China contract damages

In my last post I discussed the importance of having the right person craft your China contracts. 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. The other two deal with more mundane but extremely important issues.

1. Clarity. The first is to achieve clarity. The worst business deals fail for lack of clarity, which leads to a lot of finger pointing as the deal starts to unravel. Handshake deals are bad for so many reasons, but the primary reason to have a good China contract is 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 30 days, it will say “yes” pretty much every time. But if you put in your contract that the product needs to ship in 30 days and for every day it is late, the Chinese company must pay you 2% of the value of the order, there is a great chance the Chinese company will get honest with you and tell you that 30 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.

Too many times recently I have been reviewing Chinese contract disputes involving a poorly written contract or no written contract at all. Both sides are certain they remember conversations and swear the other side knew exactly what was expected of them. Clarity before you start the relationship. It is more important than you think. Chinese words matter. English words matter. Google translate can only get you so far.

2. Constraint. The second benefit of having a clearly written contract with your Chinese counter-party is that it will likely bring that company back to the table for whatever kind of conversation you need to have to ensure they comply with the terms of your contract. By this I mean that just having a well written contract that the Chinese side believes is enforceable means that the Chinese company knows exactly what it must do to comply. And, in most cases, it helps the Chinese company internally to get your order prioritized.

Let’s use the 30 day example as the example here as well. If your Chinese manufacturer makes widgets for 25 foreign companies and five of those foreign companies have China-specific contracts with clear time deadlines and a clear and enforceable 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 because they can clearly read in Chinese their damages per day or per week for failing to fulfill your order.

During the PPE sprint in the spring and summer of this year, buyers could not dictate terms because it was a seller’s market. The market dynamics have swung back to center, and in some instances favor buyers again. Take every opportunity to introduce liquidated damages into your China contracts so your orders get filled ahead of everyone else’s.

3. Enforceability. Our firm has written hundreds of China contracts and we have never once been called on to litigate any of them. We also are not aware of any of them having been litigated. We attribute this to reasons #1 and #2 above, but I have to admit this also means I cannot stand up and scream that Chinese courts enforce our well written China-specific contracts. 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.

China’s recent reforms secured the country’s place among the most efficient economies on contract enforcement. A local entrepreneur spends on average 496 days and 16.2% of the claim value to resolve a commercial dispute, faster and less expensive than the regional average. China improved the quality of judicial administration, and it now scores 17 out of 18 on this index. No economy in the world scores better.

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.

Are China contracts worth doing? Absolutely, if they are done right.