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China: Bad Meat, Cultural Differences And Anti-Corruption Compliance

Posted in Basics of China Business Law, China Business

In the last year or so, our China lawyers have been seeing something new: more and more American companies that have been doing business in China deciding that they “cannot take it any more.” The following two things made me think of that today:

  • A U.S. company that paid a Chinese company a fair amount of money to set up a WFOE in China. This U.S. company just learned that the WFOE was not properly set up and that the money it sent to the bank in China was never earmarked for the WFOE’s capital requirement. When I asked this company what it wanted us to do, they made clear that they “had had it with China” and all that they wanted was their money back.

The New York Times article is on the current China meat scandal and after reading it, my first thought was that my law firm needed to focus even more on our Vietnam practice.

My second thought was that we (those of us doing business with China or in China) cannot give up. Things (I am being intentionally vague here) are constantly getting better in China and they are better now than they have ever been. At least the things relevant to the New York Times article.

Most problems American companies have with China stem from the American company’s own failure to properly protect itself from what can and does so often happen in China. For some posts reflecting that view, check out the following:

As China attorneys, we almost have to believe that most China problems can be prevented either by not doing the deal because it is just too risky, or by setting up protections to prevent against the panoply of potential problems.

So I get very frustrated when I read about a company that appears to have done everything right and still has a problem. Mattel’s lead paint problems was an example of that. Near as I can tell, Mattel did just about everything it reasonably could have done to prevent the exact problem that eventually befell it. I am getting the sense that the company at the heart of the recent meat scandal also did most everything right.

According to the New York Times article, OSI — the company that supplied McDonald’s and KFC with meat — has a sterling reputation and is anything but a China neophyte. It also appears to have acted above board since problems were discovered.

So what caused the problems? The Times article provides a few hints:

Although the company had been in China for two decades, OSI embarked on a $400 million rapid expansion plan in 2011 that included three new poultry production and processing facilities and additional capacity at its Shanghai and Beijing plants. “The goal was to completely recreate the U.S. system — from feeding and watering regimes down to the exact rate of air flow and size and placement of windows in the poultry houses — but to make it locally relevant,” according to a 2013 Harvard Business School case study about OSI’s China business by Prof. David E. Bell.

*    *    *    *

Experts in food safety and plant operations say, however, that even the most rigorous protocols and standards can be undermined by culture, particularly at a fast-growing company — OSI’s revenues doubled between 2011 and 2013 — in a country where high monthly turnover of factory workers is not uncommon.

“The average Chinese factory worker comes from someplace where food has likely been scarce and picking up a piece of meat that has dropped on the floor and eating would not be unusual — it’s not unusual for us to drop food on the floor and anyway eat it,” said Andy Tsay, a professor of operations management at Santa Clara University who was one of the authors of a paper on recalls of Chinese made products in 2007.

Steve Gruler, chief executive of Global Quality Consultants, a firm that provides risk management advice to a variety of companies, recalled visiting a grain elevator in China where workers were unloading grain onto trucks. “A plume of dust comes from under the door of the elevator and rises up over the truck,” Mr. Gruler said. “Our eyes got about as big as saucers.”

Grain dust is highly combustible and such explosions have been deadly. Mr. Gruler and a colleague asked the engineer at the facility whether it had a dust collection system. “Oh, yes, he said, but it had been shut off to conserve electricity,” Mr. Gruler said. “He didn’t understand that dust could cause an explosion that would blow the place apart.”

OSI itself acknowledged such challenges in interviews with Professor Bell of Harvard. “When we began building modern broiler houses, we found that the workers often took shortcuts even though every detail was spelled out in the plans,” Stefan Chen, senior vice president and general manager for OSI’s poultry operations in China, told him. “For instance, they would change the size of a window to save material. This seems like a small thing, but it affects the ventilation, which affects the production efficiency.”

This post is NOT going to address OSI’s safety issues nor will it address safety issues in general. We are lawyers not safety specialists.

So instead, it will look at a somewhat similar issue, but one which we know well because it lies at the heart of our international compliance practice: preventing corruption.

