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Five Things About China Business Deals

China business deals

View to China blog just did a post, Five things about doing deals in China that are different from the West, [link no longer exists] enumerating some of the peculiarities of China business transactions.

The below five in normal font come from the View to China blog. My comments are in italics.

1. China joint ventures.
Negotiating these often becomes “more adversarial than it should because it feels like two parties are trying to carve out their individual niches and protect their own turfs. It can be easy to forget that the point of the exercise is to provide the basis for the ongoing management and governance (and success) of the jointly-held company.”

I completely agree that negotiating joint ventures often becomes adversarial, but I also think this is often necessary and in some ways actually a good thing. It is better to know before going into a China joint venture that it will not work than to learn this later. 


2. Rigid capital and profit distribution structures.
Along the way, a foreigner discovers that certain issues are pretty rigid in China, especially when it comes to China joint ventures. One of them is the capital structure and how much one can derive from the investment relative to one’s investment. Indeed, one obstacle private equity firms find investing in China is that China’s Equity Joint Venture structure requires profits be distributed in accordance with the proportion of equity holdings. If you own 50% of the company, you get 50% of the profits.

What China View says here applies to much of Chinese law, in that it Chinese law is more formalistic and rigid than in the U.S. or Europe. 

3. Reciprocity in negotiations. When asked to provide a certain undertaking, Chinese companies often insist on a reciprocal undertaking by the foreign investor to ensure “fairness”. At times, the request does not even make sense, e.g. when the foreign investor requests the Chinese enterprise provide warranties regarding its assets because it is buying assets from the Chinese company. Why in this circumstance should the buyer provide a warranty on its assets? Often, however, reciprocal undertakings are easy to give away, since they have no real meaning anyway.

Our China lawyers often deal with this reciprocity issue, even on something as basic as an NNN Agreement. For example, it is not at all uncommon for Chinese factories to demand that our clients sign an NNN Agreement to protect the Chinese company, but then when we ask exactly what it is the Chinese company wants to protect, they cannot name one thing. Should our client agree to sign a meaningless contract or a contract with meaningless provisions? I am a perfectionist and I have always believed contracts should not contain any meaningless provisions. My fear is that what should be seen as a meaningless provision will not be so viewed by a judge or arbitrator who will (rightfully) believe that it could not have been put in the contract for no reason, and then will seek to interpret it to have meaning. And that meaning may not be the meaning I want for my client. This is still a problem and the reason is because so often Chinese companies skimp on their lawyers and demanding whatever the other side gets (no matter whether it makes sense or not) is a classic sign of a bad lawyer. My hope is that as Chinese lawyers become more sophisticated and more international, this knee-jerk demand for reciprocity will cease, but I am not seeing any sign of that yet. 

4. Demands based on fear of the other. This category includes demands about governing law and the dispute resolution forum. Many foreign companies fear submitting to Chinese law and agreeing to dispute resolution in China. Many Chinese parties seem to feel the same way about foreign laws and foreign arbitration and courts. Agreeing to arbitration or even the jurisdiction of a court in China is not such a bad idea, since (i) arbitration at the China-based China International Economic Trade and Arbitration Commission (CIETAC) is easier to enforce than a foreign arbitration award which can be simply ineffectual in China and (ii) foreign court judgments mean nothing if the Chinese party does not have assets in that jurisdiction. Governing language clauses also fall into this category. If a foreign investor is willing to submit to the jurisdiction of a Chinese court, then it follows that the Chinese language version should govern, since the court will not read anything else. You can find much more on this issue over at the China Law Blog, and I am indebted to them for making such good sense about these issues so many times that it convinced me they were right.

Needless to say, I agree with all of the above. What I am always saying regarding the official language of a contract is that it is always better to agree on one language because having two languages just greatly increases the chances for misunderstandings and attorneys’ fees should a dispute arise. Agreements that are governed by U.S. or English or Spanish or French. or German or whatever law, with enforcement by litigation in the U.S. or England or Spain or France or Germany or by arbitration outside of China are almost always useless because the foreign court may not have jurisdiction over the Chinese company and because Chinese courts almost never enforce foreign judgments. This means you can get the foreign judgment, but you cannot get paid on it. Arbitration outside China is expensive and slow and proof is difficult or impossible to provide and it means no access to injunctive type remedies that would be available for arbitration in China. And though China is supposed to enforce foreign arbitration awards, its record of doing so is abysmal.


