Archives: China contract

Many months ago, I was in on an email exchange between a couple of our China lawyers regarding a liquidated damages provision in a product development agreement where our client was paying a Chinese manufacturer a lot of money to develop a new product that could be taken into production. Our biggest concern with the product development arrangement was that the Chinese manufacturer would sell the product to others after our client paid the large sum of money to have it developed.  So we wrote the contract to prohibit that and to give that provision added force we put in a liquidated damages provision listing out exactly how much our client would be entitled to in damages were the Chinese manufacturer to violate the non-compete provision forbidding them from making the product for anyone else.
Wikipedia nicely defines liquidated damages as follows:
Liquidated damages (also referred to as liquidated and ascertained damages) are damages whose amount the parties designate during the formation of a contract for the injured party to collect as compensation upon a specific breach (e.g., late performance).

We really like liquidated damages provisions in our China contracts because Chinese courts tend to view contractual liquidated damages provisions very favorably and so long as they are not unreasonable, they will usually be enforced. Most importantly, courts will seize Chinese company assets based on a liquidated damages provision and they will seize these assets before trial. Chinese companies know and fear this. A well-crafted China contract with a well-crafted liquidated damages provision is one of the best tools out there for preventing your Chinese counter-party from breaching your agreement, and that is the primary reason for having a contract in the first place.

In this particular product development contract, we put in a high number for the liquidated damages provision and the Chinese side immediately accepted it. This led co-blogger Steve Dickinson to write the following email:

Yes, _________  [our client] asked for a high number and I put it in at their request. Interestingly, the Chinese side signed with no complaint and with no objection from their Chinese attorneys either. I think that Chinese companies that do not plan to default simply don’t have a problem with contract damage numbers in this kind of agreement. The companies that complain are to be viewed with caution.

In terms of contract damages, it is important to be clear. As with the US, the number is not intended as a penalty. It is intended as an honest effort by the parties to predict damages in advance. If the number is too low, the injured party can ask for more. If the number is too high, the defendant can ask for a reduction. In either case, the validity of the contract itself is not affected.  The advantage of liquidated damages is that it gives you a sum certain when you go to the court to ask for preliminary relief such as seizure of assets. As long as a court is involved, the Chinese companies know that prejudgment asset seizure based on the amount of contract damages is a real risk and this makes them much more compliant in dealing with these issues. Where arbitration is involved, liquidated damages has far less utility, which is yet another reason why international lawyers should not be so quick to jump for having China contract disputes resolved via arbitration.
For more on the effectiveness of liquidated damages provisions in China contracts, check out the following:

Was cc’ed on an email between one of our China lawyers and a client that sets out what our client can do to help ensure that the seal (a/k/a chop) on its China contract corresponds with the actual seal held by the Chinese company with whom our client is conducting its China business.

Thinking the email might be helpful to our readers, I reproduce a sanitized version of it below.

The only way to be virtually certain about a Chinese company seal is to do a great deal of in-person due diligence. For example, you could visit the factory in person, inspect the seal there, and then compare it to review previous contracts executed by the company and provided to you. Or, better yet, you send a Chinese attorney to confirm with the government that the seal that will be used on your contract is actually the company’s real seal.  But since the dollar value of this particular transaction probably does not warrant your doing either of these things, we suggest you ask the Chinese party to provide you with the following:

  1. _________’s [the signatory] title, in Chinese and English;
  2. _________ name in Chinese characters;
  3. a scanned copy of __________ business card, in Chinese and English [unless you already have a copy];
  4. a copy of the company’s business license, and;
  5. an explanation as to why the “seal” on this document appears nonstandard (i.e., oval instead of circular) and does not have the company’s registration number.

Got that?

“When you ain’t got nothing, you got nothing to lose.’
Bob Dylan, from Like a Rolling Stone

 

Got the following email the other day (which email I have modified so as to strip it of any identifiers):

I need some help with a problem I have with a Chinese company I have made an order with.   The order is around the $35,000 mark, I have paid for a product and for the shipping.

I have a signed contract from the company that goods will be delivered by a certain time, they have failed to do this and keep coming up with excuses to as why the product isn’t ready.

How much notice do you have to give a Chinese company before you can sue them?

