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Enforcing Contracts In China. Way, Way Better Than You Think.

Posted in Legal News

By Steve Dickinson
At a recent meeting of foreign businesspersons in Qingdao, I sat next to a very unhappy man who loudly stated: “Chinese contracts are not worth the paper they are written on.” I told him: “Your statement is not true. As a matter of fact, the Chinese courts do very well at enforcing clear written contracts.” As usual, I was greeted with disbelief. The problem with this person’s statement is that it becomes a self-fulfilling prophecy. People who think China will not enforce contracts tend to ignore the issue. They either enter into no contract at all or they enter into a poorly drafted contract or they enter into a contract that is not enforceable in China. This is the actual story for this particular individual. As he now knows, this attitude about Chinese contract enforcement is a mistake.
My view of the Chinese contract enforcement process is based on over 30 years of experience in China. However, I am clearly not the only person who has come to this conclusion. Every year the World Bank publishes its Doing Business rankings. This report ranks 181 countries by ease of doing business. The rankings can be found here. As might be expected, China ranks about in the middle of this list. It is ranked number 83 on the list. Not the worst, but still a challenging place to do business. China gets low scores in areas that are quite familiar to me in my daily practice: Starting a Business 151, Employing Workers 111, Paying Taxes 132.
However, in the category of Enforcing Contracts, China is rated as number 18. This means that China has one of the best systems in the world for enforcement of contracts. Compare that with India, which is rated 180 out of 181 countries, or Brazil, which is rated at 100. The China rating is actually better than the United Kingdom, which comes in at 23, and better than Japan, which comes in at 21. It is therefore a serious mistake to place China in the same category as some of its developing country competitors.
Given the facts, why do people continue to say that Chinese contracts are not worth the paper on which they are written? This appears to be based on the following three basic reasons:
1. Chinese companies have an unfortunate tendency to ignore contract terms in dealing with foreigners. They do this not so much because they believe they can prevail in any eventual lawsuit, but rather, because they assume (too often rightfully) that the foreigner will not sue. This leads them to believe they can violate contract terms with little risk.
2. Many contracts entered into by foreigners are simply unenforceable in China. A typical unenforceable contract is not written in Chinese, not subject to Chinese law and provides for enforcement outside of China. Such contracts are truly usually not worth the paper on which they are written, but this is not due to a defect in China’s legal system. For more on this, check out our previous post, “China OEM Agreements. Why Ours Are In Chinese. Flat Out.
3. Many contracts are too vague to allow for effective action by the courts. The Chinese courts are good at enforcing simple, clear contracts where the standards for default are objective and where the penalty requires little analysis. The Chinese courts are not good at making a contract for the parties, as is common in the U.S. and English legal systems. It is therefore essential to use contracts in a way that will produce a good result in court. I see many foreign parties who want to base a claim on a complex set of emails, oral communications and practice over time. This does not typically work in China. An aggressive lawsuit based on a clear written contract does work.
The Chinese court system is one of the gifts the Chinese system gives to foreign investors. Given the other obstacles and difficulties the Chinese system poses for foreign investors, it is really a big mistake not to take advantage of the Chinese court system for enforcement of contracts.

  • Petronius

    Chinese companies have an unfortunate tendency to ignore contract terms in dealing with foreigners. They do this not so much because they believe they can prevail in any eventual lawsuit, but rather, because they assume (too often rightfully) that the foreigner will not sue. This leads them to believe they can violate contract terms with little risk.
    Is this not at odds with the previous post that Chinese companies tend not to sue foreign companies over breach of contract? If the enforcement is known to be good amongst local companies, why do they not sue foreign companies? Or are we talking about different groups of companies?

  • Brian O’Leary

    Brilliant!!!

  • Dr. Daniel W. Kwong

    That is a good point for discussion.
    The non-enforcements of valid contracts are
    world-wide issues, not only in China.
    We can see manny high-profile law-suits every
    day on the contract violations or non-
    performances in the western world…..not
    namely US.
    So we all need to open up our minds when
    dealing with foreign secnarios, not just taking
    a one-shot look.
    May we all enjoy our business experiences
    in Greater China Region and Mainland has
    tried to push up its own pace to meet with
    the World.
    All the best,
    Daniel W. Kwong
    Economic and Public Affairs Committee Member,
    Hong Kong Institute of Directors (HK)
    Ranking Member (life), National Committee on
    US-China Relations (invited, no dues assessed)….

  • Eric T

    I think Steve’s point is great that a well drafted contract is the first step. However, businesses should also be careful when dealing with government entities in China (even when they think they’re dealing with a private contractor, they might not be “private”.) Many of the attorneys in China I’ve dealt with just tell us that we can’t win against the government in a lawsuit and just to send a demand letter. That does nothing. When the government defaults, what are your options? Any thoughts?

  • Anonymous

    Beyond Contract
    I agree that contract is a good start but contact is just the basis of how things could works out. The problem or the point is to “get from point A to point B”. The issue is how to get your contract to work and be relevant in a difficult situation.
    The whole approach of Anglo-American legal procedual or balancing test approach to contract enforcement is only relevant in part to enforcing a contract in the PRC. Nothing beats “working the system and people” in getting legal and just results in China.
    As to other things like the ranking, I honestly think it sounded much like something comming from a PRC propaganda publication. I certainly would not have the confidence in enforcing a contract unless I have good relationships with relevant and top officials in the jurisdiction. However, no PRC lawyer would tell you that they won’t try to enforce a contract because there’s no support from officials. There will always be other reasons. I am not sure if Steve’s blog even recognize this distinction.
    Steve, it’s awesome that you know Chinese. Had you read the contract law of the PRC? I am surprise that you did not mentioned the employment contract law. enforcing an employment contract is certainly different from other contracts and enforcing some employment contract issue, such as lay off or confidential clause, is different from other employment contract issue, such as probation period. I just believe that enforcing contracts in China is more particular than what Steve had presented.
    I think contract are relationships and when it comes to relationships in the PRC there are a lot more than what meets the eyes in the above post.

  • KPH

    Hi Steve,
    thanks for the great post.! I enjoy reading it!
    Keep up the good work!

  • http://WWW.GENTILADVOGADOS.COM.BR Fabio Gentil

    Great post, but I am not really sure if we can trust the Chinese courts. I am for a 2-week visit in China and today I had a meeting with a chinese lawyer (Beijing). He was quite clear to suggest having an arbitration clause in the contract, and that such proceeding be executed in England or in the US. Well, in terms of neutrality, I do believe that an arbitration procedure run in England or in the US will be just and balanced, but I am not sure if under the laws of China it is easy to enforce the decision. Does anyone know how to manage this arbitration issue in China? Thank you.

  • http://www.thechinasourcingexperts.com Jay Peirce

    Great synopsis of a complex subject! Your comments about keeping it simple resonate, not only because simple contracts are so much easier to enforce, but they also are so much easier for both parties to sign! We find some of the biggest challenges in getting the supplier to agree to our terms. Keeping things focused on the critical criteria and deliverables tends to facilitate the negotiation. Thanks Steve for a nice and succinct summary.