China: Contract Management – Avoiding the Horror Stories

Last Updated: 20 December 2011
Article by Matthew McKee

There are very many stories about doing business in China – some exceptionally successful, others diabolical failures. These include foreign companies entering into contracts with Chinese companies that do not exist or the joint venture partner who was a "friend" that appropriates all the assets; unknowingly the joint venture was setup in a way to leave the foreign company with no legal recourse.

Our experience is that what makes these disaster stories worse is that they are usually easily avoidable. Whilst some fear that the enforcement of legal rights in China is somewhat of a hopeless endeavour, our experience is that in reality obtaining a just result is very achievable.

Problems generally occur where, in order to minimise costs or in an attempt to get a deal done quickly in a foreign language, foreign parties fail to seek appropriate representation – too much reliance is placed on people that the foreign parties know. Local legal representation is appropriate but the right local is the key. An insufficient attention to Chinese legal requirements when drafting contracts, and during the period of its performance, is fatal. This is further compounded because of a failure, in most cases, to undertake any form of valuable and practical due diligence prior to entering into contractual relationships.

The war stories should not stop you from doing business with China. Rather, they should reinforce the need to get the basics rights. Our experience shows that simple measures can be adopted to prevent problems and to provide you with the best "fighting chance" should things go wrong down the track. Let's look at a couple of simple examples and solutions to the problem.

Practice Point 1 – Know who you are contracting with.

This may seem like a simple question but when doing business in a country where English is not the native language it is something that, all too often, is ignored. The English name of Chinese companies is not the official name and it is the Chinese name that is important.

The following example, the experience of one of our clients, is illustrative. We have removed client indentifiers and used generic names to maintain confidentiality.

Acme Aussie Pty Ltd ("AA") is introduced to a potential distributor in China that they know by the name of Beijing Pipes Co Ltd ("BP"). As the representatives of both sides can read and write English they decide there is no reason to have a Chinese language version contract. AA delivers the pipes but receives no payment from BP. After a period of a few months pass, AA decides to engage lawyers in China to recover the debt. The lawyers ask AA for the Chinese name of BP. AA is not able to provide this – they only know the English name. AA's lawyers indicate that there are no records of any companies with that name and accordingly cannot take any further action.

Whether the company ever existed or perhaps there is simply no record of the English name doesn't matter, the debt cannot be enforced. This problem can be avoided from the very beginning by obtaining a copy of the corporate documents of the company maintained by the relevant branch of the Administration for Industry and Commerce – China's official company registrar. This is a very routine search and can be undertaken for a minimal cost.

Practice Point 2 – Obtaining judgment in an Australian court may be worthless

When entering into a contract it is natural that a party will desire that any dispute arising out of the contract be heard before a court with which they are most familiar – a court in the party's home jurisdiction.

In most cases, such as where the Chinese party has no assets outside of China, such insistence is, from a practical perspective, rather pointless. If the Australian party was to sue the Chinese party in Australia, any judgment may ultimately prove fruitless. This is because Australian court judgments are not enforceable in China. Importantly, pursuant to Article 265 of the Civil Procedure Law of the People's Republic of China there are only two bases on which a foreign judgment can be enforced in China; if the country in which the judgment is made has a relevant mutual recognition treaty with China or the country recognises Chinese judgments.

Neither the existence of an international treaty nor reciprocity applies in the case of Australia. Accordingly, in such cases the foreign party would need to re-litigate the matter in China in accordance with Article 318 of the Opinions of the Supreme People's Court on Some Issues Concerning the Application of the Civil Procedure Law of the People's Republic of China. This effectively means that if you obtain a judgment against a Chinese client in an Australian court you will have no ability to enforce it against any assets located in China.

Practice Point 3 – Avoiding Chinese Courts

The consequence of Practice Point 2 does not mean that foreign parties need to rely upon the Chinese court system, as long as an appropriate arbitration clause has been included in the relevant contract.

Arbitration is an alternative form of dispute resolution where, rather than using the public court system, the parties' dispute is heard before a private arbitrator. Importantly, arbitration in China can only be made mandatory via a specified clause in the relevant contract. The parties have the right to choose the arbitral body, the arbitration rules applied and the arbitration location

An arbitration hearing is not open and the decisions/judgments are not made publicly available.

There are a number of advantages of arbitration over litigation where a Chinese party is involved – the single biggest advantage being that it is far easier, in accordance with the New York Convention, to enforce foreign arbitral awards in China than it is to enforce foreign court judgments.

Importantly, and as noted above, arbitration can only be made mandatory via a specified clause in the relevant contract. The clause needs to specify the arbitral body, the location of where the arbitration will be held, the language of the arbitration, the applicable procedural rules and any other relevant matters. It is extremely important that the arbitral body be stipulated, it is not sufficient to simply say that the arbitration "will be governed by the Rules of the Beijing Arbitration Commission". Article 4 of the Interpretation of the Supreme People's Court concerning some issues on the Application of the Arbitration Law of the People's Republic of China provides that:

"Where an agreement for arbitration only stipulates the arbitration rules applicable to the dispute, it shall be deemed that the arbitration institution is not stipulated."

Practice Point 4 – Be aware of limitation periods

Article 135 of the General Principles of the Civil Law of the People's Republic of China (the "General Principles") provides that:

Except as otherwise stipulated by law, the limitation of action regarding applications to a people's court for protection of civil rights shall be two years.

The limitation period generally commences when the person knows or should know that his rights have been infringed upon (section 137 of the General Principles). However, interestingly Article 140 the General Principles and Article 10 of the Provisions of the Supreme People's Court on Several Issues concerning the Application of Statute of Limitations during the Trial of Civil Cases provides that the limitation period will be suspended where "one party makes a claim", which includes making a claim by correspondence or data message, and the claim reaches or should have reached the opposite party. The result is that if a time limit is approaching, a party can extend the period by sending a demand to the other party.

Practice Point 5 – Proper documentation

Almost as important as the drafting of a contract, is the management of the correspondence and documentation between the parties. This is because of the unique evidentiary requirements in China. Whole cases can fall apart because of an inability to produce evidence that complies with China's technical evidentiary requirements. In understanding the evidentiary requirements in China, it is necessary to understand an integral feature of Chinese civil procedure – "case acceptance". In all legal proceedings in China, the first step that a plaintiff must undertake in respect of a case is this "case acceptance" procedure. This is where the plaintiff's claim, and supporting evidence, is reviewed by a judge to determine whether there is a sufficient case for legal proceedings to commence. This can be a relatively high standard, and surprisingly, is often when the substantial part of the work in relation to a plaintiff's case is undertaken.

Our experience is that it can take 6 months (although it is usually less) to get a case accepted, after initial instructions are received. If this seems long, it may take only another 3 months before the allocation of a hearing date!

All 5 practice points represent simple ways of reducing the risk of doing business in China.

Winners of the 2010 Lawyers Weekly Asia Pacific Box Breaker of the Year Award and the 2009 NSW Exporter of the Year Award

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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