When it comes to preventing corruption in China, American companies are all over the map. Some essentially give their law firms a blank check to help prevent corruption. Others believe that they need nothing from lawyers on that score at all. We are constantly engaging in back and forth with our clients regarding their anti-corruption policies and programs.

There are services out there that for a few thousand dollars will conduct what is essentially little more than an English language internet search regarding Chinese companies and key personnel. Some of our clients believe this is sufficient to make sure they are not doing business with disreputable Chinese companies/people or companies/people on various sanction lists. These sorts of searches are worth almost nothing especially because they are not even in Chinese. Some companies simply do not want to hear this.

We have dealt with companies that insist that they do not need any anti-corruption training for their personnel in China either because they do not have anyone who would engage in corruption or because they have already made clear to their employees that corruption is not okay. When we try to tell them that the average Chinese employee has no idea what really constitutes corruption as that should be defined for an American company, they still have no interest in going any further.

If you want your China employees to perform to the standards you have set for them, you absolutely must do more than just set out those standards in a policy manual somewhere. You have to make sure again and again that they 1) understand your policies, that they 2) are abiding by your policies, and that 3) a failure to abide by your policies will have real repercussions.  For more on this, check out the following:

Cause as the New York Times implies, there are cultural difference.  What this means is not that Americans are not emminently capable of corruption themselves, but that the understandings surrounding corruption and how best to serve as an employee can differ.
What do you think?

China Distribution Agreements In Real Life

Posted in Basics of China Business Law, China Business, Legal News

Hardly a week goes by without some American SME confidently telling one of my firm’s China lawyers of how they will be working with a great distributor in China to get the US company’s product into the China market. Our job as lawyers is to write a good distribution agreement, of which we have written many.  For the legal side of China distribution agreements, check out the following:

Our China distribution contracts typically provide for the following, among other things:

  • An exclusivity provision, or not
  • Whether the distributor can subcontract out distribution, or not
  • The geographic and market territory given to the distributor
  • The term of the distribution agreement and what must be done to renew or terminate it
  • The specific products covered by the distribution agreement
  • The methods the distributor can use to sell the products
  • The pricing the distributor can use for the products
  • Payment terms
  • The distributor’s performance and sale requirements
  • Ordering and shipping procedures
  • Who is in charge of what when it comes to such things as defective products, advertising, warranties, technical support, obtaining permits, etc.
  • FCPA compliance. Anti-corruption compliance
  • Rights regarding new or modified products
  • Whether the distributor can or cannot sell the products of others
  • All sorts of things relating to intellectual property (trade secrets, trademarks, patents, copyrights, etc.)
  • Non-competition during or after the term of the distribution agreement
  • Damages for breaches
  • Dispute resolution (venue, choice of law, etc.)
I know the above sounds like a handful (and this is only part of what sometimes goes into such agreements), but for lawyers who do these agreements all the time, they do become at least somewhat standard.

But when I read Getting a Good Night’s Sleep While Distributing Medical Devices in China I was reminded how tough product product distribution is in China on the business side. This article was written by my good friend Benjamin Shobert (with whom I will be having lunch tomorrow, actually) and Juan Jimenez, both of whom have substantial experience dealing with medical device distribution in China. Their article starts out describing the following truly common yet nightmarish scenario:

Somewhere in China right now, a domestic Chinese medical device distributor for an American company is invoicing one of their dealers for a product they sold to a public hospital. This is a good thing. The dealer has built and maintained key relationships with the hospital. This is also a good thing. Both the dealer and distributor likely are covered by some sort of exclusive distributor agreement between them and the manufacturer, which is always a good idea in China. But, unbeknownst to you, when the dealer encounters a situation where your product is too expensive, or would be too complex of a sale for your dealer, they will assume a new identity and, under this assumed identity, sell a competitor’s product. The assumed identity represents another option for the dealer, another way to protect their risk in a market where selling on something more than price is many times an uncomfortable position for an unsophisticated distributor or dealer.

Substitute your product for “medical device” and the same thing is almost certainly going to be true for your product as well.

