Ha ha ha, we chuckle each and every time but that is the pervasive perception of many people who do business in China.

And these comments come mostly from people who have been on the ground in China trading punches with suppliers for years.

This reaction is common when coming from the US, where people have sued the golden arches for making them fat or that their hot beverage was too hot.

The simple fact of reality is that China does not enjoy the direct confrontation that we do in the West when problems arise and must be dealt with.

While the courts in China are changing, it will take time for the structure of the legal system to develop, just as it did everywhere else.

In the meantime, you do have several options for dealing with disputes IF you PREPARE correctly.

Mediation is a great choice and is quickly becoming a preferred method of settling disputes in Hong Kong, if fact as of January 10^th, 2010 solicitors are required by law to inform and explain the availability and differences between mediation and litigation.

This is the direction that dispute resolution will take in Asia, and those that do business in Asia will need to understand the manner in which to handle disputes with a minimum of disruption to business.

Mediation is not a one-size-fits all solution to disputes in China, there are situations when it is a good idea and situations when it is a bad idea.

Mediation is a good idea when;

• You have a solid history of cooperation with the other party
• There are many different parties involved or individual parties where there is a clear distinction about who is responsible for your relationship
  • Mediation works best between two parties that will attempt to be fairly open about their relationship
• There are no hugely overwhelming issues between the parties
  • Mediation works well for smoothing over small bumps in the relationship road, not for overly complex and involved issues
• You have an ongoing relationship with the other party
  • Mediation is not a good option for resolving disputes with a wham-bam-thank you ma’am relationship with a supplier that you are using for a single project.
• The parties BOTH want to reach an agreement
  • If one side is going to be a stick in the mud, they will have a pretty easy time stopping the mediation process

There are also times when mediation will probably be ineffective;

• If the parties have a history of adversarial relations or there is hostility between the two parties.
  • If both parties come to the table looking for a fight, they’re going to find one and nothing will be resolved.
• If the issues in dispute are overly complex or involve many different parties
  • Remember the goal of mediation is for the parties to resolve the disputes themselves, the mediator can only facilitate the parties and act as an independent third party
• If the issues are purely legal issues or one party is forced by requirement to mediate.
  • This is the inherent issue I have with judges requiring parties to mediate, when someone is forced into a situation where they must amicably reach an agreement they will often fail to do so if forced.
• If continuing the dispute is beneficial to one of the parties
  • In a situation where one party would benefit from a long a drawn out mediation, it is possible to entice the opposing party by acting as if you are serious about resolving the problem when in fact they are simply wasting time.
• If there is a significant power imbalance between the two parties.

A well trained mediator should be able to help you work through some small problems.

Their job is the help parties look forward and not dwell on the past.

They should also be able to separate the people involved in the dispute from the problem that is the core of the dispute.

Most importantly they need to be able to help the parties find common points of interest and remember why they are doing business in the first place.

Keep your eyes open and your head on a swivel, its good advice in sports and its good advice for China.

He hits a lot of good points on what you want to get from your supplier.  I am going to cherry pick some from his list to show my point.

1.   If you’re not here, you’re not getting what you ordered.

10. Nobody cares about your product as much as you do, but if your supplier sees you regularly, knows how much you care and also cares about you/likes you, you just might get what you are asking for.

These two points above are one of the biggest reasons you might have communication drop off. If you are not here in the first place, they can simply ignore you.  Knowing that you are not even the same country, can lead to this kind of conduct when things might be going wrong or you have put on the pressure.

The solution then lies in number ten of David’s list. If you can’t be here representing your interests, (which is costly in plane tickets and hotels or a change in your life style and move to China), there should be somebody here to represent you.

To tie this to legal situations, I think this also holds true for the contracts you draft for suppliers to abide by. If no one is here to over see the enforcement of those terms, there is not much bite to your bark.

Now, this is not to say that you should be in the way and overbearing to your supplier. Being on site regularly helps drive home the idea of your commitment to them and the project at hand.

