In order to purchase commodities from the People’s Republic of China, a foreign company and its Chinese supplier will usually sign a sale and purchase contract. In the case where one party to the contract is a foreign entity (e.g., a US company), the contract shall be regarded as a foreign-related contract under China’s Contract Law.
According to Article 126 of the Contract Law, parties to a foreign-related contract have the right to select the law to be applied in the event of a contractual dispute, including the law of a jurisdiction outside of China. However, it must be noted that merely having foreign law govern a contract does not ensure that a foreign entity will be able to successfully control its exposure to risk. Specifying the jurisdiction of the contract is just one potential component in a much larger strategy that must be adopted.
A US company may face various major risks when it enters into a sale and purchase contract with a Chinese supplier, but it can take steps to best control these risks in the event of a dispute.
Transaction Models
As a preliminary matter, it is instructive to look at the typical business models adopted by US companies for their cross-border transactions. In some cases, a US company deals directly with a Chinese supplier; in others, the US company would use a buying representative or agent for its transactions. No matter which model is adopted, and regardless of adopting US laws as the governing law for the transaction, U.S. companies may always face the risk of being sued in the Chinese courts by the Chinese supplier.
The following analysis takes a direct transaction between a US purchaser and a Chinese supplier as an example.
Purchase Orders
For the sale and purchase of products, a direct transaction typically uses a standard order. In many cases, parties do business by providing and accepting purchase orders—without signing any contracts setting forth the terms and conditions applicable to the transactions.
In order to avoid potential problems caused by unclear or insufficient terms, and to ensure that a US purchaser enters into a binding agreement with a Chinese supplier possessing clear and unambiguous terms and conditions for each transaction, a master supply and purchase agreement lasting for a certain period of time should be concluded between the US purchaser and each of its Chinese suppliers. The purchase order issued by the US purchaser should only indicate commercial terms (i.e., name, type and quantity of goods; lead time; place and date of delivery) for that particular transaction. In this manner, the combination of a master agreement and a purchase order duly accepted by a Chinese supplier shall constitute a complete contract between the US purchaser and the Chinese supplier.
Goods Inspection System
Disputes in connection with a sales contract often arise as a result of product defect issues. To help avoid or resolve such issues, a well-developed system for inspection and identification for the products in question should be implemented. Such a system may include the following measures:
- A demonstration of a product sample
- A pre-shipment inspection by the US purchaser
- An inspection at the final destination by the US purchaser
- In case a dispute arises, a final binding inspection by a third party designated by both parties in advance
Additionally, for product inspections, any standards and specifications for the products, as well as any inspection criteria, shall be expressly written in the master agreement for the parties to follow.
Litigation/Arbitration
Many claims of dispute arising from, or in connection with, sales and purchase transactions are brought by Chinese suppliers against US purchasers. Of course, sometimes a US purchaser claims against its Chinese suppliers for defective delivery or other problems.
Enforcement of Judgment or Award
In cases where a US purchaser is the plaintiff, it must be especially noted that any judgment from the relevant courts of the United States cannot be enforced in China because of the lack of a bi-lateral treaty for the recognition and enforcement of foreign judicial judgments between China and the United States.
However, because China is a member of the Convention on the Recognition and Enforcement of Foreign Arbitral Awards, any favourable decision awarded by an arbitral panel (including using US law as the governing law) can ultimately be enforced by the competent Chinese courts against the Chinese supplier in question.
Therefore, the US purchaser should consider adopting a clause allowing for any disputes with a Chinese supplier to be heard before an international arbitration institute, as such judgments would then be enforceable in China.
Cost-Effectiveness of Dispute Resolution
Apart from the feasibility for enforcement of a foreign judgment or arbitral award, a US purchaser also needs to take into account various other factors that would either be in favor of, or adversely affect, the interests of the US purchaser. One significant issue would be the time and cost spent in the proceedings. In general, the cost for international arbitration with the venue in China would be higher than the fees paid for a litigation at a court in China, while the time spent on the latter would take longer.
Preservation of Property
If a US purchaser files a lawsuit or arbitration against a Chinese supplier, the US purchaser, as the plaintiff or claimant, should consider requesting preservation of the Chinese supplier’s property in China. However, if the lawsuit or arbitration takes place outside of China, it will not be feasible for the US purchaser to request such preservation of the Chinese supplier’s property in China because of the lack of treaties between China and the United States in this regard. On the contrary, if the lawsuit or arbitration is conducted in China, the US purchaser has the right to request the preservation of property, and once approved by the court or arbitration tribunal, such preservation shall be conducted as requested.
Confidentiality Protection
As a lawsuit is usually publicly heard in court, whether in the United States or in China, arbitration is comparatively a better method in terms of protecting the confidentiality of information for both parties.
In conclusion, the design of a sale and purchase contract and determining a suitable method for dispute resolution are areas worthy of special attention. A foreign company that makes such good efforts to achieve satisfying business outcomes will greatly reduce the risks associated with sale and purchase transactions in China.
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