As a lawyer, I can assure you that we deal with these issues in our distribution contracts, but once the distributor relationship starts, it is mostly on our clients to monitor compliance and to decide how to handle non-compliance and that is where things get tough. If you are selling your product in China through a third party (even if that third party is your own WFOE or Joint Venture), I strongly urge you to read the Shobert/Jimenez article because it will, at minimum, help you to enhance your guard.  Unfortunately, I doubt it will make you sleep any better.

China Cosmetics From Overseas. Animal Testing Required.

Posted in China Business, Legal News

We represent a number of all natural organic cosmetic companies. Almost without exception, these companies tout how their products are “cruelty free” because they are never tested on animals. Many of these companies rightly see China as an excellent market for their products. Some of these companies have been contacted by Chinese companies interested in distributing the natural organic cosmetics our clients produce.

There is one big problem with exporting such cosmetics to China: they are simply not legal there. At least not yet.

Though China just last month removed its animal testing for most domestically produced cosmetics (under certain circumstances) imported cosmetics still require animal testing. Makeup, perfume, general skin care, hair care, nail care product, hair coloring, perming, hair products, deodorant, sunscreen, whitening products, all still require animal testing if they are manufactured outside China. There is, however, one interesting exception: cosmetics purchased on foreign e-commerce sites for shipment to China do not require animal testing.

Word has gone out about the end of the animal testing requirement in China and many American companies do not realize that end does not really apply to them.

China’s animal testing requirement means that our clients must choose between (1) not shipping their products (in large quantities) to China, (2) conducting animal testing on their products in China so as to secure government approval for their sale in China, or (3) re-branding their products for China and conducting animal testing on them. The first choice means little to no money from China. The second choice may damage the company’s reputation and sales outside China. The third choice may allow the company to avoid damage to its reputation and sales outside China, or not.

Most have chosen not to sell their products in China — rather than engage in animal testing there — with the hope that China will eventually allow foreign cosmetics to be sold without need for animal testing.

UPDATE: Quartz Magazine just came out with an interesting article on this whole issue, entitled, How cosmetics companies are diluting their cruelty-free claims to sell in China.

Where To Locate Your Business In China Or Asia

Posted in China Business

A reporter recently asked me why our clients that had chosen to locate in Vietnam had chosen Vietnam over China. I mentioned lower costs, less competition, and how some had told me that it was because they just flat out preferred spending time in Vietnam to China. He replied: “But it must be strictly the low costs in the end, right?” I said that could not be the case because if companies were choosing their locations on low costs alone, countries like Yemen and Niger would be on the top of their lists, rather than nowhere on them. I then mentioned that because we have an experienced and well-known Vietnam lawyer, we are of course going to hear more about interest in Vietnam than, let’s say, Vanuatu.

We are always getting asked why our law firm has its lead China lawyer and an office in Qingdao — we also have an office in Beijing, but nobody ever asks us why there. The answer is actually quite simple, particularly when compared to the high-level analysis companies often employ in making their location decisions. Co-blogger Steve Dickinson is in Qingdao because we have had an excellent relationship with one of Qingdao’s biggest and best Chinese law firms for nearly a decade, and that firm was instrumental in helping us establish ourselves in China. But probably the driving factor in our choosing to locate in Qingdao is that Steve loves the place and loves that he can easily afford to live in a luxury apartment with twelve-foot-high windows overlooking the East China Sea at about half the price and the pollution of Shanghai or Beijing. The fact that at least 80 percent of our China work is 2-3 hours from Qingdao by plane only adds to its attraction. Steve is completely fluent in Chinese (as is our other attorney stationed there), and so Qingdao’s small expat community and dearth of people who speak English is no deterrent.

For most companies, the decision whether and where to locate in China is of much greater complexity and we are always interested in hearing the methods employed in making this decision, especially since we so often assist our clients in choosing a location. We have worked with companies that have hired high-powered consultants, spent hundreds of thousands of dollars, and more than a year deciding on where to locate. We have also worked with companies that went into Shanghai “because there are already so many Americans there,” or went into another city simply because that city was where their best and most trusted Chinese contact lived. We have worked with companies that went into a particular city only because their competition did, and they assumed their competition had done all the right research in choosing that particular city. We have had companies choose to locate in expensive Singapore based pretty much solely for IP protection reasons.

