At the end of last year, we drafted and published the Guidelines for drafting and negotiating contracts in China, in collaboration with the EU SME Centre.

The Guidelines are intended to advice foreign companies involved in those activities of the challenges, difficulties, most common mistakes and, of course, solutions at their hand to improve their performance and minimize the risks of doing business in China.

As those Guidelines are a very detailed and comprehensive explanation of every aspect involved in the process of negotiating and concluding a contract with a Chinese partner, we will now publish a series of articles focused on specific aspects and steps we always go through when developing business in China and negotiate a contract with a Chinese company.

In this first article, we will analyse one of the most important steps (and often underestimated by companies doing business in China), which is what we call the pre-contract stage.

Many problems that foreign companies encounter when doing business in China could be avoided by carrying out due diligence in partner selection, and by establishing a clear, well-drafted, and legally workable contract from the very start of the business relationship. Doing so is not – in most cases – a particularly difficult issue.

There are three general reasons for having a contract in place when doing business in China: clarity of obligations in the business deal, prevention of a dispute, and evidence in case of a dispute.

This is regardless of whether the contract is drafted by a company without legal assistance, or by external professionals (which is the recommended option for enterprises without lawyers familiar with Chinese law and practice).

In the contract, one shall find replies to questions which look obvious, yet many still do not pay sufficient attention to asking and answering them. Some of these questions are:

Do I know my business partner well? Does the information in the contract correspond to the reality and official database of Chinese companies?

Is the person negotiating and signing the contract authorised to do so? Is the official company chop affixed to the contract an official one?

Is the product and other deliverables identified without any doubts in terms of quality, quantity, design, etc.

Are payment conditions drafted in a way that I am safeguarded against potential late payments or no payments?

Are the terms of delivery clearly formulated? Who bears liability for damage?

In the case of a breach of the contract, what are the mechanisms set to solve the situation as smoothly as possible? Is there a system of penalties or remedies set?

If the contract is bilingual, are both versions identical so that there is no misunderstanding between parties?

In case of a dispute, what action will take place? Litigation or arbitration? Under what law and in which jurisdiction?

In the case of early termination of the contract, what procedures are necessary to conduct?

Pre-contract stage

1.1. How to check on your potential business?

Before entering into a contract, it is essential to assess the legal status and reliability of the Chinese business partner, especially when doing business with them for the first time.

In China, the State Administration for Market Regulation (SAMR) departments / bureaus at the local level are in charge of the registration and administration of companies. All companies, except in some special industries, must be registered with the local department of market regulation in order to be formally and duly incorporated to obtain the business license, legitimating their status as a Chinese legal person.

Nowadays, corporate information regarding Chinese companies is available to third parties through public and private business and credit-related information platforms. 

By conducting simple searches on such platforms, it is easy to obtain relevant information about potential business partners to assess their existence (due incorporation in China), the status and nature of the company, whether it has fully paid up its registered capital, as well as civil or criminal disputes the company may have been involved in. 

Specific information such as company registration information, registered capital, address, identity of the legal representative and directors, identity of the shareholders, etc. can be obtained and be a good input to assess the reliability of potential business partners.

Another essential action is to request a copy of the business license from a prospective business partner, which contains key legal information of the company such as the official name and address, legal representative, registered capital, business scope, operating period, etc. However, these websites, as well as the original registration information, are usually only available in Chinese.

Nevertheless, the business license, combined with an online check, provide only the most basic information about a company. For sizeable business deals, more thorough due diligence on potential Chinese business partners is strongly recommended, which may include one of the following:

Try to obtain the internal file of the target company registered at its local departments of market regulation.  This file contains further detail on shareholders, registered capital contribution, copies of submission documents when the company was established and when changes to the company's registration were made, and it may even include some financial statements. 

The target company itself can always obtain (or help to obtain) a copy of this file. Regardless, it is often possible for third parties such as law firms to obtain a copy without the involvement of the target company.

Certain service providers specialise in gathering information on target companies, including financial information, information on buyers, size, etc. Law firms often have contacts with such companies; however, prudence is advisable, since some of these companies may operate in grey areas.

It can also be very useful to make a personal site visit to the target company, to check its operations and speak to its managers.  Consider being accompanied by a trusted local, as they may be able to gain deeper insights from the visit than an outsider. It is always useful to ask for references, especially from other European firms that have worked with the Chinese company and can be easily contacted.

Finally, two general principles to keep in mind are: (i) if a deal seems too good to be true, then it should be examined very closely, and with a skeptical eye; (ii) always perform some level of due diligence before committing substantial resources.

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.