We have been drafting an increasing number of contracts for foreign companies licensing their concept or technology for use in China. In the old days, this type of licensing was primarily in the industrial sector. These days, much of our work has involved licensing agreements for companies that want to capture China business without having to actually go there.
This post describes the negotiating tactics my law firm’s China lawyers so often see from the Chinese side and sets forth how foreign companies can counter those tactics.
The Chinese government is internally conflicted on how to treat this new form of licensing. In industrial sector licensing, the Chinese government is eager for the technology transfer to occur. The same is not true in the service sector. On the one hand, the Chinese government formally welcomes the transfer of Western expertise in the service sector. On the other hand, the Chinese government fears foreign participation in China’s service sector will lead to unacceptable control of the Chinese system.
This ambivalence is mirrored by many of the potential licensees our law firm deals with in the service sector. Industrial licensees bargain hard, but the bargaining is similar to any commercial negotiation. In the service sector, we are finding the Chinese side works to strike a much harder deal. This often surprises our clients, since they expect the service side to be softer than the industrial.
As part of this process, in service sector licensing contracts we are starting to see the Chinese side dust off negotiating tactics that were common in the 80’s and 90’s when Chinese companies were negotiating their famously dysfunctional joint venture agreements. In negotiating service sector licensing agreements with Chinese companies, we are seeing the following tactics from the Chinese side:
1. Endless Issues. The most common tactic is for the Chinese company to seek to wear the foreign side down with endless issues. This tactic has two variants. In the first variant, the Chinese side raises a series of issues. As these issues are resolved, the Chinese side then raises a series of unrelated new issues. The list of issues is endless and the process never stops. The second variant is for the Chinese side to make several unreasonable demands and then refuse to address the concerns of the foreign company on the other side. As in the first variant, the discussions proceed with no attempt by the Chinese side to address the concerns of the other side. All this is done to wear down the foreign side in the hopes it will simply concede. When the foreign side concedes, the Chinese side then inserts provisions in the agreement beneficial to the Chinese side, under the assumption that the foreign side is too tired to object. The success of this strategy depends on the foreign side negotiators being busy people with a lot to do, while the negotiators on the Chinese side are functionaries with no other job beyond endless negotiation.
2. Artificial Deadlines. This is my favorite because it is such an obvious manipulation of the foreign side and yet it often works. At the very beginning of the negotiating, the Chinese side sets a fixed date for executing the contract. It then sets up a public signing ceremony on that date, at which high-level officials from both sides will participate. The date is set far enough in advance to ensure that parties negotiating in good faith can reach agreement on the contract. The Chinese side then ensures no agreement is reached. This results in panic on the foreign side, since failing to get an agreement the bosses will sign is seen as a loss of face. The Chinese side then uses this concern to extract concessions from the already exhausted foreign side negotiator. This tactic also has two variants. The first variant is the crude approach. The Chinese side simply refuses to concede on key points under the quite reasonable assumption the foreign side will crumble when faced with the fixed signing deadline. The second variant is much more subtle. In this variant, the Chinese side initially concedes on key points, while still holding its ground on numerous minor points, consistent with the “wear them down” tactic. Then, just a day or two before the signing ceremony, the Chinese side announces that the contract must be revised on one or more key issues in a way that entirely benefits the Chinese side. The Chinese side usually justifies this by referring to the demand of a “government regulator” or an outside source such as a bank or insurance company. The plan is to use the pressure of the impending signing ceremony and the general fatigue of the negotiators to extract crucial concessions favoring the Chinese side.
3. Revisit the Deal Without the Lawyers. The final technique is to come back to the key issues after the lawyers have left the room. This tactic involves the Chinese side signing a contract, conceding on the key issues. By virtue of the contract having been signed, the key negotiators, China advisors, and most importantly, the international lawyers, are off working on other projects. The Chinese side then works to get the project started. Once the project is started, the foreign side is then invested in the project. This gets certain key persons on the foreign side are now committed to the project. Once this happens, the Chinese side then goes to the committed parties on the foreign side and announces the need to change certain key provisions of the contract. The Chinese side usually claims this change is mandated by law, government regulators or banks and insurance companies. The only people left at this point are the “committed parties” with a strong incentive to allow the change so the project can proceed. These people often do not fully understand the changes the Chinese side is now demanding. The foreign side then presents the change to busy upper level management as a minor technical revision and it gets signed. Everyone remembers how the initial negotiation was so troublesome and nobody wants to bring in “legal” to start the process again.
