Header graphic for print

China Law Blog

China Law for Business

China LOI and MOU: Don’t Let Them Happen to You

Posted in Basics of China Business Law, Legal News
Think different about China Letters of Intent and Memoranda of Understanding. Please.

Think different about China Letters of Intent (LOI) and Memoranda of Understanding (MOU). Please.

At least once a month a US company comes to one of our China lawyers after having spent considerable time in China negotiating a complex transaction. They then show us a Letter of Intent (LOI) or a Memorandum of Understanding (MOU) that sets out in great detail the terms of their proposed China deal. We then explain to them that it is a very bad idea in China to enter into this type of detailed LOI or MOU. The US company then usually says: “the document clearly states it is non-binding. What liability could possibly arise?”

These US companies are making a major mistake and are exposing themselves to substantial liability. Most U.S. (and many European companies) just assume that they are covered by the rule that prevails in England: no party is exposed to any liability during the negotiation period; liability arises only after the parties have executed a formal, written contract. Under this rule, if the written document clearly states that it is non-binding, no liability arises.

The rule in China is exactly the opposite. The Contract Law of the PRC has formally adopted the German law principle of liability for negligence in contracting (缔约过失责任). Contrary to the classic common law view of the United States and England, under this principle, parties to a contract owe one another a duty of good faith. In a case where negotiations have commenced but no contract is concluded, the party that caused the failure to contract can be liable to the other party for damages. The damages in this situation are not contract damages, but rather damages for compensation for loss resulting from the reasonable reliance of the damaged party on the conduct of the other.

This doctrine is embodied in Article 42 of the PRC Contract Law, which reads as follows:

Article 42 Pre-contract Liabilities

Where in the course of concluding a contract, a party engages in any of the following conduct, and thereby causes loss to the other party, that party shall be liable in the event of a claim for damages:

(i) negotiating in bad faith under the pretext of concluding a contract;

(ii) intentionally concealing a material fact or supplying false information relating to the conclusion of the contract;

(iii) any other conduct which violates the principle of good faith.

Items (i) and (ii) are directed at situations where a party negotiates in bad faith to prevent the other party from pursuing a business advantage. Though these two provisions are fairly specific, item (iii) is very broad and leaves Chinese judges with wide latitude to impose liability.

For this reason, any case of a failed contract negotiation in China can result in liability under this Article 42. For this reason, extreme care must be taken to make clear the terms of negotiation and the commitments being made by the negotiating parties. An abrupt termination of negotiations with no warning and no explanation is very dangerous under this principle. However, even more dangerous is the failure to conclude a deal when the terms have been memorialized in a detailed LOI or MOU.

The magnitude of potential damage is far greater than most companies imagine. In the case of a typical commercial LOI or MOU, compensation can be demanded for the following:

  • Direct damages: These include costs incurred in preparing for the business venture, including the costs of drafting (attorney’s fees), research and development, and travel. These also include costs for time spent negotiating and the costs spent in preparing and delivering product samples.
  • Indirect damages: These include costs arising from abandoning negotiations with a third party for a similar transaction, lost profits from the other needing to pursue the project independently, or from needing to pursue other funding or related business opportunities.

Consider how how a claim for this type of Article 42 liability could arise in the case of a complex business transaction in China. Assume that the U.S. and Chinese parties negotiated for six months and executed a detailed LOI that involved the US company purchasing product from the Chinese entity, the US company transferring technology to the Chinese entity and the US company making substantial capital equipment loans to the Chinese entity to produce the product. After the end of the six month preparation period set out in the LOI, the U.S. party terminates the LOI and enters into substantially the same deal with a Chinese competitor of the Chinese party to the LOI.

As it turns out, the U.S. company was investigating the same basic deal with multiple Chinese parties at the same time. It merely selected the best of the deals on the table. The U.S. company did not inform ANY of the Chinese companies that it was simultaneously negotiating with multiple parties. Chinese companies and Chinese courts generally view multiple negotiations without notice to all involved as a basic violation of the Chinese law requirement of good faith in contract negotiations.

Now assume the worst case. The Chinese company goes bankrupt and while looking for claims against creditors, the bankruptcy trustees find the executed, dated, sealed LOI in the company files. After investigating the facts, they bring a damages claim against the U.S. company for the following losses:

  • The Chinese company lost out on several lucrative contracts for sales of its products to the competitors of the U.S. company.
  • The Chinese company failed to act on a transfer of technology offer from a Russian company. Though not as good as the technology of the U.S. company, adoption of the Russian technology would have resulted in substantial cost savings for the Chinese company and would have opened access to several new markets in Russia and Europe.
  • The Chinese company failed to accept the offer of financing from a local bank in reliance on the commitment of the U.S. company to provide capital equipment financing.

Consider the magnitude of the financial damage that has resulted from the Chinese company’s reliance on the commitments of the U.S. company as stated in the LOI. In essence, the trustees would be seeking compensation for all of the costs resulting from the bankruptcy of the Chinese company. Would the trustees prevail in a claim of this magnitude? It is not certain. But, since it is clear that the U.S. company executed the written LOI and since it is clear that the U.S. company violated Chinese principles of good faith in contract negotiation, the risk is considerable that a Chinese court would require the U.S. company pay some compensation.

A common response to this by U.S. companies is to say, “I have no risk for two reasons. First, the LOI states clearly that it is not binding and that no liability will arise for either party. Second, because of our concern with the Chinese adoption of the good faith principle, we state in the LOI that interpretation of the LOI is subject to U.S. law.”

These arguments do not work. The good faith requirement of Article 42 is not a principle parties need to create by written contract; it is a statutory requirement that applies to all parties who negotiate contracts in China. It is an obligation that exists entirely separate from the agreement of the parties. More important, the requirement of good faith applies to the conduct of the parties, not to what they say in a written document. For this reason, a court will examine the underlying conduct of the parties to determine whether liability arises.