5. Agreeing to agree.
 Like the reciprocity requirement, many China-related contracts contain a clause mentioning that there are outstanding issues the parties haven’t yet entirely resolved and will agree on in time. This clause is often used when there is a little detail the parties can’t quite agree on but feel like they’ve had enough and need to move on and sign the thing. In the English system of law, clauses that don’t pin down an obligation on a party are called “agreements to agree,” and they are generally seen as worthless. Yet, many China contracts have “agreeing to agree” clauses that never needed to be readdressed. The main thing is the deal got done and everyone moved on. Plus, who has not seen enough “amended agreements” to know that even if parties do agree on something, they can change their minds or need to clarify things after the fact. It is just human nature. So maybe the Chinese are onto something when they recognize this upfront and don’t try to dot every “i” and cross every “t”.

This was actually my favorite of the list because it initially really bothered me when I started drafting contracts with Chinese companies, but I now actually sometimes appreciate these clauses. It is very “non-Western” and Western lawyers tend to really hate these provisions because it is so counter to our legal training. It actually comes up all the time. Here are a few examples that our China lawyers have seen lately:

A. Large, well funded Chinese company needs US technology to improve its product quality and increase its sales. It contacts our client wanting to do a joint venture. Our client wants to go into China more slowly so instead agrees to license out a few of its products to the Chinese company. The licensing is a way for our client to make good money in the short term, while at the same time, it will help it determine whether this Chinese company is one with which it should be getting even closer. We draft the licensing agreement and the Chinese company adds a number of provisions talking about how if the two companies do well with their licensing agreement, they will form a joint venture with such and such terms.

My sophisticated client and its very good in-house lawyer are completely non-plussed by this proposed language. The in-house lawyer wants it removed completely, fearing that whatever language is in there is an open invitation for a law suit if a joint venture never happens. The client is worried that stripping it out will be viewed as an insult to the Chinese company and contradict much of what they had been discussing.

I agree with the in-house counsel that such provisions are dangerous and I talk about how if we are going to sign off on the language the Chinese company has put forth, we really ought to draft up and negotiate an entire “tentative” joint venture agreement. But that makes no sense at all because, as I point out, my firm does not offer “tentative” discounts and so negotiating and drafting such a joint venture agreement will cost no less than a “real” joint venture agreement and joint venture agreements are expensive.

So I propose we replace the two pages of the Chinese company’s proposal with something along the lines of how both parties hope this licensing agreement will allow them to get to know each other well enough such that they will want to strengthen their relationship with future ventures. We did this, the Chinese company was fine with it, and the deal got signed.

 

B. We represented a large US service business that had a very successful multi-year working relationship with its Chinese counterpart. The American company would bring on its Chinese counterpart most of the time when it had China-based work and the Chinese company would do the same when it had US-based work. But one day the Chinese company proclaimed that it wanted to “formalize” its relationship with the American company. I do not think the Chinese company used the word “formalize” but that was certainly the gist of what it was saying it wanted.

Our American client was vehemently opposed to “formalizing” the relationship. The American company loved its relationship with the Chinese company, but felt that in at least a few areas, it was not the best Chinese company to use. The American company also saw no benefit in changing its relationship with the Chinese company because they had been working so well together and it worried that negotiating and putting their arrangements on paper risked doing their relationship harm. As things stood, the US company simply paid the Chinese company regular rates whenever it brought it on and everyone was happy with the financial aspects of that relationship. Lastly, the American company was concerned that if it formalized its relationship with the Chinese company, it would look strange if it did not reflect that relationship in some way on its website, and it did not want to do that for fear of offending some of the other Chinese companies with which it also did business.

Yet at the same time, our American client was worried that if it said no to “formalizing,” it would lead to the end of a great relationship.

I suggested we seek to figure out what the Chinese company really wanted from this relationship and we had one of our China lawyers do the talking with the Chinese company because our being a third party would the emotions. We talked with the head people at the Chinese company and learned that their goal was more than anything a desire to memorialize and recognize their excellent relationship with the US firm. The Chinese firm wanted to do this for the following reasons:

  • To show the American company how happy it was with the relationship.
  • To be able to brag about the relationship to their (1) Chinese clients, (2) potential Chinese clients, (3) their own employees, (4) potential employees, and (5) the Chinese government. The Chinese company wanted to be able to provide these people with concrete proof that they were affiliated with a well-known and highly regarded American company.

Working with the Chinese company, we quickly drafted a two page document the Chinese company absolutely loved, yet had no legal impact. The document merely started out talking about how great the relationship had been and how both sides wanted it to continue. The document talked about how the parties would continue to try to refer appropriate work to each other and work on matters together, when appropriate. It concluded by talking about how the parties hoped their relationship would continue to grow and prove financially sound for the two of them. The two companies got together for a great dinner with a lot of toasts and signed the document.