We have seen all of the above methods of location selection succeed. We also have seen all of the above methods fail.

We generally find that some or all of the following factors are used to determine the right China city and sometimes also used to determine the right country, not in any order of importance:

  • English Language Skills
  • Human Resources
  • Wages
  • Labor Laws
  • Environmental Laws
  • Import Quota/Duties for Equipment
  • Import Quota/Duties for Material
  • Tax Benefits
  • Physical Infrastructure
  • Financial Infrastructure
  • International Schools
  • Local Domestic Schools
  • Cost to Build a Facility
  • Quality of Already Available Facilities
  • Transportation
  • Port
  • Crime
  • Quality of the courts/Quality of the legal system
  • Political Risk
  • Economic Risk
  • Electrical Utility (Quality and Cost)
  • Water Supply
  • Vendor Support
  • Government Support
  • Cost of Living
  • Health Care
  • Language abilities of the general populace
  • Quality of life
  • Ease of getting in and out of the city/country

There are few common themes in choosing a business location, beyond the big issues like cost, labor force quality, and access to markets and the that go into choosing a business location in Asia are nearly limitless and typically very much depend on the company searching out the location.

In other words, it’s complicated and no one size fits all.

What factors did your company emphasize in choosing where to go in China or in Asia?

China Domain Name Emails. It Is Still A Scam.

Posted in China Business

One of our China lawyers just got the following email which, interestingly enough went to the spam folder.  I mention that it went to the spam folder because it shows that Outlook recognized it for what it contained, a fairly standard China domain name scam email.

The email our China attorney received was the following:

I am a longtime reader (and occasional commenter) of your blog, and I received an email that seems to be a warning from a Chinese company about a potential domain squatter in China, I thought you might be interested in it. the email seems like an fishing expedition, especially in light of my very low-profile company. My company is (at this point) just more of a fledgling hobby, and our sales for this year to date are enough to cover lunch for two at Appleby’s, and perhaps a ginger ale to assist with digestion, lol.

Here is the email, I would love to know if you hear of many companies receiving this sort of email:

(Please forward this to your CEO, because this is urgent. Thanks)

We are a Network Service Company which is the domain name registration center in Shanghai, China. On July 24, 2014, we received an application from ________ requested “[NAME OF U.S. COMPANY” as their internet keyword and China (CN) domain names. But after checking it, we find this name conflict with your company name or trademark. In order to deal with this matter better, it’s necessary to send email to you and confirm whether this company is your distributor or business partner in China?

We have been getting quite a few of these emails again, which tells me it is time to issue this warning again. These emails are virtually always a scam.

We first wrote about this scam in 2009, in China Domain Name Scams. Just Move Along…., and back then we had this to say:

If your company has done anything in China (even just sending someone there to meet with a supplier), you have probably received a somewhat official email offering, at a steep price, to “help” you stop someone from taking your domain name.

DO NOT RESPOND.

Near as I can tell, every single one of these that I have seen (and I have seen at least fifty of them because clients are always sending them to me) are a scam.

You also may get emails from someone claiming to have already registered some iteration of your company name (or one of your product names) and seeking to sell it to you. For example, if your company is called “xyz” and you already own the xyz.com domain name, your email may come from someone who has purchased and now wants to sell you the xyz.cn domain.

What to do?

First off, as soon as possible, register whatever domains necessary to protect yourself. Determine now what domain names you care about so you do not need to make this determination with a gun to your head. Right now is the time to think about Chinese character domain names.

Secondly, if someone has taken a domain name that is important to you and they are now offering to sell it to you, you essentially have three choices. One, let the domain name go. Two, buy it from the company that “took” it from you. And, three, pursue legal action against the company that took it from you.

Preemption by registration is your best and least expensive protection.

Nothing really has changed since then, but if you wish to read more about this prevalent scam, check out China Domain Name Scams. It’s A Scam! from 2011 or China Domain Name Scams. It’s Still A Scam! from 2012.

Oh, and be careful out there.