Thus, self serving statements of a party that no liability will arise will be ignored. Even worse, such statements could be seen as a part of the plan to deceive the Chinese party about the U.S. company’s bad faith intent to cause harm. Reference to U.S. law will also be ignored, because liability arises under compulsory statutory law, not the consensual agreement of the parties.

Stated bluntly: there is no way to escape from the application of the defect in contracting principle for any party who negotiates in China. This is particularly true when applied to a foreign company that has caused damaged to a Chinese entity. Since the basic principle is the opposite of what most U.S. companies think is the rule, extreme caution is therefore required. Our own advice is that foreign companies should almost never enter into an LOI or an MOU containing ANY detailed deal provisions.

Just about the only time an LOI or an MOU should be used is when the parties need to set out specific steps that will be taken to complete due diligence for a specific transaction. In this case, such a document should be treated not as an LOI or an MOU, but rather as a due diligence contract. The U.S. party should understand that it will be held liable if it does not perform strictly as required in the contract.

In all other settings, an LOI/MOU should not be used. The risk is high and there is no compensating benefit. A unilateral term sheet is the normal alternative and that is generally acceptable. However, the principle of good faith will still apply even in this case; once negotiations have begun in China, the rule of good faith applies. If no contract is ultimately concluded, then the risk of Article 42 damages is always there. For this reason, if no contract is concluded after negotiations have begun, the foreign side should carefully document the reasons and should provide those reasons in writing to the Chinese side.

Not only can signing an LOI or an MOU cause you all sorts of legal problems in China, it more commonly can result in business problems, which problems we discussed in a previous post, The China MOU (Memorandum of Understanding). Use Them At YOUR Peril, detailing a recent conversation Dan and I had just had with a reporter:

Dan then talked about how this difference in laws can so often lead to problems arising between Chinese and American companies:

The impact of this difference is that we frequently see the following: American company comes back from China and shows us their five page MOU and says that they now want to work on a contract. we tell them that what they have given us is probably a contract. They tell us that we are wrong. We tell them to tell their Chinese counterpart that they now want a contract and see what happens. Virtually every time, the Chinese company tells the American company that there is no need for a contract and then the American insists that there is and then the Chinese party thinks the American is being a jerk. The parties have already gotten off on the wrong foot.

Steve then summed up the problems:

Dan’s point is dead on. There is a major gap in legal systems here. It is not culture, it is the legal system itself. Both sides are behaving in a manner completely consistent with their own legal system. But in the end, both sides look to the other as though they are acting in bad faith, when in fact both sides are doing nothing more than trying to reach a deal as best they know how.

Dan then concurred with Steve:

Correct. And the thing is that neither side has malevolent intent. The Chinese side just puts a lot more stock in the MOU than the American side. The American side will sign the MOU thinking it is nothing and planning to come back and turn it over to their attorneys to draft the final agreement.

And then the problem starts when we tell the American company that the MOU it just signed is almost certainly a legally binding contract and that it is virtually certain that the Chinese side sees it as a contract and that the contract is terrible and that “it needs the following ten things.” The American company then goes back to the Chinese company with the ten things that need to be changed or added and the Chinese company then gets offended because it thought it had a deal and that only super minor things needed to be resolved and that those would be resolved over time. So now you have a situation where what could have been a good relationship starts off on the wrong foot or fails to start off at all.

Bottom Line: China LOI and MOU are different in China. Don’t let them happen to you.

China Contracts: Why Hong Kong Courts Are A Really Big Mistake….Really Big.

Posted in Basics of China Business Law, Legal News

We continue to see contracts rendered unenforceable because the American or European party seeks to avoid application of Chinese law and enforcement in Chinese courts. By their own actions the foreign party guarantees the contract it drafted will be of absolutely no value to them. This is what is called “to be hoisted with one’s own petard.” (Hamlet Act III, Scene 4,).

Making Hong Kong your jurisdiction in your contract with a PRC company is a really big mistake that cannot be erased

Making Hong Kong your jurisdiction in contracts with PRC companies is a really big mistake that cannot be erased.

Consider a contract between a U.S. technology company and its PRC licensee. The U.S company seeks to avoid Chinese law by providing for English as the contract language, U.S. law as the applicable law, and enforcement in a U.S. court. The Chinese side refuses and insists on the reverse: Chinese language, Chinese law and enforcement in a Chinese court. As a compromise, the U.S. side proposes the following: English language, Hong Kong law and enforcement in a Hong Kong court. The Chinese side agrees and the contract is signed.

Why did the Chinese side agree? It is because the Chinese side knows that under this “compromise” it has created the worst possible situation for the U.S. company. The contract is NOT enforceable against the Chinese company, so the Chinese company is off the hook for any liability. On the other hand, the contract IS enforceable against the U.S. company, giving the Chinese company substantial power in the event of a dispute. The U.S. company has placed itself in the worst possible position. The Chinese company is amused. I know this from my Chinese lawyer friends.

Of course, there is the chance that both parties will be disappointed because there is a risk that the Hong Kong court will refuse to hear the case because the matter has no connection to Hong Kong. It comes as a surprise to many in the U.S. that Hong Kong is an entirely separate jurisdiction from China. For this reason, a contract between a U.S. company and Chinese company governing conduct that will occur in China has no connection to Hong Kong. It is therefore entirely possible that that the Hong Kong court will refuse to further crowd its docket and refuse to hear the case.

For purposes of this post, however, we will make a leap of faith and assume that the Hong Kong court hears the case and renders a judgment. Consider what happens. If the plaintiff is the Chinese company, then the judgment against the U.S. defendant is easily enforceable in the U.S. against the assets of the U.S. company. Hong Kong is a common law country with laws and legal procedure based on the laws of England. U.S. courts regularly enforce such common law judgments and the odds are overwhelming that they would do so in this situation as well.