This was at least three years ago and every “aspiration” in this document (note how I did not say contract) has been fulfilled. Such a document is pretty much unheard of in the West, where everyone is sensitive to legal entanglements. And, in a perfect world, I would have counseled my client against signing it because it violates the rule I discussed above about legally meaningless provisions, but for business reasons it made complete sense and in the real world, business exigencies, not paranoid lawyers, do and should drive business and using “aspirational language” can be a great way to solidify relationships in Asia — we have done similar things with companies in Vietnam, Korea, Thailand, and Japan, and Russia.

What do you think?

9 responses to “Five Things About China Business Deals”

  1. I can think of two situations under Chinese law where an agreement to agree would have legal impact.
    There are a lot of provisions of Chinese law in which there is a rule that gets applied unless the parties agree otherwise (take any Chinese law and search for “unless otherwise agreed”). By putting in a statement that there is no agreement, the contract keeps those provisions from kicking in.
    The other issue is “good faith”. Chinese law is based on German law which has a very wide definition of “good faith” in executing a contract, whereas Anglo-American law only applies the concept of “good faith” in the formation of the contract rather than in its execution. What can happen under Chinese/German law is that if there is a dispute, one party can accuse the other party of not acting in “good faith” and can get the court to reinterpret the contract. By having a clause that shows that there was no agreement on a topic when the contract was formed, then if the parties start arguing about it afterwards, then you don’t have grounds are arguing “lack of good faith.”

  2. Also the fact that Anglo-American law doesn’t have a “good faith” concept makes it much more dangerous to draw an aspirational contract in the United States than in Continental law. English lawyers tend to look strictly at the contract and to not inquire much into the motives of the parties. So if you write a contract under English law, and it has a clause that is bad for you later, it’s hard to revoke.
    By contrast, if an aspirational contract under Continental law has a bad clause, then the courts will look at the motives of the parties, and it’s unlikely that clause will be enforced. Conversely, the fact that everyone is smiles can be taken as evidence that the parties are acting in “good faith” which may be important in later disputes.
    The other thing is that one has to be careful in isolating *why* something is different.
    The fact that China and the United States are different in some way may not be an Western/Eastern thing but a English-law/German-law, developed country/developing country, US/rest of the world, China/rest of the world thing, place with reliable courts/place without reliable courts thing.
    It’s interesting for example, how Russia somehow becomes Asian, while in other contexts Japan becomes Western.

  3. I agree completely with the comment that foreign clients should not fear mainland arbitration. I believe that I made this point here quite recently. My tactic with this one has been for the client to initially raise as an issue in neogiations but then to concede on it, either as a gesture of good faith or in return for a reciprocal concession.

  4. Some people are soccer fans. Some people are Star Trek fans. I’m a comparative law junkie…..
    There is a reason why Chinese companies have very rigid capital structures. Suppose you have a state-owned enterprise that needs to raise capital and the owners (i.e. the Chinese government) want to sell 10% of the company. If the PRC had a flexible capital structure, then what could happen, and would likely would happen is that you put $10 million in the SOE, and then next day, the board of the company issues “magic shares” to the CEO’s brother-in-law, and you never see a cent of your money back.
    Chinese law requires rigid capital structures, so that if the owner (i.e. the government) takes money out, you get 10% of however much money gets taken out. This also explains why you’d invest in the company even though you have zero control over the operations of the company. The majority shareholder doesn’t have to act in your interests, all you have to do is to make sure that the majority shareholder acts in their interests. They make whatever money they can, they keep 90% and you get your 10%.
    You might ask whether the majority shareholder will find some other loophole that will leave you with nothing, and the answer is that they might if the law lets them. In this sort of situation you want laws that are rigid, formalistic, and inflexible that way that there is less chance for funny business, and that way even if you are cheated, you *know* you’ve been cheated.
    If you had laws that required a judge to interpret, then you have to trust that the judge will do so fairly, and if the laws are subject to interpretation, you have no way of knowing whether the judge is cheating you. If the laws are rigid and inflexible and you throw it to a judge to interpret, then either the judge rules for you, or else it’s obvious to everyone that there is funny business going on. Note that this is a problem even if you have a fair and honest judge, because if the laws are ambiguous, it’s difficult for a judge to prove to you whether they are being fair and honest, whereas if the laws are clear and unambiguous, then it’s possible for the judges to more easily demonstrate their fairness.