And how would I go about it? I am from Canada and paid the company directly. The Chinese company is owned by a Canadian citizen but it operates out in China.

Could you please help.

We probably get some variation of this email pretty much every week and my response is virtually always rapid and pretty much the same:

I’m sorry but we can’t help because I have no idea what the contract says about where to sue nor do I have any idea where this Chinese company has its assets. I will tell you though, that unless your contract is in Chinese AND was sealed by the Chinese company AND calls for disputes to be resolved in a Chinese court AND was incredibly specific about delivery deadlines AND has a liquidated damages provision for being late, you probably will be wasting your time pursuing this.  If your contract does include most of these things, than I suggest you contact a Chinese licensed lawyer based in China to see about pursuing this.  I will note again though that suing a Chinese company is seldom easy and if your ducks are not well lined up before you do so, there usually is not point.

So to reiterate, if you want to maximize your chances of being able to pursue a Chinese company for breach of contract, your contract should be in Chinese (in most cases), should be sealed by the Chinese company, should call for disputes to be resolved in a China court (in most cases), should be incredibly specific regarding what the Chinese party is required to do to comply with the contract, and should include a liquidated damages provision setting forth the exact amount of damages to which you are entitled for the Chinese company’s failure to comply.

For more on what should go into your China contract, check out the following:

Got it?

It is widely believed by American lawyers that their clients should do whatever they can to avoid finding themselves in a Chinese court.  This widespread belief is usually wrong.  It is usually wrong because most of the time it is the American company that will want to sue the Chinese company, not vice-versa. That being the case, the best place to sue a Chinese company is in China.  Is suing a Chinese company in China a great thing? No.  Obviously not.  But if you sue a Chinese company in China and you win, you have at least a decent chance of collecting on your judgment.  If you sue a Chinese company in the United States and win, you have almost no chance of ever collecting.  Chinese courts do not enforce US judgments.  Ever.  So unless the Chinese company against whom you get your judgment has assets in the United States (or in some third country that enforces US judgments), your US judgment is of zero value. Zero. For more on this, check out the following:

So if suing Chinese companies in China usually makes the most sense, your contract with that Chinese company should be written in such a way as to maximize your chances of prevailing in China at the lowest cost.  How do you do that?

Well the most important thing is to put that contract in Chinese.  We have always done this and we have done it because if it is in English the Chinese court will translate it into Chinese itself.  This effectively means that you will not know the exact contract on which you are suing until after the court comes back to you with the Chinese version.  Certainly it makes better sense to have your lawyers dictate what your contract says as opposed to some Chinese court.  But lately I have been hearing that a number of Chinese courts will not enforce English language contracts at all.  There is no law that says no enforcement, but various courts have taken it upon themselves to hold English language contracts void.  I have heard this from two “China people” I greatly respect but I have no personal experience to back this up.  One of these people told me that a number of Chinese lawyers had told him that “English language contracts are only admissible only IF the court so chooses. They also have the right to dictate how and who translates the contract.”  Another person told me that he had his English language contract rejected by a court in Chengdu as invalid.

Would love to hear other experiences with trying to enforce an English language contract in a China court.  In the meantime though, do your China contract in Chinese.  Okay?

Though most of the contracts my law firm writes for our China clients are in Chinese, the first draft is virtually always in English (though sometimes they are in Spanish, Russian, German or Korean).  We draft the contract in English and provide that draft to the client for their review.  Once the client has given their assent to the English language version, one of our lawyers fluent in Mandarin translates it into Mandarin. Then a new lawyer makes sure the English and the Chinese completely match up. Our firm has always favored clear language for our contracts, as opposed to legalese.  Just by way of a quick example, let’s say you are selling an item of personal property for $500.  We would write the contract to say “Bill will sell x personal property to Robert for $500.”  The old way of writing this might be something like the following:  Robert agrees to forever convey, sell, assign and demise said item of personal property to Bill for the amount of $500, with Robert paying said amount to Bill….

