Had lunch yesterday with two long-time friends, both international lawyers who have spent many years living and working in China. During a discussion about an international real estate matter on which one of the lawyers was working, someone asked if we remembered back when foreigners were able to freely buy real estate in China. We all said yes, and then we ended up talking about how when the laws on that changed, so many people tried to get around it and ended up losing money. Then one of the lawyers talked about how when he was living in China he became good friends with the local police chief and the police chief offered to allow the lawyer to purchase a condo in the police chief’s name. The lawyer talked about how though he was certain the police chief had only the best of intentions, he never seriously considered the offer. We then told war stories that highlighted the risks of “handshake deals,” including the following:
- U.S. company works beautifully with a Chinese factory for nearly 20 years based entirely on oral agreements. The CEO of the U.S. company was great friends with the owner of the Chinese factory and because of that he had always refused all suggestions that the company document the terms of the two company’s manufacturing relationship just as it had done with its other factories. The US CEO insisted that to do so was not only unnecessary, but would be “an insult to his friendship with the factory owner.” The Chinese factory owner ended up dying young and his son takes over and in less than 30 days terminates the relationship between the two companies. The U.S. company had to scramble for a new supplier and it loses millions in sales and many customers by being unable to provide product during the transition time. A written contract requiring sufficient notice of termination would almost certainly have prevented this.
- Local government allows an Italian company to set up a factory even though the Italian company’s WFOE scope did not cover this. See Forming a China WFOE: Scope is Key. All is great for two or so years but then Beijing audits all of the WFOEs in this city and it shuts down the factory.
- Local government seeks to convince an American company to set up in their city with all sorts of improper tax incentives. American company — against the advice of its lawyers — sets up its China business in this city based almost exclusively on these tax incentives. Less than six months later, the local government regime gets booted out for corruption and the new regime very quickly removes every single illegitimate tax incentive given. American company’s costs soar so high that it ends up moving to the city it should have picked in the first place. The move cost them hundreds of thousands of dollars.
The moral of these stories is that what isn’t legal and in writing is ephemeral.
At another point in the lunch one of the lawyers talked about artificial intelligence software for high volume contract review. Companies use this AI software quickly and cheaply review large volumes of relatively small contracts. The software calls out “red flags” in the contracts so the in-house lawyers or contract specialists know what contract changes to seek. An example would be a contract that in one place calls for disputes to be resolved via arbitration and in another place calls for disputes to be resolved via the local court. The software will highlight a contradiction like this.
From this we started talking about how so many of the red flags we see in Chinese contracts are not so simple because they so often involve things entirely outside the contract. As an example, we talked about how it is common in the West for a buyer of products to require the product seller to have product liability insurance that protects the buyer should the product prove defective and injure people. But a provision like this in a Chinese manufacturing contract should be red flagged because this sort of provision almost certainly will not provide any real protection and yet it also very likely will be used by the Chinese factory to increase its prices. See The China Price and Product Liability Insurance: Never the Twain Shall Meet.
At the very end of our lunch, one of the lawyers talked about how he had been talking with a client earlier that same day who was just incredulous about how its Chinese counter-party had so blatantly and blithely violated a guarantee in their contract. We concluded that the only guarantee when doing business with China is that there are no guarantees.