If the plaintiff is the U.S. company seeking to enforce in the PRC, the situation is quite different. On the surface, it appears enforcement of the judgment should not be an issue. In 2008, China and Hong Kong entered into a reciprocal enforcement agreement. Thus, in accordance with law, judgments from Hong Kong courts should be enforceable in China. However, the fact is that Chinese courts simply ignore this statute and they do not enforce Hong Kong judgments. I am aware of only one case were such enforcement was successful. In every other case of which I am aware, enforcement did not succeed. This is the same result as for arbitration. China is a signatory to the New York convention on the enforcement of arbitral awards, but Chinese courts regularly fail to enforce such awards.

Chinese courts avoid enforcement in two ways. The most common way is that they simply refuse to act. They do not openly reject the demand for enforcement. They accept the demand and then do absolutely nothing. This is the most common technique.

The other approach is to find technical reasons to reject the demand for enforcement. Usually the Chinese court will reject the Hong Kong judgment based on a claim that the foreign award was based on grounds that violate of Chinese public policy. Since Chinese civil law and Hong Kong common law come from an entirely different legal background and legal procedure, it is generally easy for a Chinese court to find a public policy issue. The following are the most common public policy grounds Chinese courts use to reject enforcement:

a. Often, the Chinese party does not appear in the foreign action. In this case, the U.S. side will obtain a default judgment. Like many Asian courts (and European and U.S. ones as well), Chinese courts are reluctant to enforce any form of default judgment. When the default judgment is from a foreign jurisdiction, the likelihood of enforcement is nearly zero. Knowing this, Chinese lawyers typically instruct their Chinese clients to simply not appear when sued in Hong Kong.

b. As noted above, a contract between a Chinese entity and a U.S. entity has no factual or legal connection with Hong Kong. Chinese law allows the parties to a contract to chose the applicable law, but when the parties chose a law with no connection to the underlying transaction, Chinese courts typically deem this to violate of public policy.

But like I said, the Chinese courts oftentimes do not even rule in this cases. They simply let them sit until they die out, using one or both of the above reasons to justify their doing nothing to enforce. Whether the Court issues a written ruling or simply does nothing, the effect is the same: no action taken and no enforcement of the judgment.

I cannot emphasize enough how harmful using Hong Kong in this sort of situation can be for the U.S. company. The U.S. company has placed itself in the worst of all positions. First, it must convince a skeptical Hong Kong court to hear a case with no connection to Hong Kong. Since Hong Kong has a loser pays system, the U.S. company usually must post a substantial monetary bond to cover the risk that it will not prevail on its claim. Then it must pay the very high attorneys’ fees and court costs demanded by the excellent Hong Kong legal system. Then it must wait as the Hong Kong court takes what can be a substantial period of time to render judgment when the facts and parties are all foreign to Hong Kong. Then, when it finally receives its judgment, the U.S. company learns the hard way that this judgment has no value since it is not enforceable in China. Or even worse, the Chinese party prevails on its counterclaim and the Chinese party is free to enforce its judgment in the United States. And to top it all off, the U.S. company loses its bond, which goes to pay the Chinese company’s legal fees.

A very sad result, all because the U.S. company would not face the simple truth of what is required for enforcement of a judgment in China. It is not a pleasant thought to consider enforcing a judgment in China against a Chinese company. But dreaming about an alternative that makes matters worse is not a solution. Facing the facts and designing a practical plan is the solution.

Your Company Can Be Sued In China And That Matters

Posted in Legal News

A while back I got an email from a veteran China consultant I have known for a long time. Very prominent and very good at what he does. His email was essentially bragging about how he had managed to pull one over on Chinese factory that had hired him. Here is his email, with anything that might identify anyone having been deleted or changed.

US courts will enforce China court judgments. Just ask Robinson Helicopters.

US courts will enforce China court judgments. Just ask Robinson Helicopters.

I am giving you this “hypothetical” because I am curious to get your opinion on this.

Imagine that I owe nearly $2 million to a China factory for business I did with them. Now imagine that I didn’t pay this factory because I learned that it was paying kickbacks to be able to inflate its prices. I am having to keep this debt on our books and it is preventing us from getting a needed loan. I reached out to the China factory today to try to buy off our alleged debt for pennies on the dollar and they told me that they have just sued me in China, which really surprised me.

Fortunately, we don’t even have a contract with them as we have always operated with purchase orders as a way to prevent just this sort of thing.

My immediate reaction to that was “go ahead – you’re welcome to do so but if you win a judgement against me you’ll never be able to collect that from us.” We don’t have a bank account in China, an office in China or any real presence at all there (other than buying some other goods from a couple other Chinese supplier and I’m okay if I’m told I can never travel there again (I’ve been to China more than 100 times in the past 16 years). Am I right that this China factory cannot collect a judgement against us? Is there a simple answer here?I met with my lawyer here [in a mid-sized US city] and he assured me that no US court would ever enforce that judgment and so the Chinese company can never collect against us. Consider this a posting on your blog. How would you respond to a hypothetical such as this?

Thank you Dan. I’m really curious to hear your opinion on this…and I appreciate your taking the time to read.

My response was as follows:

You are mistaken.

This company can sue your company in China and then win in China and then bring that judgment to a US Court and convert it to a US Judgment and then start seizing your company’s assets. My own law firm actually took a Chinese judgment to California and got it enforced and we have done the same thing with a Russian judgment. We also have on at least two occasions represented US companies sued under circumstances similar to what you describe and we settled both of those cases to avoid the substantial risk of the judgments being enforced in the US.

I do not understand why you think that your not having a contract will help you here but I think all that does is sow confusion and give the Chinese company free reign to sue you in either China or the US, which gives it another good argument for why a US Court should enforce the judgment. I mean, if the Chinese company can sue you in the US if it wants, why should a US court not enforce the judgment from another country? The other thing of which you need to be aware is that whatever settlement agreement you enter with this guy had better be in both Chinese and in English and written so as to truly end things in BOTH countries. This agreements are not simple and they require certain tried and true buzzwords to work. We often hear from US companies that think that they have settled with a Chinese company only to learn that their settlement agreement was defective and in fact they have not. I cannot tell you how many times US and European companies call us after having just been sued by a person (usually in an employment case) or entity with whom they thought that they had settled. Our China lawyers then review the “settlement” agreement and give the bad news that it either is not valid or may not be valid.