China: Do Just One Thing Redux. Trademarks.

Posted in Basics of China Business Law

More than three years ago, we did the following post, entitled, China: Do Just One Thing. Trademarks.

From time to time I get calls from start-up companies about to embark on manufacturing in China. They are calling to ask what they need to do “to protect themselves.”

I tell them about NNN Agreements and how they can help prevent potential manufacturers from replicating their product. And I tell them about how important it is that they have an OEM Agreement with their Chinese manufacture

Then I tell them how if they do nothing else, they should immediately register their trademarks in China. This one usually surprises them and they often think I have misunderstood what they are planning for China. They at first do not understand why I am emphasizing the need for their filing a trademark in China when they have no plans to sell their product in China. I then explain the following to them:

China is a first to file country, which means that, with very few exceptions, whoever files for a particular trademark in a particular category gets it. So if the name of your company is XYZ and you make shoes and you have been manufacturing your shoes in China for the last three years and someone registers the XYZ trademark for shoes, that other company gets the trademark. And then, armed with the trademark, that company has every right to stop your XYZ shoes from leaving China because they violate its trademark.

Then they understand.

A recent CNN Article, Brand wars: Battling China’s trademark “squatters” does a really good job of emphasizing with examples why registering your trademark is so important in China. The article talks about how there are companies and individuals who register in China the trademarks for rising brands (or logos) outside China:

Savvy to China’s complex trademark laws, these individuals target valuable foreign brands and register them as trademarks in China.

When international companies want to launch their products on the Chinese market, they’re often left with little choice but to cough up huge sums to buy back the trademark, rebrand their product or fight for the right to use the brand through lengthy legal battles.

The article talks of how Penfolds, an Australian winery, “is currently at the center of a legal dispute over the use of its own name in China” after “a notorious squatter” registered Penfolds’ Chinese name, “Ben Fu — a transliteration that means ‘chasing prosperity.’”

The article goes on to discuss similar issues companies like Tesla, Pfizer, and Castel Frères have had with China trademark squatters and then nicely outlines what foreign companies can do to avoid such problems, including first and foremost “immediately” figuring out what trademarks should be protected in China and then securing that protection through registration.

For more on China trademarks, check out the following:

Stiffed By Your China Manufacturer? It’s Probably Your Own Fault.

Posted in Basics of China Business Law, Legal News

In the last five years, the China lawyers at my firm have been contacted literally hundreds of times by foreign companies (mostly American, Canadian, British, German and Australian) that have received bad product or no product from their suppliers in China. And no exaggeration, I cannot remember a single time where the foreign company did not bear at least some responsibility for its own problems.

What are these foreign companies doing wrong, and so often?  Two things.

First, buying product from companies that they do not really know, or at least do not know well. We have written so often on what it takes to conduct due diligence on Chinese companies that instead of rehashing all that again here, I will simply refer you to the following posts:

The second thing that consistently gets foreign companies in trouble with their Chinese manufacturers is failing to have a written contract that actually makes sense for China. I have recently gotten into email discussions with a few companies that I have for years been telling need a contract with their Chinese manufacturers. These company (years after we last communicated) recently wrote me after having lost six figure amounts due to having received bad quality product from their Chinese manufacturers. Each of them asked if my law firm would consider suing their Chinese manufacturers on a contingency fee basis and I responded by saying that we would not take their cases on even a 100% contingency (i.e. my law firm getting every penny of whatever we collected on their behalf) because the lack of a good contract made these cases not worth our time.

The US companies then usually complain by email how difficult it now is for small businesses buying product from China — the below is a composite of some of these emails:

Those of us who are small business people and who are almost forced to deal with Chinese manufacturers because of price have been forgotten about as we have many problems that the Chinese manufacturers take advantage of and we do not have the funds to solve those problems.

My industry is _____ and the Chinese in this industry pretty well know that a North American company has little chance of winning legally in China, and just as little a chance of collecting when we win a suit in North America.  These suits are very costly and most of us bow out and take our loss and lose customers. Chinese companies won’t even sign the agreements we give to them.

