Understandably, Chinese buyers prefer the familiarity of their own system of legal rules and processes and will often push for a Chinese law contract. While commercial lawyers advising in Chinese projects are getting used to Chinese law and arbitration procedure, the differences between Chinese and English business law are too many and substantial to be simply glossed over.
They assume particular importance in the high-end manufactured goods export sector, where substantial elements of the constituent goods or services originate from outside China. The reason is simple - subcontract step-down. With the commercial focus very much on price, resulting in already competitive margins having to be stretched ever thinner across profit, overheads and contingencies, there is seldom any substantial margin for risk. What limited margin exists is best applied to risks that are non-delegable or insurable.
Stepping down plays a key role in project risk management. We see it attempted a lot. But how often is it done well across international trade transactions? While a precise use of the language of the step down mechanisms will ever be at the heart of an effective risk management strategy, an integrated approach to governing law and dispute resolution procedures is also important. Where different legal regimes govern the various web of contracts across the supply chain this can lead to quite unintended and unfortunate results.
To take a few examples, PRC contract law does not require a contracting party to assume responsibility for deleterious events that are unforeseeable, unavoidable and insurmountable. English law, on the other hand, except in extreme cases, fixes responsibility upon the party carrying the obligation, notwithstanding that performance of that obligation has been rendered more difficult by an event of force majeure. In the event of unforeseeable, unavoidable and insurmountable non-granting of Government approval, for example, under PRC contract law the Chinese buyer may secure a release from his obligation, at least so long as approval is withheld. English law is less forgiving. The exporter's subcontractor is not, as a matter of law, taken to have assumed this risk and, absent suitable contractual protection, may insist on the contract proceeding and payment being made. If the exporter is unaware of the PRC contract law approach to force majeure, he will not see the mismatch. Consequently, where the obligations of the Chinese buyer (underpinning the exporter's own obligations to subcontractors) are suspended, the exporter will remain saddled with English law contractual obligations downstream.
Another incidence of mismatch arises over subcontract payment guarantees. English law contains no special rules as to legal capacity over who may assume an obligation by way of guarantee or indemnity, but the position under Chinese law is different. The Guarantee Law of the PRC explicitly prevents state organs, certain public institutions and certain functional departments of state enterprises from assuming these commitments. In similar vein, the Rules on Foreign Exchange Guarantee by Resident Institutions in China require approval from the State Administration of Exchange Control. Sound flow-through of buyer insolvency risk will recognise and deal with these limitations.
In the area of dispute resolution the scope for mismatch is of no less concern. In most commercial contracts between Chinese and foreign parties, arbitration is king. The Chinese party will often ask for an arbitration clause, requiring the submission of all disputes arising over the contract to be submitted to the China International Economic and Trade Arbitration Commission (CIETAC) for final and binding arbitration.
This, of itself, is no bad thing. CIETAC offers a relatively high-quality dispute resolution process, enhanced this year by new rules. However, unless the contractor effectively embeds the CIETAC process into his downstream subcontracts, the inefficiency and risk of multifarious proceedings under different regimes will be no less troublesome.
These examples of the pitfalls in back-to-back drafting across Chinese and foreign contracts, in the context of present day pricing economics, illustrate the value of having supply chain contractual schemes reviewed by international lawyers experienced in Chinese commercial law.
Nicholas Brown is a lawyer at Pinsent Masons Hong Kong SAR, Tel: +852 2521 5621.