Good thing this is just a hypothetical.

The above email exchange was a long time ago, but I pull it out now because the American Bar Association Journal just came out with an article, Chinese companies doing business in the US build barriers to legal remedies, propagating the same mistake. I came across this ABA Journal because it quotes me on how Chinese courts will not enforce judgments from US courts, but it then quotes another lawyer saying that “never in history has a US Court enforced a Chinese judgment”:

A Chinese court can enforce a foreign judgment, according to Davis. “But never in history has a Chinese court enforced a [U.S.] judgment against a Chinese firm.”

Conversely, he says, “no U.S. court will recognize a Chinese judgment against a U.S. firm.”

Wrong, wrong, wrong. First off, it is my understanding (based on one conversation I had with an international family lawyer years ago and the fact that I know this to generally be the case regarding other countries) that US courts generally enforce Chinese family law and custody decisions. Second, there is the case of Hubei Gezhouba Sanlian Indus. Co. v. Robinson Helicopter Co., which Ted Folkman wrote about in US Courts For Chinese Litigants. The Year In Review:


Everyone knows that US judgments are not readily enforceable in China, but the converse is not true, as Hubei Gezhouba Sanlian Indus. Co. v. Robinson Helicopter Co., 425 Fed. Appx. 580 (9th Cir. 2011) shows. Hubei first sued Robinson in Los Angeles, but Robinson, perhaps planning a “boomerang litigation” and thinking that a US court would never enforce a Chinese judgment, successfully sought dismissal on forum non conveniens grounds. But the Chinese court entered a default judgment against Robinson. Robinson appealed, arguing, among other things, that the judgment should not be recognized because China does not recognize US judgments.

The court gave that argument short shrift. Reciprocity or lack of reciprocity simply is not one of the grounds on which a court may refuse recognition or enforcement under the Uniform Foreign Money Judgment Recognition Act or similar statutes. It’s noteworthy that neither Robinson nor the court took the view that there were any systematic problems with the Chinese judiciary that precluded recognition of a Chinese judgment. There is a growing recognition in the US of the increasing maturity of the Chinese judiciary. And it’s interesting that neither Robinson nor the US court raised the issues of lack of finality that have caused courts in the Hong Kong SAR to question whether mainland Chinese judgments are entitled to recognition and enforcement.

There is indeed no treaty nor any reciprocal arrangements between the U.S. and China that mandates U.S. courts enforce China judgements. However, Thirty-Two US States have adopted the Uniform Foreign Money Judgments Recognition Act and that act, with specific exceptions, generally requires signatory state courts to enforce judgments that are final, conclusive and enforceable under the law of the jurisdiction in which it was rendered. There is no “China exception.”

Third, there is a case in which my law firm got a US court to enforce a Chinese judgment. I talked about that case in the same post in which Ted talked about Robinson Helicopter:

CHINA LAW BLOG NOTES: My law firm recently took a Chinese judgment and secured its enforcement in the United States, with pretty much no hassle. I have to remain somewhat mum on this because we intend to use that judgment to seize the assets of a Chinese company, but I have always been of the (minority?) view that it really just isn’t that tough to get Chinese judgments enforced in the United States, even though the opposite is pretty much impossible. I have been involved in about a dozen cases involving the enforcement of foreign judgments in the United States — on both sides of the issue — and of those cases, the foreign judgment was enforced every single time. In maybe five of those occasions, the foreign judgment came from Russia. If the US courts will enforce Russian judgments, I just don’t see why they won’t enforce Chinese judgments as well.

In the case obliquely referred to above, we took a Chinese judgment obtained by an American company and we converted it to a Washington State Court judgment, without the Washington State Court raising any issues regarding its ability to do the same. As I recall, the court did make us jump through a number of hoops in terms of translating and explaining the Chinese court decision, but it never raised any issues regarding the propriety of a US Court enforcing a Chinese court judgment. We subsequently took the Washington State Court judgment and converted it to a California Court judgment. The California court never batted an eye. I should note though that this judgment was against a Chinese company, but I do not see that as necessarily making a legal difference.

The very first day my law firm first set up its website I got a call from a company in Mississippi that had been sued by a Chinese company for allegedly having provided that company with millions of dollars in factory equipment that did not work. This MS company had been sued in a Chinese Court by the Chinese company to whom the MS company had provided the allegedly defective equipment and the MS company’s MS lawyer had told it that it need not defend the case in China because “the Chinese courts do not have jurisdiction over you and nobody would ever enforce any of its rulings.” The MS company asked me if this was true and our conversation then went something like the following [I was so shocked by the call based solely on our website that I actually have a pretty good recollection of our conversation]:

Me: Have you ever sold your equipment to a company in another US state and then been sued in that state for the product you supplied?

MS Company: Yes. Multiple times.

Me: And in those cases did you ever argue that the company suing you in its home state needed to be suing you in Mississippi instead.

MS Company: At the beginning we did, but eventually after losing every time we stopped making that argument.

Me: Right. And we should at this point just assume that China will be the same way. In other words, why shouldn’t a Chinese court have jurisdiction over your company when your people went to China to market your equipment and when you regularly sell and even service your equipment there. [He had told me these facts, and he also mentioned that his company even had a brochure in Mandarin]

Me: Okay, so now we know that you have to at least consider that you can be sued in China. And has the Chinese company complained to you about your equipment in the past?

MS Company:  Yes, pretty much from day one and I have to admit that much of their problem stems from our own people having installed it incorrectly.

Me: So are you saying that the Chinese company’s claims against you have some merit.

