents – By Zongyang YU, Attorney at Law, M&T Lawyers

Abstract

In the realm of international trade, the intersection of intellectual property (IP) rights and contract performance often creates complex disputes. This article analyzes a recent high-profile appeal case, Southern Truck LLC v. Anhui Aggeus Automotive Technology Co., Ltd., currently pending before the Wuhu Intermediate People’s Court. By examining this case alongside the landmark Supreme People’s Court ruling in Sinochem International v. ThyssenKrupp, we explore how Chinese courts apply the United Nations Convention on Contracts for the International Sale of Goods (CISG). Specifically, we discuss the strict liability of sellers regarding IP warranties (Article 42) and the determination of fundamental breach (Article 25) when goods are blocked by overseas administrative orders (such as US ITC Consent Orders).

1. Case Background: The “Hidden” IP Risk in Global Sourcing

The dispute arose from a typical international procurement scenario. The US buyer, Southern Truck LLC, purchased automotive parts from Chinese manufacturer (the Appellee) for resale in the US market. While the goods were delivered physically, their legal utility was destroyed when a third-party patent holder initiated a Section 337 Investigation at the US International Trade Commission (ITC).

To mitigate legal exposure, the Chinese seller signed a “Consent Order” with the ITC, effectively agreeing to a ban on selling the products in the US. However, in the subsequent contract dispute in China, the court of first instance ruled against the buyer, citing a lack of “proven infringement” and accepting the seller’s Freedom to Operate (FTO) report as a defense. This ruling raises a critical question: Does a seller’s obligation under CISG Article 42 depend on actual patent infringement, or simply the existence of a third-party claim that hinders trade?

2. Legal Analysis: The “Sinochem” Standard and CISG Interpretation

Our legal opinion, submitted to the appellate court, leverages the principles established in the Supreme People’s Court’s guiding case, Sinochem International v. ThyssenKrupp.

The “Independent Interpretation” Principle:

The Supreme Court has clarified that CISG must be interpreted independently of domestic law. In the context of Southern Truck, this means the “right or claim” under Article 42 should not be conflated with the domestic standard of “proven tortious infringement.” The ITC Consent Order represents a substantial third-party claim that blocks market access. The seller’s FTO report is irrelevant to the fact that the buyer is legally barred from selling the goods.

Defining Fundamental Breach (Article 25):

Under CISG, a breach is fundamental if it “substantially deprives” the other party of what they were entitled to expect. In this case, the buyer’s core expectation was resale profit. The ITC ban rendered the inventory worthless and legally toxic. The appellate strategy emphasizes that the destruction of the goods’ commercial purpose constitutes a fundamental breach, regardless of the seller’s subjective intent or prior due diligence.

3. Damages Calculation: Beyond Direct Loss

Another pivotal issue is the scope of damages under CISG Article 74. The principle of “Full Compensation” aims to restore the aggrieved party to the position they would have been in had the contract been performed.

In Southern Truck, the losses extended far beyond the purchase price. They included:

a. Lost Profits: Verified by accountant reports.

b. Product Disposal Costs: Expenses for destroying non-compliant inventory.

c. Legal Fees: Significant attorney fees incurred in both the US (handling the ITC investigation) and China.

We argue that under international standards (specifically CISG Advisory Council Opinion No. 6), reasonable attorney fees incurred to mitigate loss or defend against third-party claims are foreseeable damages that must be compensated.

4. Practical Takeaways for Global Business

For international companies sourcing from China, this case highlights critical compliance strategies:

a. Contract Clarity: Explicitly reference CISG Article 42 in purchase agreements and define “third-party claims” to include administrative investigations (like Section 337) and settlement agreements, not just court verdicts.

b. Evidence of Loss: Maintain rigorous accounting records. In litigation, Chinese courts are increasingly accepting international evidence (credit notes, foreign legal bills) if properly notarized and legalized.

c. Prompt Notification: Under CISG, buyers must notify sellers of defects within a reasonable time. For IP issues, this “clock” starts when the buyer should have known of the claim—usually upon receipt of a cease-and-desist letter or court summons.

Conclusion

The upcoming appellate decision in Southern Truck v. Aggeus will serve as a bellwether for how Chinese courts handle complex cross-border IP disputes. By adhering to the spirit of the CISG and the precedents set by the Supreme People’s Court, we anticipate a ruling that reinforces the security of international trade and upholds the strict liability of sellers regarding IP warranties.

Disclaimer: This article is based on a specific legal opinion regarding a pending case. The views expressed are those of the authors and do not constitute legal advice for other matters.