China Contracts: The Deadline Trap

Negotiating China contracts
Negotiating contracts with Chinese companies

When negotiating a contract with a Chinese party, firm deadlines are essential, but also dangerous. They are dangerous because many (most?) Chinese companies have mastered the technique of manipulating deadlines to their advantage.

There are many reasons to set a deadline for concluding a contract with a Chinese party. In any deal where the Chinese side will be required to make a payment, such as the purchase of an offshore asset, the Chinese side will tend to delay making a final decision. Setting a tight contract deadline controls this tendency. On the other hand, when the money is flowing in the other direction, the Chinese side will often impose an artificial deadline unrelated to the deal. In my experience, the most common is for the Chinese company to assert that the deal must be done on a specific date because a public signing ceremony has already been scheduled.

If you are negotiating with a Chinese company that has set a deadline for completion, you need to be prepared to deal with what is now the fairly standard Chinese program for manipulating contract deadlines. Without regard to who set the deadline and without regard to why the deadline has been set, you must be willing to simply walk away from the deal if all of the terms and all of the drafting is not complete on the deadline date. If you are not willing to simply walk, then you will be manipulated by the Chinese side.

The standard program Chinese companies use for manipulating a deadline usually works in three stages, as follows:

Stage One: The first draft of the contract is always submitted by the foreign party. The Chinese company never provides the first draft because that would require they “tip their hand.” The foreign party works overtime on a tight timeline and provides its draft thirty days before the deadline. This is done under the assumption that thirty days is sufficient to work out all the deal issues and arrive at a final draft agreement on the deadline date.

The foreign party hears nothing, not even an acknowledgment of receipt. This causes concern and after three or four days the foreign party asks the Chinese side about receipt and comments. The Chinese side responds that it did a quick review and everything looks okay. The foreign party is relieved and begins preparing to implement the project on the terms stated in the draft contract.

Stage Two: Seven or so days before the deadline, the Chinese side finally sends its comments on the draft agreement. At this stage, the Chinese side proposes two or three changes. However, these changes are designed to make the contract completely unenforceable against the Chinese side. Here are my three current favorites:

1.  The key to the contract is that the obligations provided in the contract are absolutely binding on the Chinese party for a period of three to five years. The Chinese side makes no revision to the 35-page contract. Instead, they insert a single article that provides that the Chinese side can terminate the contract at will on 30-days notice.

When challenged, the Chinese side claims mutual termination is common in international contracts.

2.  The Chinese side adds what it calls a force majeure provision. The standard force majeure provision provides that neither side can be compelled to perform in situations where performance is impossible due to matters outside the control of that party: war, strike, typhoon, earthquake. The key to a standard force majeure provision is that neither party is required to perform. If the force majeure condition continues, the affected party is required to return the matter to the pre-contract status quo.

The Chinese provision is always written in a way that stands the standard force majeure provision upside down. In the Chinese version, the Chinese side is concerned only with the actions of the Chinese government. The Chinese force majeure provision will provide that if the Chinese government or its agents (foreign exchange bank) makes performance by the Chinese side impossible, the Chinese side is not obligated to perform. But the foreign party is still obligated to perform and the Chinese side is not obligated to return the matter to its pre-contract status quo.

When challenged, the Chinese side replies: force majeure provisions are standard in international contracts.

3.  In the critical provisions of the contract, in every place where it says “the Chinese party shall be obligated to do” the contract is revised to say “shall not be obligated to.” This is usually done where the revisions are not redlined or otherwise identified in a cover memorandum. The added word is only located after careful review of the contact. The longer and more detailed the contract, the more difficult it is to find this kind of revision.

When challenged, the Chinese side replies: we only inserted one word. What is your problem with that?

When the foreign side objects, the Chinese side will complain that the foreign side is being unreasonable. If well advised the foreign side will hold the line and refuse to agree to revisions like these that will essentially render the contract meaningless. The Chinese side then agrees to back down and the foreign side then feels relieved, assuming the agreement as drafted will be executed on or before the deadline. The unsuspecting foreign party does not realize that the opposite will almost certainly happen, leading to stage three.

Stage Three: Two to four days before the deadline, the Chinese side returns the contract with extensive revisions throughout the entire document, usually with no redline of the revisions. Some Chinese parties will redline some but fail to redline others. No explanation is ever given for the large number of revisions. No explanation is ever given for why these revisions were provided so close before the deadline when it is clear the Chinese side was aware of the issues weeks earlier when the draft was first provided to it.

Most foreign parties at this stage fall directly into the trap laid by the Chinese side since day one The foreign party works desperately to revise the document in the face of the by now ridiculously short deadline. In this setting, the Chinese side is hoping two things will happen. First, the foreign side will make concessions just to get the document signed. Second. the foreign side will make drafting mistakes due to the short timeline and the need to work in two or more languages. The Chinese side will then ruthlessly take advantage of those mistakes at a later date.

It is always a mistake to fall into the deadline trap. The better response is to realize from the start that the deadline is not relevant to the Chinese side. The Chinese side is merely using the deadline as a tool to gain an advantage over you. The first step when faced with this trap is to refuse to make the revisions and execute the agreement under this time pressure. Instead, tell the Chinese side that since they are the ones who responded late, you view their response as a contract rejection and for this reason, the deal is off.

Then simply walk away. Do not propose a new deadline. If you propose a new deadline, the Chinese side will go through exactly the same steps (as above) in almost exactly the same way. The only useful course of action is to tell the Chinese side that if it is still interested in doing the deal it should come back with a reasonable set of proposals and if we are still interested, we will take a look. But, since the deadline has passed, we may never come back to you. It is your risk.

In that situation, some Chinese parties will simply capitulate and come back with a reasonable set of proposals quite soon, often within one week. However, the most common response is that the Chinese side will continue to act in a manner designed to force the foreign party into making an unreasonable concession or a mistake. The only way to prevent that is to treat the deadline as a hard date and to walk away when the Chinese side is unreasonable.

It is impossible to predict what the Chinese side will do when you walk away. The Chinese side is not using this three-stage technique because it is inexperienced. The opposite is true. These entities are very experienced and they have learned that the deadline manipulation technique works very well. The only appropriate response from the foreign side is to call the bluff by walking away. But like a poker game with a stranger, you never know what will happen when you call the bluff. The response from the Chinese side is entirely unpredictable.

Be prepared.

This article was written by Steve Dickinson and published on China Law Blog. Original Post:      

View the original article here.

Steve Dickinson

Steve focuses on assisting foreign companies who do business in and with China. He prides himself on working primarily in the “real” China: the world of the factories, fish plants, and farms that lie outside of Beijing and Shanghai. Work in these areas requires a command of the Chinese language and an appreciation for the history and culture of China, and Steve possesses both of those in spades.