Archives: Liquidated damages

The title is stolen from the Warren Buffett line, “You can’t make a good deal with a bad guy, regardless of any piece of paper. And it is so true.

Our China lawyers are always telling our clients the following:

  • Legitimate Chinese companies do not want to get sued. In our experience, they are even more concerned about getting sued than are American companies. They do not want to get sued because getting sued is both expensive and damaging to their reputation.
  • Crooked Chinese companies do not mind getting sued, because they can always just shut down and they have little to no reputation to protect.
  • The above means that a good contract with a good company can be very valuable at making sure the Chinese company does what you want it to do.
  • A great contract with a crooked Chinese company has virtually no value at all, because the crooked Chinese company does not much care.
  • The above means that you must be careful about with whom you do business in China (or anywhere for that matter).  Do your due diligence before you contract.

There are three primary reasons for having a good contract with your Chinese counter-party.

1.  Clarity. The first is to achieve clarity. To make sure you and the Chinese company are on the same page. For example, if you ask your Chinese supplier if it can get you your product in 20 days, it will say “mei wenti,” or not a problem, pretty much every time. But if you put in your contract that the product must ship in 20 days AND for every day it is late, the Chinese company must pay you 5% of the value of the order, there is a great chance the Chinese company will get honest with you and tell you that 20 days is impossible. At that point, you and the Chinese company can figure out a more realistic time frame and then you know what to realistically expect going forward. Needless to say, we can give countless examples of this sort of thing, but this is yet another reason why our China attorneys advocate putting your contract in Chinese. Clarity before you start the relationship is critical.

2.  StrictureThe second benefit of having a well written Chinese language contract with your Chinese counter-party is that the Chinese company knows exactly what it must do to comply. And, in most cases, it might as well. Let’s use the 20 day example as the example here too. If your Chinese manufacturer makes widgets for 25 foreign companies and five of those foreign companies have very clear time deadlines with a very clear liquidated damages provision in their contracts, and the Chinese company starts falling behind on production, to which companies will the Chinese manufacturer give production priority? Of course it will put the five companies with a good contract at the front of the line. Why wouldn’t it?

3.  Enforceability. My firm has written hundreds and hundreds of China contracts and we have never once been called on to litigate any of them nor are we aware of any of them having been litigated. We attribute this to reasons #1 and #2 above, and this just reinforces our claim that good contracts help prevent problems. It also bears mentioning that the World Bank ranks China 19th among 189 countries at enforcing contracts.

What do you think?
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:

Got the following message on linkedin a few weeks ago:

Been following [China Law Blog] for about 8 or 9 months — it’s been helpful as I’ve been setting up a foreign branch here (sourcing appliances for overseas), preparing employment contracts, renegotiating OEM deals, etc. The site is by far the most useful, practical, concise advice I’ve had on dealing with legal issues here in China. I had all the management dealing in China subscribe as well. Thanks for the resource you guys provide — cheers.

I got it more than a week ago, but  I have yet to respond.  We have been writing this blog for going on eight years and this is the first time it ever occurred to me that someone would think that the snippets of information we provide here are enough for writing international cross-border contracts. Does this person (a non-lawyer) really believe that he is now qualified to act as a China lawyer and write cross-border US-China contracts.  His email has left me nonplussed and I do not know how to politely respond.

But I first want to talk about another, earlier email I received , along with an article in today’s local (Seattle) newspaper.

The other email was from someone who had just attended a continuing legal education course in which one of the speakers talked about the importance of having a disclaimer on your blog so that readers realize that a blog is not the equivalent of legal advice.  This person emailed me with this information to make sure that we had such a disclaimer.  I emailed back saying that we have the following disclaimer:

This Blog is made available for educational purposes only, as well as to give general information and a general understanding of the law. It is NOT to provide specific legal advice. By using this blog you understand there is no attorney-client relationship between you and the Blog publisher. You should NOT use this blog as a substitute for competent legal advice from a licensed professional attorney

I then talked about how stupid I find such disclaimers and of how unnecessary they are, but that out of an overabundance of caution, we have had one since our inception.  This email correspondence with the lawyer predated the email from the person who apparently uses our blog exactly as we tell people not to do.