Most under 35 Chinese business people are only concerned with themselves and are not interested in building a business relationship that lasts.  As long as they get their money they do not care who gets burned as they usually have many customers and orders to replace the ones they lose.

I hope one day these business people will understand how important quality and on time delivery means to our industry but I personally do not think it will ever happen.

The Chinese government wants foreign trade but does nothing to protect us. They only protect the Chinese even though it is blatant to see how they let them get away with such dishonest business practices.

My typical response is something like the following:

I disagree. You have chosen not to spend the money upfront to protect yourself and now you are complaining about the inevitable problems that result from that.  You are choosing to do business with China as though it has not changed in the last twenty years, when in fact it has and the smart ______ companies (even the smaller ones) are using contracts and other legal protections to account for that. It is on that which I will write.

The China lawyers in my firm have done literally hundreds of contracts (mostly NNN and OEM Agreements) with Chinese manufacturers in the last three years, not a single Chinese company has refused one.  There are three main reasons for having a contract with your Chinese manufacturer

1.  To create clarity.
2.  To avoid litigation.
3.  To win in court.
You are focusing only on the third, when it is the second one that is most important. The right contract causes the Chinese supplier to comply because it wants more than anything to avoid being sued because it knows if it is sued that it will lose.
But in the end whether it makes sense for you to have a good contract drafted with your Chinese suppliers depends on how much you are spending and how much you are losing due to problems. But generally, if you are not going to do what it takes to protect yourself from all of the problems you describe, you should seriously look into moving your production back home or to some other, cheaper country. Because doing what you are doing seems no longer to be working and, if anything, it will only get worse.
 Nuff said….

China Commercial Contracts: Writing the Contract Damage Provision

Posted in Basics of China Business Law, Legal News

In our standard commercial contracts we often include a specific damage amount for certain (not all) violations of the contract terms. We work with our clients to ensure that such provisions are not a penalty, but rather an honest assessment of what real damages might result from the breach. This system has worked well in China and actually helps prevent litigation due to the certainty of result these contract damage provisions provide.

Common law lawyers often express concern about such contract damage provisions based on the general common law aversion to “liquidated damages.” This concern shows a lack of understanding of how the Chinese civil law system works in the realm of contact damages. The Chinese side will also often object. Their reason is clear: they understand the effectiveness of such provisions and they want to escape from this very real threat.

The term “liquidated damages” is a common law term that has no meaning in the PRC. PRC contract law provides for “contract damages.” Though contract damages are both permitted and encouraged, they cannot be imposed as a penalty. For this reason, in recent cases and under guidance from the PRC Supreme Court, Chinese courts have indicated that a defendant is free to argue that the contract damages are too high and that the court should award a lower amount. The court is then free to accept this argument and award the lower amount. However, the presence of the contract damages provisions does not in any way serve to invalidate the contract or the basic notion of awarding contract damages.

Note also that under PRC law, the plaintiff always has the right to argue for an amount higher than the contract damage amount. That is, the contract damage amount is treated as a floor, not a ceiling. Though the concept is a floor from the plaintiff’s point of view, the Supreme Court recently held that the defendant is also free to dig a basement, allowing for an award lower than the contract damage amount. Though these recent interpretations obscure the concept of contract damage amounts, we still include contract damages in PRC contracts for two reasons: 1) We want a set number when we contact the breaching party and having contract damages allows give us a specific damage amount to discuss and 2) we want a specific number to use for a prejudgement attachment of assets.

We also provide for contract damages because though China has no law/equity distinction (unlike common law countries), injunctive relief generally does not work well in China. We therefore want to have an agreed contract damage amount in cases where the actual amount of damages is difficult/impossible to calculate. In these cases where there is no clear monetary damage (the classic common law injunctive relief situation), the PRC courts generally have NOT allowed defendants to argue that no relief should be awarded. For this reason, though there is risk that the PRC court will reduce the contract damage amount, the risk is for a lower award. The risk is not that there will be no damage award at all or that the contract will be invalidated. Chinese courts very much prefer making a monetary award as an alternative to issuing an order (injunction) that they know they cannot enforce.