Though crude and obvious, the above three tactics work often enough so Chinese companies do not hesitate to regularly employ them. There is one simple antidote for each tactic:
1. If the Chinese side uses the “endless issue technique,” you should refuse to participate. You should firmly state your position and not bend until the Chinese side moves closer to your position.
2. Never agree to a fixed signing date. Make clear that the signing ceremony should be scheduled only after the contract has completed final negotiations. This seems like obvious advice, but we see this rule constantly violated. Chinese companies love signing ceremonies and foreigners fall into the trap because they do not want to cause offense at the start. The Chinese have contempt for a sucker, so refusing to go along on this obvious technique will not cause offense: it will instead earn the respect of the Chinese side.
3. Make clear there will be no changes to the contract after signing and any attempt by the Chinese side to change the contract will be treated as a material breach, leading to termination and a lawsuit for damages. Chinese companies are well known for using the signing of a contract as the start of a new negotiating process, not the termination. If you accept this approach, you should at least be sure to get your legal and China advisory team involved in this new round of negotiations.
Below are five common Chinese negotiating techniques everyone should learn to recognize:
1. Death by a thousand cuts
The Chinese company is presented with a carefully drafted written contract and it responds with a reasonable number of objections to the contract language or to the contract terms. It seems odd to the foreign party because the list seems random. The parties negotiate the issues and reach solutions. The foreign side naturally assumes the negotiation process is complete and expects the next step will be to move to executing and implementing the contract.
The actual result instead is that the Chinese party provides a new set of randomly selected objections and requests for changes. The foreign side again negotiates, reaches a resolution and expects execution and implementation. Instead, the Chinese side returns with a new list of issues. This time, however, the list of issues includes changes and revisions to matters decided in previous rounds of negotiation. Often, these requests are hidden among other trivial matters in the hope the foreign side will either fail to notice or will concede this time due to a change in negotiators or simply out of fatigue.
In cases where the Chinese side has been forced to concede on important matters, the death by a thousand cuts round of demands from the Chinese side will be extended by the Chinese side indefinitely; the Chinese side will not stop until it gets what it wanted at the beginning.
This technique provides several unfair benefits to the Chinese side. In negotiating the initial set of objections from the Chinese side, the foreign side will often make concessions that weaken their position. This was done as part of the normal negotiating give and take and on the assumption both sides have made concessions to do the deal. However, when the Chinese side comes back with new demands, it has already extracted concessions from the foreign side and is now seeking additional concessions.
The plan of the Chinese company is to simply wear down the foreign side so it will concede on important points merely to get the deal done and move on. The Chinese negotiators are often very clever at mixing important issues together with trivial issues and at hiding important changes with seemingly minor changes in wording.
The foreign negotiator must make sure to avoid death by a thousand cuts. The way to do this is to be very strict with the Chinese side. The Chinese side must be told clearly: you have only one chance to comment, so make sure all your comments and objections are included in your first communication. Later comments will be ignored. Of course, the Chinese side will ignore this rule and will still come up with additional comments even after having been told that they will be ignored. The only way to deal with this is to live up to the commitment. Tell the Chinese side that the contract is now “take it or leave it.” The problem with this is that as often as not the Chinese side will decide to “leave it.” That is, the Chinese side will abandon a deal that would be good for both sides just because it cannot tolerate not forcing the last remaining concession down the throats of the foreign side of the deal. In this setting, the foreign side has to be the party that does a rational analysis. Often, the final resolution can be achieved if the foreign side concedes on several minor issues, giving the Chinese side the impression that it won the battle.
