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In the News

Chinese Contracts. Because They Really Do Make A Huge Difference.

What is the value of the Chinese Court System?   I have been reading Dan and Steve’s China Law Blog for a while. They keep asserting the value of legally binding contracts, and note how good Chinese courts are at enforcing them. The World Bank rankings also support this view.

On the other hand, I regularly read about how useless the Chinese court system is. For example, in his latest book, Andrew Hupert writes:

“Bringing suit in China is generally considered a terrible option. It is at best a last resort.”

“A Chinese businessman, when confronted with a rigid set of rules and a counterparty he does not feel a connection with, will immediately start figuring out a way to game the system. When you give him a thick contract document, he sees an instruction manual, and that fixed corporate structure is really the set of rules to a game he plans on winning.”

“The court system offers incomplete remedies at best and has been known to be quite harmful to foreign interests.”

Opinions? Who is right?

My short answer is that both sides are right. My longer answer is that only my side is correct.

Let me explain.

Andrew Hupert says that “bringing suit in China is a terrible option.  It is at best a last resort.”  I 100% agree with Andrew on this.  As anyone who has been involved in litigation anywhere in the world will tell you, it is a horrible thing. It is expensive, time consuming, and imperfect. Litigation signifies the end of discussion between parties and, as such, it should only be undertaken after all other avenues have been exhausted. As I am constantly telling clients, “if you have to sue, you have already lost. You can win the litigation, but even so, you will have lost.”

I also completely agree with the quote about how “the court system offers incomplete remedies at best and has been known to be quite harmful to foreign interests.”  Again though, this quote holds just as true for the United States and anywhere else as it does for China. Litigation virtually never brings anyone a complete remedy.  If you are owed $250,000 and you sue and the court awards you $250,000 and the other side pays you in fairly prompt order, you still have not achieved a complete remedy.  What about the time you spent trying to settle the case before suing? What about what you might have done with the $250,000 had you received it sooner? What about your attorneys’ fees in dealing with the problem? What about all the time you and your employees had to spend on the case?  Litigation is not a complete remedy, which just underscores point number 1 on how it should always be a last resort.

As for foreigners doing poorly in Chinese courts, that too is true.  Again though, if you are Citibank, would you rather be a defendant in a court in Manhattan, New York City or Manhattan, Kansas?

But so what?  So what if litigation is horrible and time consuming and fraught with risk and not always fair?  What does that have to do with contracts in China?  Shockingly little. Renaud, everyone tells me that no matter what you do, you will always have quality problems with your Chinese factory.  Should I take that to mean that quality control is a waste of time?  Of course not.  Contracts are no different.

There is huge value in having a contract with your Chinese counterpart.  Way back in 2006, in a post entitled, China’s Courts Are Fair, we explained why corruption and unfairness and run of the mill judicial imperfections are overrated and no reason to just give up on contracts:

Every time I tout the fairness of China’s courts, however, I still feel called upon to make clear I am not a naif.  I fully realize that Chinese courts virtually never rule against the government when central government policy is at issue.  And, when I am talking about fairness, I am completely ignoring criminal and political cases.  I also recognize that even though China’s courts are controlled from Beijing, the chances of getting a fair trial are much greater in prosperous commercial cities like Shanghai, Tianjin, or Qingdao, than they are in a small city in Anhui Province.  I know too that a foreign company prevailing against a powerful local company in a Chinese court is always going to be less likely than if all parties are of the same strata.

So China’s courts are not always fair.

But, they are fair way more often than credited by the western media and I am absolutely convinced (as are all of the Chinese lawyers with whom we work) that they are fair often enough to make it as ill-advised to do business in China without written contracts or Intellectual Property (IP) protections as to do business that way in the West.

Even if China’s courts are fair only 60% of the time, this is enough to cause the rational Chinese businessperson to make decisions based on legal ramifications.

There is a commonality to judicial corruption worldwide.  Corrupting a judge is expensive.  The greater the amount at issue in the case, the more the judge will charge for a favorable decision.  The more publicly visible the case, the more the judge will charge.  The more the judge has to trample the law to reach the decision for which he or she is being paid, the bigger the bribe will need to be.  Local, trial court judges (who are most likely to know the lawyers and/or the parties) are more likely to be corrupt than appellate court judges.  Supreme Court Judges are the least likely to be corrupt.

All of this means that even in the most corrupt legal systems, the better your contract, the more it will cost your opponent to prevail and the better your chances will be as you climb each step of the court system and the more it will cost to change that.  When I tell clients this, their reaction is usually, something like, “great, all this means is that my opponent will need to pay the judges half a million dollars to beat me, rather than only $10,000. That still doesn’t help me.”

Oh yes it does.

If the other side is going to need to spend $500,000 to beat you, they should be willing to settle with you for even more than that.  They should be willing to pay you more than a judge because settling with you has a greater certainty of finality and outcome and because it has a much greater certainty of their not getting arrested for bribery.  If you have no contract or a lousy contract, the other side may be unwilling to pay you anything, figuring a small judicial bonus is all it will take to assure legal victory or that you will choose not to sue at all.

Chinese courts generally fairly resolve commercial disputes and they are continuing to improve.  China’s courts already are sufficiently fair that Chinese businesses for the most part do consider the legal ramifications of their actions and act accordingly.

Bottom Line:  There is no justification for failing to take legal precautions there (such as written contracts and IP protection) when doing business in or with China that you do when doing business in the West.  Those who justify their failure to do things by the legal book in China because “the courts don’t enforce the law there anyway” are both empirically wrong and foolish.

