At a recent meeting of foreign businesspeople in Qingdao, I sat next to a very unhappy man who loudly stated: “Chinese contracts are not worth the paper they are printed on.” I told him: “Your statement is not true. As a matter of fact, the Chinese courts do very well at enforcing clear written contracts.”
As usual, I was greeted with disbelief. The problem with this person’s statement is that it becomes a self-fulfilling prophecy. People who think China will not enforce contracts tend to ignore the issue. They either enter into no contract at all or they enter into a poorly drafted contract or they enter into a contract that is not enforceable in China. This is the actual story for this particular individual. As he now knows, this attitude about Chinese contract enforcement is a mistake.
My view of the Chinese contract enforcement process is based on over 30 years of experience in China. However, I am clearly not the only person who has come to this conclusion. Every year the World Bank publishes its Doing Business rankings. This report ranks 181 countries by ease of doing business. As might be expected, China ranks about in the middle of this list at number 83 countries. Not the worst, not the best, but still a challenging place to do business. China gets low scores in areas that are quite familiar to me in my daily practice: Starting a Business 151, Employing Workers 111, Paying Taxes 132.
However, in the category of Enforcing Contracts, China is ranked number 18. This means China is one of the best countries in the world for enforcing contracts. Compare that with India, which ranks at 180 out of 181 countries, or Brazil, which is at 100. The China rating is actually better than the United Kingdom, which comes in at 23, and better than Japan, which comes in at 21. It is therefore a serious mistake to place China in the same category as some of its developing country competitors.
Why then do people continue to say Chinese contracts are not worth the paper on which they are printed? This appears to be due to the following three things:
1. Chinese companies have an unfortunate tendency to ignore contract terms in dealing with foreigners. They do this not so much because they believe they can prevail in any eventual lawsuit, but because they assume (too often rightfully) the foreign company will never sue. This leads them to believe they can violate contract terms with little risk.
2. Many contracts foreigners companies enter with Chinese companies are not enforceable in China. A typical unenforceable contract is not written in Chinese, not subject to Chinese law, and does not provide for enforcement in China. Such contracts are usually not worth the paper on which they are printed, but this is not due to a defect in China’s legal system, that is due to the foreign company having used a no-good terrible contract.
3. Many contracts are too vague to allow for effective action by the courts. The Chinese courts are good at enforcing simple, clear contracts where the standards for default are objective and where the penalty for breach requires little to no legal analysis. The Chinese courts are not good at making a contract for the parties, as is common in the U.S. and English legal systems. It is therefore essential to use contracts that will produce a good result in a Chinese court. Too many foreign parties want to base their claims on a complex set of emails, oral communications and industry practice over time. None of these things typically works in China. An aggressive lawsuit based on a clear written contract does work.
The Chinese court system is one of the gifts the Chinese system gives foreign companies. Given the other obstacles and difficulties foreign companies, it really is a big mistake not to take advantage of the Chinese court system for enforcing contracts.