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Five Things About China Deals That Differ From The West. Aspiration Matters.

By Dan Harris and Steve Dickinson

Geraldine Johns-Putra over at the View to China blog (just added it to our blogroll) just did a post I really love, called, "Ten things about doing deals in China that are different from the West ? Part 1." I love it both because it is helpful and because it does a great job of expressing some of the peculiarities of deals in China. 1. The Sino-foreign joint venture. Ms. Johns-Putra's take on these is that negotiating these often becomes "more adversarial than it should because it feels like two parties are trying to carve out their individual niches and protect their own turfs. It can be easy to forget that the point of the exercise is to provide the basis for the ongoing management and governance (and success) of the jointly-held company." I completely agree that negotiating joint ventures often becomes adversarial, but I also think that is often necessary and in some ways can actually be a good thing. Better to know before going into a joint venture that it is not going to work than to learn about it only later. For more on the difficulty of doing joint ventures in China, check out the following: -- China Joint Ventures Again. This Time We Blame The Victims. -- Love The One You're With. When China Joint Ventures Make Sense. -- China's Joint Venture Jeopardy 2. Rigid capital and profit distribution structures. Ms. Johns-Putra has this to say about the rigidity of joint ventures:

Along the way, a foreigner discovers that certain issues are pretty rigid in China, especially when it comes to the Sino-foreign joint venture model. One of them is the capital structure and how much one can derive from the investment relative to one?s investment. Indeed, one obstacle that private equity firms found investing in China is that the Sino-foreign Equity Joint Venture structure requires that profits be distributed in accordance with the proportion of equity holdings. If you own 50% of the company, you get 50% of the profits.

She's right and what she says here applies to much of Chinese law, in that it is much more formalistic and rigid as compared to the West. 3. Reciprocity in negotiations. Ms. Johns-Putra does a great job explaining this one, which really does require a full explanation:

I confess I used to find this one amusing. I think it is less and less an issue, as Chinese counter-parties become more sophisticated and are less demanding of complete reciprocity in a contract. Some years ago, however, it was not unusual that a Chinese counter-party, when asked to provide a certain undertaking, would insist on a reciprocal undertaking by the foreign investor to ensure ?fairness?. At times, the request didn?t make sense, e.g. when the foreign investor requested that the Chinese enterprise provide warranties regarding its assets because it was buying them from the Chinese. Why should the buyer then provide a warranty on its assets?? Often, however, reciprocal undertakings are easy to give away, since they have no real meaning anyway. (And from a philosophical viewpoint, in a negotiation, should you really be asking for something you would not give anyway?)

I too have had to deal with this issue in drafting contacts with Chinese companies, only I never found it amusing. I am a perfectionist and I have always believed contracts should not contain any meaningless provisions. My fear is that what should be seen as a meaningless provision will not be so viewed by a judge or arbitrator who will (rightfully) believe that it could not have been put in the contract for no reason, and then will seek to interpret it to have meaning. And that meaning may not be the meaning I want. This is still a problem and the reason is because so often Chinese companies skimp on their lawyers and demanding whatever the other side gets (no matter whether it makes sense or not) is a classic sign of a bad lawyer. 4. Demands based on fear of the other. Again, I will quote Ms. Johns-Putra directIy:

I put into this category demands about governing law and the dispute resolution forum. Many foreign clients I have known had a fear of submitting to Chinese law and agreeing to dispute resolution in China. Many Chinese parties seemed to feel exactly the same way about foreign laws and foreign arbitration and courts. There is more to this than I can go into here, but essentially agreeing to arbitration or even the jurisdiction of a court in China is not such a bad idea, since (i) arbitration at the China-based China International Economic Trade and Arbitration Commission (CIETAC) is easier to enforce than a foreign arbitration award which can be simply ineffectual in China (just ask Danone) and (ii) foreign court judgments mean nothing if the Chinese party does not have assets in that jurisdiction. Governing language clauses also fall into this category. If a foreign investor is willing to submit to the jurisdiction of a Chinese court, then it follows that the Chinese language version should govern, since the court will not read anything else. For many years, I used to automatically provide for both English and Chinese language versions to prevail, but I am no longer convinced this is workable. You can find much more on this issue over at the China Law Blog, and I am indebted to them for making such good sense about these issues so many times that it convinced me they were right.

I agree with all of the above. What I am always saying regarding the official language of a contract is that it is always better to agree on one language than two languages just greatly increases the chances for misunderstandings and attorneys' fees should a dispute arise. For more on why one language is so much better than two, check out "China OEM Agreements. Why Ours Are In Chinese. Flat Out." 5. Agreeing to agree. Again, I have to just quote Ms. Johns-Putra directly, British spellings and all:

Another personal favourite of mine, like the reciprocity requirement, chiefly because this had some lessons for me. Many China-related contracts I?ve drafted contain a clause that there are outstanding issues that the parties haven?t yet entirely resolved and would agree on in time. Often, the clause ? or at least the principle ? is handy when there is just some little detail the parties can?t quite agree on but feel like they?ve had enough and need to move on and sign the thing. In the English system of law, clauses that don?t pin down an obligation on a party are called ?agreements to agree," and they are generally seen as worthless. Yet, I have drafted many contracts with ?agreeing to agree? clauses like that, that never needed to be readdressed. The main thing is the deal got done and everyone moved on. Plus, I?ve drafted ?amendment agreements? so many times, that I know that even if parties have agreed on something, they can change their minds or need to clarify things after the fact. It is just human nature. So maybe the Chinese are onto something when they recognise it upfront and don?t try and dot every ?i? and cross every ?t?.

