Archives: written contract

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?

The All Roads Lead to China Blog did an excellent post the other day, entitled, “Save Money in China GUARANTEED!”  Though I wholeheartedly concur with the advice, I must, as a China lawyer add some fine print.

All Roads sets forth a nine fold path for guaranteed cost savings in China outsourcing, of which I highlight the following four:

1) Know what you want to gain by going through this process:

  • What is the end game?
  • How much money must be saved before moving?
  • Should any move involve a gradual shift from current suppliers to new suppliers?
  • Is a higher cost acceptable until full volume is moved over?

 

2) Check your gut:

  • Do you like this person, or do they just have the best price?
  • Would you hire this person in-house under normal conditions?
  • Do they respond to your requests for more information?
  • Do they understand your concerns and work with you to work through them?
  • Can they do what they say they will?

 

3) Build relationships and trust:

Many buyers will do all they can to drive down prices and will always be looking for a better deal.  this is a strategy that often leads to short term gains and long term pains as relationships are never stable, and both parties are suspicious’. A situation which often leads to supply chain instability and time/ money spent to find new suppliers.

Working with a supplier and developing each other’s businesses is a far more effective strategy that will lead to tighter relationships and long term stability.  With China 101 rule #1 being relationships are everything, the above is the goal.

 

4) Understand and work with relationships when there are problems:

Suppliers will always have a learning curve to climb, and understanding that is critical.  No one is perfect, and no process is.  There are bound to be issues in quality, and it is not always because a supplier is trying to use lesser quality materials or processes.  Sometimes, it is a simple mistake, and at other times it is a serious issue that needs to be talked through. however, if at all possible, one should not simply walk away from the relationship as no one gains from that, especially the buyer.

I urge everyone to check out the full post here.  My favorite is “check your gut.”  I say this because my firm is surprisingly often brought in to write contracts on deals that simply make no sense for the non-Chinese company.  When we ask our client about the portion (or portions) of the deal that make no sense, their response is invariably not to explain it to us from a business perspective, but rather, to tell us that the Chinese company with whom they are doing business has told them “this is what the law requires in China.”

WRONG.

Chinese law is NOT written to harm the foreigner.  If the Chinese company with whom you are doing business tells you things that make no sense to you, there is a 99% chance it is nonsensical, rather than that you do not understand China.  Just by way of example, the following are some of the things Chinese companies have said to our clients doing that are virtually never true:

  • You [the foreign company] need to license or give title to your IP to a Chinese company if you are going to be doing business in China.
  • You need to deposit the initial funds into the personal bank account of the Chinese company’s president.
  • You need to pay the Chinese government $100,000 to do this kind of business in China, through the Chinese company.
  • You need to do this business as a joint venture (JV), not as a wholly foreign owned entity (WFOE).
  • You need to do this business with your having a minority interest in the joint venture.
  • You need to turn over your client list to the Chinese company so that it can confirm with the Chinese government that none of the companies are forbidden from doing China business.
  • This sort of business cannot be memorialized in a written contract.
  • Chinese companies are not allowed to consent to arbitration.
  • Chinese companies never enter into written contracts

Now for the fine print:  Even if you follow all of the above advice, you can still lose money if you  have a bad contract, if you pick a bad company with which to do business, if your business in or with China is fundamentally not a good one, or if you fail to protect your IP.

Business everywhere has its risks, and China is, of course, no different.