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China Contract Templates: the Cons and the Cons

Monday, May 1, 2017 5:04

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We are often asked to draft China employment contracts for WFOEs and Joint Ventures. Our first response is to ask the potential client whether their Chinese entity already has a set of Rules and Regulations (sometimes called employer manual or employee handbook). If the answer to that question is yes, our lawyers will use those Rules to determine what should go into the employment contracts.

If the answer is no, our response is to say that we cannot draft the employment contracts standing alone; we need to be retained to draft both the employment contracts and a set of Rules and Regulations (and sometimes more). Our reasoning on this is three-fold. One, nearly all locales in China now require employers to have Rules and Regulations, especially those locales with more than a handful of foreign companies. Two, having an employment contract without any Rules and Regulations is like having a car without an engine; it just doesn’t work. Without such Rules and Regulations you cannot discipline or terminate your employees and you are at great risk of your employment policies and decisions being fodder for employee-employer disputes. The third reason is both more personal and selfish: we do not want our law firm’s name associated with an imminent disaster.

Many times the potential client will respond with something like the following: “In doing our Rules and Regulations, would it be possible to use a standard template to keep costs low?” Our typical response to this is something like the following:

Every time we draft Rules and Regulations, we begin by reviewing our own Rules and Regulations to find the best one to use as a model for what you will be doing in China. This requires we gather up all sorts of facts from you even to be able to figure out which of our existing Rules and Regulations will most closely fit your situation. If you are a factory in Qingdao, do we use the Rules and Regulations we did for a an accounting firm in Qingdao two months ago? Or do we use the Rules and Regulations we did for a factory in Suzhou three months before? Or do we use the Rules and Regulations we did for a factory in Yantai six months prior, since Yantai and Qingdao are in the same province? Actually in this sort of situation we would probably research the relevant laws for factories in Qingdao and probably end up using parts of all three Rules and Regulations to create a new one that will work for a factory in Qingdao today.

An employer’s Rules and Regulations will always vary depending on the type of company, the type of employees, and, usually most importantly, its location. Just by way of an example, the overtime rules are going to vary greatly for a CEO as compared to factory workers and those rules are also going to vary greatly as between Chengdu and Shanghai. We have many Rules and Regulations that can serve as an appropriate starting point but we must first make sure everything in that document is current (the relevant laws and regulations constantly change in China) and fits your location and your exact situation, and then we must modify it in English and in Chinese accordingly.

We get the “template question” a lot on the licensing and manufacturing side too and many times in those situations, the potential client will ask whether it would save them money to have their in-house lawyer or their less-expensive local domestic lawyer draft it first and then have our law firm use that draft contract as our template. Our response to that question is usually something like the following:

We have drafted literally hundreds of China licensing agreements and manufacturing agreements and we do not really use any of them as a “template.” Instead, we spend hours gathering up the facts from our clients and then we figure out which of our many contracts — if any — make sense to use as a model in creating what will essentially be a new contract for you. Our agreements have been specifically drafted for use in China and that means they are dual-language agreements with Chinese as the official language. We draft them under Chinese law and we make sure to draft every provision to benefit you as a foreign company that is licensing its products or services in China or having its products manufactured in China. Our existing contracts are as close to ready as you could possibly find and it makes no sense for you to pay another lawyer who knows nothing about Chinese law to create a brand new English language contract which will not even be close to what makes sense for China. Not only would the money you pay that lawyer go to waste, but my law firm’s fees would soar as well, because instead of our starting with our own Chinese and English contracts as the model (not as a template, and there is a difference), we would start with an English language contract that is not even going to be close to what makes sense for what you are looking to do in China. We would have to revise nearly every provision to make it China-appropriate, and it would take twice as much time as if we just used one of our own previously drafted contracts as the model for yours.

And then there are the requests to buy one of our law firm’s templates, to which our response is always something like the following:

We never sell our templates and that is for multiple reasons. First off, it would be a huge disservice to you because we have literally hundreds of contracts for everything we do and unless you were to first retain us as your lawyers, we would not have any real basis for determining which of these contracts makes sense for you even as a starting point. Our making that determination is itself providing you with legal advice and to do that we would first need to run a conflict check and then onboard you as a client and then work with you in determining the appropriate model contract. And here’s another thing: around half the time when a company thinks it needs a particular contract for what it is doing in China, it actually needs an entirely different one, and we only discover that after gathering up all the relevant facts.

Second, whatever of our contracts we end up giving you will not be right for what you are doing and whatever changes you make to it will only make it even less right. There is a lot more to doing a deal with a Chinese company than simply sending it a contract and getting it to sign it. You first need to do at least basic due diligence to make sure the company you have been negotiating with is the same company signing the agreement and to make sure you have the company’s name and address correct. This is often far more complicated than people think. At least 30 percent of the time the contracting party is actually a Hong Kong or a Taiwan entity and in those cases a PRC contract does not make sense. At least another 30 percent of the time we find irregularities in the company information and we need to investigate further to clarify. And then there are the times we determine there is actually no company at all and the Chinese “company” was actually a complete fraud. See China Fraud Season Starts Early This Year.