Even if you never intend to sue anyone in China, it makes sense to have a good contract, preferably in Chinese.  There are three main reasons to have a good contract, and suing and winning on it is only one of them.  Another reason is to make sure you and your Chinese counter-party are on the same page.  We actually wrote about this very topic just a few weeks ago, in Chinese Manufacturing. Delivery Date? What Delivery Date?

One of the most common problems we see between American companies and their Chinese manufacturers is “late” delivery.  I put late in quotes because many times I think the problem is not so much that the Chinese manufacturer was late, but rather that the contract and the American buyer were unclear on the actual delivery date requirements.

Let me explain.

When we draft an OEM Agreement (a/k/a Manufacturing Agreement or Supplier Agreement), we are always very careful regarding delivery times.  Most of the time, our clients come to us with a term sheet or an oral agreement with their Chinese manufacturer dictating something like 30 days for delivery.  We like strictly tying the Chinese manufacturer to the “agreed-upon” delivery time and we usually do that with a liquidated damages provision tied to late delivery.  Just by way of example, we might put into the OEM Agreement a provision saying something along the lines of delivery shall be within 30 days and for every day beyond thirty the Chinese manufacturer shall be required to pay US Company 1% of the purchase order price within ten days.

Perhaps more than any other contract provision, we tend to get blow-back on the delivery time provision from the Chinese manufacturer. Oftentimes when faced with the reality of having to pay a set amount for late delivery, the Chinese manufacturer gets really serious about delivery times and tells us that they simply cannot promise delivery within the previously “agreed” time frame.  Our client usually realizes it is better to get real agreement (even if longer than originally anticipated) before ordering, rather than getting late delivery after ordering.

The other, somewhat related issue we face on delivery times is that when our client comes to us and says it has agreed with its Chinese manufacturer to a 30 day delivery schedule, we then have to figure out 30 days from what.  We typically go with 30 days from the issuance of the purchase order, but oftentimes the Chinese company pushes for it to be 30 days from its receipt of payment or 30 days from its receiving proof of payment.

Bottom Line:  Certainty is important with respect to delivery dates and, without a doubt, the best way to achieve that certainty is a written contract, in Chinese (so that there is no doubt the manufacturer understands what is on the paper) clearing setting forth the delivery date.

The third reason to have a good contract is to put a little scare into your Chinese counter-party.  I call this the “bike-lock theory of Chinese contracts” and I wrote about this too way back in 2006, i China OEM the Smart Way:

The best solution for this is to prevent it from happening in the first place and the best way to do that is to choose the right supplier and use a good OEM contract.  When we draft OEM contracts for our clients, we always put in a provision precluding the Chinese manufacturer from subcontracting out production. Without exception, the Chinese manufacturers have agreed to this provision and, again without exception (at least as far as we know), they have always abided by it.  The reason for this is simple.  The manufacturer may have twenty some companies for whom it produces goods, but probably less than half of them forbid subcontracting.  When the Chinese manufacturer is so busy as to require subcontracting, it makes sense for it to first subcontract out work for those foreign companies for whom it is NOT prohibited by contract from doing so.  I am always analogizing this to bike locks.  Even the best bike lock cannot prevent all thefts, but its efficacy comes from the fact that bike thieves generally find it easier to steal a bike with a poor quality lock or none at all than one that is difficult to break.

Any contract that makes your Chinese counter-party think twice about messing with you has at least some value.  My law firm is constantly settling cases with Chinese companies based on well-written contracts.  Chinese company clearly owes our client a million dollars per a well written contract and we settle for $650,000.  Had it been in the United States, we might not have taken less than $850,000.  But had there been no contract, my firm would not have even taken the case and settlement would likely have been for nothing at all or something really nominal.

Having a well written contract does not mean you will always win your lawsuit if you are forced to sue on it. But it does mean you will have some leverage if things go wrong and it does mean you will at least have a chance. Having no contract means no chance. Hey, it’s your choice.

Ain’t no way am I gonna back down on this one.  Who’s with me? Renaud?

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Edward Lehman 雷曼法学博士
Managing Director 董事长

LEHMAN, LEE & XU China Lawyers

Lehman, Lee & Xu is a top-tier Chinese law firm specializing in corporate, commercial, intellectual property, and labor and employment matters. For further information on any issue discussed in this edition of China Litigation In The News or for all other enquiries, please e-mail us at mail@lehmanlaw.com or visit our website at www.lehmanlaw.com and Mongolia www.lehmanlaw.mn.

Lehman, Lee & Xu Mongolia is one of the first and only international law firms with a full time presence in Mongolia.  Our Ulaanbaatar office is staffed with resident foreign legal consultants having significant experience in Mongolia and qualified Mongolian attorneys. The firm’s foreign legal consultants and local attorneys are fully acquainted and experienced with Mongolia’s laws and legal system, business climate and political affairs. For any Mongolian legal matters please refer to our Mongolian website www.lehmanlaw.mn.

© Lehman, Lee & Xu 2012.
This document has been created for educational purposes for clients, potential clients and referrers of services to Lehman, Lee & Xu, and to alert readers to the services provided by Lehman, Lee & Xu. It is not intended to serve as definitive professional or legal advice, and should not be relied upon as such. Lehman, Lee & Xu does not endorse any personal opinions which may be contained herein.
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