Liuming International China Business Lawyers

NNN for China: firing silver bullets or just blanks?

November 4th, 2019

Introduction & background

“… Don’t worry, we have the NNN agreements in place….”

A snippet of a telephone conversation overheard in the lounge of a major hotel in New Orleans. The speaker was American, presumably a lawyer, and speaking confidently to a client about a China manufacturing deal.

Many, including lawyers, now regard the NNN agreements as the key to risk management in dealing with China. That is an error.

NNN agreements

The NNN agreements (non-disclosure, non-compete and non-circumvent) have been the subject of much Internet chatter and numerous articles. Unfortunately, their claimed effectiveness gets fortified only by repetition. Little, if any, of the NNN commentary comes from China licensed local or foreign law firms. Licensed Chinese lawyers are also mostly silent. Why?

China is a sovereign country

China is sovereign country. It is a Civil Law jurisdiction with its own civil procedure, court system, trial procedures and rules of evidence. As might be expected, it is a little different from other Civil Law jurisdictions. It is totally different from a Common Law jurisdiction. Commercial and legal strategies that might be perfect elsewhere may not be as effective in China.

NNN agreements are just contracts

NNN agreements are just contracts. A contract by definition is an agreement enforceable at law. To have commercial value, a contract needs to be technically and practically enforceable. Enforcement has to be cost effective to be practical. This is rarely addressed by NNN commentary where various remedies are mentioned as if they are items on a menu awaiting selection.

A brief contract refresher

A contract can only bind the parties to it. So your remedy must come from the other party to a contract. Your counter party. If others offend you must be able to prove a material link in the offending to your counter party. Your counter party is the only one that you can sue in contract.

A basic principle in contract is that if it is breached, the innocent party should be restored to the position that they would have been in if the contract had been fully performed. The preferred remedy is damages or monetary compensation.

Sometimes, although it is known that the contract has been breached, there are not yet losses that can be quantified in terms of money. It might be very clear however that there will be real losses in the near future.

Then an injunction (an enforceable court order to do or refrain from doing something) can be sought. These take two forms: an interim injunction restraining the other party until a full court hearing is completed; and a permanent injunction issued at the end of the case as part of the judgement.

To end this very quick and incomplete outline, there are also liquidated damages. Sometimes it is difficult to quantify and prove the actual amount for damages. Parties to a contract might agree, for example, that delayed delivery will result in damages of $5,000 per day. There are jurisdiction specific rules about this.

Each of these remedies is discussed below in the context of NNN agreements.

NNN remedies for breach

The NNN agreements are just contracts for specific purposes. They may also be terms to similar effect in more comprehensive contracts.

Breach scenarios

Weeks, months or years after your China contract has shipped, something very similar or identical appears on the market. Originating from a city that you have never visited and from a company that you have never previously heard of. You suspect that your previous counter party may have something to do with it. What then?

You may have actual losses to support a claim for damages. The issue then is to find and prove the link to your previous counter party so that the NNN agreements can be enforced. All the issues referred to below, except showing actual losses, are there. You have the burden of proof.

Sometimes contracts are breached, but there are no immediate losses. For example, you have just become aware that your miscreant counter party has set about copying your tooling – say a mould for making plastic parts. Or your confidential information has been disclosed, but preparations for use are ongoing. Or your competitor seems to have new knowledge about how to make products very similar to yours.

Do you have to sit back and wait until your business is really harmed so you can show monetary losses? That is one option, but who wants to wait until their business suffers harm? Enter the injunction.

China injunctions

Injunctions are hard to get in China. Funds have to be guaranteed to offset any potential losses of the injuncted party if the case is lost. Except for IP infringement or unfair-competition, interim injunctions are rarely issued by the courts. At the end of a case a final injunction may be issued, but that can be long after the event. Chinese courts are very cautious in granting any injunction and would usually review the actual substance of the whole case for an interim injunction, and would not be easily persuaded. Because of the different role of judges, prior contractual consent to injunctive relief is largely irrelevant.