The article to which I refer above is a Seattle Times interview with Gary Locke, the US Ambassador to China. In that interview, Ambassador Locke is asked what advice he would give to American businesses that want to do business with China, and he responds as follows:

There are great opportunities but be very careful. Study the market. Perform due diligence. Get outside advice from experts in the law and so forth. It’s tempting to enter into a two-or three-page contract with a Chinese partner. But that won’t be adequate to protect you from disputes or other hiccups that can happen.

Correct.

Here’s the deal people.  Every single contract is what we in the law call sui generisor one of a kind.  This is why my law firm always refuses to provide “template” or “generic” contracts.  Whenever someone asks us for a template contract or a copy of one that we did for someone else, we always refuse no matter how much they offer to pay.  We will not stake our reputation (and our malpractice policy) on a contract that almost certainly will not be right for the company seeking to purchase it. And if the contracts we draft for our own clients are not good enough when used off the shelf, certainly our blogged advice on how to draft such contracts has even less value.

Now for some examples.

We often write of how we generally (generally is the key word here) write our contracts in Chinese with a China court as the jurisdiction.  Generally, but not always.  If the contract is with a Hong Kong entity, we usually do not want a China court.  What if the contract is with a Hong Kong parent company and its mainland manufacturing subsidiary?  There is no one answer.  What if the Chinese company has substantial assets in the United States?  Well then US jurisdiction might very well make sense. And it is not as though this is an unimportant issue; if you get it wrong you may end up having no remedy at all.

We also often write about how well liquidated damages provisions work in Chinese contracts. But even if we assume that someone other than an experienced China lawyer can write a liquidated damages provision that makes sense, for what amount will that provision be written?  There is no one right amount; choosing the amount is at least as much art and experience as science.  We base the amount usually on the nature of the contract, the value of the transaction, and the court in which the dispute will be resolved. It is not at all uncommon for two to three lawyers to discuss this amount before it is finalized.

I could go on and on.

Lest anyone still thinks drafting a China contract is easy, I urge you to check out the following:

Not going to tell you that using our blog as a guide for drafting your China contracts is the equivalent of using a blog as a guide for performing open heart surgery, but I will say that anyone who does either is making a huge mistake.

Does anyone really think otherwise?

 

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?

I am often asked (usually right after I quote our fee) whether a China contract I am proposing to write “is even enforceable in China.” I always give the same answer, which is more or less the following.

There are three reasons why it makes sense to have a contract with your Chinese counter-party, and only one of those reasons is enforceability in court.

1.  Clarity. The first is to achieve clarity. To make sure you and the Chinese company are on the same page. For example, if you ask your Chinese supplier if it can get you your product in 20 days, it will say “yes” pretty much every time. But if you put in your contract that the product needs to ship in 20 days AND for every day it is late, the Chinese company must pay you 10% of the value of the order, there is a great chance the Chinese company will get honest with you and tell you that 20 days is impossible. At that point, you and the Chinese company can figure out what is realistic and then you know what to expect, realistically, going forward. Needless to say, I can give countless examples of this sort of thing, but this is yet another reason why we advocate putting your contract in Chinese. Clarity before you start the relationship. It is more important than you think.

2.  Stricture The second benefit of having a contract with your Chinese counter-party is that it will likely bring that company to heel. By this I mean that just having a well written contract that is at least potentially enforceable means that the Chinese company knows exactly what it must do to comply. And, in most cases, it might as well. Let’s use the 20 day example as the example here as well. If your Chinese manufacturer makes widgets for 25 foreign companies and 5 of those have very clear time deadlines with a very clear liquidated damages provision, and the Chinese company starts falling behind on production, to which companies will the Chinese manufacturer give production priority? Of course it will put the five companies with a good contract at the front of the line.

3.  Enforceability.  Here’s the funny thing. My firm has written hundreds and hundreds of China contracts and we have never once been called on to litigate any of them nor am I aware of any of them having been litigated. I attribute this to reasons #1 and #2 above, but I have to admit that this also means I cannot stand up and scream that Chinese courts enforce well written contracts. Even better though, I can stand up and scream that they do certainly seem to prevent problems. Even though I cannot speak regarding the enforcement of my firm’s contracts, I can say that where my firm has sued or threatened to sue or arbitrated or threatened to arbitrate on contracts written by others, we have felt that China does enforce contracts. More importantly, however, the World Bank feels the same way, ranking China 16th among 183  countries in terms of enforcing contracts.