MS Company: I don’t remember at all what he said at this point, but I do remember the essence of it was that the installation had been bad and some of the Chinese company’s complaints about the product were valid, some might be valid and some were not valid. But to summarize, the Chinese company had brought a legitimate case.

I then confirmed with the MS Company that it had been given plenty of notice about the pending China case against it as it had JUST begun. I then asked him if his company wanted to continue doing business in China and he emphatically said yes. At which point I noted that even though I thought his company would be at serious risk (based on the facts above) of a US court enforcing any China court judgment against his company, his wanting to continue doing business in China meant that a Chinese court judgment could be enforced against his company’s operations there and that would be a really bad thing.

Bottom Line: US companies should not bet on US courts not enforcing Chinese court judgments. When U.S. lawyers or US companies call one of our China lawyers to try to get our firm to help them enforce a US judgment in China, we tell them that is impossible and we then start talking to them about other options. But for enforcing foreign judgments — including Chinese court judgments — in US courts, our lines our always open.

Quick Question Friday, China Law Answers, Part VII

Posted in Basics of China Business Law

Because of this blog, our China lawyers get a fairly steady stream of China law questions from readers, mostly via emails but occasionally via blog comments as well. If we were to conduct research on all these questions and then comprehensively answer them, that would soon become all that we do and we would soon be out of business. And that would be a bad thing for us and for this blog. So what we usually do is provide a super fast general answer and, when it is easy to do so, a link or two to a blog post that may provide some additional guidance. We figure we might as well post some of these on here.

China employment laws generally apply to foreign employees too.

China employment laws generally apply to foreign employees too.

A common question we get (from both companies doing business in China and from expats employed in China) is whether foreign employees in China are covered by China’s employment laws.

The short answer is “generally yes.” For more on this, check out China Employment Contracts: If Yours Are Not Current, You Have A Problem and Employer Social Insurance In China. I See Foreign People.


How to Execute a Chinese Contract So It Will Work

Posted in Basics of China Business Law, Legal News

A China-centric written contract is an effective tool for doing businesses in or with China. A first step in creating this effective tool is to carefully follow the rules for execution. Chinese courts are bureaucratic and formalistic. Make use of that tendency so that you can prevail. Don’t blunt the edge of your instrument with sloppy execution procedures. A casual approach to execution is neither appropriate nor effective for China. A failure to follow China contract law formalities can lead to a Chinese court not enforcing your contract.

Get your Chinese company counter-party to properly seal your contract.

Get your Chinese company counter-party to properly seal your contract.

The basic rules for execution by the Chinese side are as follows:

1. The date of execution must be specified for each entity that signs. Do not rely on a single date at the top. Each party should enter a date indicating when that party signed.

2. The legal name of the signing entity and the legal, registered address of that entity must be stated, in the Chinese language, in the document. Many Chinese companies will only provide their common name or English-language name, or provide a business address rather than the registered address. Failing to request the proper information is a major mistake.

3. The individual who signs on behalf of the Chinese entity must have the authority to sign that contract on behalf of the Chinese entity. If the individual is the legal representative of the Chinese entity, his or her authority is clear. In other cases, however, that person’s authority must be demonstrated by the title given to the individual by the Chinese entity. If that title is sufficient to show authority, then the Chinese entity is bound to the contract, regardless of the individual’s actual status with the company. Care is getting this right is required. A person with the title “foreign acquisitions manager” clearly has authority to purchase from foreign buyers. But what if the title is “accounting department manager” or “research and development department manager”? It is not certain that these persons have any authority at all with respect to executing contracts.

4. The contract should be stamped with the official, registered company seal. Chinese entities often have seals in addition to the standard company seal. For example, many companies have seals specifically designated for executing contracts. Such seals are acceptable, provided they are registered and provided that they are individually numbered if the Chinese company has more than one, which is common. Chinese entities may have other seals such as technical verification seals, tax department seals and banking/financial seals. These additional seals should never be used for sealing contracts. Only the official company seal and registered contract seals should be used on a China contract. Every legitimate Chinese company has documentation of the registration of their official company seal or their registered contract seal(s). Just ask for a copy. If they do not provide that, it means they are planning to use an unofficial seal, with predictable results in the event of a dispute.

The area that causes the most confusion is the requirement of a seal. An unsealed contract is not invalid on its face but it can cause you all sorts of trouble. Chinese law on the issue of seals and contracts provides as follows:

  • Article 10 of China’s Contract Law provides that contracts may be oral or written.
  • Article 32 of the Contract Law provides that contracts must be executed by the company legal representative OR by a person with authority  to execute the contract. It also provides that execution may be by signature OR by seal.
  • Article 50 of the Contract Law provides that if a person with apparent authority executes a contract beyond that person’s actual authority, the contract is still valid with respect to a third party who had no knowledge of the scope of actual authority.

Thus, by the terms of the Contract Law, a contract that is not sealed is still a valid contract if it was executed by a person with apparent authority. So why is it so important to get your China contracts sealed? The purpose of a written contract with your Chinese counter-party is to provide you with an effective tool that you can use in a Chinese court to obtain swift and certain relief against a Chinese entity that has breached the terms of your contract.

The first thing Chinese courts usually do in any contract action is determine the authenticity of the contract. Where a contract is sealed with the official, registered company seal, the contract is prima facie valid. Chinese courts nearly always rule against a Chinese entity that argues that the seal is false or that the seal has been lost or similar if a registered company seal was used to seal the contract. This is the situation that you want to be in when you are a plaintiff in a Chinese court: the authenticity of your contract is clear and certain. Any contract that lacks any of the four elements I set out above is subject to challenge. Though you may prevail over that challenge, this will lead to considerable delay that can extend over many years. You also might not prevail and the uncertainty alone can be enough to give the Chinese company enough comfort to fight you hard and to force you into a less than favorable settlement.