Liquidated damages

Because of the difficulty in getting an injunction in China, NNN advocates often suggest that substantial liquidated damages be specified. Millions of Renminbi, the Chinese currency, are sometimes suggested as the amount of liquidated damages to induce fear of breach in the other party.

The real problem with that strategy is Chinese law. Chinese law provides that where there is a material discrepancy between the amount of liquidated damages and the actual damages, either party can apply to the court to set the liquidated damages aside or to reduce them to align with the actual harm suffered. If the court finds that the agreed amount is not fair, it will adjust the claim accordingly. In our simple examples above you don’t yet have any actual losses. It is going to be hard to sustain an argument for your liquidated damages.

Freezing bank accounts

NNN advocates also suggest that the counter party will fear having its bank accounts frozen by a Chinese court (an interim remedy analogous to an injunction that is available in China). The advocates are right: they will fear that – to a point! Let’s take a realistic look at this remedy.

You are the plaintiff and have the burden of proving your case. There is no pre-trial discovery and almost all relevant information is in Chinese. There are few publicly accessible registers of business information. You have to prove to the satisfaction of the court that you have losses because of your counter party’s breach of NNN obligations. Stop and think about that for a moment. In China, as everywhere else, there is a big gap between believing something has occurred and being able to prove it in a court of law. Particularly in a court system that prefers documentary evidence that has been notarised. Quite rightly, the first step in freezing a bank account, or preserving evidence, is to file your case. To do that you will need to have evidence linking your counter party to the breach. Filing fees will be based on the amount you claim as compensation – your millions in liquidated damages?

Back to freezing bank accounts. First, you have to be able to identify to the court the bank account and its links to your counter party. Knowing litigation is pending there may be a move to a different bank. You will have to prove to the court that your rights will be irrevocably damaged if the court does not approve your application to freeze the bank account. Then you have to deposit funds with the court or provide a guarantee – 30% of the amount to be frozen is typical. The wisdom of the RMB 10 million specified as liquidated damages in your NNN agreements may not be quite so apparent now. And the difference between actual and liquidated damages is not relevant at this point.

It is also not simply a matter of transferring money in. China is a foreign exchange controlled country. It is very difficult to get the security funds into China. The usual practice is to get a guarantee from a local security company. They charge a percentage of the guaranteed amount for this. They will typically also require security.

Damages

Damages are the routine remedy for breach of contract in China, as elsewhere. The process for proving the amount must take account of China’s rules of evidence, but that is not unduly onerous.

Commentary

The Internet is an amazing source of information. Unfortunately, much of the information about China is incomplete, out of date, or just plain wrong.

Are the NNN agreements silver bullets? Clearly not! But that does not mean that you are always firing blanks. As part of a well thought out and executed China engagement strategy they have a role, but they are not a substitute for real management of the China project.

For example, have you registered all of your registrable IP in China? Calling it IP in a contract does not make it legally so.

Legal and other due diligence is far more important than the NNN agreements because it is preventative, not attempting to be remedial. Who is the other party? What is their reputation in China? Do they have the necessary approvals and licences to make your product? Are they financially sound? Are they really a manufacturer or just a hidden agent for a real manufacturer? Or even worse, are they fraudsters?

Practical China knowledge and experience in the drafting of China specific contracts is important. The often seen verbiage about liquidated damages being a carefully considered estimate of damage, or consent to injunctive relief, or agreement not to oppose injunctive relief, usually suggest that it is not a “China” contract. Understanding where things are likely to go wrong in China and having contract terms and procedures to cover them is important.

If you have done your homework the NNN agreements may be an added security. We use them in appropriate cases but we make sure our clients understand their limitations. Our clients also know that if you have really done your homework, and have contracts drafted specifically for the purpose, the need to rely totally on enforcing NNN agreements will probably not be an issue of great concern.

