China Contracts: Worth Every Dollar You’d Rather Not Pay
Paying lawyers can seem expensive, even if they are only mediocre lawyers. But good lawyers can often save you money because they can save you from your own mistakes. They do that by having both the experience and gravitas to teach you from others’ mistakes.
I wrote in a previous post about the PPE nightmare that continues to unfold as purchasers, manufacturers, and suppliers wrestle in pre-litigation disputes about the quality of PPE provided earlier this year. Good businesspeople who generally act with measured steps threw caution to the wind for a brief moment, and some are paying for their recklessness in chasing ephemeral profits. More than one business owner has commiserated in recent months that they absolutely knew better than to get into their current China business dispute.
For fewer headaches in contracts with Chinese companies and any international counterpart, the best practice is to heavily invest in the negotiation, preparation, and enforcement of contracts, even if that goes against your basic nature to get the deal done and smooth over potential issues with a smile and a (virtual emoji) handshake.
Even though Chinese companies do not view contracts the same way as Western companies, having a strong agreement pays dividends. In the Chinese viewpoint, once you have signed your agreement, that is when the second round of negotiations really start. They are more likely to view a contract as a roadmap than a strict binary agreement. Seasoned China hands can share their horror stories of partners violating contracts and thinking nothing of it or setting up new legal entities to skirt inconvenient agreements.
Although it may seem counter-intuitive to seemingly over-invest in contracts when there is little guarantee your partners will strictly adhere to them, investing the time and energy to structure a detailed contract can pave the way to alleviate future contract disputes that almost always appear in the relationship.
For instance, you should start with a firm, detailed timeline and deliverables for your China counterpart and then give yourself a lot of opportunities to pre-approve, check, and continue to check the quality of the product they are producing for you. Rather than include an annual deliverable, break it down into monthly or biweekly deliverables so that if they start to fall behind in delivery or quality you can put the brakes on your installment payments. This scenario will force both sides to think through the entire relationship process. This definitely takes time and money, but you are laying the detailed foundation so future disputes can be dealt with in measured ways by pointing to explicit contract terms.
When you are starting the relationship, an off the shelf US style NDA is virtually never going to work. First off, they focus on preventing unauthorized disclosure, which can be very important, but the primary focus should be on preventing and stopping the Chinese company from competing with you in whatever creative way they may think of that doesn’t expressly violate the contract’s terms. Second, these US style NDAs usually call for litigation and enforcement in the United States, which pretty much every Chinese company knows will have no impact on them because Chinese courts do not enforce US judgments. See NDAs Do NOT Work for China but NNN Agreements Do.
We write our China agreements very differently. We write to convince the Chinese party that it would be better off not violating our agreement than violating it. We do this by making sure our dispute resolution clause has teeth, by making sure the Chinese party will be held liable if it manufactures our client’s product or skirts the relationship (non-circumvention), and by making clear what the damages/penalty will be for any violation.
We have written hundreds of these agreements, and about half the time they come back signed without changes. The other half of the time they come back with reasonable changes, and then we do a bit more negotiating and the agreement gets signed. In a few instances, the Chinese company refuses to sign and then we tell our clients to find someone else because that company is refusing to sign because they want to be free to compete without a good NNN Agreement making their life difficult. Any way the deal turns out, we like to make sure that we’re providing the right value to our clients to get them as secure as possible in their commercial relationships.
The main reason for having such an agreement is to prevent future problems, with an eye toward winning in court if there are problems. Even a great agreement is no guarantee against IP theft and other problems, but if you have a good agreement and you are dealing with a legitimate Chinese company, the odds will be very much in your favor. And if you do not have such an agreement, your chances of having problems will go way up because you do not look like a legitimate threat to the Chinese company.
A legal system need not be perfect to be relevant and important. The U.S. legal system is neither perfect nor certain, and yet nobody questions the value of a written contract. The Chinese legal system is far from perfect, but it has improved over time, providing more certainty to potential litigants. Even if the US system works 95% of the time in a commercial context and the Chinese system works 70% of the time in that same context, it still makes sense to have a good contract to increase the odds of your venture being a success.
As my recent PPE-dispute client would tell you, keep in mind that spending the money and time to put a good contract in place initially is much smarter and significantly less expensive than paying your lawyer to fight about a nonexistent or sloppily drafted contract later.