And that is a lot of the point. If your Chinese counter-party believes your contract will be enforced or even if it just believes it may be enforced, it is likely to act accordingly.

China contracts worth doing? If done right, you’d better believe it.

What do you think?

Every other month or so, we get a harried call from someone wanting our help in “getting their molds” back from their Chinese supplier. Though I know this cannot be the case, it does seem that nearly every time a foreign company decides to terminate its Chinese manufacturer, the Chinese manufacturer refuses to return the foreign company’s molds. The Chinese manufacturer holds on to the molds either to extract money from the foreign company or simply out of revenge. 

We have yet to take on a case for a foreign company wanting to sue to get its molds back. We have turned down all of these cases both because we have yet to deem one good enough and because they are generally too expensive in relation to the value of the asset. in other words, these are not good cases and the key to this sort of case is to avoid getting yourself into a situation where you feel you may need to bring one.

How can you achieve that?

The way to avoid having your Chinese manufacturer run off with your molds is to make sure you require the manufacture to sign (and seal) a contract (preferably in Chinese) that makes very clear to whom the molds belong (to you) and what will happen to the Chinese manufacturer (liquidated damages) if it fails to return your molds to you. 

Even better, you should, if possible, get a deposit for your molds, which deposit you will return when your molds are returned to you. If the Chinese manufacturer will not give you a deposit for your molds, (most will not), put in a liquidated damages provision that applies if your mold is not returned when specified. That provision alone goes a long way towards taking away any incentive for your Chinese manufacturer to hang on to your molds.

You wanna keep those molds for which you paid? Do something about it now, not later.

What do you think?

Someone called KAS just left us the following comment:

We have a pretty blatant patent infringement where the Chinese manufacturing company (with whom we have a contract) has sold the product to Australia. Our goal is to shut down the sales in countries outside of China, e.g. Australia. Under these circumstances, would it make any sense to sue? We are just starting down this path and I do not want to waste my client’s money. Thank you for your informative posts.

For various reasons, we virtually never answer comments seeking legal advise. The main reason we demure is simply because there is usually no way to give a real answer without knowing all of the facts and without going into great depth as to the additional facts needed. And that is definitely true here as well.

This comment raises such an interesting question and it so well highlights the sort of initial analysis that goes into answering these sorts of fairly typical questions, that I am going to venture an email like response (without a “yes” or a “no”) as though this comment had just come to me via email from a potential client.

Dear KAS,

For us to be able to know whether it would “make any sense to sue,” we would need to gather up all sorts of additional information from you and then conduct our own research regarding various aspects of it. At this point, I am going to give you a taste of just some of what more we would need to know and if you wish to continue the discussion, I would urge you to answer the questions below and then we should follow that up over the telephone. 

For us to have any sense at all regarding whether you should sue or not, we would want to know the following:

  1. Is there really a patent infringement?  You say it is pretty blatant, but what do you mean by that? We would first need to see your patent and then see exactly what it is you say is infringing it.
  2. Where do you have this patent? If, for instance, you have this patent in the United States and nowhere else, your case is not looking so good. This is because for you to assert patent infringement against a company that is manufacturing your product in China and selling it in Australia, you almost certainly (note how lawyers always hedge a bit) will need to have a patent in either China or in Australia.
  3. Where do you propose suing this Chinese company? if you propose suing the Chinese company for violating your Australian patent, you probably (yes I know I am hedging again, but without conducting the specific research, I am always hesitant to say that anything too strongly) can only sue in Australia. If this Chinese company does not have any assets in Australia, there will probably be no point in suing it in Australia unless you can then take your Australian court judgment to China and enforce it there. i know that Chinese courts do not enforce US judgments but I do not know whether or not they enforce Australian ones. It is possible that they do and that is something it may end up making sense for us to research.
  4. Alternatively, if you have a Chinese patent, then your best bet may end up being to sue the Chinese company in China.
  5. What are your damages? Patent lawsuits anywhere are expensive and so if this Chinese company is not hurting your profits all that much, it may not be worth suing it. Of course, the fact that it may not be hurting your profits all that much right now does not necessarily mean that things may not get a lot worse and you may determine that it is critical for your business that you sue to stop the infringement. This is something we will need to discuss.
  6. Do you really have a valid patent? I hate to pose this question, but I must. Patent boards are notorious for being easy in granting of patents that courts then hold should never have been granted in the first place. We will certainly need to look at this issue.
  7. You say that the Chinese company infringing on your patent is (or at least was) your own manufacturer. Do you have a contract with that manufacturer?  I can tell you that when my law firm writes a China manufacturing agreement for our clients, we almost always put in provisions forbidding the Chinese company from copying our client’s product for itself or for others. I am very much hoping your contract has something similar and that it also provides for you to be able to sue the Chinese manufacturer in China and to receive liquidated damages for contract breaches. If all those things are true, you may very well have a good case against this Chinese manufacturer in China. Please send me the contract so I can review that. I am also hoping that your contract is in Chinese as that will make things go a lot smoother in any lawsuit in China. 

