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China OEM Agreements. Why Ours Are In Chinese. Flat Out.

Posted in Legal News

Had a nice conversation with a potential client last week. Company has a great new product it wants made in China. Like many companies starting out in China, this one is in the process of shopping for its China lawyers and my firm was one of four suggested to it by its regular corporate counsel.

Our conversation was interesting because we were the fourth law firm with whom she had spoken. This gave me an opportunity to ask how we differed from the other three firms and, not surprisingly, we really differed, both in how we bill for these things and, more importantly, how we typically handle these contracts.

I told this company that we would almost certainly do their OEM contract in Chinese and I quoted them a flat fee for doing that, along with an English language translation. They told me that the other law firms were saying that the contract would be in English and they would “need to” charge by the hour and it would even be impossible to estimate how long it would take due to the negotiations that would take place between this company and its Chinese manufacturer.
I think one big reason so many US law firms do not write their OEM agreements in Chinese is simply because they do not have any lawyers who can read and write Mandarin fluently. My firm has four lawyers (and various others) who can read and write (and speak) Mandarin fluently and we usually favor putting our clients’ OEM contracts in Chinese for the following reasons.

Because international contracts are so often between parties from different countries, they commonly are written in two or more languages. Nearly all of the contracts we draft for our Western clients doing business in China are in English and Chinese (though about ten percent of the time, we also translate them into German, Spanish, Korean, or French as well). This duality of language can, if not handled properly, pose big problems.

When we do a contract in both English and Chinese, we always call for the contract to specify ONE official language to control if there is a dispute. We do not advise drafting a contract that is silent on the official language, nor do we advise drafting contracts that call for both English and Chinese to apply. Having two official languages pretty much doubles the chances for ambiguity and pretty much doubles the attorney time (and fees) that will be incurred in fighting over the meaning of the two contracts. It is expensive enough litigating on one contract; there is no benefit litigating on two.

So the question for us comes down to whether English or Chinese should be the official language of the contract and the answer to that question requires we first decide where we would most like to see disputes resolved. If we go for arbitration in English (and if the Chinese manufacturer actually agrees to this, which is quite rare), then we almost certainly will want English as the official language. But if we decide the Chinese courts will be the best place to resolve conflicts, then we want Chinese to be the official language.

Now I know most of you think the obvious answer here is to do anything possible to avoid Chinese courts, but you would be wrong. Let me explain.

In determining where best to resolve conflicts on an OEM contract, the analysis has to begin with first trying to determine the most likely and the potentially most damaging disputes and then analyzing where best to handle each sort of dispute. Disputes between foreign companies and Chinese manufacturers most often involve the following:

1. The Chinese company provides poor quality product. To say this is common would be an understatement. The best way to deal with a dispute involving the Chinese company providing poor product is usually to seek to work it out with the Chinese manufacturer. If that proves impossible AND there is enough at stake to warrant suing, arbitration is likely going to be the best course of action. Not to minimize the importance of these cases, but they usually involve only one shipment and they usually involve a finite amount of money.

Litigation outside China against a China based manufacturer usually does not make sense. Because most Chinese companies do not have any meaningful assets outside China and because China does not enforce foreign judgments, getting a judgment outside China against the Chinese company will likely have virtually no value. Therefore, there is no point in having a contract that calls for jurisdiction in a court outside China. For more on the difficulty/impossibility of enforcing foreign judgments in China, check out “Taking Judgments To China (And Korea), Let’s Not Sue Twice.

2. The Chinese company manufactures the foreign company’s product without the foreign company’s permission and in direct violation of the OEM agreement. You have a great product and you have taken it to China for manufacturing there. You are currently selling in just a few countries, but your plans call for you to eventually sell into China and India and maybe even Africa some day. All of a sudden, you learn that your Chinese manufacturer is not making just the 100,000 units you ordered, but, in fact, is making 500,000 units and shipping the extra 400,000 to India, Africa and the rest of Asia, where it is selling them for 1/5 of what you are charging.