So why does this matter for China contracts that end up being in Chinese anyway?  Three reasons.  First off, do you want your lawyers charging you to draft and translate a fifteen-page contract when a five-page contract will do just as well? A fifteen-page contract will not cost three times more than the five page one, but it is likely to cost more, especially when it needs to be translated.  Many years ago, a company came to us with questions regarding complicated international IP issues, involving mostly Russia, but China and Korea as well.  The company provided us with a 25-page memorandum their Russian law firm had given them on the IP issues.  I asked the client if they understood the memorandum and they said no.  I then told them that I did not understand it either.  I then told them that if they retained my law firm, I would make two guarantees. One, that our memorandum would be five pages or less and, two, that they would understand it. We got the project and we gave them a five-page memorandum that they understood.

Which gets us to reason number two.  There is a lot to be said about a clear contract.  If we give our clients an easy to understand contract we are increasing their ability to provide us with constructive feedback, especially as relating to the aspects of their business that they know far better than us.  The better the client feedback, the better the contract.  It is that simple.

Reason number three.  Chinese contracts are generally not nearly as long-winded and legalistic as American or British contracts.  So if we start with a clear language English language contract and put that into Chinese, the Chinese language contract will match what Chinese companies expect and this likely means faster and thus cheaper negotiations.  Our new clients often ask us to try to keep their contracts with their Chinese counter-parties short so as not to scare them away.  We see this as a perfectly reasonable request and we tell them that we always seek to keep our contracts short.

This is all my rather long-winded and less than clear language way of leading into a review of a great book that I recently received.  The book is called A Manual of Style for Contract Drafting, and it is written by Kenneth A. Adams.  I have known Ken for many years and he is the real deal.  The guy just flat out knows contract drafting and does an amazing job writing about it.  I am going to pull a small portion from a chapter on the term “reasonable efforts,” a term which by the way, should pretty much never be used at all in any contract that is going to be enforced in China:

8.67   Ensuring that reasonable efforts provisions are clear and effective requires that you pay attention not only to how the term reasonable efforts is defined — if you do define it — but also to how you word any provisions that use the phrase reasonable efforts.

8.68  Have a party undertake to use reasonable efforts, as opposed to  use its reasonable efforts or use all reasonable efforts.

8.69 Because it’s the simplest and clearest option, have a party use reasonable efforts as opposed to making, exerting, or exercising reasonable efforts.  If contracts filed with the U.S. Securities and Exchange Commission are at all representative, use is also the most popular option.

8.70 In efforts provisions, effort is generally used in the plural rather than the singular, although some contracts require a party to use every reasonable effort or make a reasonable effort.  Use the plural, if only for consistency.

8.71 It’s commonplace for a contract to require a party to use efforts to accomplish something “to the extent possible” (or words to that effect).  That notion is redundant, as it’s implicit in an efforts provision that the party under the obligation might be unable to perform it, even after making the required effort.

8.72 Using best efforts instead of reasonable efforts is bad enough — don’t make matters worse by using two or more different efforts standards in one contract.  Doing so only invites a court to ascribe a different meaning to each.

8.73 Don’t refer to good faith or diligence in a reasonable efforts provision, as in Each party shall use reasonable efforts, undertaken diligently and in good faith, to obtain all Consents before Closing. Mixing different standards would only muddy the waters.

Which brings me to a fourth reason why clear contracts matter for China, just as they matter for anywhere else.  As you can see from the above, one of the main reasons for clarity in a contract is to avoid a lack of clarity later.  If you have a clear, understandable contract (in any language), the likelihood of a dispute decreases and the cost of any dispute will decrease as well.  The fewer things on which lawyers can argue at trial or arbitration, the less you will need to pay your lawyers. For more on this, check out Chinese Contracts. Because They Really Do Make A Huge Difference.

I know it’s geeky, but we lawyers live for this stuff and I even had to grab back my copy of the book from another attorney who is already addicted. We need to order multiple copies.

Adams book is simply the best.  The best. And it works for drafting China contracts too.

 

In several recent posts (see here and here), I have stressed that written contracts are the key to the next wave of doing business in China. I mentioned that relying on written contracts now makes sense in China because of the major improvements in the legal system that have been implemented in China over the past decade. These improvements have come about because Chinese business people have found that they need written contracts to make business work in China. In the old days, business people relied on the Party to resolve disputes. The Party is now engaged in other matters, so business people are forced to rely on the court system. Foreign business people can now take advantage of this purely domestic trend.

