India-China Education Series Contract What contract – The biggest mistake made by Indian companies in China
Columns

India-China Education Series Contract What contract – The biggest mistake made by Indian companies in China

Bar & Bench

Bar & Bench brings to you the third column of the India-China Education Series written by DH Law Associates Partner and Head of China Practice, Santosh Pai on the biggest mistake (of not executing formal contracts or execution of improper contracts) made by Indian Companies in China.

Bar & Bench brings to you the third column of the India-China Education Series written by DH Law Associates Partner and Head of China Practice, Santosh Pai on the biggest mistake (of not executing formal contracts or execution of improper contracts) made by Indian Companies in China.

In 2011, Indian companies imported goods worth US$ 50.49 billion from China and exported goods worth US$ 23.41 billion to China. China is India’s largest trading partner and India is China’s seventh largest trading partner. Considering these statistics one would expect several hundreds of contracts being executed between Indian and Chinese parties every day. Wrong. It is astonishing to note the number of Indian companies, listed, unlisted, big, medium and small, that operate like cowboys in the Wild West while doing business in China.

The logic goes something like this – China is a communist authoritarian country where the legal system or courts cannot be trusted. Plus the Chinese always try to cheat foreigners in every possible way. Therefore, contracts in China will be of little use. Hence, why waste time and effort in negotiating, drafting and executing contracts. Even in instances where Indian companies do insist on executing formal contracts, a great deal of effort is directed at turning such exercises into grandiose acts of futility by dressing up purchase orders to look like contracts, grabbing the nearest template that was used for a contract with a supplier in some other country, etc. As a result, failure to execute formal contracts or execution of improper contracts ranks as the biggest unpardonable mistake that Indian companies commit while doing business in China.

This has dire consequences. To start with, very often there is a vast difference between what the Indian company believes to have been agreed and what the Chinese company believes. In the absence of a contract there is nothing preventing either party from modifying its expectations as the business relationship runs its course. Very soon a deep chasm develops between mismatched expectations that either results in high maintenance costs for the relationship or pre-mature termination causing losses to the Indian companies. Yes, unfortunately it is almost always the Indian party which suffers since the Chinese are far more diligent in insisting upon formal contracts when their interests are at risk.

When things go wrong as they invariably do in China or for that matter in any unfamiliar business setting, Indian companies are faced with the prospect of either arriving at a settlement to recover a sum of money owed by the Chinese party or suing to recover damages. This is when things go horribly wrong for the bolder cowboys among Indian companies which have not bothered to execute a contract at all. They simply have no legal recourse.

Under Chinese law, oral agreements are enforceable only for matters that are to be performed ‘immediately’. In all other circumstances, a contract must be reduced to some tangible written form such as a written contract, letter, e-mail, facsimile, etc.

In the absence of a formal contract, if there is a commercial dispute between an Indian company and a Chinese company, the Indian company involved starts knocking on the doors of the Indian Embassy or consulates in China for redress. Such companies also pour out their ‘grievances’ to Indian journalists looking for juicy China stories. They hope for some sort of divine intervention motivated by sympathy, pity or mercy which will rescue them from their predicament. Nothing of that sort happens. Instead such incidents often surface as instances of Chinese companies ‘cheating’ Indian companies so the myth that all Chinese companies are not trustworthy business partners is given a fresh lease of life.

Even when Indian companies execute contracts with Chinese companies there are several common mistakes that are committed –

a)  Not comprehensive – Most Chinese parties tend to ignore pre-contract discussions and agreements when signing a formal contract. Unlike other jurisdictions, Chinese courts and parties tend to focus exclusively on the formal contract. Hence, an Indian company must ensure that the contract is comprehensive in its scope regarding all aspects of the transaction it seeks to document. For example, a contract which merely specifies the price of products, a delivery date and payment terms will be entirely useless when it comes to other aspects such as dispute resolution, quality norms, protection of IP, etc.

b) Liquidated damages – There are a number of problems that can be reasonably foreseen in a particular contract. For example, in a contract for supply of goods one can foresee quality problems and late delivery. Chinese courts tend to uphold most reasonably worded clauses for liquidated damages so it is essential that Indian companies take sufficient care to include reasonable estimates of liquidated damages in their contracts.

c) Obligations of the Chinese party – Breaches of contract often have underlying reasons that can be foreseen. Indian companies will do well to identify such reasons and include them in their contracts to ensure that the Chinese party has no excuse for non-performance. For example, a supply contract that specifies the exact type of raw materials to be used in the manufacture of the final product will be far superior to one that merely provides specifications of the finished product since quality problems often materialize due to bad quality inputs. In general, the chances of obtaining compliance from a Chinese party is directly proportional to the number of specific obligations imposed in a written contract.

d) Applicable law and forum for dispute resolution – A number of considerations are involved in making the most appropriate choices of law and forum. A detailed discussion on these considerations will need to be covered in a separate article. Unfortunately  most legal practitioners with no exposure to China tend to believe that there is a single rule that dictates the most appropriate choice of law and forum for all contracts relating to China. For example, many Indian lawyers will argue application of English law or Hong Kong law with Singapore or Hong Kong as the seat of arbitration is the best compromise. Such a broad brush rule might severely curtail an Indian client’s legal recourse in certain circumstances.

e) Formality – Every Chinese company has a company seal which needs to be applied to every contract that the company executes. In addition to this, the legal representative of the company must sign the contract. The identity of the legal representative of a Chinese company can be ascertained from its business license so there is no scope for misrepresentation on this front.

If every Indian company insists on documenting its transactions with Chinese parties properly the so-called ‘trust’ deficit between the two countries will be reduced drastically. It is high time that Indian companies started treating China as just another ‘normal’ business jurisdiction where it pays to be diligent rather than paying heed to the numerous China-baiters and adopting ‘unconventional’ and risky business practices.

Santosh Pai is a Partner at D.H. Law Associates, which is the only Indian law firm to have an active China practice since 2010. He is based in Beijing and can be reached at santosh@dhlawassociates.com. He regularly blogs about India-China business topics here.

Bar and Bench - Indian Legal news
www.barandbench.com