what we think

By Qiao Peng and Linda Ji

During a compliance investigation, a complaint was received alleging that a former employee of Company A colluded with a third party, Company C, through an intermediary to fabricate contracts, thereby defrauding both Company A and the actual purchaser, Company C. The individuals involved profited by buying low and selling high, then disbursing the profits through fraudulent contracts. The complaint was filed following a dispute between Company B and Company C.

Company A's sales model involved multi-tier distribution: Company A sold to a general distributor, which sold to a second-tier distributor, which then sold to the end-user. As a result, Company A did not directly sign contracts with end-users. However, internal policies required that any discounts granted for end-user projects must be fully passed on to the end-user; otherwise, the discount application would be rejected or revoked. Sales personnel were further required to upload the contract between the second-tier distributor and the end-user into Company A's audit system for formal review to ensure compliance. Company regulations explicitly stipulated that uploaded contracts must be authentic and valid, with sales personnel bearing full responsibility for the accuracy of submitted materials. Any falsification or fabrication would trigger legal liability.

In this case, a former employee of Company A forged a company letter addressed to the end-user, Company C, and instructed Company C to sign a sales contract with a second-tier distributor, Company B. The employee also directed Company B to forge senior management credentials and coordinated negotiations with Company C. Ultimately, Company C signed a contract with Company B at an initial offer of CNY 20 million—higher than Company A's recommended retail price. The employee then persuaded Company A to approve a discounted transaction for CNY 10 million.

Subsequently, the employee guided Company B to forge Company C's official seal and prepare a fraudulent contract for CNY 10 million. The forged contract was uploaded to Company A's audit system, where the authenticity of the forged seal went undetected. This resulted in approval of the fraudulent transaction. Under the employee's direction, Company B used fake contracts to distribute approximately CNY 10 million in illicit proceeds among those involved.

The case was later filed by local authorities. Initially, it was registered solely under the charge of seal forgery, reflecting limited local experience with complex contractual fraud cases. Following further legal analysis and submission of extensive supporting documentation, authorities were persuaded that the conduct involved fabrication of facts and concealment of truth for the purpose of illegal possession, meeting the legal definition of contract fraud under the Criminal Law of the People's Republic of China. The forged seals and false contracts had been used to mislead both Company A and Company C, leading to significant unlawful gains. The procuratorate ultimately reclassified the case as contract fraud and included Company C as a party to the prosecution.

Judgment Summary (First-instance Judgment)

Under Chinese law, contract fraud refers to fabricating facts or concealing the truth during the signing or performance of a contract, with intent to illegally obtain property from the counterparty, and where the amount involved is substantial.

In this case, the court found that the former employee and others had conspired to fabricate a price difference during the signing and performance of contracts, misleading the contracting parties and illegally appropriating significant funds. To manage and conceal the illicit proceeds, they also fabricated a service agreement with Company B.

The court held that the conduct constituted contract fraud, as it involved deliberate fabrication and concealment for the purpose of illegal possession. The defendants were held criminally liable accordingly.

Legal Significance and Implications

This case illustrates the application of contract fraud provisions in complex commercial structures involving multi-tier distribution. It confirms that:

• Fraudulent manipulation of contract documents, seals, and internal compliance systems can establish criminal liability even where intermediaries are involved.
• A lack of direct contractual privity with the victim company does not preclude findings of fraud if the perpetrator's conduct leads to illegal enrichment through deception in the contractual process.
• Compliance systems relying on document uploads and digital audits should include additional verification mechanisms to detect falsified seals or contracts.

Qiao and her team bring extensive experience in conducting internal compliance investigations for private, multinational, and state-owned enterprises. For inquiries about how they can support your compliance needs or resolve disputes, please contact Qiao at [email protected] or reach out to your trusted contact at R&P.