Case Description

Company A has signed an automobile parts sales contract with Company C, which stipulates that Company A will provide automotive parts to Company C. In order to fulfill the aforementioned contract, Company A signed a sales contract with Company B to purchase raw material steel. Company A and Company B have agreed on a "back to back" clause in the contract, which means that Company A shall pay Company B for the steel within 10 days after receiving the payment from Company C. After the contract was signed, Company B completed all supply as agreed and there were no quality issues with the supply. However, Company A delayed payment due to not receiving payment from Company C. So, can Company A refuse to make payment on a "back to back" basis?

Lawyer Analysis

The "back to back" clause generally refers to the clause in the contract that stipulates that the buyer's payment must be conditional on the buyer receiving the corresponding payment from a third party. Based on the principle of freedom of will in civil contracts, the effectiveness of "back to back" clauses that break through the relativity of contracts is widely recognized in judicial practice. However, in order to prevent the buyer from using their advantageous position to harm the legitimate rights and interests of the seller, in judicial practice, the achievement of the "back to back" clause usually follows the principles of integrity and fairness, and is comprehensively considered based on the specific situation of the case. Under normal circumstances, a "back to back" clause cannot become a defense for the buyer to refuse payment if the following factors exist:

1、 During the performance process between the buyer and a third party, the third party has committed a breach of contract

The achievement of the "back to back" clause is based on the fulfillment of obligations by a third party to the buyer, one of the prerequisites being that there is no breach of contract by the third party. If there is a breach of contract by a third party, even if there is a "back to back" clause, it is not appropriate to use the breach of contract by the third party as a defense or exemption condition for the buyer to refuse to pay the goods, because an unconditional back to back clause is infinite and cannot guarantee the legitimate rights and interests of the seller who has already fulfilled the contract obligations. In this case, the buyer shall first fulfill the payment obligation to the seller. As for the liability arising from the breach of contract by a third party, it belongs to another legal relationship and is claimed separately by the buyer from the third party.

2、 During the performance process between the buyer and a third party, the buyer has committed a breach of contract

The achievement of the "back to back" clause is based on the fulfillment of obligations by a third party to the buyer, one of which is that the buyer has fulfilled its contractual obligations to the third party as agreed and there is no breach of contract. If a third party fails to make payment to the buyer due to the buyer's breach of contract, based on the protection of the seller's rights and interests, the seller shall not be liable for the buyer's breach of contract. Therefore, the buyer cannot refuse to fulfill the payment obligation to the seller on a "back to back" clause. As for the liability arising from the buyer's breach of contract, it belongs to another legal relationship and is claimed separately by a third party against the buyer.

3、 The buyer is negligent in claiming rights from third parties

During the performance of a contract with a "back to back" clause, the buyer has a collateral obligation to claim payment from a third party and actively urge the third party to make timely payments as agreed. The Buyer's active supervision obligations here include, but are not limited to, taking measures such as sending a Demand letter, filing a lawsuit or arbitration, and applying for enforcement. And the buyer has the burden of proof in this regard. If the buyer is negligent in claiming rights from a third party or is unable to provide evidence, it will be considered as negligent in fulfilling the obligations attached to the contract and will be deemed as maliciously obstructing the achievement of payment terms. At this point, the buyer cannot refuse to fulfill the payment obligation to the seller on a "back to back" basis.

4、 There is a situation where a third party loses the ability to perform

When encountering situations where a third party loses the ability to perform, even though the buyer has taken measures such as arbitration, litigation, and enforcement, it still makes it impossible for the third party to make payment to the buyer. At this point, the buyer refused to make payment to the seller on the grounds of the third party's inability to perform, and in fact, the buyer evaded the payment obligation in a disguised manner, resulting in the seller's inability to achieve the purpose of the contract. In judicial practice, some judges believe that the "back to back" clause attached to the contract cannot occur, and it is deemed that there are no conditions attached, and the buyer should make payment to the seller.

Because of the above situation, the "back-to-back" clause is not the "Sword of state" of the buyer's non payment, which needs to be analyzed in combination with the specific situation of the case. In this case, after trial, it was found that the third party's failure to pay was due to quality defects in the products sold by the buyer. Therefore, Company A's defense reasons were not supported by the court.