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:
- 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.
- 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.“
- 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.