2. What if gravity stops?
Most already know Chinese companies are uncomfortable with well-written complete contracts that tie them down on key issues. Chinese companies generally prefer vague contractual commitments that allow for constant re-negotiating and clarifying of points as the transaction progresses. Of course, this is exactly what the foreign side seeks to prevent in negotiating a written contract.
This basic attitude by Chinese companies often produces an odd result when a Chinese company is forced to deal with a clear written contract. In response to clarity, the Chinese company often will demand “hyper-clarity.” Since Chinese companies inhabit a world where good faith negotiation and commercially reasonable contract interpretation is unknown, they will insist every contract provision be specified in minute detail.
At the extreme, they will start coming up with scenarios like: “What if gravity stops and all workers in the factory are levitated exactly three feet from the ground, making it impossible to walk around the factory floor? What do we do then?” If you provide a solution, they will then come back and say: “OK, now what happens if they are levitated exactly four feet from the ground.” This then goes on in an endless sequence, much like death with a thousand cuts. In other cases, they will interpret a perfectly reasonable and common boilerplate contract provision in a way that assumes the foreign party intends to act in a bad faith and unreasonable manner to catch the Chinese side in some form of drafting trick.
The thing that makes this technique so difficult to counter is that the Chinese side will never propose a solution to any of the fanciful problems it raises; they will simply raise the issue without a solution. More problematically, they will sometimes propose an obviously bad-faith and commercially unreasonable “solution” on the assumption the foreign proposed “screw job” can only be countered by an equally malicious Chinese screw job.
No contract can be negotiated under these circumstances. When a foreign party senses the start of the “what if” trend in negotiation, it should forcefully stop it. It is dangerous even to entertain the first round of “what if” questions and proposals, because discussion of the first round only encourages the Chinese side to think of more progressively far fetched scenarios. Since this kind of negotiation is by definition an exercise in bad faith, the only thing the foreign side can do is to refuse to participate. You have to say: “If you think that is our intention, and if you think a court would enforce that kind of bizarre interpretation of our perfectly standard language, then there is clearly no basis for us to move forward on this contract.” If the Chinese will not come back to reality, you should pack your bags and go home. I have been negotiating contracts with Chinese companies for more than twenty years and I can assure you that things will not get better over time.
3. The headless horseman
Several of our readers have commented on their frustration with the “headless horseman” negotiating technique. This technique is used all over Asia, not just in China.
This technique is used in face-to-face negotiations conducted in China. At great trouble and expense, the foreign side sends a negotiating team to China. Usually, preliminary negotiations have been completed and the plan is to finalize the deal in a final, conclusive negotiating session.
During the negotiation, the Chinese side then announces that none of their negotiators have the authority to make binding commitments for the Chinese side. At the end of each day of negotiation, the Chinese negotiators must return to the Chinese company to secure permission from their “boss” on whether or not any decision on any major point is acceptable. This is often a shock to the foreign negotiators, since their team has authority to make binding decisions on behalf of the foreign company. For the foreign negotiating team, it makes no sense to negotiate with people who cannot make decisions.
This headless horseman negotiating is not just a reflection of the poor way in which Chinese companies are managed. Chinese companies use this technique to gain a negotiating advantage against the foreign side. In each round of negotiation, the foreign side will make concessions in response to corresponding concessions from the Chinese side. This is done as part of a balancing of risks and analysis characterizing face-to-face negotiation. The Chinese side then takes everything back to the head office and carefully reviews the day’s results. Often, there is no discussion with the “boss.” Rather, the negotiating team conducts its own careful review and then comes back the next day with a revised response.
The essence of the approach is that the foreign side does not get a chance to take back their own agreements. Only the Chinese side has this opportunity, using the excuse that “the boss would not agree.” This is just a form of cheating. Either the negotiations are live or they are not. It is not consistent with normal commercial practice to make one party negotiate “live” while the other party has the opportunity to analyze and then pick and choose.