Take-aways

  • A contractual right without a cost effective remedy, or a remedy at all, is empty.
  • NNN agreements provide little real protection in many common contract situations.
  • China is a sovereign country.  It is a Civil Law jurisdiction. Its civil procedure, court process, rules of evidence and the role of judges follow that system.
  • China legal strategies based on another system are unlikely to be effective. Irrespective of how effective they might be elsewhere.
  • If NNN agreements are unlikely to be practically enforceable in your particular situation, you are just getting empty comfort from moving risk around on paper.
  • There is no substitute for real legal and other due diligence when engaging with China.
  • Legal advice should be supported by on the ground experience in China, not the Internet.

© Graham Brown 2019. The assistance of Peng Wei and our team in the preparation of this article is gratefully acknowledged. Any errors belong to the author.

 

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The language used for a China contract is very important

March 23rd, 2016

The language used for a China contract is very important. Cross border contracts in general raise many issues beyond those in purely domestic contracts, including those of governing language. China related contracts need special consideration if they are going to be both technically sound and practical in use. The language used for a China contract is particularly important if dispute resolution, arbitration or court, is to take place in China, but that is not the only consideration.

Common approaches to the language used for a China contract

The four common approaches to the language used for a China contract are (for simplicity, here we assume here that the foreign language is English):

  1. Chinese or English only (English only is now relatively uncommon, but still seen);
  2. Chinese only with a “reference” translation to English;
  3. English only  with a “reference” translation to Chinese; and
  4. Both Chinese and English versions of the same contract as a single document or set of documents.

We need to think about contracts in principle. A practical definition of a contract is an agreement enforceable at law. A key part of what lawyers do is to ensure that an agreement becomes a contract by being technically and practically  enforceable at law.

The language used for a China contract is not just about enforcement

If the trappings of enforceability are there, but there is no true agreement there may not be a contract at law: even if there is a contract at law, without full understanding of the content, there are likely to be issues with performance. You might wonder how a party can agree to the detailed content of a contract where they lack the language skills to read and understand it. At best, they are relying on an assurance of what it contains, at worst, they do not know the detailed content. Understanding the content of a contract is integral to its performance, and performance issues are usually raised well after signing and in the absence of advisers. At that point, there is just the contract itself.

“Reference” translations

Any suggestion of using either language with a “reference only” translation, whether in writing or delivered orally should be considered carefully and skeptically. “Reference” in this context usually means that the translation is not complete.  At best, “reference” may means something like “we think this is accurate but we are not prepared to include it in the contract itself, just in case it is not completely accurate”.

Of course, there is a chance that the “reference translation” is both complete and accurate, but if it is, why is it not contractual?

In some ways the use of “reference” translations is understandable.  As previously commented, it is not easy to get good contract translation.  It has a cost and requires highly skilled people. Not every law firm can or wants to provide this. Sometimes a party, without fully understanding the risks they are taking, accepts the “reference” approach for economy. It is false economy in most cases.

A rarely discussed issue with translations that are not incorporated in the contract document set is that they lack authority and acceptance and may also be lost. Oral translations are ephemeral and of little practical use.

Our policy is that the only really sensible approach to the language for a China contract is that the contract should be accurately set out in the languages of both parties: ie Chinese and English.

Issues with using more than one language for a China contract

Once the bilingual approach is accepted, it immediately raises the question of what is to happen if there are differences between the language versions.  In most bilingual contracts a “governing language” provision is used to deal with this. Typically, one or the other of the languages is stated to prevail in the case of conflict between versions.  If dispute resolution is to be in China, making the English govern can raise as many problems as it solves, as mentioned below.

Arbitration can be conducted in a foreign language in China, but if the arbitrator(s) are Chinese they will be most comfortable and fluent in Chinese.  Human nature being what it is, and irrespective of the “governing” clause, they are likely to refer to the Chinese language version, at least for guidance;

If a Chinese court is the chosen dispute resolution venue, all evidence, including the English governing version,  will have to be translated into Chinese by a court designated translator. In a bilingual contract this is unnecessary, unproductive, and also a needless cost.