This was actually my favorite of the list because it was one that initially drove me crazy, but with which I have learned to deal and even sometimes appreciate. It is so non-Western and Western lawyers tend to really hate it because it is so counter to our training. It actually comes up all the time. Here are a few somewhat composite examples: 1. Large, well funded Chinese company needs US technology to improve its quality and increase its sales. It contacts our client wanting to do a joint venture. Our client, quite wisely I think, wants to go into China more slowly so instead agrees to license out a few of its products to the Chinese company. The licensing is a way for our client to make good money in the short term, while at the same time, it serves as a great mechanism to determine whether this Chinese company is one with whom it wants to and should be getting closer. We draft the licensing agreement and the Chinese adds a number of provisions talking about how if the two companies do well with their licensing agreement, they will form a joint venture along such and such terms. My sophisticated client and its in-house lawyer are completely non-plussed by this language. The in-house lawyer wants it removed completely, rightly fearing that whatever language is in there is an open invitation for a law suit if a joint venture never happens. The client itself, however, rightly feels that simply stripping it out will be deemed an insult to the Chinese company and go contradict much of what they had been discussing and one of the purposes for the joint venture. I agree with the in-house counsel that such provisions are dangerous and I talk about how if we are going to sign off on the language the Chinese company has put forth, we really ought to draft up and negotiate an entire "tentative" joint venture agreement. But that makes no sense at all because, as I point out, my firm does not offer a "tentative" discount and so the drafting and negotiating of such a joint venture agreement will cost no less than a "real" joint venture agreement and joint venture agreements are expensive. In fact, in deference to #1 above, joint venture agreements are pretty much the only agreement we seldom do on a flat fee basis and the reason for that is that they are so unpredictable in terms of how much attorney time they will require due to the impossibility of predicting how contentious they will be. So instead, I propose we replace the two pages of the Chinese company with something along the lines of how both parties hope this agreement will allow them to get to know each other well enough such that they will want to strengthen their relationship with future ventures. We did this, the Chinese company was fine with it, and we achieved Kumbaya We represented a large US service business that had a very successful multi-year working relationship with a Chinese counterpart. The American company would bring on its Chinese counterpart most of the time when it had China-based work and the Chinese company would do the same when it had US-based work. But one day the Chinese company proclaimed that it wanted to "formalize" its relationship with the American company. I do not think the Chinese company used the word "formalize" but that was certainly the gist of what it was saying it wanted. Our American client was vehemently opposed to formalizing the relationship. The American company loved its relationship with the Chinese company, but felt that in at least a few areas, it was not the best Chinese company to use. The American company also saw no benefit to changing the relationship because it had been working so incredibly well and seamlessly and it worried that negotiating and putting it all on paper risked doing it harm. As things stood, the US company simply paid the Chinese companies regular rates whenever it brought it on and everyone was happy with the financial aspects of that relationship. Lastly, the American company was concerned that if it formalized its relationship with the Chinese company, it would look strange if it did not reflect that relationship in some way on its website, and it did not want to do that for fear of offending some of the other Chinese companies with which it also did business. Yet at the same time, our American client was scared to death that if it said no to "formalizing," it would lead to the end of a great relationship. At this point, I will admit that in both of the two above examples (and probably in every other one in which I have been involving aspirational language) at least one person has always sought to analogize the situation to dancing at a prom, dating, going steady, or going to bed with someone. I note this but also note that I have refrained from resorting to such language in this post. So I suggested we seek to figure out what the Chinese company really wanted from this relationship and that my law firm do the talking with them as we could do so in a more neutral less emotional way and we could do so in Chinese. So we talked with the head people at the Chinese company and learned that their goal was more than anything a desire to commemorate/memorialize/recognize their excellent relationship with the US firm --yes, commemorate/memorialize/recognize are the words I am meaning to use here. The Chinese firm wanted to do this for the following reasons: -- as a way of showing the American company how happy they were with the relationship; -- so they could brag to their Chinese clients and potential Chinese clients that they had an affiliation with a top American company -- so that their employees and potential employees would know that they had an affiliation with an American company. So working with the Chinese company, we were, in very short order, able to draft up a two page document the Chinese company absolutely loved and yet had virtually no legal impact. The document merely started out talking about how great the relationship had been and how both sides wanted it to continue. The document talked about how the parties would continue to try to refer appropriate work to each other and work on matters together, when appropriate. It concluded by talking about how the parties hoped that their relationship would continue to grow and prove financially sound for the two of them. The two companies got together for a great dinner with a lot of toasts and signed the document. This was at least three years ago and every "aspiration" in this document (note how I did not say contract) has been fulfilled. Such a document would be pretty much unheard of in the West where everyone is super sensitive to legal entanglements and, in a perfect world, I would have counseled my client against signing it as well in that it violates the rule I discussed above about legally meaningless provisions. But in the real world, business exigencies, not ultra paranoid lawyers, do and should drive business and using "aspirational language" can be a great way to solidify relationships in Asia (we have done similar things with companies in Vietnam, Korea, Japan, and Russia -- which is in many ways more "Asian" than "Western" in how it conducts business). Don't want to sound like too much of a geek, but I can hardly wait for Ms. Putra to come out with part II. What do you think?

Full post as published by China Law Blog on March 04, 2010 (boomark / email).