Will That Chinese Company Ever Pay You?

My law firm’s China lawyers have lately been seeing a massive upsurge in emails and phone calls from companies and lawyers seeking our assistance in determining the strength of their claims for getting paid on indemnification agreements, settlement agreements, and for breaches of investment or merger contracts. China’s tightening of capital controls has made it very difficult to get money out of China for paying these things. To get a better sense of the issues related to China’s crackdown on money leaving the country, start with Getting Money Out of China, Part 6 and read the first five parts of this series also.

A problem in these situations is that the Chinese government may be preventing the money from leaving or perhaps the Chinese company simply has decided it does not want to pay and is using “China government capital controls” as a convenient excuse. Another problem in these situations is that it can be difficult — often impossible — to know whether the failure to pay is due to the fault of the Chinese company or because the Chinese government has prevented it.

Chinese companies virtually never carry insurance for indemnification or for most (pretty much all) sorts of settlement payments and we are skeptical about their getting permission from the Bank of China to convert RMB into dollars for these kinds of payments. This means your odds of getting money for these things are not so good to begin with, but in every instance in which we have been contacted, the companies seeking payment (and their lawyers) have already done things to reduce their odds of ever getting paid. In most of these cases, our “sense” is the Chinese companies deliberately had the contracts written to make payment difficult. And why not? What company that has been sued and had to settle for millions of dollars will not try to set things up so it does not actually end up having to pay? This holds true with equal force on the indemnification side as well. And on the transactional side, Chinese companies tend to encourage contracts that make payment difficult, figuring that if they do end up wanting to complete the deal, they can agree to a revised contract that will make government approval more likely.

We are seeing this problem of non-payment quite often these days in investment deals as well. The Chinese side will enter into an agreement with a foreign company to buy that company or invest in it. The contract will require the Chinese company make an X dollar (or Euro) payment at some early stage and it oftentimes will also include a liquidated damages provision setting forth what will happen if the deal does not close. The Chinese company never makes the first payment, claiming the Chinese government is not letting them do so. The American or European company then wants to sue for breach of contract damages (one company that contacted us even went bankrupt waiting to get paid!) and/or for the liquidated damages. These companies and lawyers often come to the China lawyers at my firm expecting us to bless their pursuing litigation against the Chinese companies, but in most instances, we throw cold water on those plans by pointing out how the applicable contract(s) make prevailing and collecting on any claim difficult or even impossible.

We typically see two main problems in these contracts, one of substance and one of procedure. The substantive problem is that the contracts’ force majeure clause is broad enough to allow the Chinese side to claim their inability to pay is due to Chinese government capital controls and that qualifies as a force majeure event under the contract. And if the company seeking payment cannot prove non-payment is for some other reason — and as I stated above, this is usually not possible — the Chinese company could prevail on this argument. For some ways you can reduce these risks, check out How to Reduce China Payment Risks. The typical procedural problem is the dispute resolution clause. See e.g., Enforcing US Judgments in China. Not Yet.

To get paid from China you need to think about how that is going to happen before you draft your contract, not after you have not been paid. You need to draft these contracts with extreme sensitivity to China’s hard currency controls, otherwise the Chinese company will be able to point to the Bank of China as its reason for not paying and then what can you do? You should not enter into any agreement with a Chinese company without accounting for “the payment from China issue” and for what is required to get paid under Chinese (not domestic) law and practice.