Why Contracts with Your China "Friends" Are So Necessary

China Contracts That Work

Not a month goes by without a company telling one of our China lawyers how great their relationship is with their Chinese counter-party, be it the Chinese company with which they are contemplating a joint venture or the Chinese company that manufactures their widgets.

As lawyers, our thoughts upon hearing this sort of thing tend to be as follows:

1. Great. Truly great. It is always better to have a good relationship with the companies with which you do business, whether in China or in Peoria. I am always saying that our China attorneys “can draft the world’s best contract, but if it is with a crook, it won’t be worth the paper on which it is printed.” So yes, the character of those with whom you do business does matter.

2. But to us as lawyers, that you are friends with your Chinese counter-party or that you have a great relationship is legally irrelevant. We have been trained to ask the what ifs and the what ifs here are easy for us because we deal with them pretty much every day, usually in one of the following three situations. One, the foreign company was wrong about its Chinese counter-party and their relationship with it. Two maybe they were right but the situation changed enough so that the relationship soured. Three, the existing ownership or management structure changed and the relationship changed with it.

We as lawyers can help a company having to deal with one of the above situations if they have written documents to protect them. And if they don’t, we typically cannot help them.

Contracts are generally written when the relationship among the contracting parties is good. There are three reasons why it makes sense to have a contract with your Chinese counter-party — even if your relationship with it is great:

1.  Clarity. The first is to achieve clarity. To make sure you and the Chinese company are on the same page. For example, if you ask your Chinese supplier if it can get you your product in 20 days, it will say “yes” pretty much every time. But if you put in your contract that the product does not ship in 20 days the Chinese company must pay you 2% of the value of the order for each day it they are late, there is a great chance the Chinese company will get honest with you and tell you that 20 days is impossible. At that point, you and the Chinese company can figure out what is realistic and then you know what to expect going forward. This is yet another reason why we advocate putting your contract in Chinese (and not just translated). Clarity before you start the relationship: it is more important than you think and it totally makes sense no matter how good your relationship may be.

2.  Stricture The second benefit of having a contract with your Chinese counter-party is that it will likely bring that company to heel. Just having a well written contract that is at least potentially enforceable means the Chinese company knows exactly what it must do to comply. And, in most cases, it might as well. Let’s use the 20 day example as the example here as well. If your Chinese manufacturer makes widgets for 25 foreign companies and 5 of those have very clear time deadlines with a very clear liquidated damages provision setting out damages if the Chinese company starts falling behind on production, to which companies will the Chinese manufacturer give production priority? Of course it will put the five companies with a good contract at the front of the line and that is relevant even if you have a good relationship. Or are you willing to go to the back of the line because your Chinese counter-party believes you are the safe one to delay because of your good relationship?

3.  Enforceability. You may at some point need to sue your “friend” and if you do it will help to have a China contract that works. And for those who do not  believe China is good with contracts, note that the World Bank ranks China 5th (yes 5) among 183  countries in terms of enforcing contracts.

Contracts protect.

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