Headless horseman negotiation is a form of bad faith and should not be tolerated by the foreign party. Since this technique is so common in China, the foreign party should confirm the situation before even considering face-to-face negotiations in China. If the Chinese side is going to use the headless horseman technique, the foreign side has two choices. It can send a work group to China that is also not qualified to make any binding decisions. The two work groups can then seek to develop a common program, subject to review by both companies’ senior management at some later date. Alternatively, if the Chinese side insists on binding negotiations, then the foreign side must insist that it will not participate unless the Chinese negotiating team contains at least one person who can make on the spot binding decisions on behalf of the Chinese company. If the Chinese company will not agree, do not come to China. If the Chinese side agrees and then changes the rules during the negotiation, terminate the negotiation, pack your bags and take the next plane out of China, or at least take the next train to Hong Kong.
4. Never never land
Chinese companies often justify their outrageous demands with the vacuous statement that “China is different.” It is shocking how many foreign negotiators accept this. China is different from other countries. This is a trivial statement, since every country is different from every other country.
But in terms of laws and regulations, China is not all that different from other countries. Chinese laws are not original. They are based for the most part on foreign models. In addition, as far as foreign investors are concerned, the content of Chinese laws is further constrained by China’s participation in the World Trade Organization (WTO), the World Intellectual Property Organization (WIPO), the Convention on the International Sale of Goods (CISG) and other international standards setting bodies and conventions.
China has for the most part brought its foreign investment and business laws in line with international standards. In most cases, China’s laws hew closer to international standards than the often eccentric laws of the United States and England. Chinese laws are based on the civil law standard. What often seems to a U.S. investor as an unusual legal provision is often nothing more than the difference between the common law and the civil law approach to certain issues.
Whenever the Chinese side of a negotiation argues that “China is different,” I request that it provide me with a copy of the Chinese statute or regulation that imposes this difference. In my more than 20 years of negotiating contracts in China, I have never once received a substantive response to this request. On occasion the Chinese side will send over a host of Chinese language documents. but they always turned out not to have anything to do with the issue at hand and none imposed the rule the Chinese claimed to require we honor their unreasonable request. Our China lawyers just this week wrapped up a negotiation where when the Chinese side did provide us with the law, it said exactly what we had been saying it said all along, just as we knew that it would.
What is “different” about China is that Chinese negotiators do not feel constrained by the rules of good faith negotiation. Thus, when a Chinese company argues “China is different,” what they really mean is that the fair and impartial laws of China do not reflect the reality of China. The reality is the Chinese side must take advantage of the foreign side. This means the foreign side must accede to the unreasonable request of the Chinese side. If the foreign side does not concede to patently unreasonable terms, no deal can be made.
In this sense China is different. However, this is a difference that should not be tolerated by the foreign party to any contract. The response from the foreign side should be first to demand to see the law that requires the unreasonable condition. After the Chinese side fails to provide that law it will usually say something like: “well, the law does not provide for this but our government will not approve the deal unless we include this provision. The response to that statement should be that “if your government will not approve the deal, then we will not do the deal.” This should be made very clear. If the Chinese side does not back down, you should terminate the negotiation.
Let me give an example. It is common in negotiating China Joint Ventures for the Chinese side to insist the foreign party contribute its intellectual property to the JV. The same is true in many technology license agreements where the Chinese side will say: “sorry, but you cannot protect your IP. You must transfer everything to us at the end of the license.” This situation is obviously the opposite of what the foreign side wants from these transactions. When the foreign side resists, the Chinese side will then play the “never never land” card and state that Chinese law requires such a transfer. Chinese law does not make any such requirement; this is simply what the Chinese side wants out of the deal. Of course, the Chinese government supports the Chinese side, since the free transfer of technology arguably benefits China, so everyone in China is on the same side. Thus government authorities involved will usually do nothing to clarify the situation.
The foreign side will all too often accept the “China is different” justification and go forward with the deal. Later, the Chinese side will drive out the foreign JV partner or terminate the license and appropriate the technology. When that happens, the foreign side will complain about the Chinese law that mandates such a result. However, there was never such a law. It is virtually always a case where the foreign side agreed to a contractual provision that guaranteed its own eventual doom. Chinese law is not at fault. Gullibility in falling for the China is different argument is where the fault lies.
