China Contracts: Good and Bad

Our China business lawyers see 5-10 China contracts a month written by others. We often are sent these from a potential or actual client who wants us to review and revise their contract or determine how it might fare were they to pursue a breach of contract claim. Other times, we get them simply because our law firm is on one side of a deal reviewing a contract drafted by the other side.

The first thing I do when given a contract to review is spend a couple minutes skimming it to get a sense of whether it is workable or not. By workable, I mean whether it can be revised to work or whether it is so flawed that it would be faster cheaper, and easier to just scrap it and start over. Lately, our quick contract skims are finding an increasing number of contracts that are not only horribly written, but scream fraud.

About half the time, the contracts we see will — with changes — work. The below is an amalgamation of emails we typically write to clients that want us to “China-fy” a well written international distribution contract:

We’ve looked at your standard international distribution contract and it’s definitely workable; it will be faster and easier for us to modify your existing agreement than to start over and draft a new one.

Based on our quick skim of your distribution contract, we recommend we do the following, among other things:

1. Remove the provisions that do not work for China, including the disclaimer of warranty provision and the provision disclaiming consequential damages.

2. Discuss with you removing various provisions that rarely make sense for China, such as the mandatory insurance provision and the mutual indemnity provision.

3. Replace the confidential information provisions with NNN provisions that will work for China. This is actually more complicated than it sounds as it is absolutely critical your NNN protections be specifically tailored to your individual situation and IP and trade secret and confidentiality needs.

4. Discuss with you certain provisions in this contract that are unclear or do not make sense.

5. Make the entire contract China-centric. This will likely include our making the official language Chinese and re-crafting it into Chinese. This will also likely include our changing the applicable law to Chinese law and changing the venue to the appropriate Chinese court or arbitral body. We also will likely want to dispense with the provision requiring discussions and then mediation before filing any lawsuit. This sort of provision can sound good in theory, but our international dispute resolution lawyers tell us that in real life these provisions just increase attorneys’ fees and delay resolution.

6. We will work with you to remedy some inconsistencies. For example, in one place the shipping terms are listed as FOB but in another place it says EXW.

When I am quickly reviewing a China contract — or what is being put forward as a China contract — I typically look first at the following three basic and nearly universally required terms, because if these terms are not included or are not written in a way that reveals international sophistication, the odds are overwhelming that the contract is not workable.

1. Payment. For obvious reasons, payment terms are critical and many (most) disputes stem from this. Does the contract address how payments are to be determined and when and how they are to be made? Does it state the currency in which payment must be made? I am big on checking on this one because during the Asia crisis about a decade ago, our international litigation team handled cases where companies lost huge sums due to contracts that did not protect against currency risks.

2. Termination. I’ve seen contracts that mandate a one year termination and with the termination the Chinese company is free to use the foreign company’s IP and even sell the foreign company’s product to the foreign company’s clients. Not a good idea. I’ve also seen many contracts with no termination date and no provisions even for allowing termination. Do you really want XYZ China company to be your exclusive China distributor forever, no matter how terrible it is in selling your products or services? Wh0 pays for what at termination?

3. Dispute Resolution: Jurisdiction, Choice of Law, Official Language. It takes us all of 30 seconds to determine whether these provisions make sense or not. A provision that calls for British law to be applied to an arbitration in Geneva that is to be conducted in Chinese (yes we have seen this) is an example of one that makes no sense at all.

These provisions can mean the difference between a China contract that works and one that does not. See China Contracts: Make Them Enforceable Or Don’t Bother.