But why is a seal “required” when China’s Contract Law clearly provides that a signature is sufficient. Again, this is matter of proving authenticity. It is the custom in China to have ALL contracts sealed. Every company in China, no matter what size and no matter what form of ownership is issued a registered company seal upon its formation. Government regulation requires state owned enterprises to seal all contacts. This practice is followed by all legitimate private companies.

For this reason, a document that has not been sealed is immediately suspect. Chinese courts have lots of experience in determining the authenticity of seals. They have virtually no experience in determining the authenticity of signatures. For this reason, it is virtually certain that if a Chinese defendant questions the validity of a contract that is signed but not sealed, the court will deem the contract invalid. I have never read or heard about a case in China where the validity of a non-sealed contract was upheld by a Chinese court in the face of a challenge from a defendant. Now just imagine how the Chinese courts will treat your “email contract,” your PO/Invoice contract or your oral contract.

What happens if the seal is not in fact the official, registered company seal? Litigation in this area has been common in China over the past fifteen years. The usual facts involve a Chinese or a foreign entity that enters into a contract with a Chinese company for the provision of goods or services. The entity provides the goods or services to the Chinese company, but the Chinese company then  that has received the benefit refuses to pay because the written contract was not properly sealed. The following are standard seal defects:

  • The wrong type of seal was used: perhaps a technical seal instead of a contact seal.
  • The Chinese company has many unofficial seals and one of these unofficial seals was used rather than an official seal.
  • The party who signed the contract for the Chinese company is an agent of the Chinese company, but not an employee, but the seal is an official seal.
  • The primary contract is improperly sealed but its supporting receipts are properly sealed.

In all of these cases, the courts have held that for the defendant to prevail the defendant must prove that the plaintiff falsified the seal and sealed the document with such a false seal in to defraud the defendant. This burden has been impossible to meet in cases where the goods and services have already been delivered.

Even though plaintiffs have prevailed under these circumstances, this is not a reason to depart from the basic rule. Even though the plaintiff eventually prevailed under these circumstances, the defects in contract execution turned a routine, six month collection case into an expensive, multi-year ordeal. Note also that in all of these cases, the goods/services had already been provided. Finally, in all cases the contract or other documents were sealed in some way. I have not found any China court cases* where a bare signature was sufficient.

Chinese courts are hyper-technical when working with written documents. If there is any surface flaw, a party will object to the authenticity of the document and then force the party offering the document to prove its authenticity. Chinese lawyers will seek out all of these minor surface flaws and then object to authenticity even where that objection is clearly ridiculous. The courts in China then reward them for this behavior because this is a good way for them to clear the docket of commercial cases, which allows them to concentrate on their real job of doing criminal work. But if you follow the above rules the Chinese courts will almost certainly find your contract to be authentic and because of this, you will have leverage against your Chinese counter-party should something go wrong between the two of you. Most importantly, you will in most instances forestall an authenticity argument entirely. If you don’t follow the above rules, you will likely create create uncertainty and added costs.


* If you are now thinking that the way to avoid all of the above problems is to draft a contract calling for disputes to be resolved in a U.S. or some other foreign court, DON’T. China does not enforce U.S. court judgments so even if you prevail against your Chinese counter-party in a U.S. court, unless that Chinese company has assets in the United States, you probably will never collect a penny from that Chinese company. The same is true with respect to most other countries as well. Arbitration outside China has its own special risks as well.

China Guanxi: You Want Complicated?

Posted in China Business
Study Guanxi. become more enlightened.

Study Guanxi. become more enlightened.

Back in the day when I was working at a Chicago mega law firm, a good friend of mine there was a Sicilian who grew up in New York. While in high school this friend worked at a New York deli, where he learned to subsume his Italian accent in favor of the accent and intonations required for that particular line of work. Is the corn beef lean, my friend would be asked. Lean, he would reply, you want lean? I got lean. If you don’t find this funny, I guess you had to have been there.

I can’t help thinking along similar lines whenever someone talks or writes about guanxi. Complicated? You want complicated. I got complicated. guanxi is one of those things that is borderline impossible to fully comprehend if you did not grow up in China, or at least grow up in a Chinese family. Yes, those of us who are not from China can grasp portions of the meaning of guanxi by studying it and seeing it “in action,” but the non-Chinese who truly understand are few and far between (far less than the number who claim full understanding) and I most certainly do not include myself in that rarefied company.

But that does not mean we neophytes cannot benefit from learning as much as we can about guanxi, and towards that end I recommend you read this just out post: Is Guanxi China’s Cultural System of Grass Roots Business and Justice? And in reading this post, I also recommend that you read that to which it links, including the videos. If you do all that, you will not achieve total guanxi comprehension but you will be closer to that sort of enlightenment.

For more on guanxi and, in particular, how it relates to doing business in China and with China, check out China Guanxi: You Don’t Have It.


China Product Sourcing Writ Large

Posted in Basics of China Business Law, China Business, Recommended Reading
Tell Mark Rothko that color shades don't matter.

Mark Rothko knew that color shades matter.

Yesterday’s post, China’s New NGO Law and Calculating China Business Risks, talked of how really good micro posts on what at first appear to be small topics can when done well serve as a great platform for understanding how to do business in China overall. Today’s post has the same theme.

The micro post is by Jacob Yount, who helps foreign companies source their promotional products from China. That alone is micro but the post is more micro still in that it talks about how to avoid color confusion. That’s right, the post, appropriately entitled Color Confusion in China Manufacturing is about how to make sure that your China manufacturer gets your color right? Now before you stop reading believing that this post has nothing to do with you, let me tell you that it most certainly does.

One of my standby speeches is on How to Succeed in Sourcing Product from China and one of my favorite stories in that speech involves — you guessed it — color confusion. The story goes something like this:

Many many years ago, a U.S. company out of North Carolina called me wanting my firm’s China lawyers to pursue litigation against a Chinese company that had provided the U.S. company with “bad” shirts. What was bad about the shirts was the color. This U.S. company had sent a sample shirt to a Chinese manufacturer and the Chinese manufacturer in turn had made its own sample shirt (or maybe it had just bought a sample shirt elsewhere, something that is not terribly uncommon) and sent that to the U.S. company. The U.S. company liked the sample shirt and then ordered another million dollars or so more of them.

