Contracting in China: The Old and the New
It used to be common for OEM manufacturing in China to be done on a purchase order basis, with no underlying contract. Much service work done by foreigners for Chinese clients was based on an exchange of emails.
Today, however, to be able to bring a plausible claim against a Chinese company, the foreign plaintiff almost always must be able to show a formal relationship between the parties. Unlike in the U.S. or the EU, Chinese courts rarely allow for proving the existence of a contract by putting together scattered POs, invoices, emails, and desperate phone calls. The court will insist on a written agreement that unambiguously names the parties and provides the basis for the agreement.
Enforceability Criteria for Chinese Contracts
The contract must also be enforceable in China. As a practical matter, Chinese courts rarely enforce foreign judgments, and it can be quite difficult to get them to enforce a foreign arbitration award.
A contract enforceable in China must meet the following basic standards:
1. The contract is governed by Chinese law
Under Chinese law, it is permissible to provide that the contract be governed by foreign law. However, providing for foreign law all but guarantees failure in a Chinese court because Chinese courts require the party prove every relevant element of foreign law. This is a disaster for several reasons. First, proving foreign law is expensive. Second, proving foreign law leads to delay. Third, skillful defendants will dispute the application of foreign law, rendering your case and even any judgment you receive uncertain.
2. Chinese is the contract’s governing language
Under Chinese law, it is permissible to provide that the governing language of the contract is a foreign language such as English. To do so, however, nearly always leads to disaster. Chinese courts will only work with Chinese language documents. This means the contract must be translated into Chinese. The translation will not be done by the parties but rather by a court appointed translator. The translator is often not particularly skilled, and the resulting translation is often simply wrong. Even when the translation is correct, the defendant will often dispute the translation, leading to delays and ultimate uncertainty in the decision. Having someone else translate your contract after you sue means that you do not even know exactly what the contract says on which you are basing your lawsuit. We are also aware of Chinese courts simply refusing to hear cases that involve contracts in a language other than Chinese.
3. The contract should be enforceable in a Chinese court with jurisdiction over the defendant
This normally means jurisdiction in a court in the district where the defendant has its principal place of business. China has excellent domestic arbitration panels with extensive experience in resolving foreign disputes. But litigation is usually a better alternative for several reasons.
First, in disputes with smaller Chinese companies, there is a concern the company will dissipate assets before a judgment can be obtained. Chinese courts can order a prejudgment writ of attachment that prevents this. In addition, a prejudgment writ will often convince a smaller Chinese company to resolve the matter quickly.
Second, the plaintiff in a dispute with a Chinese company will often want an order instructing the defendant to take some action such as ceasing to infringe IP rights, return molds or tooling, or appointing a manager or officer of a company. In other words, what would be called injunctive relief in a common law system. Chinese courts have authority to issue such orders and arbitration panels do not.
4. Litigation location matters
Many foreign parties will seek agreement for jurisdiction in some neutral district such as Beijing or Shanghai. This is a mistake. First, Chinese courts usually ignore such agreements. Second, and more important, Chinese courts are reluctant to enforce judgments from other districts and they often ignore orders issued by Chinese courts from other districts. This means if you get a judgment in Beijing but need to enforce it in Chengdu against your Chinese counterparty, you may not be able to do so.
Realities of Chinese Court Litigation
The above basic requirements help but they don’t guarantee success for foreign plaintiffs. Like all courts in undeveloped legal systems, the Chinese court system has many weaknesses. However, in most instances litigation in Chinese courts is more likely to produce a good result for a foreign party than litigation in virtually every other Asian court. That is, litigation is not futile and my law firm’s international dispute resolution attorneys have had excellent results when overseeing litigation in courts all over China.
A Common Mistake
In most instances China’s courts are better than the alternatives for pursuing recourse against a Chinese company. Several times every month an American or European company will contact my law firm for help in resolving a dispute with a Chinese company. The aggrieved foreign party sends us their 30-page long expertly crafted English language contract, but despite the document being a masterpiece of legal drafting, we immediately page through to the end to look at the dispute resolution provision. Its dispute resolution clause almost always violates these rules. Thus, the exact dispute resolution provision on which the foreign party insisted makes the contract unenforceable for the foreign party. The dispute resolution clause chosen by the foreign party makes negates its ability to enforce its contract. We are then forced to tell them that our law firm has no interest in litigating their case because we think the odds of success are low.
Of course, sometimes prevailing with any form of dispute resolution is difficult to impossible. In some cases, due to the district in which the Chinese company is located (small, one factory town) or due to the nature of the Chinese party (SOE or military or owned by a princeling), there is little hope of receiving a fair trial in China. But, if there is little hope of receiving a fair trial in the defendant’s hometown, there is also little hope of enforcing any other judgment or award in that district either. It therefore is not useful even in this sort of situation to be fooled into relying on a dispute resolution technique that will never be of benefit. It is critical to be realistic. If the contract cannot be enforced in the Chinese courts, the foreign party must enter into what we call a self-enforcing contract. See Drafting Contracts for Countries with Unreliable Legal Systems.
Conclusion: Ensuring Compatibility with Chinese Legal Frameworks
China’s transformation from informal agreements to relatively clear contractual standards speaks volumes about its legal progression. For businesses that seek to operate successfully in or with China, it’s imperative they understand and adapt to these current legal realities.
This means ensuring your contracts align with China’s contractual legal framework by having a contract that is governed by Chinese law, that uses Chinese as the governing language, that is enforceable in a local Chinese court with jurisdiction over the defendant, and that will be litigated in the district where the Chinese defendant operates. To ignore these key elements in your China contracts is to jeopardize your legal interests.