Archives: MOUs

We have a number of times written on the problems that can arise from using memoranda of understanding (MOUs) with Chinese companies. See the following for some of those posts:

Mostly we have talked about how Chinese company (and to a large extent Chinese law and courts) are much quicker to view an MOU as the contract itself than are American companies and American courts. Because of that, we warned of the dangers in using an MOU.

Since we did these posts though, we have received a number of emails from readers saying essentially that they are having trouble completely eschewing MOUs in their China business and asking us what they should do. Also since that time, our China lawyers have probably done around a deal a month that involved an MOU. In other words, like them or not, MOUs are a fact of life when it comes to doing business with China.

That being the case, in this post we address why MOUs so common to China business and how you can and should handle them, short of just saying “no” and walking away.

MOUs are common with China business for the simple reason that Chinese companies love them. But why do Chinese companies love them? In our experience, we see them used typically to achieve the following two things:

  1. To memorialize in writing the existing state of the agreement before the underlings at the Chinese company pass it on to their boss or bosses for approval. We frequently see this at large Chinese companies, particularly SOEs.
  2. To memorialize in writing the existing state of the agreement and then to use that written document as a starting point for additional negotiations intended to favor the Chinese company only.

If you are negotiating with a Chinese company that insists on an MOU, you should try to discern the reason the MOU is so important and if it is for reason number two above, you should make clear that once the MOU is signed, you will not be in a position to re-negotiate critical terms and you should stick by that statement.

Let’s face it, China MOUs are sometimes necessary for getting the deal done and an MOU that gets a good deal done is a positive/pro. On the flip side, they can be used to lull foreign companies into going beyond where they wanted to go on their deal and as we have previously written, to create a binding agreement without the foreign company realizing that.

Those are the pros and cons of MOUs with China.

What do you think?

My last blog post was a CBC (Canadian Broadcasting Interview) regarding my reaction to press releases/media stories regarding North American companies entering into an MOU (Memoranda of Understanding) with a Chinese company. The point I made in the interview is that stories about such MOUs are just not worth much because the MOU itself could very well be non-binding. My whole point was that I just don’t view these announcements as a big deal because so often no binding agreement ever follows:

AK: And do companies and organizations in North America generally view them in the same way as their counterparts in China

DH: Probably yes, and the way they’re generally viewed is that they can range from being fairly important to being completely meaningless. So you don’t see them all that often between two North American companies, but they’re fairly common with Chinese companies and Chinese governmental bodies, because those companies and governmental entities like to show them off in China to show that they’re doing something outside of China. But whether they’re really doing something or not is always open to question. And quite frankly it’s really the same on this side, in that, when I see someone saying that they have a Memorandum of Understanding with a company in China, my first thought is “Yeah, so what. Why don’t you just wait to announce that you actually have a real deal?”

AK: So how do you tell the difference between an MOU that doesn’t hold much weight and an actual announcement of weight or actual deal that indicates a real relationship?

DH: When I see an announcement of an MOU, I really have no choice but to assume that it has no weight, unless and until something comes down the road later that shows that it did have some weight. And that something down the road later would be an enforceable contract. In my experience, MOUs lead to enforceable contracts probably less than 10% of the time. So when I read about MOUs, I just completely ignore them.

AK: So you don’t feel like there’s much weight to a press release or an announcement or a photo opportunity around an MOU?

DH: I feel like there’s no weight. In fact, my first reaction is, why are you announcing something that may or may not happen down the road? If something’s really going to happen down the road — if something’s really imminent down the road — then why not just wait until you’ve gotten down the road? Why are you taking the risk of acting as though some big thing has happened, and then two or three months later what are you going to do when it really doesn’t come to fruition? Are you going to issue another press release saying, “oh we were just kidding three months ago,” or are you going to do what most companies do, which is just say nothing?

In the same interview, however, I also made clear (or so I thought) that MOUs can and sometimes are binding on the parties that sign them:

AK: In your blog you do warn that MOUs with Chinese organizations can sometimes actually be more than they appear.

DH: That’s exactly right. That’s sort of the flip side of all of this, and that is that MOUs, in North America but even more so in China, sometimes are not really MOUs—they’re contracts. And the American company doesn’t realize that. We’ve had companies come to us and say “hey, could you help us with this MOU and then we’re going to have to figure out what to do to by way of a contract.” And then we look at the MOU and we tell them that under Chinese law this [what they thought was an MOU] is a contract. And a lot of times in those instances, that’s how the Chinese company views the MOU, and the American company didn’t even realize it. So they’ve gone over [to China] and signed something without the authority of the higher-ups in their own company, and that something they signed is a two-or three-year contract that they nobody ever really approved. So that’s the flip side of all of this. Just calling something an MOU doesn’t mean it’s an MOU as is commonly defined by North American business people.

Then at the end of the post, I referred back to one of our previous posts, The China MOU (Memorandum of Understanding). Use Them At YOUR Peril, on how MOUs can and sometimes are binding and that American companies far too often believe that simply calling something an “MOU” is enough to prevent them from being bound by the MOU they sign.