Well when the shirts arrived the U.S. company had a major problem. You see we are talking North Carolina here and as every college basketball fan knows, the University of North Carolina has its own specific shade of blue, with its own name. It’s called Carolina blue and my just mentioning it here immediately conjures up images of Indiana University’s Dan Dakich holding Michael Jordan to 13 points. But that color obviously holds a different but equally visceral meaning for the people who would buy a blue University of North Carolina jersey. And let me tell you, those people are not going to buy a North Carolina jersey that is not the exact color of Carolina blue.

And that was the problem with the million dollars of shirts this U.S. company had bought and paid for. They were blue all right, but they were not Carolina blue. That meant that instead of this U.S. company being able to sell them for maybe $30, he would maybe be able to get $3 a shirt. The U.S. company had obviously suffered major damages.

But my firm turned down the case because we did not want it on a contingency fee basis and we also did not want to charge our hourly rates on a case we did not think could be won? Why would it be so difficult to win? Because generally if you are in front of a Chinese court and something is not specifically in your OEM contract (in Chinese) with your Chinese manufacturer, it essentially does not exist. What you want if you are going to be suing a Chinese manufacturer in a Chinese court is a written contract, in Chinese, sealed/chopped by your Chinese manufacturer (see China Contract Signing Formalities: You are not in Kansas anymore) that describes in excruciating detail exactly what the product you are having manufactured should be. In other words, you need a China contract that works. This poor guy in North Carolina had only some emails written in English saying that he wanted his shirts to be like “the samples.” What samples?

Note that this North Carolina company could have sued its Chinese manufacturer in a U.S. court and won. However, because China does not enforce U.S. judgments, and because this Chinese shirt manufacturer did not have any assets in the United States, the U.S. judgment would have been worth less than the paper on which it was printed. Yes, the NC company was stuck, out nearly a million dollars over a few shades of blue.

I tell the above story to emphasize how China and its laws are so different from the United States and Europe and how Western companies so often lose big money by just assuming that they can do things with Chinese companies just as they do things with American or European companies. I use this micro story to writ large on how to operate when doing business with China.

Jacob Yount writes about sourcing promotional products from China to instruct on how to source promotional products from China, but he so knows his stuff and explains it so clearly that what he writes often goes well beyond that, and his color post is a great example of that. Yount starts his post describing what both he and the China attorneys at my firm so often hear and then recognizing that his post likely will apply well beyond promotional products:

“But I gave the factory the Pantone number!”

In the trials and tribulations of China manufacturing when a buyer finds out the color of their sample, or, even worse their production is “off”, this is a common exclamation.

Perhaps not completely wrong, but not completely right.

The result is a color that is deemed different from the official Pantone. Why is this?

Is it the typical that “factories don’t care”. Or, “they didn’t pay attention”.

Or is there more to it?As always, most of my posts are geared towards the Promotional Product Industry, but undoubtedly this will ring true across the board where color matching is critical.

Going in to my 15th year of working and manufacturing from China, here are some of the basic points and lessons I’ve learned on color mixing and matching.

Yount then explains in painstaking (but necessary) detail how you can minimize your risk of getting the wrong color product from your China supplier. To summarize, Yount emphasizes the need to use multiple strategies to make sure that your Chinese factory knows exactly what you want and the importance to you that you get it.

To which I would only add that once you have done all that Yount mandates, you appropriately memorialize it in a China-centric contract. Do all that and you will greatly minimize the likelihood of your seeing some variation of red the next time you have your product manufactured in China.

China’s New NGO Law and Calculating China Business Risks

Posted in Uncategorized
David Wolf on China NGOs, China law, and calculating China risks

David Wolf on China NGO law and calculating China business risks

There are a handful of China people (note that I am not using the term China expert) who just seem to nail China every time they write about it. And by nailing it, I mean that I read what they write and when I am done I think to myself little more than, “Yes.” And then my next thought is “I wish I had written that because that expresses better what I am thinking than anything I have written — or probably could write — on the topic. I had that reaction the other day to a Linkedin post by David Wolf, entitled, NGOs in China: Seeing through a Law, Darkly.

I have known David ever since we both were on an AmCham panel a long long time ago on the topic of writing about China. David has doing business in China since the 1980s and he has lived there for around 20 years. David is managing director of the Global China Practice for Allison+Partners LLC, and he just came out with a book Public Relations in China (published by Macmillan) in October. I have that book on order and I hope to eventually review it on here.

Back to David’s Linkedin post. The post is on NGOs but like so many good “micro” posts, its value goes way beyond that. It as a great post on Chinese law and, more particularly, on how foreign businesses should incorporate Chinese law into their business calculations. The other day a reporter asked me how foreign companies should plan their businesses in light of the TPP. This reporter wanted to know how a foreign business can make plans in light of the “huge uncertainty posed” by whether TPP will or will not pass and what it will mean for international businesses either way. I explained that businesses always operate in a world of risk (even the most local domestic business must deal with multiple risk factors) and that each business must  gather up as much information as it can to analyze TPP and then decide for itself how it might or might not impact its particular business. It then must act accordingly.

When I first saw David’s Linkedin post, I left the following comment: “Great article! I am sure I will at some point quote you on this: “As always with Chinese regulations, it is unwise to panic when word of new laws or policies are announced. Such occasions call for questions rather than statements, study rather than action, and engagement rather than estrangement.”

This is what I am talking about! So without further ado, here is David’s post:


Over the past six months, there has been a great deal of consternation about the new law being drafted in Beijing covering the operation of NGOs, both domestic non-profits and foreign organizations. The NGOs I work with have been, each for their own reasons, concerned about what to make of both the law itself, and, perhaps more important, what it signals about the broader policy environment around China’s nascent civil society.