If your agreement calls for arbitration in Hong Kong or New York, or even Beijing . . . good luck. What you need, and what you need fast, in these situations, is a court order requiring the Chinese manufacturer to stop making your product and to stop NOW. And guess what, pretty much the only way you are going to get that badly needed court order is from a Chinese court, not that that will be easy. If you did everything right with your contract, it will have liquidated damages provisions that will also allow you to relatively quickly secure a judgment from a Chinese court for damages and will also, in the meantime, give the Chinese court a strong basis for freezing the assets of the Chinese manufacturer before you even secure your judgment. The threat of all of this is oftentimes enough to convince the Chinese manufacturer to cease and desist.

If your contract calls for arbitration and you sue in a Chinese court to get an injunction to stop your manufacturer from breaching your contract by manufacturing and selling your product, you almost certainly will not succeed. The Chinese manufacturer will show the court your arbitration clause and request it decline the case in favor of resolving the dispute in arbitration. Once you are in arbitration, you pretty much will not be able to get an injunction or an asset freeze.

It is possible to write your OEM contract to call for arbitration with a Chinese court “carve out” for injunctive relief or an asset freeze, but many Chinese courts do not to enforce these sorts of provisions.

For these reasons, we usually favor our OEM contracts calling for dispute resolution in the Chinese courts. And if you are going to be in a Chinese court, you do want your contract to be in Chinese. The reason for this is simple. If your contract is in English, the Chinese courts will use their own translator to translate it. Translations can be easily manipulated and it is virtually always better to have your contract translated by your own law firm in advance so you know exactly what it says before you sign it, than to have it translated into Chinese by an unknown translator only after you have sued on it.

3. The Chinese manufacturer refuses to return the foreign company’s molds after the foreign company seeks to terminate its relationship with the Chinese manufacturer. This often happens when the foreign company terminates its relationship with the Chinese supplier. Not surprisingly, the key here is to have a contract in Chinese that makes clear that the mold belongs to you and that there will be hell to pay (in legal terms) if the Chinese manufacturer does not return these to you pronto. But what if the manufacturer does not return your molds? Damages are usually not what is needed. You need the molds immediately because without them you cannot manufacture your products. Again, the best positioned foreign company is the one with a contract in Chinese who can go to a Chinese court for an injunction mandating the manufacturer return the molds. Or at least a large enough asset freeze to convince the Chinese manufacturer to back down.

Lastly, and perhaps most importantly, we have become convinced that most (yes most) problems that arising between foreign companies and their Chinese manufacturers stem from a lack of clarity between them regarding the manufacturing terms. The best way we know to resolve those sort of communication issues upfront is to resolve them before the first widget is made and then to memorialize those agreements in a written form that both parties cannot fail to understand. The best written form for the Chinese manufacturer is obviously going to be a Chinese language document.

We have also learned that we differ from virtually all the other law firms in our pricing structure. We gave this client a flat fee price based on the complexity of what we anticipated doing for it. This price was to draft an OEM agreement in Chinese, with an English language translation for the client.

None of the other law firms were willing to give a similar fee, even when the company went back to them (at my suggestion) and suggested they do so. They all begged out, claiming they had no way of knowing how long it would take and so they would “have to” charge by the hour. This is, of course, complete malarkey. (I wanted to use a much stronger word here, but since I long ago committed to writing a blog that I would not mind my now 11 year old kid reading….). If law firms do not know how long these OEM agreements typically take, who does? Seriously.

My law firm has done enough OEM Agreements that we know, within around 3-4 hours, how long 90 percent of them will take, and we are willing to take the risk on the remaining 10%. The real answer is that law firms are simply resistant to change and resistant to taking on any risk on behalf of their clients. For more on how law firms are so incredibly resistant to changing their billing paradigm, check out this recent study resoundingly confirming this.

What do you think?

  • Tim

    Most do not realize there is a big difference between being able to simply translate into Mandarin and being able to translate legal terms into Mandarin. Same can be said for Japanese.

  • http://twofish.wordpress.com/ Twofish

    And also people don’t realize how easy it is to get wrong. Even simple terms like “should” can cause huge problems. When you say that someone “should” do something, are you saying that it is a good idea or that it is mandatory that they do it.
    Both English and Chinese legal writing deal with this problem by using specific terms with precise meanings and avoiding terms that have ambiguous meanings, but you have to be pretty specialized to know what those terms are.
    Also, there are concepts that don’t carry across well. “Consideration” is a concept in common law that doesn’t exist in Chinese law. Also there are terms that mean completely different things. My favorite is “unilateral contract.”

