China: [Business In China] Guidelines For Business In China -Part 3/2: Provisions & Clauses

This is the second part of the third and last section of our Guidelins for business in China. For the first part, please check here.

8. Confidentiality and IP rights protection

In many transactions, one of the key reasons for a strong and extensive contract is the protection of confidential information and other intellectual property (IP) rights, such as trademarks or designs.

In fact, this is among the most underestimated points by foreign companies when doing business in China and, actually, one that causes most troubles, especially with regards to the protection, registration and use of the trademark in China.

When a foreign company sells a product to a Chinese company that contains IP rights, it wants to make sure that the Chinese buyer continues to respect such IP rights. Therefore, even before initiating any contact with a potential business partner, a foreign company should carefully consider the two following aspects, and take corresponding measures.

Yet, the above aspects alone are not enough. In fact, the protection of those IP rights also needs to be reflected and secured in the sales agreement by means of a specific clause, where not only the rights but also the use of the foreign company´s distinctive signs are thoroughly regulated and limited to only those scenarios or fields in which the Chinese buyer is allowed to use them.

Furthermore, it is essential to expressly state that all the IP rights owned by the foreign company over the specific distinctive signs to be used or embodied in the products, shall remain the sole properties of the foreign company and the Chinese partner shall not dispute them in any way.

Ideally, foreign companies should also try to add a provision setting out that the Chinese company has no interest in and agrees that it will not at any time register or attempt to register their trademarks or any other distinctive sign confusingly similar thereto or any patent or utility model similar to a patent owned by the foreign company.

9. Language

Considering that the representatives of many Chinese companies do not speak fluent English, while those of European companies generally do not speak Chinese, the question is often asked whether it is necessary for the contract to be in Chinese, or bilingual in both English and Chinese.

From a legal enforcement perspective, this is not necessary. A contract in English is perfectly valid and enforceable under Chinese law. However, there are a number of reasons why it is often a good idea to use a bilingual or Chinese contract:

• The Chinese party will often insist on a Chinese version, especially if it plans to involve its lawyers
• Having a Chinese version will ensure that the Chinese party knows perfectly what it is signing
• If the case goes to court, then a Chinese translation will need to be prepared anyway

10. Contract validity and effectiveness

In most jurisdictions, a contract becomes valid when signed by its authorised representative. In China, the signature of the authorised representative (usually referred to as the legal representative) binds a company as well, but every Chinese company also has a registered company chop (or company stamp/seal) which formally represents the company, and is used to confirm contracts.

The best solution, therefore, is to ask the Chinese company to add its company chop on the document, and for big contracts also the signature of the buyer's legal representative.

One further issue is whether an original signed/stamped contract is necessary, or whether a copy (sent by fax or email) is sufficient. Generally, Chinese courts and arbitration tribunals will require the original, as copies may be easily faked. Exceptions can be made where the copy can be notarised (e.g., from a computer server), though it is better to insist on the original, as protection in case of disputes.

11. Choice of law

The partners of an international sales contract are basically free to choose the law governing the interpretation of the contract, as well as the forum that will deal with any disputes arising out of or in connection with the contract).

Accordingly, it is possible to draft the sales contract in accordance with the laws of EU Member States, Chinese law, or even the United Nations Convention on Contracts for the International Sale of Goods (CISG) – all EU Member States have joined the CISG, except Ireland, Malta and Portugal.

No matter what, it is best to specify the choice of law in the contract, to ensure that in case of a dispute it is clear which law should be applied.

Application of law means the procedural stage in litigation of a case involving the conflict of laws, when it is necessary to reconcile the differences between the laws of different legal jurisdictions, such as sovereign states. Namely, which law the court (or arbitration tribunal) and parties should refer to. Key issues when negotiating the choice of law clause include the following:

• Foreign companies may be more familiar with their own laws, and will often prefer them over Chinese laws. In practice, though, especially when the foreign is the supplier and the Chinese company is the buyer, it will be difficult to convince a Chinese company to accept the application of an unfamiliar foreign law.
• The choice of law often relates closely to the choice of forum – the place and mode of dispute settlement. For example, a Chinese court has not extensive expertise on foreign laws, and so asking a Chinese court to apply, say, French law will complicate things and result in higher costs. To avoid this, it is advised to refrain from establishing application of a European law where a dispute is to be resolved by a Chinese court.

12. Dispute settlement

Even more important than determining the governing law, is to include a clause in the contract that establishes where disputes will be settled. There are three main options:

1. a) Choosing foreign Courts.

A natural instinct of a foreign company is to choose the court in its home country as the competent court of jurisdiction. However, not only is such an agreement often not acceptable to the Chinese counterpart; it could also put the foreign company at a distinct disadvantage.

In fact, China has signed very few agreements with European countries on the mutual recognition and enforcement of judgments. In practice, this means that it will be difficult, if not impossible, for the judgment issued by a European court to be recognised and enforced in China.

Moreover, even if China does have a bilateral treaty with a country (such as France or Italy), recognition and enforcement is still a long and difficult process, with a multitude of risks.

1. b) Choosing Chinese Courts

Many foreign companies are not enthusiastic about the prospect of litigating in China. Beyond the standard concerns of litigation, including inefficiency, cost, and time, commercial litigation in China raises a number of other significant concerns — many related to factors such as the lack of transparency, the lack of a litigation tradition for resolving commercial disputes, and the relative infancy of the country's judicial system.