Once we get answers to the above, we will have a better sense of whether it will make sense for you to pursue litigation (or anything else) against the Chinese company. At that point, we will also be in a much better position to give you suggestions on how best to proceed and the estimated costs of the various options.  In the meantime, please don’t hesitate to contact me if you have any further questions.

Every few months we get a frantic call from someone wanting our “immediate” help in getting them their molds back. These situations usually present themselves as follows:

Small to mid-sized company (“SME”) has spent $25,000 to $250,000 building a mold(s) for manufacturing their product in China. SME provided this mold to its one Chinese supplier so that their Chinese supplier can make product for the SME. The Chinese supplier provided bad product to the SME and now there is a dispute between the SME and the Chinese supplier and the SME wants its mold(s) back right away so that it can move on to a new supplier, without their being any interuption in product supply.

The SME wants us to sue “right away” in China to get their mold(s) back.

I then ask to see the SME’s written contract with their Chinese supplier and then I tell them how difficult their case will be because of their contract, or lack thereof. 

Without going into too much detail, the bottom line is that if you want to have a good chance of getting your molds back quickly, you need to lay the groundwork for this in your written and sealed. For more on this, check out “How To Write A Chinese Contract That Works.” That contract must state very clearly that the molds belong to you and it must set out very clearly the molds to which it is referring. If you do not do this, the Chinese manufacturer will (just about every time) claim that its deal with you involved them taking over ownership of the molds.

This contract should be in Chinese and it should also very clearly set out the damages the manufacturer will be required to pay you if it fails to promptly (which will also be defined in the contract) returned.  These provisions are called liquidated damages provisions and to find out more on why they are so critical to Chinese manufacturing contracts, check out “China Manufacturing Agreements. Make Liquidated Damages Your Friend.

If you want to read more on Original Equipment Manufacturing (OEM) Agreements and on what they should be comprised, check out the following:

Bottom Line: Plan for getting your China-based molds back before you need them back.

One of the hallmarks of a good China OEM Contract is that it provides for very specific penalties if the Chinese manufacturer fails to abide by its crucial terms. These penalties will typically be in the form of a liquidated damages provision, which Wikipedia defines 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).

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.

Liquidated damages provisions make sense in many different types of contracts with Chinese companies and they make particular sense in the context of a product supplier relationship.

We most often put in liquidated damages provisions to “encourage” the Chinese supplier to comply with the following:

1.  Shipping Dates.  If the product our client is having made in China is at all time sensitive, it is our practice to specify the delivery date and a penalty to the Chinese manufacturer for not meeting that date. We sometimes set the penalty at a flat dollar amount and at other times, we make it a percentage of the value of the order. We sometimes set out just one penalty and at other times, we hae the penalty escalate as the lateness increases. The key is to make sure the provision is very clear on the date (or dates) that trigger the penalty.

2. Quailty Specifications. We also often put in a liquidated damages provision if the quality of the product falls short on what was promised by the contract. These provisions make particularly good sense if what you receive can still be sold, but for less money. For example, if you are buying a food product that is industry-rated from A to D and you pay for an A product and half of what you get is B, you will be much better off with a contract that clearly states you get $1 for each level below A the product falls than having to prove up your damages by showing how you could have made X dollars more with the A product than with the B you were provided.

We generally strive to make the penalties reasonable not only because the courts are more likely to enforce such penalties, but because the Chinese manufacturer is more likely to take them seriously as well. The thing to remember about penalities is that the best ones need never be enforced because they were so effective in molding the manufacturer to comply.

For more on what should go into an OEM Agreement, check out the following: