China Contracts: Make Them Enforceable Or Don’t Bother

By Steve Dickinson

Every foreign business person who enters into a contract with a Chinese company needs to consider a fundamental question: how will the contract be enforced. To be able to pursue a claim successfully against a Chinese company, the following is usually required:

First, there must be a written contract between the parties, executed by both parties in accordance with the requirements of Chinese law. Traditionally, it has been common in China to do business without a contract. Much OEM manufacturing in China is done on a purchase order basis, with no underlying contract. Much service work done by foreigners for Chinese clients is based on an exchange of emails. Back in the days when China had no laws and no courts, this informal approach made some sense because there was no alternative. Today, however, to be able to bring a plausible claim against a Chinese company the foreign plaintiff almost always must be able to show a formal relationship between the parties. Unlike the U.S., Chinese courts will not allow the plaintiff to prove the existence of a contract by putting together pieces evidenced by scattered POs, invoices, emails and desperate phone calls. The court will insist on a written agreement that unambiguously names the parties and provides the basis for the agreement.

Second, the contract must be enforceable in China. As a practical matter, no Chinese court will enforce a foreign judgment and it can be quite difficult to get them to enforce a foreign arbitration award. A contract enforceable in China must meet the following basic standards:

1. The contract is governed by Chinese law. Under Chinese law, it is permissible to provide that the contract be governed by foreign law. However, providing for foreign law all but guarantees failure in a Chinese court. This is because foreign law is not assumed by the Chinese court. Chinese courts require the party to prove every relevant element of foreign law. This is a disaster for several reasons. First, proving foreign law is expensive. Second, proving foreign law leads to delay. Third, skillful defendants will dispute the application of foreign law, rendering any your case and even any judgment you receive uncertain.

2. The governing language of the contract must be Chinese. Under Chinese law, it is permissible to provide that the governing language of the contract is a foreign language such as English. To do so, however, nearly always leads to disaster. Chinese courts will only work with Chinese language documents. This means that the contract must be translated into Chinese. The translation will not be done by the parties but rather by a court appointed translator. The translator is often not particularly skilled and the resulting translation is often simply wrong. Even when the translation is correct, the defendant will often dispute the translation, leading to delays and ultimate uncertainty in the decision. Having someone else translate your contract after you sue means that you do not even know exactly what it is on which you are suing. We are also aware of Chinese courts simply refusing to hear cases that involve contracts in a language other than Chinese.

3. The contract should be enforceable in a Chinese court with jurisdiction over the defendant. This normally means jurisdiction in a court in the district where the defendant has its principal place of business. China has excellent domestic arbitration panels with extensive experience in resolving sino-foreign disputes. But litigation is usually a better alternative for several reasons.

First, in disputes with smaller Chinese companies, there is a concern that the company will dissipate assets before a judgment can be obtained. Chinese courts can order a prejudgment writ of attachment that prevents this. In addition, a prejudgment writ will often convince a smaller Chinese company to resolve the matter quickly.

Second, the plaintiff in a dispute with a Chinese company will often want an order instructing the defendant to take some action such as ceasing to infringe IP rights, return molds or tooling, or appointing a manager or officer of a company. In other words, what would be called injunctive relief in a common law system. Simply stated, a court has the authority to issue such orders while an arbitration panel does not.

4. The place of litigation should be in the district where the Chinese defendant has its principle place of business. Many foreign parties will seek an agreement for jurisdiction in some neutral district such as Beijing or Shanghai. This is a mistake.

First, Chinese courts will simply ignore such agreements. Second, and more important, Chinese courts are reluctant to enforce judgements from other districts and they often will ignore orders issued by Chinese courts from other districts. This means that if you get a judgment in Beijing but need to enforce it in Chengdu against your Chinese counter-party, you may not be able to do so.

In setting out these basic requirements, I am not suggesting that litigation in Chinese courts will result in a good decision for the foreign plaintiff. Like all courts in undeveloped legal systems, the Chinese court system has many weaknesses.

However, I can say that litigation in Chinese courts is in most instances more likely to produce a good result for a foreign party than litigation in virtually every other Asian court. That is, litigation is not futile and my firm has had good success overseeing litigation in courts all over China.

However, my real point is not to tout the merits of the Chinese legal system. My point is a practical one: in most instances China’s courts are better than all of the alternatives for pursuing recourse against a Chinese company. Several times every month I or one of the other China lawyers at my law firm will be contacted by a North American or a European company wanting to resolve a dispute with a Chinese company. The aggrieved foreign party sends us their 30 page long expertly crafted English language contract, but in spite of the beauty of the document as a masterpiece of big law firm legal drafting, we immediately page through to the end to look at the dispute resolution provision. Almost without exception we find that its dispute resolution clause violates all of the above rules. Thus, the exact dispute resolution provision that the foreign party insisted on makes the contract unenforceable for the foreign party. We are then forced to tell them that our firm has no interest in taking on the case because we think the odds of a positive result are so low

Of course, sometimes prevailing with any form of dispute resolution is difficult to impossible. In some cases, due to the district the Chinese company is located in (small, one factory town) or due to the nature of the Chinese party (SOE or military or owned by a princeling), there is little hope of receiving a fair trial in China. But, if there is little hope of receiving a fair trial in the home town of the defendant, there is also little to zero hope of enforcing any other judgment or award in that district. It therefore is not useful even in this kind of situation to be fooled into relying on dispute resolution technique that will never be of benefit. In this type of situation it is critical to be realistic. If the contract cannot be enforced in the courts, then the foreign party must enter into what I call a self-enforcing contract. That will be the theme of my next post.