The basic legal rules for dealing with China contract damages are as follows:

In accordance with the PRC Contract Law, if the agreed contract damage amount is lower than the actual amount of damage, then the plaintiff can argue for a higher amount. On the other hand, if the agreed contract damage amount is substantially higher than the actual amount of damage, then the defendant can argue for a lower amount. (Article 14 约定的违约金低于造成的损失的,当事人可以请求人民法院或者仲裁机构予以增加;约定的违约金过分高于造成的损失的,当事人可以请求人民法院或者仲裁机构予以适当减少)

Therefore, the plaintiff always has the right to argue for an amount higher than the contract damage amount and that the contract damage amount is not a ceiling. Unfortunately for the plaintiff, the contract damage amount is also not treated as a floor.

Pursuant to Interpretation II of the Supreme People’s Court of Several Issues Concerning the Application of the PRC Contract Law (《最高人民法院关于适用〈中华人民共和国合同法〉若干问题的解释(二)》), if the defendant argues that the actual damage is lower than the contract damage and thus should be lowered, the court will consider it on the basis of actual damage, and will take into account the parties’ actual performance, degree of fault, parties’ expectation, and other factors and will apply the principles of fairness and good faith in making a ruling. (Article 29 当事人主张约定的违约金过高请求予以适当减少的,人民法院应当以实际损失为基础,兼顾合同的履行情况、当事人的过错程度以及预期利益等综合因素,根据公平原则和诚实信用原则予以衡量,并作出裁决).

The threshold for “substantially higher (过高)” is 30%: if the contract damage amount is more than 30% higher than the actual amount of damage, then it is deemed to be substantially higher than the actual damages. In principal, the contract damage amount should only be lowered if it meets this “substantially higher” threshold. However, the situation is not that clear. Chinese judges fundamentally believe in doing “justice,” which means that they will not necessarily follow the judicial interpretation strictly and may adjust the amount as he or she sees fit. The plaintiff has the burden to prove its actual damage, and if the judge is not satisfied that plaintiff has met its burden of proof, the judge may lower the amount even though the 30% threshold is not met. This is one of the many areas of uncertainty plaguing the Chinese litigation system.

Bottom Line:  Despite the risk that the court may end up adjusting the amount, contract damages oftentimes make sense in Chinese contracts. The key is choosing the right amount for your contract damages; one that is neither too high nor too low.

China Dispute Resolution Clauses. Choose Certainty Over Flexiblity.

Posted in Basics of China Business Law, Legal News

When my firm’s China lawyers draft a contract concerning China, we nearly always use a simple and clear dispute resolution provision:

  1. The contract is governed by Chinese law.
  2. Chinese language controls.
  3. Disputes will be resolved in China.

On the third point, we work with our client to choose either litigation in the PRC courts or arbitration in China. We point out that the client must pick one method: litigation or arbitration, but not both. What is known in logic as the exclusive or.

In discussing the dispute resolution clause, clients often propose a flexible dispute resolution provision such as the following:

  • Plaintiff has the option to choose arbitration or litigation. Once plaintiff chooses, defendant must comply.
  • Litigation or arbitration will occur in defendant’s home location; the Chinese party must be sued in China and the U.S. party must be sued in the United States.

In the 80s and 90s, most U.S. entities were reluctant to allow themselves to be sued in China. As a result, many contracts from that era included such “flexible” dispute resolution provisions. However, with the growth of sophisticated court litigation and arbitration in China in the post 2000 era, it quickly became clear that such a flexible approach is a mistake. In many cases, U.S. parties using such provisions have found themselves with no remedy of any kind. In other cases, working through the issues has resulted in substantial delay.

It is for these reasons that we write our China contracts to provide for one (and only one) method of dispute resolution and one forum for that process. We reject flexibility in favor of certainty. When the time to pursue dispute resolution arises, we want to be able to move quickly and decisively. In addition, during contract negotiation we do not want to waste time on these issues when the legal and practical best practice is already clear.

