Graham Brown & Wei Xin of Liuming International takes part in Negotiating Effective Contracts & Dealing with Disputes

QUESTION ONE – Which techniques are typically used by international counterparties in your experience to overcome challenges in the negotiation process?

Successful China negotiations depend on a methodical approach, an acceptance that China is different, and reliance on experienced on-the-ground advice and support. It is common to hear a foreign party complaining about China. China just “is”. How you engage with it is the key to success. Language is very important.

Knowing who you are dealing with is an essential first step. There is no point in negotiating with a party that cannot deliver on your project, or whose reputation is such that they would not be a suitable partner. Really relevant information is only available in China and in Chinese. The expertise for conducting these enquiries is unlikely to be found outside China.

China is a challenging place to do business. Among its major challenges are the legal and regulatory environment. Any transaction with a foreign element is likely to involve legal and regulatory issues that may not apply to domestic transactions. Understanding these, and their impact on a proposed transaction is an essential preliminary to successful negotiations. Foreign exchange controls impact every cross border China transaction and must also be taken into account.

When the legal due diligence is complete and it is decided to proceed, it is time to plan the negotiation process.

It is best to enter the negotiation process with draft heads of agreement (HOA) that takes account of all of the major issues to be agreed, including those uncovered in the preceding two steps. This document should be in English and Chinese and serve as the agenda for negotiations. The Chinese language is important at this stage because everyone on the Chinese side will understand the issues.

As negotiations proceed and the agenda items are generally agreed, they should be ‘signed off’ and only reopened if absolutely essential. Only give up something if you get something in return. Be aware that, very often, the Chinese side of the table has limited authority to give up anything in negotiations. If you do not get an offer of compromise to match yours, it is probably a sign that you need to insist that someone with the authority to negotiate is present. Pending that, it might be best to suspend negotiations.

Controlling the documents, version by version, is very important. If, as we suggest, you have commenced with an HOA agenda, it is best to follow through and control all subsequent documentation. As with the HOA, all documents should be maintained in English and Chinese. Resist suggestions by the Chinese side that they translate or maintain documents.

It is important to have your own translation at meetings. The Chinese side will always have somebody fluent in English, probably someone that has studied abroad. Very often they will know more about you, your company and your business culture than you know about them and theirs. The process of knowing who you are dealing with partly compensates for this, but not completely.

Execution of documents is important. The only person that can bind a Chinese company on a signature is the holder of the statutory position ‘legal representative.’ The only other way to bind a Chinese company is by use of its company seal. We recommend that both signature by the legal representative and affixing of the company seal be adopted.

QUESTION TWO – Is there anything special or peculiar about commercial contract law in your country that General Counsel should be aware of?

China’s contract law, like that of many countries, has its traps and quirks. These are known and understood by experienced practitioners. Some of them are not in the contract law itself but arise from interactions with other law. For example, foreign exchange control in China impacts almost every cross border contract.

In many cases, parties wish to use a foreign law as the governing law of a contract because of a lack of familiarity with Chinese law. Chinese law permits the choice of governing law, but this choice is subject to some limitations.
Chinese law must be the governing law of contracts between Chinese entities unless a sufficient ‘foreign’ element is present. In practical terms, this means that almost all contracts between Chinese entities in China, including foreign-invested entities, must be governed by Chinese law.

Chinese law also provides that foreign law, even in international contracts, cannot be used to override mandatory provisions of Chinese law. Practically, this means that in many contracts where foreign law governs, the contractual provisions must also comply with Chinese law. If this is not adhered to, the contractual provisions can be unenforceable. Even if international arbitration is the dispute resolution method in such a contract a Chinese court is unlikely to enforce the award on policy grounds.

The Chinese side will always press for dispute resolution in China, court or arbitration. This should only be considered after receiving competent advice. There are very few treaties that permit the enforcement of a foreign legal judgement in China. Very often arbitration is the preferred dispute resolution method when the value of the contract is sufficient to warrant it.

Moving risk around in documents and relying on dispute resolution is not effective. Contracts should take account of the practical realities and contain provisions to manage the practicalities of risk. Formal dispute resolution provisions should be a last resort.

QUESTION THREE – What recent legislative developments in your jurisdiction affect commonly drawn up contracts?

China’s personal income tax regime prior to 2019 operated in a way that meant most foreigners deriving income in China would not be tax resident, limiting their liability for personal income tax to their China derived income.

China adopted the new Individual Income Tax (IIT) law on August 31, 2018, which became effective on January 1, 2019. This new IIT law, similar to common practice elsewhere, is a significant change providing that a foreigner who is not domiciled in China, but has stayed in China for 183 days in a tax year, will be regarded as a Chinese resident taxpayer. The result is that the global income of a tax-resident foreigner is subject to Chinese individual income tax from 2019.

This change significantly impacts foreign employers and employees in China, but the real effect is yet to be seen.

TOP TIPS FOR: Successful negotiations

Ensure that your advisers are licensed in China, and are not just a consulting company claiming to provide professional advice.

Engage experienced on the ground legal counsel.

Prepare thoroughly and seek competent advice very early in the project.

Be certain that you know who you are dealing with. Legal and reputational due diligence is essential.

Work closely with your local council, to plan what you want to achieve, what you are prepared to give up, and when you will walk away.

Successful negotiations require exceptional Chinese language and cultural skills.

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