And what will you do when (not if) the Chinese company says it agrees with 11 of the 16 provisions you propose in your contract, but it wants you to make specific changes to the other five? You not only won’t know how to make those changes (remember the official version of this contract is in Chinese), you very likely won’t know whether it makes legal or even business sense for you to do so.

Just by way of one example: the contract damages provision is a critically important element of nearly all China contracts. More than anything else it is what will make your Chinese counter-party abide by your agreement. See The Effective China Contract: Liquidated Damages for why this is the case. And yet we never know what to fill in as the amount of contract damages until the very last minute because that amount must be determined on a case to case basis, using all sorts of factors in making the determination. How will you fill in that amount when you do not even know the factors to use in determining it? And even if you had a list of those factors how would you know how to apply them? We could spend a few hours trying to teach you the factors and how to apply them, but in the end your choice of an amount could never be nearly as good as ours because ours is based on decades of experience and thousands of China contracts. See China Contract Damages: More Art Than Science. A bad decision on this alone would weaken or even nullify the value of your even having a contract.

So no, we won’t sell you one of our contracts as some sort of template. The last thing we want is our law firm’s name associated with something we know cannot work.

When I asked one of our China lawyers to review this post before publication, his response was as follows:

We don’t use “templates” for our agreements. After a lot of analysis, IF we find that what the foreign buyer is trying to do fits into a pattern from a previous transaction, then we will of course use an agreement from a previous transaction as a model. But even in the most basic transactions, what we do is to customize it for the current transaction.

In drafting pretty much any contract for China there are literally dozens of variables that can in turn be combined in a nearly infinite number of configurations. So the final contract from one transaction may have no application to any other transaction. This is why providing a contract from a past transaction will have no benefit to the Western side and would likely only harm it.

As you note, our clients also need at least one of our China lawyers involved in dealing with the Chinese response. Did the Chinese side change the Chinese and not the English as they so often do? Did they redline in a way that the changes to the Chinese portion are even apparent? More important is whether their changes are the normal technical changes that are part of normal business practice (45 days to deliver a product instead of 30 days) or are their changes destructive to the whole approach, such as: “no, you do not own the technology, we do.” Or, “no, we won’t provide any warranty at all.” Or, “no, we own the molds, not you.” I do not see how anyone without a deep understanding of Chinese law and Chinese business could even begin to deal with these sorts things.

In drafting our contracts, we do of course usually pull some language from other contracts, such as confidential information language. However, the core agreement is almost always completely unique to the specific client before us and when we do use prior language, we nearly always revise it to customize it for the specific client and the specific transaction.

Form having written thousands of China agreements and we know there are certain issues that need to be resolved pretty much every time. So we work with our clients to identify those issues and then we work them on how they want to deal with those issues and then we put the agreement together to achieve the goals our client has told us it has. Of course, for some of these components we use as a base some of the language that has worked in the past in China. This is the benefit of working with us: we know what works and we know what fails. But the resulting contract in each case is unique.

So in that sense, there is no template. There is just decades of experience in drafting agreements for doing business in China or for doing business with China. This is why whenever someone asks me to send them a “template” agreement I tell them I cannot because I have no way to know which of the nearly infinite number of alternatives they should follow. How will they pick and choose from a dozen options for a relatively simple provision? What is unique about their situation? Will the most common solution we have used in the past even make sense for them? Does it make sense for their industry? Their business? Their product? Their location? What if the law has changed? What if the law changes two days after we start drafting?

I usually propose to each client three options for every important issue and I usually come up with those three from about a dozen possible. Say there are ten critical issues for their contract. Each selection of an option affects all of the other options, often in ways we have previously encountered. Before the client answers the questions, we don’t know even what structure to use. After they answer the questions, the agreement that meets all their needs does not exist.

It is also true that in-house counsel cannot write an agreement that can serve as a basis for what our client wants us to craft. Our approach to China contracts is based on three supports: 1) Decades of China experience, 2) A deep understanding of the Chinese civil law system and the Chinese court system, 3) A deep understanding of how contracts actually work in China. Any company with an in-house lawyer who combines all three does not need to come to us for a contract and they don’t. It is not helpful to us to have a common law contract [China is a civil law system] based on a highly idealized and impractical American/European practice that has no applicability or use in China.

More succinctly, you get what you pay for.

We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.

Source: http://www.chinalawblog.com/2017/05/china-contract-templates-the-cons-and-the-cons.html

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