The fact is, however, that no contract is worth anything if it cannot be enforced. Foreign companies, however, generally ignore the question of enforcement. In our experience, foreigners from all over the world routinely insist on contract provisions that effectively render their contracts unenforceable in China. That is, by their own efforts they make their contracts worthless, much to the amusement of the Chinese side of the business transaction.

There are three rules for making a contract effectively enforceable in China:

1.   Enforcement is in China through litigation in the Chinese court system.

2.   Governing law is Chinese law.

3.   Governing language is Chinese language.

I seldom see contracts drafted by foreign lawyers that follow these three simple rules. The typical contract that we regularly see drafted by US attorneys provides that governing law is the law of the home state of the US party (our last two were Iowa and Alabama), that the governing language is English and that enforcement is exclusively in the state court of the home state.

Why is this a disaster? The reason is simple. This type of contract violates rule number one, so we do not even need to discuss the other two rules. Chinese courts will not enforce US court judgments. Thus, any judgment obtained in a US court cannot be enforced in China. If the Chinese party has no assets located in the United States, the judgment is effectively worthless. For more on this, check out the following:

Some attorneys have figured out this issue on court judgments and will provide for arbitration in the US These attorneys argue that China is a signatory to the New York Convention on the Enforcement of Arbitral Awards. Accordingly, the Chinese courts are obligated to force US arbitration awards. However, on the ground this simply is not true. The fact is that US arbitration awards are virtually worthless in China. There are several reasons for this:

  • China is one of group of Asian countries (Indonesia is another) that have strong cultural aversions to enforcing foreign arbitration awards. The courts will therefore find any reason they can to avoid enforcing a foreign arbitration award. This is especially true at the local court level. In certain types of cases there is some chance of prevailing on appeal. This is uncertain and the time delay can be so long that the whole process makes little sense. Oftentimes, rather than issue a ruling saying that they will not enforce the foreign arbitration award, the Chinese court will simply issue no ruling at all.
  • In many cases, the Chinese party will not participate in the foreign arbitration process, making any arbitration award a default award. Chinese courts are averse to enforcing default awards and the likelihood that they will enforce a foreign default from an arbitration tribunal is very low.
  • Stated quite simply, Chinese courts do not generally take orders from foreign arbitrators. Many arbitrations concern intellectual property or company management disputes that require some form of injunctive relief. Chinese courts apparently view it is an affront to Chinese sovereignty to be told what to do by a foreign arbitrator and they invariably ignore such orders from an arbitrator.

What this means is that China is a modern country with a reasonably good legal system; the World Bank recently ranked China 19th worldwide in contract enforcement. If you enter into a contract with a Chinese entity, you should plan to settle any contract disputes by legal action taken in China. The attempt to litigate or arbitrate outside of China is a mistake that must be avoided.

Though I sometimes see contracts that follow rule one and provide for litigation in China, those contracts far too often violate rules two and three by providing that the governing law is the law of the home of the foreign party and that the governing language is English. They justify doing this by noting that Chinese law provides that contracting parties are free to choose the law that will govern their contract so long as that law has some relation to the transaction and that the parties are free to choose the language to govern their contract.

These statements are technically true in that Chinese civil law drafters are big believers in party autonomy and the laws allow business people to make whatever decision they want in these areas. However, in the practical world of litigation, these two simple decisions usually render a written contract unenforceable.

Why? Effective litigation in China requires quick and decisive action. In particular, Chinese litigation procedure allows for preliminary seizure of assets and other pre-judgment relief that can be remarkably effective in quickly resolving issues. Use of Chinese arbitration rather than litigation prevents the plaintiff from taking advantage of this preliminary relief.  So litigation rather than arbitration is always preferable. However, with the court system, contracts that provide for foreign law and a foreign language lead to endless delay that makes litigation essentially futile.

Take the governing law issue first. Under the Chinese system, the court will require the parties to prove what is the foreign law on any issue that is important for a decision.  Thus, before any proceedings begin, the court will require the plaintiff to prove all important aspects of foreign law. Proving the law on these points is time consuming and expensive. The same applies to a foreign language. When confronted with a foreign language contract, the court will engage its own translator. Often this translator is barely competent. On important points of translation, both parties will often disagree with the translator, leaving the judge in the hopeless position of having to choose between three competing translations of a language he or she probably does not know.

As you can imagine, a clever defense attorney in this situation can devise an almost infinite number of objections to any statement of foreign law or any translation from a foreign language into Chinese.  Usually, the judge is not motivated to end these disputes, so the potential for delay is almost limitless. Even if the court gets to the point of making a decision, any chance of making use of preliminary relief is lost, rendering the litigation ineffective.

Use written contracts in China to follow the current trend. Follow the above three rules to make them enforceable.

 

“Stole” the below from an email on which I was cc’ed from one of my firm’s China lawyers setting forth who from a China SOE (State Owned Entity) should sign its China contract.

1. SOEs have business licenses just like other Chinese companies.

2. Each Chinese company has only one “legal representative” (a term of art under Chinese law). That person is identified as such on the company’s business license.

3. Any agreement signed by the legal representative is binding, whether or not a chop is attached.  (Of course, to enforce the contract you will need to prove that the signature is really that of the legal representative.)

4. Any agreement affixed with the company chop is binding, regardless of who signed on behalf of the company. (Of course, to enforce the contract you will need to prove that the chop is actually the correct chop from the correct company.) This is why control of the company chop is quite important, and the chop is usually kept by the legal representative or some high-ranking company officer/director.

5. Having an agreement signed by the legal representative AND affixed with the company chop is therefore a belt-and-suspenders approach. In China, it is also advisable.

6. It is also possible that an agreement that is not chopped and not signed by the legal representative will be enforceable against a company, if a company executes a number of agreements in this fashion. This is fact-specific and is definitely not a desirable approach.

7. One way to verify (or at least to gain some more certainty) that an agreement is executed in a technically correct fashion is to go to the company’s offices and review several other contracts that have been executed by the Chinese party. And, if possible, also contact other parties that have executed contracts with the Chinese party. Does the execution page bear the same chop? The same signature? If there are any differences, are the differences consistent? For instance: perhaps the chop is always used, but depending on the type of contract or type of customer, maybe the sales manager signs or maybe the VP signs or maybe the legal representative signs.

8. In larger companies, many (if not most) of the contracts are signed by someone other than the formal “legal representative.” For instance, the _______ contract on which we are currently working will be signed by ___________’s president and co-founder, who is not the company’s legal representative.

Just received a long email from a lawyer friend of mine at a well known international law firm, in response to our post the other day on Myths About China Law And Business.  This lawyer wishes to remain anonymous, but here is what he had to say:

Your post on China legal myths is great. You list as a China myth “don’t do a contract with the Chinese because they will not comply anyway.” Your response deals with an entirely different issue. The statement quoted is not really a myth. It is simply a nonsense statement that does not make sense. It is EXACTLY in the case where you think that a party will not comply that you enter into a binding written contract. If you were sure that the Chinese side will comply then you would not need to bother with a contract of any kind.

The issue that is not nonsense deals with a different statement: “Don’t do a contract with a Chinese party because the courts will not enforce the contract.” That is a logical statement. The question then becomes an empirical one: is the statement true or not? My experience shows that the Chinese courts will enforce a contract written in Chinese between parties of relatively equal status that is governed by Chinese law and enforceable by litigation or arbitration in China. You and I have discussed this many times and I know that you agree with me on this.  Of course there are many who say we are not right about this but those people always seem to rely on anecdotes concerning contracts that we fully agree will NOT be enforced in China.

You and I fully agree that the following types of contracts will NOT be enforced in China:

  • Contracts that by their terms are subject to foreign law and foreign jurisdiction.
  • Contracts solely in the English language.
  • Long, complicated, common law style contracts, even when they are translated into Chinese.
  • Contracts where the Chinese company has special status because it is a military company or is owned by a powerful official or is a locally very powerful SOE [State Owned Entity].

In my experience, contracts with small to medium private Chinese companies are enforced by Chinese courts.  As noted, almost always when people refer to their own problems in enforcing contracts in China, the contract falls into one of the above categories.

Maybe you could write a blog post on this.

I just did. What do you think?