Writing a rock solid contract IN CHINESE is just one part of your interaction with the company. Backing up those agreements and showing commitment is the other part.

Third party contracts cover a side variety of topics that concern people doing business in China. These types of contracts involve;

• Contracts of carriage, a contract where you (A) have a shipping company (B) deliver goods to a client (C).

• Some types of insurance contracts where you (A) purchase insurance from a company (B) payable to another company (C).

• Third party inspection contracts where you (A) hire a company to inspect goods (B) from a supplier (C).

What are the obligations of a third party? These contracts are specifically different from contracts in which a task is delegated (subcontracting). These types of contracts are those in which a third party is added to a contract to perform a responsibility or a part of a contract. Under Chinese Law, you are still responsible to uphold your obligation.

So, who is to blame when things go wrong? What happens when a shipping company refuses to deliver goods to your client? When an insurance company refuses to pay a claim? When a line of products that were inspected results in a massive recall? In situations where the third party refuses an obligation or performs their obligation in an unsatisfactory manner, what course of action can you take?

Unlike the Common Law system in Hong Kong, in which consideration, compensation, must be made before a contractual promise becomes legally binding. In the Chinese legal system, even an orally made promise can be legally binding, as long as the three conditions for making a legally enforceable contract are met.

Those three conditions are,

1. The person must have capacity (mentally sound and of age)

2. The person must have intention (no duress or forced conditions)

3. The promise must be legal (no refunds for your illegal drug mules) As long as these conditions are met, any promise that you make can be considered legally binding.

So what are the implications for third party contracts? If the intention of the two parties is to place a legal, contractual obligation on a third party and this intention is accepted by all three parties, then the wronged party has a legal claim against the third party. This means that you have a claim against your insurance company for not paying, against the inspection company for failing to inspect properly and against the shipping company for failing to deliver the goods as agreed to.

The next time you are finalizing a deal make sure that your intentions are clearly expressed. What are each of the parties’ individually responsible for? What are their obligations? What are the remedies in case anyone should fail to perform in a satisfactory manner? It is better for you to decide ahead of time about the solution to a problem rather than rely on a judge here to take a guess.

This post originally appeared on two other blogs;

http://silkroadintl.net/blog/2009/03/12/voidable-contracts/

and here

http://www.chinasuccessstories.com/2009/04/30/voiding-contract-situations/

There are, unfortunately, times when contracts, for whatever reason, need to be voided.  The problem is, when can contacts legally be voided?  There are specific circumstances when this indeed can be done.  But to make it work, you have to meet specific legal criteria.

The key to understanding these types of contracts in to note when they are actually void-ABLE. There are three situations in which you have the option of voiding a contract in China.

• A contract made by a “significant misconception” – This one is tough, because there are not really enough cases on the books in China to even attempt to take a guess at what “significant” implies.  Tentatively, if you are able to prove that in some aspect of the contract, one of the parties made significantly misleading promises that are not in sync with industry standards, you may meet this standard.
• Contracts that are “significantly unfair” – This has more to do with contracts in which some aspect of the agreement has changed significantly from the time the contract began to be effective to the time of performance by one of the parties
• A contract signed “under duress” – While this seems like a straight forward idea, no one can somehow force you to sign a contract and force you to perform it, in reality duress can be difficult to prove.

Basically, proving legal voidability will come down to three things, how well you know your industry, what the specific standards are and how influential your lawyer can be in arguing that you were mislead, tricked or coerced into signing a contract.

The tricky part about these types of contracts is that while they are indeed voidable, they are still valid until or unless the party that is getting the short end of the stick exercises their right to have the contract voided. These contracts are not inherently unenforceable. Chinese courts have treated many cases in which a contract has been created by fraud as a voidable contract. This means that unless you catch the other party to your contract cheating and blow the whistle on them, the contract is still perfectly legal.