  5. Two Fish,
    I would tend to agree that good faith is not overly strong in Anglo contract law (here I generally refer to UK, HK, Australia and similar jurisdictions) but it certainly applies in respect of specific contracts (insurance is an example) and relationships (trusts).
    Aspirational contracts still face the problem that the common law distinguishes between agreements and an indication of an intention to agree. That is a fundamental principle that, at the very least, runs through Anglo common law. Given how fundamental this rule is I am not sure that a strong doctrine of good faith would remedy this.
    Aspirational clauses can be enforceable or at least form the basis of an action in some jurisdictions as a misleading representation. That provides another basis as to why Dan is right to ensure such clauses don’t get in merely for the sake of placating the other party.

  6. Dan: Such a document would be pretty much unheard of in the West where everyone is super sensitive to legal entanglements.
    I think these sorts of documents are quite common in the West. They are called press releases.
    http://www.free-press-release.com/news-synygy-and-health-market-science-form-strategic-partnership-1264677469.html
    I think what is happening is that when you are in a multi-national environment, lawyers get called to do things (i.e. draft a press release) that they wouldn’t normally do in a domestic environment.

  7. I should make clear that I would not advocate putting something into a contract that neither party was prepared to go through with, but was in there just because deal fatigue had set in and maybe one party hoped it would never get noticed.
    The point I was trying to make, but perhaps didn’t get across adequately, was that there are areas where you might not get agreement on every point, but they are areas where full agreement on all the points are not key to signing the deal. In such a case, I think that setting out principles or a general direction can be helpful. Under English law, you may not have sufficient certainty to have a valid contract on the issue. The Chinese however are a lot more prepared to do this and it may have its basis in the larger good faith doctrine to which Twofish has alluded.
    Clearly there are risks to such an approach, under Chinese law or English law. As a lawyer, you must explain this to the client. But my clients tend to be rational and pretty smart and understand the issues. I guess I’m lucky.
    This brings me back to what I said in my original post and I do stand by what I said for this very reason. Sometimes as a lawyer you need to appreciate the commercial issues, use your judgment and trust your client to use his or hers, once you’ve explained things. As a transactional lawyer, I see this as being a crucial part of my role.
    And I have to say I’m glad to have engendered quite a lot of discussion on this!

  8. One thing about contracts is that there is an underlying tension between enforcing the contract as written and trying to achieve a “fair and just” result even if means having a judge rewrite the contract. The problem is that if you give the judge the ability to rewrite a contract to make it “fair and just” you also decrease the amount of predictability in the contract.
    Different legal systems will handle things in different ways. English courts (and those in Hong Kong) as well as French courts will tend to enforce the contract as written to make things predictable even if it leads to a bad result. German, US, and mainland Chinese courts will tend to reinterpret and rewrite the contract in order to achieve a fair result even if you lose predictability.
    This isn’t a civil/common law distinction. US commercial law is based on the UCC which has some elements of German civil law, and if you look at the influences on mainland Chinese law, you end up with a German foundation, with heavy borrowing of US and Taiwanese concepts, all of which result on a strong element of “good faith.”
    One thing that *is* a civil/common law distinction is that general principles in civil law are extremely important, whereas in common law they are generally meaningless.
    One other thing in international transactions is that when dealing with people from different cultures and different legal systems, a lot boils down to basic human decency and honesty. Even if you aren’t an expert in the law, you can often get very far by convincing people that you are a good guy and the person you have a conflict with isn’t, or if you both can convince whoever is mediating the dispute that you both are good guys and you just need some third party to break an impasse.
    What’s curious about a lot of commercial transaction is how often you get a “friendly dispute.” Not every commercial argument because a screaming grudge match, and often you have two companies that agree to the principles and just need an impartial third party to fill in the gaps. What’s curious is the attitudes of the courts to these sorts of cases. English and American judges *hate* being mediators, and will do everything they can to make sure that you settle these sorts of disputes outside of court. If you try to get an English or American court to be a “marriage counsellor”, the judge will make both parties regret it.
    By contrast, mainland Chinese judges are quite willing to be mediators in these types of disputes. I think this is because of two reasons. The first is that the Chinese judiciary is pretty weak, and Chinese judges like it when people find them useful. The second reason is that the Chinese Party-state would prefer people to handle disputes through the state apparatus rather than to go outside the court system, because by having a judge handle the dispute the Party-state has some input over the outcome, whereas this would not be true if people went totally outside court system.

  9. Five Things About China Deals That Differ From The West. It’s The Government, Stupid.
    A few days ago, I did a post borrowing from and remarking upon an excellent post by Geraldine Johns-Putra on five ways doing deals in China differs from doing deals in the West. I loved her first post and she has just come out with a second, entitled, …

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