I have been on the road the last few days, first speaking at a Bank of America client only event in San Fransisco and then today speaking on various international law topics at Indiana University School of Law. So I went through old emails from Steve to clients relating to their China software licensing agreements. I took those emails, stripped them of any identifiers and then combined them into one. The following is a fairly standard email we write to our clients who are licensing their software to China.
I have reviewed your basic agreement. I understand the basic structure. I do have the following questions that must be resolved before I begin work on the document:
1. How do you plan to make arrangement for payments? I note that your normal system is 30 days net. In general, this is not a good idea in China the Chinese government has made it progressively more difficult for Chinese entities to convert RMB into dollars for payment to foreign software and service providers. The restrictions come in two forms: 1) unreasonable demands for contract registration and then delays and unreasonable documentation requirements for contract registration, and 2) imposition of withholding and other taxes, often in unreasonable amounts. All of these burdens must be met before the Chinese party is permitted to make payments. The demands and requirements vary from district to district and from bank to bank with no predictable pattern. This process can often delay payments for many months or even years.
Because of the above, it is not usually prudent in China to deliver software product or to provide services until after you have been paid or at least until after you have been paid for a significant amount of your fee. These payment problems are entirely beyond the ability of the Chinese customer to control, so even customers acting in good faith may be in a position where they cannot pay.
I usually provide that 1) the Chinese party is responsible for all registration and licensing at their own expense, 2) the Chinese party is responsible for payment of withholding and any other tax at their own expense and 3) no product is delivered and no service is provided until after the appropriate registration has been made and the relevant amount has been paid to you. The “relevant amount” can be the entire fee, a substantial deposit, or a retainer payment. In each case, the amount is sufficient to eliminate risk.
For software delivery, the normal is 90% of the license fee in advance with 10% due after installation. The Chinese side usually vigorously opposes this approach, seeking to place the risk of payment entirely on the U.S. side. Most of our clients are not willing to take that risk, and an impasse is reached. The clients who have been willing to take the risk usually end up regretting their decision. Since this is a critical issue and since it comes up 100% of the time in this kind of transaction, you need to consider the approach you will take to payment in advance and we need to build the basic approach into the agreement. You can put the detailed terms into a pricing addendum, but the basic obligations need to be outlined in the main agreement.
2. How will you provide maintenance and support services? All on line, or will staff be dispatched to China? If online and through call in support, will you modify your support hours or maintain your current system. Note that to the extent any of your services are provided by sending staff to China, you need to consider carefully issues of 1) how will you get paid, 2) who will do the work, and 3) to the extent that you will send staff from outside China, who will pay travel, lodging and related costs.
3. To effectively protect your company, you have to be able to enforce the terms of the agreement in China. China does not enforce U.S. court judgments as a matter of law and China in fact often does not enforce U.S. arbitration awards as a matter of practice. The most effective system is to provide that the Chinese translation controls, the agreement is subject to Chinese law and enforcement will be in the Chinese courts. Many of our U.S. technology clients are uncomfortable with that approach. We therefore usually do a fallback to a less powerful system in China as follows:
a. Agreement is subject to U.S. law.
b. English language agreement controls.
c. Dispute resolution is through arbitration. The place of arbitration is usually Beijing. The arbitration is done by CIETAC according to its rules. The arbitration will be in English.
This system works well when the issue is determination of a specific monetary award or when the issue is a technical issue relating to the quality of the product. It works less well when the issue is preventing the Chinese party from illegally appropriating or using your IP. Note that the Chinese side will often object to even this system, especially if they are a Chinese public entity. They often will insist on Chinese law and Chinese language for both the license document and the arbitration.
Please let us know how you would like to proceed on this enforcement issue. The matter is complex and I would be happy to discuss the matter with you in more detail. In general, there is no benefit in having an agreement that you cannot enforce, so we need to approach this issue with great care. Note that if you provide for litigation in China, that means it will be very difficult for a Chinese party to effectively sue you on quality issues because U.S. courts probably will not enforce their China judgments. The U.S. does enforce Chinese arbitration awards, so arbitration in China does subject you to enforcement of a CIETAC arbitration award.
4. Installation of software is normally an enormous problem in China, leading to disputes concerning payments of the portion of the fee due upon successful installation. In our experience, the majority of software installations result in a dispute about installation. I notice in your agreements that you do not discuss installation issues in connection with the payment of fees. That is, it appears that you have no installation hold back. Is this correct? Do you anticipate that your software is of a type that will not result in installation disputes? Please consider this carefully because, as I have indicated, installation disputes are very common in China.
5. Please note that if you provide unlimited service and support in the first two years, the Chinese side is likely to substantially over-use your service and support functions. You need to carefully consider how much service and support you will provide in order to control the usage by your Chinese customer. I suggest that you provide for controls that are reasonable for both sides to the license transaction.
We need to get this all clear before we start drafting because these issues have a substantial impact on the language we will use in the agreement for matters such as IP enforcement and warranties/waiver of warranty.