Why Contracts with Your China “Friends” Are So Necessary

Your enemy won’t do you no harm, ’cause you’ll know where he’s comin’ from; don’t let the handshake and the smile fool ya.
Take my advice I’m only tryin’ to school ya. Smiling faces, Smiling Faces, Sometimes they don’t tell the truth.

                 Smiling Faces Sometimes, by The Undisputed Truth

Not a month goes by without some 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, be that company be in China or in Peoria. I am always saying that “we 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. A lot.

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-peasy (sorry, but I just wrapped up season two of Stranger Things, which BTW, is every bit as good as season one).

The what ifs here are easy for us because we deal with them pretty much every day, usually in one of the following two situations:

• The foreign company was wrong about its Chinese counter-party and their relationship with it. Or maybe they were right but the situation changed enough so that the relationship soured.
• The existing ownership or management structure changed and the relationship changes with it.

Either way, 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 can’t 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 needs to ship in 20 days AND for every day it is late, the Chinese company must pay you 10% of the value of the order, 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, realistically, going forward. Needless to say, I can give countless examples of this sort of thing, but 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. By this I mean that just having a well written contract that is at least potentially enforceable means that 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, and 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.

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.