But for some reason, a number of readers missed this aspect of the post and I ended up getting hit with a flurry of emails pointing out how I was wrong to be so flippant about MOUs with China.  To the extent my interview was not clear, I accept the criticism and I want to clarify.  The point of my interview was to note how outsiders to an MOU have no idea regarding the meaning of the MOU as such documents can range from “hey let’s cooperate” all the way to a binding deal.  Generally though, if a company is going to announce an MOU, it means that they likely do not have a binding deal (or at least do not realize that they have a binding deal).  Put simply, if the company has a binding deal or thinks it has a binding deal, why bother announcing an MOU?

The post was not intended to minimize the importance of the MOU that you may go off and sign.  Far from it as these documents can be critical to anyone doing business in China.

One commenter talked of how they are important to Chinese companies and they are.  And as I keep saying, they also can be binding.  Where we often have a problem with them as lawyers is when a client comes to us with an MOU that says A and then wants us to draft a contract “based on it” that says B.  We then tell the client that going from A to B might offend the Chinese side and the client usually says something like, “but it is just an MOU.”  Yes, it is just an MOU, but binding or not, Chinese companies generally take these pretty seriously.  In fact, I cannot tell you how many times we stress to our clients the need to give us (as lawyers) a chance to review their MOUs before they circulate them because binding or not, MOUs do have meaning.  And just to be as clear as I can be: what you call an MOU may very well be what a Chinese Court or your Chinese counterpart calls a binding contract:

The impact of this difference is that we frequently see the following: American company comes back from China and shows me their five page MOU and says that they now want to work on a contract .  I tell them that what they have given me is probably a contract.  They tell me that I’m wrong.  I tell them to tell their Chinese counterpart that they now want a contract and see what happens.  Virtually every time, the Chinese company tells the American company that there is no need for a contract and then the American insists that there is and then the Chinese party thinks the American is being a jerk.  The parties have already gotten off on the wrong foot.

China MOUs can matter. China MOUs can be important.  China MOUs can be binding.  Believe it.

What more can I say?

What do you think?

The other day, Steve and I were emailing with a reporter regarding how Memoranda of Understanding, (MOU), are so different in China than in the United States and how that difference often causes early discord between Chinese and American companies.

Steve started the discussion by talking about the differences in the meaning of Memoranda of Understanding (between China (an essentially civil law country) and the United States (a common law country):

In the common law tradition like that in the United States, an MOU means little. Only a signed deal really counts. This is not true in the civil law tradition. In the civil law tradition, there is the concept of good faith negotiation. Under that concept, it is not acceptable to simply walk away from an MOU if that would constitute “bad faith.” Common law lawyers hate the concept, but it is deeply ingrained into the civil law tradition. In fact, it is a core concept in the Chinese contract law of 1999. Since the traditions are so different, you can see where conflicts may arise.

In practice, the Chinese side often will try to turn an MOU into a concrete commitment when it suits them and ignore it when it does not. This is how most people behave and it should be no surprise. The problem is that under Chinese law the Chinese side might be justified in insisting that the MOU is binding if the behavior of the foreign side constitutes bad faith.

What is bad faith? The standard example is signing a China MOU and then negotiating with two parties at the same time without informing the two parties and using the MOU to keep one party from taking the initiative on a venture. And then sign a deal with the other party, cutting the first party out of the deal. This sort of strategy is not rare in common law countries, particularly in the mining/minerals and other natural resources businesses. Under the common law, the party cut out under this scenario usually has no claim. Under Chinese law and under civil law, the party that has been cut out has a claim under the bad faith doctrine.

Very few common law lawyers are even aware of this issue or they say that the Chinese are “wrong.” However, China is a civil law country. It makes no sense to say the Chinese are just wrong. In fact, to the extent that the matter is subject to Chinese law, the Chinese are “right” by definition.

I then talked about how this difference in laws can so often lead to problems arising between Chinese and American companies:

The impact of this difference is that we frequently see the following: American company comes back from China and shows me their five page MOU and says that they now want to work on a contract .  I tell them that what they have given me is probably a contract.  They tell me that I’m wrong.  I tell them to tell their Chinese counterpart that they now want a contract and see what happens.  Virtually every time, the Chinese company tells the American company that there is no need for a contract and then the American insists that there is and then the Chinese party thinks the American is being a jerk.  The parties have already gotten off on the wrong foot.

Steve then summed up the problems:

Dan’s point is dead on. There is a major gap in legal systems here. It is not culture, it is the legal system itself. Both sides are behaving in a manner completely consistent with their own legal system. But in the end, both sides look to the other as though they are acting in bad faith, when in fact both sides are doing nothing more than trying to reach a deal as best they know how.

I then concurred with Steve:

Correct.  And the thing is that neither side has malevolent intent.  The Chinese side just puts a lot more stock in the MOU than the American side. The American side will sign the MOU thinking its nothing and planning to come back and turn it over to their attorneys to draft the final agreement.

And then the problem starts when we tell the American company that the MOU it just signed is almost certainly a legally binding contract and that it is virtually certain that the Chinese side sees it as a contract and that the contract is terrible and that “it needs the following ten things.”  The American company then goes back to the Chinese company with the ten things that need to be changed or added and the Chinese company then gets offended because it thought it had a deal and only super minor things needed to be resolved and those would be resolved over time.  So now you have a situation where what could have been a good relationship starts off on the wrong foot or fails to start off at all.

Bottom Line: MOUs are different in China and failing to realize this can lead to problems.

What do you think?