A potential client recently sent me a contract written in both Chinese and in English. The English portions were silent about the controlling language but the Chinese portion made crystal clear that the Chinese language portion would control.  And guess what? The Chinese language portion was very different from the English language portion. So different, in fact, that the American company that sent me the contract had no claim under the Chinese language portion, yet it would have had a claim under the English language portion.  My firm always rejects this sort of case because we just assume that the Chinese court will look only to the Chinese language portion of the contract.

This taking advantage of what looks like a dual language contract is a very old trick, and one I have seen at least a dozen times, and not just with China/Chinese.  But for the trick to work, the non-English speaking party has to assume that the foreign language in its contract (in this particular case, Chinese) is the same as the English and never even bother to get it translated.  The foreign party is betting on ignorance/laziness/cheapness/naiveté.  Unfortunately, that is too often a good bet.

I also have on two recent occasions received poorly drafted “Non Disclosure Agreements” (NDAs) from potential clients who want to use those agreements to sue their manufacturer for copying their product and stealing their customers. In both cases, I have had to write the following email:

Near as I can tell, your “NDA” does not help you one bit. It says that your Chinese manufacturer cannot disclose confidential information to any third party, but it does not say a thing about it stealing your designs or competing with you.  In fact, it makes clear that it is free to do whatever it wants with whatever is in the public domain and it will no doubt argue that your __________[product] is in the public domain. I also note that the manufacturer did not chop/seal this document so there is also a good chance that it may not even be binding on it and an even better chance that it will at least make that claim.

It is possible that you can bring a trade secret/unfair competition (or some other non-contractual) claim against your manufacturer, but in many ways, your existing contract may hurt you in pursuing even those claims. If you want to sue this company I suggest you seek to retain Chinese counsel to do so, but I suspect that you will have difficulty finding a good firm that will take this case on a contingency basis.
Whatever you do in terms of your present problem, you should get a new contract in place for any new China orders. That new contract should, among other things, state clearly that your manufacturer cannot use your designs or copy your products or solicit your customers.
Sorry I cannot be more encouraging on this.
Before anyone accuses me of writing this post to try to convince those who are doing business with China to retain a qualified and Mandarin-fluent lawyer to assist them with their China contracts, let me say that I plead guilty. I have said it before and I will say it again. Nearly all of the contracts we see that were drafted without such assistance are of little to no value to the foreign party.  I know that is strong language, but it is also the truth.
What are you seeing out there?

Yesterday, I did a post, entitled, “Drafting A China Manufacturing Agreement. Watching The Sausage Get Made,” seting out many of the questions we typically ask our clients before we begin drafting their OEM agreements. A reader, Phil,  left us the following comment to that post:

Can I ask about the wording of your agreements in Chinese? A deal I’m involved with has been running into a lot of trouble because the American law firm who wrote our contracts have written them in highly complex legalese, very different to the language of Chinese law and standard Chinese contracts. In the third tier city where we are trying to operate, our partner and potential collaborators are having real trouble just reading and understanding the documents. (I’m a translator, and I’m reasonably sure that both sides are right on this – the contracts are correct, but they really are very difficult to read.)
How does your firm walk the line between the conventions of English (American) legal drafting and Chinese drafting?

Great question.

We write our contracts the modern way. By that I mean that we eschew legalese (and using strange words like “eschew“) and we strive to avoid unnecessary boilerplate. This is true of our contracts in both English and in Chinese. Most importantly though, we do not really need to “walk the line between the conventions of English (American) legal drafting and Chinese because of how we draw “the connection” between our English version of a contract and its Chinese version.

When we draft a contract for a client, we first draft it in English. We do this for the benefit of the client and we work with the client using the English language contract. Once we have finished the contract in English, we then move on to re-writing it in Chinese. Notice how I did not say “we then translate it into Chinese.” We use lawyers and only lawyers to take the English and re-write it into Chinese and the re-write is not a direct translation. 

Just the other day, in an effort to save a few bucks, a potential client asked me if we would reduce our flat fee on a contract by $300 if he had his own people translate our English version into Chinese. My response was that if we gave such discounts, it would be greater than $300, but that my firm will not do a China contract unless we do both the English and the Chinese. As I wrote in “No China Translation. What Were You Thinking?” and in “Dual Language China Contracts Double Your Chance Of Disaster,” we do not write dual-language contracts. The contracts we write have one official language and that language is nearly always Chinese.