We have been drafting an increasing number of contracts for foreign companies licensing their concept or technology for use in China. In the old days, this type of licensing was primarily in the industrial sector. These days, most of our work has involved licensing agreements in the services sector in China. Much of this licensing is for operations in China prohibited to foreign companies, such as publishing, media, telecom, insurance and finance. Most of these foreign companies are choosing to license, rather than to participate in a China Joint Venture.
This post describes the negotiating tactics my law firm’s China lawyers so often see from the Chinese side and sets forth how foreign companies can counter those tactics.
The Chinese government is internally conflicted on how to treat this new form of licensing. In industrial sector licensing, the Chinese government is eager for the technology transfer to occur. The same is not true in the service sector. On the one hand, the Chinese government formally welcomes the transfer of Western expertise in the service sector. On the other hand, the Chinese government fears foreign participation in China’s service sector will lead to unacceptable control of the Chinese system.
This ambivalence is mirrored by many of the potential licensees our law firm deals with in the service sector. Industrial licensees bargain hard, but the bargaining is similar to any commercial negotiation. In the service sector, we are finding the Chinese side works to strike a much harder deal. This often surprises our clients, since they expect the service side to be softer than the industrial.
As part of this process, in service sector licensing contracts we are starting to see the Chinese side dust off negotiating tactics that were common in the 80’s and 90’s when the Chinese were negotiating their famously dysfunctional joint venture agreements. In negotiating service sector licensing agreements with Chinese companies, we are seeing the following tactics from the Chinese side:
1. Endless Issues. The most common tactic is for the Chinese company to seek to wear the foreign side down with endless issues. This tactic actually has two variants. In the first variant, the Chinese side raises a series of issues. As these issues are resolved, the Chinese side then raises a series of unrelated new issues. The list of issues is endless and the process never stops. The second variant is for the Chinese side to make several unreasonable demands and then refuse to address the concerns of the foreign company on the other side. As in the first variant, the discussions proceed with no attempt at all by the Chinese side even to pretend to address the concerns of the other side. All this is designed to wear down the foreign side in the hopes it will simply concede. When the foreign side concedes, the Chinese side then inserts provisions in the agreement that are beneficial to the Chinese side, under the assumption the foreign side is simply too tired to object. The success of this strategy depends on the foreign side negotiators being busy people with a lot to do, while the negotiators on the Chinese side are functionaries with no other job beyond endless negotiation.
2. Artificial Deadline. This is my favorite because it is such an obvious manipulation of the foreign side and yet it seems to work extremely well. The tactic works like this. At the very beginning of the negotiating process, the Chinese side sets a fixed date for executing the contract. It then sets up a public signing ceremony on that date, at which high-level officials from both sides will participate amidst much pomp and circumstance. The date is set far enough in advance to ensure that parties negotiating in good faith can reach agreement on the contract. The Chinese side then ensures no agreement is reached. This results in panic on the foreign side, since failing to get an agreement the bosses will sign is seen as a loss of face. The Chinese side then uses this concern to extract concessions from the already exhausted foreign side negotiator. This tactic also has two variants. The first variant is the crude approach. The Chinese side simply refuses to concede on key points under the quite reasonable assumption the foreign side will crumble when faced with the fixed signing deadline. The second variant is much more subtle. In this variant, the Chinese side initially concedes on key points, while still holding its ground on numerous minor points, consistent with the “wear them down” tactic. Then, just a day or two before the signing ceremony, the Chinese side announces that the contract must be revised on one or more key issues in a way that entirely benefits the Chinese side. The Chinese side usually justifies this by referring to the demand of a “government regulator” or an outside source such as a bank or insurance company. The claim is “we don’t want to go back on our word, but these other folks have forced us to do this.” Again, the plan is to use the pressure of the impending signing ceremony and the general fatigue of the negotiators to extract crucial concessions favoring the Chinese side.
3. Revisit the Deal Without the Lawyers. The final technique is to come back to the key issues after the lawyers have left the room. Though this is an obvious technique, it works well with service businesses. This tactic involves the Chinese side signing a contract, conceding on the key issues. By virtue of the contract having been signed, the key negotiators, China advisors and most importantly the international lawyers, are off working on other projects. The Chinese side then waits a reasonable amount of time and works to get the project started. Once the project is started, the foreign side is then invested in the project. Since service projects involve people, certain key persons on the foreign side are now fully committed to the project. Once this happens, the Chinese side then goes to the committed parties on the foreign side and announces the need to change certain key provisions of the contract. The Chinese side usually claims this change is mandated by law, government regulators or banks and insurance companies. The only people left at this point are the “committed parties” with a strong incentive to allow for the change so the project can proceed. Often, these people do not fully understand the implications of the change the Chinese side is now demanding. The foreign side then presents the change to busy upper level management as a minor technical revision and it gets signed. Everyone remembers how the initial negotiation was so troublesome and nobody wants to bring in “legal” to start the process all over again.
Though crude and obvious, the above three tactics work often enough so Chinese companies do not hesitate to regularly employ them. There is one simple antidote for each tactic:
1. If the Chinese side uses the “endless issue technique,” the foreign side should refuse to participate. The foreign side should firmly state its position and not bend unless and until the Chinese side moves closer to the foreign side’s position.
2. Never agree to a fixed signing date. Make clear that the signing ceremony should be scheduled only after the contract has completed final negotiations. If that takes forever, it takes forever. Never allow the Chinese side to use a deadline as a tool. This seems like obvious advice, but we see this rule constantly violated. Chinese companies love signing ceremonies and foreigners fall into the trap because they do not want to cause offense at the start. The Chinese have contempt for a sucker, so refusing to go along on this obvious technique will not cause offense: it will instead earn the respect of the Chinese side.
3. Make clear there will be no changes to the contract after signing and any attempt by the Chinese side to change the contract will be treated as a material breach, leading to termination and a lawsuit for damages. Chinese companies are well known for using the signing of a contract as the start of a new negotiating process, not the termination. If the foreign party accepts this approach, it should at least have clear procedures for bringing back their legal and China advisory team. The neutral players on the foreign side must make the decisions, not the foreign side players who have already become committed to the project.
Negotiating a good licensing agreement with Chinese companies is difficult and time consuming, but much less so if you know how to handle Chinese negotiating tactics. There is no reason to make the situation worse by falling for the simple negotiation tactics discussed above.