  • ceh

    Why are Chinese courts reluctant to enforce injunctive relief carve outs? Simply because they don’t want to bother with litigating the merits of a case that may need to be litigated in parallel elsewhere as well? If so, why not simply provide that for any case invoking injunctive relief, the whole shebang gets done in the People’s court (_not_ The People’s Court)?
    The broader question is in what circumstances would you want an arbitration/foreign forum clause in a contract with a Chinese OEM? If the chips hit the fan, you will pretty much always be either be suing for money and/or injunctive relief, which only a Chinese court can meaningfully provide if the OEM is like 99% out there that have no real assets outside of China.
    I agree with your comments on the Chinese language issue and the hourly law firm malarky wholeheartedly.
    (p.s. it’s between “us” parties)

  • http://realclearchina.blogspot.com Realclearchina

    So Dan, did you get their business?

  • Mark Shuo

    Dan – China translations also need to be certified by a translations company (in China) to be legally binding. What you did is not enough.

  • http://www.chinalawblog.com Dan

    Tim,
    So true…. So true of translating in every language. There are incredibly few people who can do legal translations well.

  • http://www.chinalawblog.com Dan

    TwoFish,
    You are absolutely right on both counts. Any contract that wants US law to apply, should (almost always) set forth the particular state law it wishes to see applied. We have litigated contracts that call for US law and the way the courts have handled those is to figure out which state’s law is most appropriate, but even that leads to unnecessary fees and costs.
    Here’s another thing that needs to be considered. Even if the contract calls for US court jurisdiction, the US courts will not assume jurisdiction for this reason alone. There has to be some basis for involving a US court. In other words, if a Russian and a Chinese company engage in a product transaction that has nothing to do with the United States, even if the contract calls for US court jurisdiction and US law, the US courts usually won’t touch it. And yet, I have seen these contracts too and they seem to happen with foreign companies that do not understand the difference between arbitration and litigation.
    You also raise a good point about the need to be careful about calling for application of a foreign law. It is generally not a good idea to call for US law to apply with the Chinese courts as the selected forum, and vice versa. About all you are doing there is confusing just about everyone….

  • http://www.chinalawblog.com Dan

    ceh,
    What you are proposing IS a litigation carve out. I do not know why Chinese courts do not like injunctive relief carve outs. Good question.

  • http://www.chinalawblog.com Dan

    Realclearchina,
    I will…..

  • http://www.chinalawblog.com Dan

    Mark,
    WRONG. We are not really translating anything. We are writing the contracts strictly in Chinese and then providing an English language version strictly for our own clients. For purposes of China, there has never been a translation. All China knows is that there is a Chinese language agreement, just like any other Chinese language agreement. The Chinese language agreement makes no mention of the English language translation we gave to our client and that English language translation is completely irrelevant legally.

  • http://twofish.wordpress.com/ Twofish

    I’m guessing here but I think the reason that Chinese courts are reluctant to agree to a carve-out for injunctive relief is that it’s very hard to say “injunctive relief” in Chinese.
    In common law, injunctive relief and damages occur under two different legal systems, and so when you go to a court, you have to specify which one you want.
    In Chinese law, the court can offer either injunctive or monetary damages after it has been established that there has been an injury. So you have a chicken and egg situation. You want to send the case to a Chinese court instead of an arbitration panel to get an injunction, but you really don’t know if you are entitled to an injunction until after you’ve gone through the arbitration panel.
    So you go to the court asking for an injunction. The counterparty can then say, well I think we do ow them something, but we’ll pay damages, and which point the Chinese judge will send the case to arbitration.
    This illustrates the land mines in legal translation. Even the term “injunctive relief” or even “law” is hard to translate sometimes.