A compromise position, frequently used when the parties are unable to agree on a prevailing language,  is a provision that states that both language versions are equally authentic.  The consequence of this is that the tribunal or court can decide which language version they will use – in China, it will most probably be the Chinese version.

Of course, the contract can provide that the Chinese version governs. Properly explained, a foreign party will usually agree to this.

Overall, if a bilingual approach is to be adopted, accurate translation will be important. Unfortunately it cannot be assumed that all translators will be competent for a legal document. They are not. Legal translation, like legal drafting itself, is a special skill. Never be embarrassed about inquiring who will do the translation and how it will be checked for accuracy.

Practical benefits of bilingual contracts

The most important benefit of using a bilingual contract is that the parties will each have adopted the details of the terms it contains during the negotiations and ultimately by signing. It is the most certain way of ensuring that both parties understand and have agreed to its content, including:

  1. their rights and obligations – who will do what and when;
  2. the processes to be adopted if something unforeseen arises – consultation, notices, etc etc;
  3. the method for the resolution of disputes that the parties are unable to resolve themselves.

Hard to imagine how a contract can function otherwise. Practically, the signing a contract in a language that a party cannot read and understand is likely to lack the personal adoption and commitment that very often is the key to successful performance.

Another often underestimated benefit is that the translation is an inherent part of the contract document.  It cannot be separately misplaced. It is there when, as often happens, the people originally involved in the contracting process have moved on, taking with them their corporate memory including details of the reference translation.

The Language used for a China contract is important because it is the only tool that the parties and the tribunal or court have to work with.  A contract is too important for any party to rely on anything less than a contract that they can read in their own language.

Take away points

  • China related contracts are likely to be most effective if they are bilingual because it is important that both parties understand what is required of them.
  • A bilingual contract requires accurate legal translation, but this is not always easy to get. Why should you accept anything less than accurate translation in a bilingual contract?
  • The consequences of specifying a governing language in a bilingual contract need to be thought through.
  • Overall, any additional costs involved in preparing a quality bilingual contract are likely to be far outweighed by the increased confidence in the contracting process.

© 2016 Graham Brown. All rights reserved.

 

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Translation of a China Contract

June 29th, 2014

Translation of a China contract is very important.  I was reminded of this recently when I was reading an article written by another lawyer.  His basic point was that language in contract is very important, and where two languages are involved, it was important that the “language” provision in each version should correctly state the same governing language. To be frank, anything else is just incompetence.

Good translation is difficult to get

Unfortunately the article said nothing relevant about the really key point in China contracts – translation of a China contract. Good translation of a China contract is important, but it is difficult to get. That is one of the reasons why we do all translation of a China contract in-house – to ensure accuracy.  The other reasons is confidentiality, but that topic is for another time.

Why is it so difficult to get good translation of a China contract?  There are a number of reasons:

  • Legal translation requires particular skills – of course a high level proficiency in both languages is necessary, but so is an excellent understanding of legal terms in both the base language and the target language.  Both are required for good translation of a China contract.  Language alone is not enough – it is quite a different skill set from that required to translate poetry or a novel where the reader is sympathetic to the writer and trying to find the intended meaning.
  • When the language of a contract comes under scrutiny, it is likely to be in an aggressive context where one party is trying to establish a particular meaning from the words used and the other is trying to deny it.  Very often in a court or at arbitration. That is quite a different test for translation and the one that is really relevant for a China contract.
  • Translation is a skill that is generally not highly regarded in China.  There is a view that anyone can do it, which is another way of saying that it is unimportant work.  A glance at the instruction book supplied with a Chinese made appliance, or local signs, will, confirm this.  Very often translation is contracted out to language students at the nearest university for a pittance.  The result is what you would expect.
  • Good translation of a China contract is hard to do. It takes the skills previously mentioned, a lot of experience, and great attention to detail if an accurate translation is to result.  Some expressions in English (or Chinese) are very difficult to accurately translate into the other language.  Sometimes we have to amend the English (or Chinese) to facilitate accurate translation.  Good translation of a China contract is not something that comes at bargain rates, but the price is well worth paying if it helps get a successful outcome.

