Yesterday, I did a post highlighting two negotiating tips from an Andrew Hupert article. I got an email from a China lawyer I know who had this to say about my post:
My favorite one is #5, where Hupert says: Prepare now for the second negotiation. If you are failing to plan for a second post-signing negotiation in China, you should plan on failing. Westerners are the only ones who think a signed contract stops clocks and seals the deal in amber.” That’s the mistake so many entrepreneurs keep failing to realize about China: A signed deal is not the end of the negotiation.
I did not list that fifth tip because I hated it, not because it is not true, but because this is becoming less true and it is defeatist.
First off, Andrew is not right when he says “Westerners are the only ones who think a signed contract stops clocks and seals the deal in amber.” This is far too sweeping a comment. In fact, just the other day, I met with a large client of ours in the paper business who told told me how when the price of paper plunges, virtually all companies (except maybe half the Chinese companies) honor their contracts. He said his company (and many others) were no longer doing business with those Chinese companies that had failed to honor their contracts and this was causing “a cleaning out of the industry.” Korean and Japanese (non-Western) companies did not try to back out of their contracts.
A few weeks ago, I was on a “Doing Business in China” panel where a fellow panelist made some distinction between the Asian way and the Western way on something and I noted that the distinction was not so much between the Western way and the Asian way, but rather between the way of developed economies and emerging market economies. I have been handling Russian and Korean and Turkish law matters for a long long time and in that time I have seen those countries become increasingly sophisticated in their business and legal methods and I attribute that to development and international experience, not to a geographical shifting.
But what Hupert says about how Chinese companies will try to renegotiate their contracts after they are inked is often true and it is good to be prepared for that. Andrew’s implication is that you should always prepare to be flexible on the next go round and I disagree with that and I have some completely made up numbers to support my position.
About seventy-five percent of the time, your Chinese counter-party will try to change the terms of your arrangement. About twenty-five percent of the time they will be entirely justified in seeking to change the terms. The reality is that this sort of thing goes on with all sorts of domestic and international contracts. Companies will often ink a deal in writing and then say something like, “let’s see how this works out and if we don’t like it, we will sit down and see if it makes sense to change it.” Nothing wrong with that as many times it takes getting into a contract to know which terms really make sense and which do not. And the number of Chinese companies seeking to unfairly negotiate their contracts now is way down from even a few years ago and will be down even more within a few years.
So now the question becomes what do you do when the Chinese company comes back to you seeking to change your inked contract for no reason other than because it believes it has you over a barrel and it can. It depends on the proposed changes and, more importantly, it depends on how over the barrel you are. The following two situations illustrate how different situations call for different actions.
1. Chinese manufacturer has been making widgets for our client for six months at $7 a widget and now says it needs to be paid $7.50 because the price of a particular material has gone up. Our client has a great contract with the Chinese manufacturer and the price of this particular material has only gone up a tiny bit, while the prices of some other materials that go into the widget have actually declined. Our client tells the Chinese manufacturer to hold off on the price increase for a month so they can meet together in China and then, in the meantime, it lines up another manufacturer at $7.00 and tells its Chinese manufacturer it cannot pay more than $7.00 for the part and the Chinese manufacturer backs down.
2. Chinese manufacturer has been making widgets for our client for six months at $7 a widget and now says it needs to be paid $7.50 because the price of a particular material has gone up. Our client has a great contract with the Chinese manufacturer and the price of this particular material has only gone up a tiny bit, while the prices of some other materials that go into the widget have actually declined. Our client has orders lined up with key clients over the next five months and switching suppliers will take at least that long. Our client negotiates a new price (between $7 and $7.50) with its Chinese manufacturer and hunts down a second supplier so as to avoid this same situation happening again.
The World Bank ranks China 18th in “enforcing contracts” and though I do not believe it deserves that high a ranking, I also believe it wrong to think contracts in China are unenforceable. Chinese companies know Westerners believe Chinese courts will not enforce contracts and they oftentimes seek to take advantage of this by claiming their actions are “the Chinese way.” Chinese companies often claim that renegotiating a contract is how things are done in China, implying that the Western company has absolutely no choice but to go along. Not true.
Go ahead and prepare to have to renegotiate your Chinese contract, but in many instances, that preparation should involve an assessment of your chances of prevailing in litigation or arbitration against your Chinese counter-party and if your chances of prevailing are good you should stand in front of a mirror in preparation for saying “no.”