  • Benjamin

    Twofish:
    According to my handy dictionary:
    injunctive relief=强制令救济
    (That’s also the only translation given for the term)
    law, however has 5 that I would translate as such, and another that I would translate differently. The 5 are (法,律,法律,法则,法度). The one I would do differently is 国法。
    Source:
    英汉-汉英双向法律词典
    主编:程超凡
    出版社:法律出版社
    Cheers!

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  • Sam

    Benjamin:
    1. There is no the equal legal terms in Chinese for”injunctive relief”, though it’s ofen translated into”强制令救济”. In Chinese legal system, there is no such measure called “injunctive relief” or “强制令救济”.
    2. As for a case of infringement, like infringing the right of trade mark or patent, the complainant may apply to the people’s court to demand the defendant stop using the trade mark or patent prior to the dispute result.

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  • http://www.spicyspirit.com/blog Elle

    Mark,
    What you said about certified translation is actually a situation when a Chinese has to show a translated document to US agencies such as visa office or DMV in order to apply for visa or driver’s license.
    The contract is initiated in Chinese. So no translation involved at all. English version is only for internal reference.

  • wert

    You need the molds immediately because without them you cannot manufacture your products. Again, the best positioned foreign company is the one with a contract in Chinese.

  • Mark Wood

    Hi,
    I have just come back from China after the factory signed a confidentality agreement in Chinese and English,but i have a problem as i am new to this and did try to find everything out before i went i have sinse found out that in the confidentality agreement i have put a clause saying this is under UK law,is it right that the contract is now worthless?
    Also i would be greatfull if someone could tell me if i dont have a tooling agreement where would i stand,i take it the factory would own it but what could they do with it , as i do have design patents worlwide.
    Soory to be dumb but many lawyers here dont know Chinese law and do i trust one in China.
    Thanks
    Mark

  • Robert

    A flat-fee? What kind of craziiii-talk is that. You’re a standup guy, possibly the first honest working law firm in the world, and go figure, in China. Cheers mate!

  • Franklin

    Fascinating stuff. Had no idea this could be so complicated, but I did know that just a PO is not enough.

  • http://WWW.GENTILADVOGADOS.COM.BR FABIO GENTIL

    Great post. Congrats.

  • http://www.global-linq.com jos bults

    Yeah, and then some. Even with Chinese language contracts (we do the same for the same reasons) and a good law firm it won’t get you far if you don’t take care of the legal side of your intellectual property as well: China legal system does recognize foreign patents, but those have to be registered (and translated) in Chinese. What if the translator didn’t grasp it properly? Better apply for your patents IN China. The procedure is the same, it also goes through WIPO, the fees are slightly lower than in US and EU, but it gives you the advantage of protection in China. We have a patent here and our provider also did as per the example: make 1000 units for us, and then another 1000 (using our externally bought stock of components!) for sales in China – at half our price. The moment we found out we contacted our Embassy, they contacted the Public Security Bureau and within 24 hours the factory was raided by over 40 public security agents…
    So: have Chinese contracts. AND have Chinese patents.

  • Larry D.

    Here’s another reason to have them in Chinese, especially if you speak Chinese. I had an English language agreement with my manufacturer and it ended up failing to provide me with about $20,000 of product. Since I am fluent in Chinese, I would have had no problem going to a Chinese lawyer who does not speak English to help me on the case, but because it was in English, I ended up having to use a Chinese lawyer who could read English and I ended up having to pay more because of this. Maybe not relevant for everyone, but I’ve been doing my contracts in Chinese ever since and it definitely works out better that way for a lot of reasons.

  • http://www.rosettatranslation.com N Ogtong

    One additional note on legal translation: make sure you know what type of certification your translation will require in order to be accepted before court or any other recipient body.
    Because even if your translation agency offers certification service, they usually aren’t in a position to check your requirements from their end.

  • Clive

    In my dealings with China, it comes my awareness that China does accepts English as the contract language. But practical approach needs to be considered. It is difficult to enforce abroad judgments that are obtained in U.S. courts. If a dispute is most likely to be brought in China – if you have to enforce it, the ideal situation is a Chinese contract that leaves no room for the court or supplier to dispute on not understanding the English language. The benefits of a good contract in Chinese will surpass any disputes that subsequently happened later.

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