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?