Spotlight: Division on International Law/Eight — Contracting in the People’s Republic of China

Vol. 14 No. 2

By

Richard W. Pearse is a Shareholder in the Corporate Group of Vedder Price. Mr. Pearse’s practice is concentrated in domestic and international Infrastructure Project Development and Finance. He represents international and domestic lenders, owners, manufacturers, OEMs, contractors and engineering firms in structuring, drafting, negotiating and administering project acquisition and loan documents, complex design, engineering, procurement and construction agreements, equipment purchase and sale agreements, supply and off-take agreements, operation and maintenance agreements, power sale/tolling agreements, interconnection agreements, steam agreements, fuel supply and transportation agreements, pipeline leases, joint venture/development/partnership agreements, equity commitments and guaranties, and related project and financing documentation.

It is generally advisable when contracting for construction projects in the People’s Republic of China (PRC) to avoid, when possible, the substantive laws and judicial proceedings or arbitrations under the laws of the PRC. Foreign companies contracting with PRC companies are permitted to negotiate for a non-PRC governing law, arbitration rules and situs for the arbitration, and Chinese companies are often accustomed to stipulating that Singapore or Swedish substantive laws apply and that arbitrations will take place in a neutral location, such as Hong Kong or Singapore. The PRC is a signatory to the New York Convention, so an arbitration award will (at least in theory) be recognized by Chinese courts against the Chinese company’s assets within the PRC. However, it may be difficult for a foreign company to avoid PRC law if the contract is lucrative and the Chinese counterparty is large and controlling. Moreover, it is not possible for contracts between two domestic PRC companies (including foreign-owned enterprises or joint ventures registered in the PRC) to select non-PRC governing laws or arbitration rules, since the PRC substantive laws and venue (including the rules and place of arbitration) automatically apply as a matter of law. Therefore, a US lawyer should have a general understanding of the basic risks and pitfalls of navigating Chinese contract law.

There are three general sets of laws that affect construction contracting in the PRC; (a) the Contract Law, which covers contract breach, remedies, termination, delay liquidated damages and the like; (b) the Construction Law, which covers mostly commercial and residential buildings; and (c) the Tender and Bidding Law, which covers the selection of methods and procedures of bidding used for construction projects and other public or private contracts.

Keeping these different sources of law in mind, there are some important PRC laws that affect the outcome of freely negotiated contracts:

i. Consequential Damages. Although the Chinese recognize the concept of “indirect loss,” there is no specific concept of consequential damages, and merely providing that “consequential damages” are excluded may not be sufficient. Accordingly, it is prudent to list categories of loss to be excluded, such as lost profits, business interruption, loss of product, loss by reason of shutdown and the like, and these are likely to be given affect under Chinese law.
ii. Personal Injury, Grossly Negligent Property Damage. Provisions excusing a party for causing personal injury and grossly negligent property damages are specifically void under the Contract Law. However, key terms such as “willful misconduct,” “gross negligence” and “property loss,” are not defined in the PRC laws, and providing a self-serving definition may assist the client in limiting liability for such matters.
iii. “Fairness.” Certain contract terms can be avoided or varied by court or Arbitration if they violate certain provisions of the Contract Law: For example, Article 5 of the Contract Law provides that “The parties shall abide by the principles of fairness in prescribing their respective rights and obligations.” This is different from good faith and fair dealing. One-sided provisions in pre-printed Western forms may cause a Chinese court or arbitrator to set aside the provisions as “unfair,” even though the contracting parties are sophisticated and the provisions were thoroughly negotiated. This is similar to the doctrine of adhesion familiar to US lawyers, and it is prudent to make it clear that the other party is aware of any harsh terms, by printing them in bold and all capital letters, and by providing that the contract was entered into voluntarily by both parties without using either party’s form.
iv. Delay Liquidated Damages. In contrast to practice in common law countries, a Chinese court or arbitrator can adjust or set aside agreed liquidated damages if the actual damages are more than or less than the liquidated amount, no matter how reasonable the amount may have seemed at the time of contracting. As a possible way around this, the parties may contract to limit the overall damages from any cause to, say, 10%, 50% or 100% of the Contract Price, since provisions stipulating overall limitation of liabilities are enforceable.

As a practical note, it is not unusual during negotiations for the PRC counterparty to insist that (1) clauses such as those discussed above are unenforceable under PRC law; (2) no one else asks for those exclusions; or (3) your client is the most frustrating (i.e., “worst”) vendor they have ever had to deal with. The exact opposite is generally true, and an effective response is to insist, patiently and politely, that your suggested modifications are the international norm for similar contracts.

In short, if PRC laws can’t be avoided, it is possible with a little effort to successfully negotiate provisions that approximate the protections provided under Western laws.


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