Questions you might ask about translation of a China contract.

  1. What is the process followed for translation?
  2. Who does the translation?
  3. What legal experience and training does he/she have?
  4. Who checks the translation?

Each of these questions is important, but those regarding who does the translation and checking are particularly so.  If translation is being contracted out, or being done by the other party, it is something to be concerned about. Translation should be done by someone able to talk directly with the person that drafted the contract so any ambiguities can be resolved and accurate translation obtained.

Checking is actually very important for good China contract translation because translators sometimes make mistakes that they cannot “see” because they created it. It requires fresh eyes.  Checking translation is a bit like proof reading a document, but goes further because a good checker will pick up ambiguities in the translation itself.  Perhaps needless to say, the person checking a translation should have superior skills to the original translator.

It is quite common in law firms operating in China for the person that drafts a contract, although a very competent lawyer,  to have very limited language skills in another language.  In these circumstances the drafter cannot check the translation so there must either be total reliance on the translator, or there has to be a competent checker.

Responses to the questions like “our translator is very experienced” or  “we have been doing this for many years and never had a problem”, or “all of our lawyers are bilingual” simply do not cut it.

Your contractual rights and obligations deserve more than a “trust me” response and there should be a proper process for legal translation.

Some advocate that one language should prevail.  Technically this is quite sound, but some practical realities need to be considered.  Very few people are equally fluent in more than one language. A  Chinese person  will typically be more comfortable with Chinese, an English speaker, with English.

If the governing law and dispute resolution is Chinese law and courts,  it is safe to assume that the Chinese language version is important, and will prevail.  But that is not the end of it.  Contracts have to be performed and it is important that both parties have accurate and authentic versions of the contract to guide their behaviour.

The only really sensible approach is to have good translation of a China contract so that both versions are equally authentic.  The contract can state that one prevails, but that is not a substitute for good translation, and both versions actually being the same.

Take away points

Good translation of a China contract is essential if it is to be legally and practically effective.

  • Good translation is not easy to get, and not every law firm can deliver it, but it is essential.
  • Be prepared to ask questions about the process: who will translate your China contract, who will check it for accuracy, and their qualifications and experience.
  • If you are not satisfied with the answers received it is probably time to seek an alternative source of contract expertise.

WX

© 2014 Graham Brown and Wei Xin. All rights reserved.

 

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“Our China contract must be used”

June 5th, 2014

In a previous post I wrote about the dangers of using contracts drafted for another purpose as China contracts. This is particularly risky with China contracts and I had yet another real life example of a defective China contract this week.

Simple China contracts can be good

A good friend, a small businessman, provides services to large companies in China. He has a simple two and a half page China contract that is governed by Chinese law and provides for Chinese courts as the means of resolving disputes. It is appropriate for the type of work that he does and the sums of money involved.

Recently he approached me with a ten page contract for comment. He had submitted his usual China contract to the local China office of very large multinational company but had been told that “the legal department” had a rule that their China contract had to be used for all transactions. My friend thought that their China contract was overly complicated, but it was an important new client and just wanted me to check it before he signed.

Not all “standard” China contracts are good

I had a quick  look, suggested a couple of minor changes, and smiling to myself, said it was OK for him to sign. I explained that I was smiling because the China contract was unenforceable against my friend, but he could take action and have a judgment enforced against the other party, if it came to that.

How could it be that a large multinational company was insisting on using a China contract that provided them with no real protection?  Standard documents is the simple answer.  Their China contract was created for a different legal environment.  In particular it provided for home country law, and the exclusive jurisdiction of home country courts.  Unfortunately, sovereignty made that provision  practically useless

Sovereignty sounds old fashioned, but it is at the core of international transactions, and cannot be ignored.  Practically, sovereignty just means that each country has the power to do what it likes within its borders. A necessary consequence of this is that a judgment of a court in one country has no effect in another country unless that country agrees to it.  Agreements of this type are typically called treaties – judicial assistance treaties.  Without a treaty in place, or an agreement on a case by case basis, a judgment made in one country will not be enforceable in another country.