While this may seem to tilt the field of play in favor of those who will steal cookies all day long and just take their losses when the one time they get caught with their hand in the jar, the Chinese courts have actually rationalized this position by pointing out that it may be in the interest of the party being misled to continue to enforce the contract.

While there may be some hypothetical situations in which the party being wronged would benefit if the contract were to be enforced, it seems to me that more often than not, these “significant misconceptions” will not be understood by the party being wronged. The other point of view from the courts is the recognition of the intent of the parties when they signed the original contract, they decided, by free will, to do business with each other in the first place and it should be up to them whether or not they continue to uphold the contract.

The most important point to take from this discussion is that, if you find yourself being deceived in a contract, it is up to you to go to the court and have the contract declared void.

A similar issue is the right to the rescission of a contract. This right deals with rescission as well as the modification of a contract. In Chinese courts, modification is almost universally preferred to rescission.  While modification of the contract is preferred, it is usually too difficult to try to decide what the true intent of both parties was had they been honest when putting together the original contract.

The statue of limitations for rescinding a contract is one year from the point one of the parties ought to have known they had cause to rescind the contract. Also, your right to rescind a contract may be waived through an explicit declaration or through your actions, if you continue to perform a contract after the evidence that you had cause to rescind was uncovered.

There are also many possible legal consequences to voiding contract. If a contract is declared void, (meaning it does not meet the minimum requirements of a contract) the contract will not have the intended outcome. If part of a contract is void (this is known as severance) you can basically cut that part out of the contract without damaging other parts of the contract that are still valid. Also, the dispute resolution clauses of a contract may still be valid as well, determining arbitration, mediation or conciliation and even the choice of applicable law. Just because the terms of the contract are void, does not mean that the contract disappears, there may still be very real responsibilities that can be costly.

Problem:

The non-compete clause they drafted up only included the employee’s responsibilities and no responsibilities of the employer. When they go to the court, the court judges in the employee’s favor, because the contract only stipulated the responsibilities of the employee, but did not stipulate what the employer was responsible for. The court also stated, both parties should have equal rights and responsibilities. The employee was liable/responsible for a certain set of rules stated within the non-compete clause, but there were no equal responsibilities for the company to abide by in the contract. Whether this was the company’s intent or not, the contract was clearly biased. Therefore, the contents should not be binding on the employee.

This is an interesting situation above. Now the employee can take other job, of the same title, at other competing company and approach old customers to do business. Everything the non-compete clause was supposed to prevent, had utterly failed. Again, there is this sense of “fairness” gong on. Chinese courts will not follow a completely one sided and winner-takes-all contract. The concept of “Good Faith” is a big reason for this. Negotiating in good faith, creating contracts in good faith, and performing a contract in good faith is an idea used today and written into law.

While the court did not mention good faith in the case, we could take a stab at a possible theory that the company could have been charged with “failure to negotiate in good faith” because of the one sided contract. Next week, I will get into what good faith means to you.

When you find yourself in a situation where you think you are in the mist of a breach of contract situation, it is more complicated than you think.

China PRC contract law,Art 107: Where a party fails to perform his contractual obligations or where his performance of the contractual obligations is not in the conformity with the agreement, he shall bear liability for the breach of contract by continuing his performance, taking remedial measures, paying damages and so forth

In terms of compensation, the law does not try to punish the party breaching the contract but rather protect the innocent and give compensation.

Two common types of breaches:

No performance

-          Impossibility- factually impossible or legally impossible

-          Repudiation- they claim they will not perform, BUT still possible

-          Delay- when you are not sure if contract will be performed.

Delay is not a breach at first until you give additional time and a specific date. Your product is 3 weeks late, and in order for delay to be a valid reason for breach of contract , you will have to give them a extension first to show you are interested in completing the contract. Once that has passed, you now have a breach of contract. The situation explained above it called “Nachfrist”

Defective performance

-           The important part of this is determining what is the defective performance.