5. Revenge is a dish best served cold
In the discussion above, I advise the foreign side resist agreeing to unreasonable Chinese demands and if the Chinese side will not back down, the foreign side should terminate the negotiation and return home. The foreign side should not enter into a bad deal or a deal that it does not understand simply because it has been manipulated by standard Chinese bad faith negotiation techniques.
In these tough negotiations, it is usually required that the foreign side just has to say “take it or leave it.” In a surprisingly large number of cases, the Chinese side will “leave it,” even in cases where this decision seems to make little economic sense. Thus, when the foreign side gives the final ultimatum, the foreign side has to be prepared for the Chinese side to walk away from the deal.
In some cases, however, the Chinese side will back down and will accept restrictive provisions against which it has been vehemently fighting during negotiations. It will accept the challenge and it will “take it,” rather than walk away from the deal. In that case, the foreign side will congratulate itself on having “won” the negotiation.
Not so fast. The problem is the Chinese side oftentimes does not fully accept its concession and it will then work to unwind the concession in some way during the life of the transaction. It will focus on taking revenge for its defeat on the contract issue. It will focus on this revenge with little regard for whether it obtains economic benefit from its actions. Even when it will actually suffer economic damage from its conduct, it may still focus on obtaining revenge for its defeat. The passage of time makes little difference. Their only concern is on obtaining revenge.
Why is this? Social researcher Ian McKay has this to say in general about people who seek revenge:
People who are more vengeful tend to be those who are motivated by power, by authority and by the desire for status. They don’t want to lose face.
This description nicely describes the typical Chinese businessperson. They treat contract concessions as a loss of face, and they will focus on getting back their “face” to the exclusion of everything else. The economics of the deal do not matter. What really matters is the balance of power and their face. This attitude is quite foreign to most foreign business people who treat contract negotiations as an economic, not a personal issue. It is therefore difficult for foreign business negotiators to understand how this issue can impact their future business relations with a Chinese party.
The issue goes beyond face. If you discuss these matters with Chinese businesspeople you will learn that the Chinese side views the Western approach to contract negotiation as fundamentally unfair. They see the Western insistence on certainty and clarity as fundamentally a bad faith phenomenon. For the Chinese, certainty in contract terms is justified only for a one off, single transaction, “horse trade” style sales contract. The sale of an office building or a single shipment of a commodity is an example of this type of contract.
For any contract that requires continuing performance over time, the Chinese see attempts to pin them down and impose certainty as fundamentally unfair and contrary to reality. For the Chinese, the future is essentially uncertain and the attempt to impose certainty on this uncertain future makes no sense. Where the Chinese side agrees to such certainty, it does so under protest and with the belief that unequal bargaining power forced them into an inherently unfair transaction. Thus, they do not have moral qualms in taking their revenge by undoing the terms of this inherently unfair agreement at a later date. Their belief that they have the moral high ground fuels their need for revenge and explains why they will seek revenge even in cases where there is no economic benefit.
This feeling runs deep in China and is difficult to deal with rationally with the typical Western company business calculation. For foreign parties, it leads to complex assessments of negotiation strategy. Total victory is seldom useful in China. This then leaves open the question of what sort of compromise short of total victory will result in a contract that is still acceptable to the foreign party.
In my experience, there are two viable options for dealing with the final battle over key terms. The first is to walk away from the deal. No deal is better than a bad deal, and what looks like bad deal in China will certainly turn out to be just that. Where abandoning the deal is not acceptable, the foreign side should plan to concede on some issues important to the Chinese side so as to provide the Chinese side with some feeling of victory. This concession should always be balanced against an overall assessment of the benefits of the deal to the foreign side. No deal should be concluded in China that does not provide for substantial benefit to the foreign side. Close deals never work out in China. The foreign side needs room on the benefit side to overcome constant pressure to chip away at the foreign benefits at every stage in the process of performance.
What are you seeing out there?