If not correctly drafted, China contracts may be unenforceable

To return to the China contract imposed on my friend.  It provided for home country law, and the exclusive jurisdiction of home country courts. In signing, that is what the parties were agreeing to.  But the country concerned has no agreement in place that would permit a judgment against my friend to be enforced in China.  He has no assets in their home country so any judgment there would be empty.  The multinational could not take action in China, because by their own “standard” China contract, they had ruled that out.

My friend however has no such problems.  He can take action in the home country courts and that is where at lest some of the multinational’s assets are located.  His judgment will not be empty.

So how is it that a company with virtually unlimited resources can end up in this position?  A kind response is lack of attention to detail (other responses might be less generous).  The relationships between the parties are such that there is really very little likelihood that either party would resort to litigation if there was a dispute. However the danger with misapplied “standard “ contracts is that they lead to a baseless sense of security – no-one sets out to have unenforceable ten page China contracts, but it happens, as this case illustrates.

Filing cabinets full of unenforceable contracts?

I imagine that the multinational company concerned must have filing cabinets in China full of these signed China contracts, all of them with one thing in common – they are unenforceable against the other party.  At least some are likely to be for matters where failure to perform will have serious consequences.

China, as a sovereign country has its own rules and requirements and ignoring them has consequences.  China contracts drafted without due regard to the laws of China are almost certainly going to be defective, at best and may be totally unenforceable.  This real life example, setting out the most common form of defective contract, confirms that.

Take away points

Here are a few:

  • The legal department does not always get it right with standard China contracts.
  • Attention to detail is important for effective China contracts.
  •  Contracts that are sound elsewhere may be unenforceable in China.
  • There is no substitute for on the ground China contract experience.

GB

© 2014 Graham Brown. All rights reserved.

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China contract necessary for a China deal – contracts do not travel well.

May 23rd, 2014

The China contract

Use a specific China contract for China deals! A useful definition of a contract is an agreement enforceable at law.  If it is not enforceable, it may be an agreement, a memorandum, a note, or a minute, but it is not a contract.

At least 30% of the foreign created China contracts I see in China are technically defective to the point that they are legally or practically unenforceable.  Think about that for a moment.  “Contracts” are being created and signed that are not contracts at all!

How does it happen?

Usually it is because a document that was created for one purpose has been used for a different purpose.  Sometimes it is an attorney lacking in international experience taking on work that he/she should pass on to someone more experienced.  Both of these are not China specific so presumably defective contracts are found whenever there are international transactions. China’s legal system imposes its own requirements and these cannot just be ignored in a contract.

Why does it happen?

Many reasons – here are a few:

  • Inappropriate use of precedents or templates by law firms;
  • Large companies and their in-house legal departments want to have “standard” documents for use throughout the world. Unfortunately there are no “standard” legal systems;
  • companies or individuals want to save on legal costs so they take a contract that was originally created for a transaction in one country and use it as a China contract; and
  • counsel that would otherwise be quite competent, take on a China contract without the China specific background and experience to do so.

The unfortunate aspect of all of this is that the parties involved believe that they have contract and usually find out the truth only when they are facing a loss and want to rely on the “contract”.

Take away points

  • “Standard” documents are likely create more problems than they solve when they are applied to China transactions. There is only one sure path to contract certainty for China – documents competently drafted for use in China. Recycling legal documents for a China transaction without taking China specific advice is just an accident waiting to happen.
  • The cost of having a China contract reviewed by competent counsel is very reasonable, even more so when compared with the costs that can result from a defective contract. Taking a chance on enforceability and effectiveness in China makes no sense at all.

GB

© 2014 Graham Brown all rights reserved.

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