Remedies

Remedies for the two above conditions are not cut and dry. Neither does it mean when suing you will get what you want. As I said above:

In terms of compensation, the law does not try to punish the party breaching the contract but rather protect the innocent and give compensation.

But something else to think about is, will the court consider fairness for each party? A great blog, China Law Blog, has a couple blogs detailing the nature of the court deciding on fairness, rather than winner take all. On the issue of no performance, it could be easier to assign fault but I am almost certain that one will not receive the full compensation they are looking for. One of the flaws of Chinese courts is, they don’t have an effective enforcement of rulings afterwards but recently there has been a database set up to compile all of the delinquent rulings of people that have not fulfilled their obligation. Even this is not an effective system as well, but it is a start.

Defective performance can get a little complicated as well. Most of these situations can be remedied and will not constitute a valid reason for canceling a whole contract.

Some things the Chinese court will be looking at with this situation above:

- Does the breaching party have the right to repair?

- Does the innocent party have a right to demand repair?

- Is it economically fair to the breaching party for the innocent party to refuse repair?

- Time of when defect was brought to attention?

- Was due diligence done?

As anything in China, consider your problems and remedies well. Before you throw your hands up or jump in with two feet,consider what can be the biggest win for you in the environment detailed above. For Westerners, it sounds like a unmanageable mess to deal with, but I like to think of it more as “Controllable Chaos”

To explain a little about what that large title means,”Interpretations” by the Supreme Court in China are ways to clarify and give direction to the court. This interpretation is the second version and clarification from the last interpretation 10 years ago. The new interpretation covers a lot of issues but I am only going to cover a couple text bites. If you are interested in reading the Interpretation, I should have it up soon.

Let me give you a taste of what Henry Liao presented:

The necessary terms of a contract:

-          Names of the parties

-          Subject matter

-          Quantity

*unless law prescribes otherwise.*

These are the bare bones of a binding contract. I would not recommend going this simple. It is a guide line for people who need to prove they have a contract, not a guide for setting one up. The more details the better.

Forms of contracts:

-          Written

-          Oral

-          Other forms

The interpretation gives more clarification on the term “other forms”. This is to say if there is no written or oral contract, both parties’ conduct/actions can be translated as performing a contract. For example, if one parties action is a benefit to the other and the other party in turn, let’s say, gives a payment. This is considered a contract, even though there has been no formal contract.

Drawing attention to important clauses:

-          Highlighting

-          Changing color of font

-          Modifying of font

-          Using symbols

You know when you get a credit card application and all that small text on the bottom of the sheet, so you cant read it and confuses you about why rates will jump sky high without notice or the explanation of roll over balance billing?

Those forms never draw attention to the stuff you want to know or might not even understand, but this interpretation has made it clear on highlighting important information. This could be a certain condition that makes or breaks continuing a contract, fees or responsibilities of a party. Matters that are particularly important to you and the other party in the contract should be more ! noticable !

Protectionism ?

As a practicing lawyer, Henry Liao gave a lot of good examples of real situation outcomes for contract disputes. One of his most interesting comments was on the question of pursing in court or going with dispute resolution. He commented on the Economic Crisis and how the squeeze has been put on local economies. He has suggested local protectionism has come into play. One piece of advice he has given to his foreign clients, in this climate, is to settle outside of court (if possible). His reasoning was not only tied to protectionism but this option works better for a small business getting the much needed funds and decisions sooner than later. He also noted that sometimes this works out to be more economical for the filing party. Instead of taking on years of fees and possibly a lower settlement, you can gain time and faster settlement. In the same breath, he explained that not all companies can / wish to operate this way, especially when the financial stakes are much higher.

From the outside looking in, it sounds pretty unfair. Like it or not, courts are tied to local government via payroll and future career success. What is not good for local economy is not good for the courts. Understanding the situation above may save you some headache and frustration. (I only said some) In China, learning to play the game is more “fun” , rather than fighting against it.

Any thoughts or experiences on the above?