PRC Arbitration Law requires that the agreement to arbitrate must include, among other things, the parties’ intent to arbitrate and the arbitration institution where they will arbitrate. A dispute resolution provision is likely to be viewed as invalid if it lacks either of the above. If the dispute resolution provision gives the plaintiff a choice of the dispute resolution method, there is substantial risk that the provision will be held to be fatally vague. For example, pursuant to Article 7 of the Interpretation of the Supreme People’s Court Concerning Several Issues on the Application of the PRC Arbitration Law (最高人民法院关于适用《中华人民共和国仲裁法》若干问题的解释), an optional provision like this will mean that the agreement to arbitrate is invalid.(第七条当事人约定争议可以向仲裁机构申请仲裁也可以向人民法院起诉的,仲裁协议无效).

Of course, this rule only comes into effect if the respondent objects. If a party submits an application with the arbitration institution to arbitrate the matter, and the respondent does not object before the first arbitration hearing, then the arbitration may proceed. (第七条但一方向仲裁机构申请仲裁,另一方未在仲裁法第二十条第二款规定期间内提出异议的除外) This may not happen often in the real world. Chinese lawyers are masters of delay. Once the defendant/respondent has lawyered up, it become almost a certainty that it will object to arbitration on the grounds that the arbitration agreement is invalid.

In the early 2000 era, this result often meant that the plaintiff was simply denied a remedy. The situation in this regard has improved. Most recently, PRC courts have taken the reasonable position that even though the arbitration agreement is considered invalid, the plaintiff will still have access to the court. However, this result comes after substantial delay, which places the plaintiff in a weak position at the start of litigation.

Given this result, most experienced Chinese litigators agree with our position that a flexible dispute provision like this is almost meaningless because the very reason to have a dispute resolution provision is to clarify what will happen should any dispute arise. Choosing a dispute resolution provision that is not clear defeats the purpose of drafting such a provision.

The approach that provides that the place of dispute resolution as the location of the defendant is legal and enforceable in both China and the U.S, but it is impractical. The first issue concerns governing law and language. It is not very practical to litigate a Chinese language/Chinese law contract in a U.S. court. Chinese parties have become quite sophisticated and they are aware of this issue. For this reason, Chinese parties typically refuse to accept such a provision which then results in a lot of fruitless and costly discussion over a provision that made no practical sense from the beginning.

We also do not like the provision that prohibits an actual lawsuit unless and until the parties have spent 30 days “amicably” trying to resolve their dispute and then mediated their dispute.  Nine times out of ten this sort of provision only drives up costs and increases delay.  If your Chinese counter-party has breached your contract with it, do you really want to be required to have to spend 30 days trying to work it out and then another 6-8 months seeking agreement by mediation?  No, you don’t, especially since you can always propose such actions after the breach in the rare case that it would make sense for you to do so.

The China Bank Switch Scam Lives On. No Surprise.

Posted in China Business, Legal News

I got an email from my law firm’s banker today saying the following:

I just wanted to inform you of a type of fraud we are seeing happen in regards to wire transfers.  We have had customers who have received emails from their normal vendors they send wires to informing our clients that the bank account of the vendor has changed and to send it to a new account number.  However, in these cases the vendor’s email was hacked and once the wire is sent it is very rare that we can recall the wire once the money is sent in these situations.  We just want to ensure if you do receive an email from any vendor that they have a change in their account numbers you are wiring money to; please confirm with them over the phone verbally just in case.  Let me know if you have any questions.
My first thought was “no shit,” but then I decided to respond by letting her (our banker) know that my law firm could help, so I responded with the following:
We are well aware of this fraud as we have dealt with literally a dozen of these for companies that have been victimized by it in just the last year alone.
We are constantly writing about it on our China Law Blog, as you can see from the below:
We help the scammed company deal with its insurance issues and, more importantly, we try to work out a deal with the vendor that has in many instances allowed the fraud to have been perpetrated by allowing outsiders (or insiders!) to hack in to its computers. We have handled these frauds for people out as little as $40,000 and as much as $4 million and our work on this just keeps increasing.
If any your customers need help, please let them know about us because I’m guessing we do more of this work than anyone. We also provide training to our clients on how to avoid these sorts of frauds. I have cc’ed our compliance lawyer, Chris Priddy, on this, as he is the one who leads this sort of work.