On the Importance of Knowing China Legal and Business Differences

China contracts are different

A Canadian company reached out to my law firm to see if we could help it get its tooling and molds back from its former Chinese manufacturer. This company’s Canadian lawyer had drafted a manufacturing contract with the Chinese manufacturer that was silent regarding ownership of the products’ tooling and molds. When the Canadian company started getting bad product from its Chinese manufacturer, it requested its manufacturer return the tooling and molds. The Chinese manufacturer claimed to own the tooling and molds. The Canadian company claimed that was not possible because it had the tooling and molds made by someone else and it had proof of payments showing this.

On top of this, the CFO of the Canadian company kept telling me that its lawyer insisted that it owned the tooling and molds as though the more he said it the truer it would become. He stopped saying this when I asked whether the lawyer claiming this was the same lawyer who had drafted its contract with the Chinese manufacturer.

I told the Canadian company it essentially had the following three choices with respect to getting its tooling and molds back.

1. Get new tooling and molds made. The Canadian company told me that would take months and was unacceptable.

2. Sue the Chinese manufacturer in China to try to get the tooling/molds back. I said this would take months and since the Canadian company did not have written and signed proof (preferably in Chinese) making clear that the tooling and molds belonged to the Canadian company AND not to the Chinese manufacturer, I was not certain who would prevail. The Canadian company told me this was not acceptable due to the time, costs, and uncertainty.

3. Try to negotiate a purchase price for the tooling and molds from its Chinese manufacturer, maybe at half their value. The  Canadian company let me know that having to buy its own tooling and molds back from its Chinese manufacturer was incredibly unpalatable, but, as compared to its other options, this was its best one.

What should the Canadian company (or more particularly, its lawyer) have done to prevent this horrible situation? Its lawyer should have explicitly put into the Manufacturing Agreement (because if it isn’t explicit it pretty much doesn’t exist when it comes to China) that the Canadian company owned the tooling and molds. The Manufacturing Agreement also should have contained a provision making clear that if the Chinese manufacturer did not return the tooling and molds within five days upon receiving written notice to do so, it would be on the hook for $10,000 in contract damages for every day that it failed to return the tooling/molds. See China Contract Damages Done Right. All of this should have been done in Chinese and it also should have had its Chinese manufacturer seal/chop the contract as well.

The above is the sort of Manufacturing Agreement Chinese manufacturers understand and, more importantly, this is what Chinese courts understand and will enforce. See Drafting China Contracts That Work. As far as I know, no company that used a Manufacturing Agreement drafted by one of my law firm’s international manufacturing lawyers has ever not quickly gotten its tooling and molds back from its Chinese manufacturer.

Way back in 2013, the South China Morning Post ran an article, Businesses often fail overseas because the world is much less ‘global’ than they assume. Its premise is that “many companies do not reach their full potential abroad” due to “incomplete preparations.” Per the article, “many companies, even large multinationals, do not analyze the competitive landscape of the local market to determine whether it is possible to operate profitably.” Sort of like the American company and its lawyer who were surprised at what happened to the company’s tooling and molds simply because they never even considered seeking to determine whether the rules on such things might be different in China than in the United States.

The article notes that “the tendency to fall for the fallacy that the world is indeed ‘flat’ increases with corporate seniority.” Though the reason for this is “natural, as senior executives extrapolate from their own experiences within a confined international elite,” it also is “highly problematic, because it leads key strategic decision-makers to underestimate just how big the differences are. And as the international business literature has shown time and again, what kills companies abroad is their inability to handle these differences and deal effectively with the attendant ‘liability of foreignness.'”

It goes on to discuss how institutional variations occur between countries and at “the most fundamental level, they show themselves in what a society accepts as the legitimate purpose of doing business.” Western business schools generally teach that firms exist to maximize shareholder value, but few societies and senior managers outside the Anglo-Saxon world accept this view:

To simplify very crudely, Hong Kong firms exist to produce family wealth; German firms, to produce needed goods and services for society; Japanese firms, to provide benefits to their employees; and South Korean firms, to keep highly conflictual demands by controlling families and hostile stakeholders in balance.

Few companies ever pause to consider these issues and their implications when expanding abroad. Many an international partnership was, foreseeably, doomed from the beginning because fundamental objectives did not match.

Why do some companies seem to just coast into China while others stumble in and never recover? What more should we be writing about here on the China Law Blog to help those seeking to do business in China or to sell their products or services to China? Who would you like to write guest posts for us? The knowledge foreign companies have about doing business in China is considerably higher today than even five years ago, and yet, still far too many assume that they know how to do business with China just because they know how to do business domestically.

What are you seeing out there?