As always with Chinese regulations, it is unwise to panic when word of new laws or policies are announced. Such occasions call for questions rather than statements, study rather than action, and engagement rather than estrangement. For a start, The Economist offers some clarification:

The draft law represents a mixture of limited progress and major party retrenchment in a sensitive area. Under Mao Zedong, China had no space for NGOs. But they have multiplied in the past decade to fill the gaps left by the party’s retreat from people’s daily lives. Officials say the law will help NGOs by giving them legal status, a valid claim. But it will also force strict constraints on foreign or foreign-supported groups. No funding from abroad will be allowed. And all NGOs will have to find an official sponsoring organisation. They will then have to register with China’s feared public security apparatus, which will now oversee the entire foreign-backed sector.

The article goes on to explain that while in practice the government may back off from enforcing some of the more draconian clauses, they will keep those provisos in place to use selectively against groups they seek to censure.

This means that international NGOs in China, from the American Chamber of Commerce to environmental organizations like Greenpeace, will live under a sharper Sword of Damocles than ever. Worse still, the law could be used as a device to quell discussion and debate about China abroad by holding an NGO’s right to operate in China hostage against better behavior overseas.

International NGOs operating in China not only need to understand how the law will regulate their operations in China, but also how the exigencies of their China operation may compel them to alter their behavior abroad. At some point, many NGOs will face a hard choice between sticking to their principles globally on one hand, and continuing to operate in China on the other.

The wiser NGOs will not wait for that choice to come, but will address it now, and preferably before even venturing into China. The sooner all of an NGO’s stakeholders understand the potential scenarios, the sooner the organization can delineate the terms under which it is – and is not – prepared to operate in China. This is also a good time for international NGOs to identify and engage their allies, partners, and supportive voices.

This is not to say that the worst will happen. China’s government is not a monolith, and there are regulators and bureaucrats in Beijing who understand that a healthy civil sector, and even a degree of foreign participation therein, is an essential part of the solution to many of the problems China has encountered in its development and growth.

But that support offers no guarantee against turbulence ahead. For international NGOs in China, the coming year should be spent preparing for the worst while working to make the situation better.

Copyright Takedowns in China

Posted in China Business, China Film Industry

China has a pretty good system for takedowns of copyright subject matter stored or posted online without the approval of the copyright owner. Our China lawyers are have helped motion picture producers, motion picture distributors, gaming companies and other copyright owners invoke this process and the results are generally good when the copyright owner is well prepared.

This is the first in a series of posts looking at online takedowns. In this post we provide a general summary of the regulations that establish the takedown procedures for copyright subject matter.

China take down notices.

Copyright takedowns in China

The copyright takedown regulations protect the right of “communication through an information network.” This right is one of several comprising the copyright in audiovisual recordings and sound recordings under Chinese copyright law. References below to “recordings” include both sound recordings and audiovisual recordings.

The right of communication through an information network means the right to make recordings available, by wire or wireless means, to members of the public from places, and at times, chosen by them individually. Making recordings available to the public through an information network requires permission of the right owner. The right owner is entitled to remuneration when the right is exercised.

The regulations apply to “network service providers” (网络服务提供者)and to “service recipients” (服务对象), but neither term is defined. A service recipient can be any person or any legal entity that causes content to be posted online.

There seem to be two kinds of network service providers: Internet access providers (IAPs) and Internet presence providers (IPPs).

IAPs are entities that provide access to the Internet. Examples of Chinese IAPs include China Telecom, China Mobile and China Netcom.

IPPs provide network space for users to upload information. They also provide search engine services. IPPs often provide the disk space, high-speed Internet connection, or even the web site design, for those wanting an Internet presence. Youku, v.qq.com and www.letv.com are examples of Chinese IPPs.

This is how the copyright takedown system applies to network service providers and service recipients:

  • The right owner may give written notice to the network service provider requiring the removal of a recording if the right owner believes that the information network is infringing the right by allowing the recording to be stored, searched or linked without approval. The notice must contain certain details, including preliminary proof of infringement.
  • After receiving a notice, the service provider must promptly remove the recording or disconnect the link. The service provider must then forward the notice to the service recipient.
  • The right owner is liable in damages if, as a result of a notice, the service provider wrongly removes or wrongly disconnects and this causes loss to the service recipient.
  • If the service recipient believes the network communication right has not been infringed it may deliver an explanatory statement to the service provider and request reinstatement of the recording or the link.
  • If the service provider receives such a statement it must promptly replace the recording or reinstate the link and then send the explanatory statement to the right holder.
  • On receiving an explanatory statement the right owner cannot issue a fresh complaint and would, we presume, need to initiate court proceedings to take the matter further.
  • A service provider that does not follow these procedures can be required to cease the infringement, issue an apology, eliminate the “bad effects” or compensate the right owner for losses. If the public interest is affected the authorities can confiscate any illegal gains and impose fines. In serious cases, computers and other equipment used to provide a network service can be confiscated.

The regulations draw a distinction between service providers that provide searching or linking services and those that provide storage space. The liabilities of each are different. We look at this distinction in our next post.

China Property Guide and the Rest of the World Too

Posted in Recommended Reading
Shanghai's French Concession. A nice place to live in Shanghai.

The French Concession: a nice place to live in Shanghai.

For years now, I have been recommending the Global Property Guide as a good first stop to my residential real estate developer clients and to anyone else who asks me about China residential real estate. I did so yet again today. And then I realized that I have never listed it on here for everyone else, so I am doing so now.

This site is a terrific first (maybe even second) stop for anyone interested in international residential real estate. Within its site it contains just about every residential real estate statistic and prediction on just about any country you could ever want.

If you are contemplating buying, selling, or renting a property in any major city in the world, I recommend you at least check out the Global Property Guide. It makes for a good initial China property guide as well, and here is their China real estate page.