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China Contracts Make Sense

Posted in Legal News

I am constantly asked whether it makes sense to bother having a written contract with a Chinese company.  This question is usually followed by the statement that Chinese companies “never follow their contracts” or that “it is impossible to enforce a contract in a Chinese court, anyway.”

I always give the following answer:

It absolutely makes sense to have a contract with Chinese companies, and it makes sense for the following reasons:

1.  Clarity Before the Relationship Starts. A contract is the best way to make sure that you and the Chinese company with which you are contracting are on the same page. For example, if you ask your Chinese supplier if it can get you your product in 30 days, it will say “yes” almost every time. But if you then put in your contract that the Chinese company must pay you a penalty if it fails to ship your product within 30 days, there is a very good chance the Chinese company will tell you that 30 days is impossible. At that point, you and the Chinese company should figure out realistic shipment dates and put that in the contract. You then know what is actually realistic to expect by way of shipment dates and you can act accordingly with your own customers. Spending the time to negotiate a contract with your Chinese counter-party, especially if that contract is in Chinese is the best way I know to achieve clarity before you lock yourself into a relationship.

2.  Stricture Having a well written contract (preferably in Chinese) that is at least arguably enforceable means that the Chinese company knows exactly what it must do to comply. And, in most cases, it might as well comply. Just by way of an example of how this works, assume that your Chinese company makes widgets for thirty foreign companies. Ten of those foreign companies have well crafted Chinese language contracts that set out very clear time deadlines with very clear liquidated damages provisions for failing to meet the time deadlines. Now let’s assume that the Chinese company starts falling behind on production.  To which companies do you think the Chinese company will give production priority? To the ten companies that are best positioned to sue it and win or to the twenty other companies? The Chinese company will of course put the ten companies with a good contract at the front of the line.

3.  Enforceability.  My firm has written hundreds of China contracts and yet I am not aware of even one time where our client has had to sue on one.  I attribute this to reasons one and two above. I use these numbers as proof that thoughtful and appropriate Chinese language contracts can prevent problems. I should note though that the World Bank ranks China 16th among 183  countries in terms of enforcing contracts. So it certainly is not unreasonable to think that if your Chinese counter-party believes a Chinese court or arbitral body will enforce your contract, or even if your Chinese counter-party simply believes enforcement is simply possible, it has real incentives to abide by your contract.

Not surprisingly, I am not the only person with the above views.  I just read a post on the Emerging Markets Insight Blog, entitled, “China’s channel challenge,” that lends strong support to the benefits of having a China contract.  The post is based on a meeting with “eight senior-most China executives from leading technology, healthcare, and industrial companies to discuss best practices for managing the channel and driving growth despite the headwinds.”

When it came to contracts with Chinese companies, all eight agreed that “the best practice is to more heavily invest in the negotiation, preparation, and enforcement of contracts.”  Even though Chinese companies do not view contracts the same way as Western companies, having a strong agreement “pays dividends”:

Local Chinese partners are more likely to view a contract as a roadmap than a strict and binary agreement.  And, every executive in the  room could share his own horror stories of partners violating contracts (or setting up new legal entities to skirt inconvenient agreements).  Although it may seem counter-intuitive to over-invest in contracts when there is little guarantee that partners will strictly adhere to them, a strong argument was made that investing the time and energy to structure a detailed contract can pay dividends, and furthermore, these contracts should be negotiated annually.

Chinese contracts. Well worth it.

What do you think?

  • adi k

    China was actually ranked 19th and not 16th in the World Bank survey in terms of enforcing contracts. And in a very bad rank (of 100 among 183) for “protecting investors”