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?

Alicia Beverly, Chief IP (intellectual property) strategist with IP Wealth, an Australian company, “based on the Gold Coast in Queensland, [that] specializes in identifying, protecting, managing and monitoring intellectual property assets for clients around Australia and overseas,” wrote a helpful article entitled “Protecting and Enforcing Your IP Rights In China.”

The article starts out with a couple of fairly typical China IP horror stories involving Australian companies. The first is of a manufacturer of pub dispensing equipment who went to China to investigate manufacturing a product there, only to discover it was already being produced “in the thousands, with the IP rights applied for by the rogue manufacturer.”  The second is of another manufacturer who discovered his ex-manager had set up his own rival operation that sold the same product right down to the trademark.

Forgive me for yawning, but both of these stories more likely reflect carelessness on the part of the Australian company than any shortcomings in Chinese law.  In the first story, the Australian company could have prevented the problem simply by filing its trademark in China.  In the second story, the Australian company should have had its manager sign non-compete and trade secret agreements.

The article then goes through a strange history of improving Chinese IP protection and wrongfully predicts the 2008 Olympics in China “will have the most impact on routing out IP thieves and dramatically improving intellectual property enforcement.”  Though I wish it were otherwise, I do not see the 2008 Olympics having anything more than the most marginal impact on improving Chinese IP enforcement.

But when it comes to explaining what to do to protect IP in China, Ms. Beverly’s recommendations are all right on.  She prescribes the following:

  • China is not a DYI [Do It Yourself] country – Get Professional Help.
  • Contracts must also be translated into Chinese, cannot be common law centric [The United States, England, Canada, and Australia are all common law countries] and must cover everything because anything omitted is fair game.
  • China is a “first to file” country with no recognition given to use or ownership by other parties.  It is therefore essential that you file for your rights — trade marks, patents and designs —  before you enter China.  Failure to do so is an invitation to the manufacturer or distributor you are working with to do it themselves.
  • Investigate whether your current trademark is useful for the Chinese market, conduct searches, and then protect several versions of your trade mark — the English version, the Chinese translation, and even a phonetic version of the English.
  • Design products that are harder to imitate and commit to continuous innovation to keep one step ahead.
  • Consider splitting up elements of your production in different locations.

Nothing new here, but all very solid advice.   In discussing the need to have contracts in Chinese, because we are talking about protecting IP, I assume she is talking about contracts that aid in IP protection.  On that score, it often makes sense to require those with whom you are dealing in China to sign a trade secret contract, requiring them not to divulge your trade secrets and/or non-compete agreement, whereby they agree not to compete with you within certain geographic and temporal limits.

If Ms. Beverly is advocating for companies always securing a China trademark in English, Chinese, and even “a phonetic version of the English,” I disagree.  In many instances, just the English is enough and I am of the view that these determinations should be made on a case by case basis.  Registering additional trademarks is not terribly expensive, yet it still makes economic sense to register only those that are necessary for the business.

For more on protecting your IP in China, check out “China’s Trademark Laws, Simple and Effective,” which talks about how Chinese trademarks are indeed good protection, and When Your IP Is In China …. and “Nike On China IP Protection: Just Do It With Green Tea,” both of which contain a number of additional good suggestions for protecting your intellectual property in China.