Such concerns are less of a worry in highly-developed cities, such as Shanghai, Beijing, Guangzhou, and Shenzhen – their courts frequently deal with disputes involving foreign parties, and the experience of foreign firms with these courts is often quite positive, if one has the right (Chinese) lawyers to provide support.

On the other hand, however, one can only choose a court in Shanghai, for instance, if either the Chinese party is Shanghai-based, or if there is another strong link to Shanghai when implementing the transaction. So, choosing a "developed" court is not always an option.

One huge advantage of litigating in China is that the same court can also accept applications for preliminary injunctions, and particularly for asset preservation. Chinese courts are relatively open to freezing assets (such as bank accounts) of the defendant pending the outcome of a trial.

Especially when the Chinese company is a trading, service, or small manufacturing company, the preservation of assets is imperative to ensure that they will not just disappear. In addition, the asset preservation may also pressure the defendant to settle, to avoid a long and protracted court battle.

1. c) Arbitration

Arbitration refers to the settlement of disputes by a third party jointly appointed by the parties. It is generally referred to as an alternative dispute resolution mechanism. Chinese also recognise the use of arbitration to resolve disputes, and it has been common for foreign parties dealing with Chinese counterparts to choose arbitration over litigation.

There are two main advantages to using arbitration to resolve disputes.

First, the parties can agree to a specific institute, and thus have a higher level of influence on the process. For example, the parties can appoint competent experts in their field to hear the dispute, and they may agree to conduct the arbitration in English.

Second, an arbitration award in one country can be recognised and enforced in another country, as long as both countries are signatories to the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York Convention, 10 June 1958).

In the past, arbitration was seen as the best way to avoid Chinese courts and so enjoyed a high level of popularity among both foreign companies and their Chinese subsidiaries. In recent years, however, as Chinese courts have become more experienced in dealing with disputes involving foreign elements, the drawbacks of arbitration have become clearer, as well.

For example, arbitration is more expensive than litigation. International arbitration (e.g. through the ICC) is even more costly. Finally, arbitration is often not faster than litigation (whether domestically or internationally).

In addition to deciding whether to seek arbitration, another key issue is to determine which arbitration institute will be dealing with the dispute. Chinese law holds that for an arbitration clause (e.g., the agreement to submit all disputes to arbitration, which is normally included as part of the sales contract) to be recognised by a Chinese court for enforcement, the parties must agree on the specific arbitration institute.

There are basically two options of having international arbitration or arbitration in China.

1. International arbitration

For large deals, parties often prefer to choose arbitration outside of China, for example in one of the more famous arbitration centers (e.g. Singapore, Hong Kong, Stockholm, Paris, Vienna or London). The principal advantage of international arbitration is that the arbitrators can provide more expertise and a high level of neutrality, while the award can still be recognised and enforced by a Chinese court. However, international arbitration is often not ideal for many smaller deals, for a number of reasons:

• International arbitration is generally very expensive;
• International arbitration is often very slow, while individual arbitrators have a high level of influence on shaping procedures (meaning if they work slowly, there is little you can do);
• Chinese courts do not accept applications for preliminary injunctions if the arbitration is on-going in a foreign jurisdiction (Hong Kong being the exception). This means that there is no way to preserve (freeze) assets, resulting in the risk that the defendant will ultimately have insufficient assets for the final award to be enforced;
• The procedure for recognition is complex and time-consuming, and always requires a considerable investment in time and funds. Local Chinese courts sometimes can find problems with the arbitration agreement, or with the arbitral procedure, that allows them to refuse recognition. But even if this recognition is not refused, it is quite common for the final decision to be a long time coming.

2. Arbitration in China

Arbitration in China is usually preferred by the Chinese counterpart. Though procedures are often more rigid, costs are lower than international arbitration, and the plaintiff retains the option to apply for preliminary injunctions (such as asset preservation) as part of the arbitration process, but through the local court.

The most experienced bodies in China in conducting foreign-related arbitration, are:

• China International Economic Trade Arbitration Commission (CIETAC): subordinated to the China Council for the Promotion of International Trade. Its main office is in Beijing, but it has branches in several cities, including Shanghai and Shenzhen.
• In Shanghai and Shenzhen, however, the preferred options are usually the Shanghai International Economic and Trade Arbitration Commission (also referred to as the Shanghai International Arbitration Centre, SHIAC) and the Shenzhen Court of International Arbitration (SCIA). The SHIAC and SCIA used to be the Shanghai and Shenzhen branches of the CIETAC, until they split in 2012 after a dispute about the arbitration rules. The SHIAC, in particular, has a good reputation of dealing with disputes in a commercial way.

Most large cities also have local arbitration centers. These arbitration centers have considerable experience dealing with local arbitrations, but they have had much less exposure to foreign companies, and therefore are best avoided.

To ensure that the Chinese arbitration institute accepts jurisdiction, and (especially in the case of an international arbitration) that a Chinese court will recognise and enforce the arbitration award, it is important to be absolutely sure that the agreement between the parties for arbitration, as personified in the arbitration clause, is legally valid and effective under Chinese law.

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.