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Beyond dispute avoidance and resolution techniques, your contracts play a crucial role in protecting your business interest in China. When negotiating a China-related contract, foreign businesses must consider whether it will be governed by Chinese or foreign law. In this third post of our dispute resolution series, we will be covering the importance of the governing law clause when entering into a commercial contract with a Chinese party.
Governing law clause
It is important to specify, when possible, which laws will govern your contract. Many non-Chinese parties prefer that their contracts are governed by the laws of their home country. However, there are circumstances where Chinese law can be advantageous to the foreign party and situations where it is required to govern a contract. Here’s why:
1. Foreign law clauses may be unenforceable
In China, parties to a civil commercial contract are allowed to choose which country’s laws will govern their contract, provided that the contract is deemed "foreign related". However, any commercial contract that is not considered “foreign related” will be governed by Chinese law. Foreign related contracts contain any of the following characteristics:
- At least one party is a foreign national/corporation;
- At least one party has its habitual residence outside PRC;
- The object of the contract is located outside PRC;
- The contractual relationship was made, amended or ended outside PRC; or
- Other circumstances which may be construed as foreign related.
2. Chinese law is mandatory in some situations
Even if a contract is considered foreign related, Chinese law must be applied if the contract falls under any of the following categories:
- Sino-foreign equity or co-operative joint venture contracts
- Contracts for Sino-foreign joint exploration and development of natural resources within China
- Contracts transferring shares in Sino-foreign equity or co-operative joint ventures and foreign-owned enterprises
- Management contracts allowing foreign nationals/corporations to manage Sino-foreign equity or co-operative joint ventures established in China
- Purchase contracts involving foreign nationals/corporations acquiring shares in wholly Chinese owned companies established in China
- Purchase contracts involving foreign nationals/corporations acquiring assets of wholly Chinese owned companies established in China.
3. Trying to enforce foreign law in Chinese courts is not always worth it
Most courts apply domestic law of the country they are located in, so it should come as no surprise that courts in China follow Chinese law. Since the judges are likely to be most familiar with Chinese law, it is your party’s responsibility to explain the relevant foreign laws to be enforced. Considering the technical and legal nature of the task, you will need to hire lawyers to explain the laws, which could cost a significant amount of money. Beyond the cost, explaining foreign laws can be complicated and may not be enforced if the judge cannot reasonably or conveniently apply them.
4. There are many grounds for the rejection of foreign laws
According to Chinese law, foreign laws shall not be applied if they offend China’s public interest. In these situations, Chinese law will prevail. While this may seem straightforward, "Public interest" is a vaguely defined concept in China, meaning that it could be used to reject any governing law. Foreign laws may also be rejected if they conflict with other concepts like "basic morals" or "PRC sovereignty", which are also loosely defined and therefore tough to dispute. Finally, foreign law will also not be applied if it represents an attempt to avoid Chinese laws, regulations or prohibitions, another concept that is at the discretion of the judge.
Bottom line
Contracts are an essential tool in defining commercial relationships and resolving disputes. One of the many things to consider when negotiating your contract is the governing law clause, as it will directly influence the contract’s enforcement and process of dispute resolution. This guide serves as an introduction to the governing law clause, but it is not direct legal advice. For real-world applications of this concept, it’s important to seek advice from an experienced legal professional with knowledge of the governing law clause in China. Sign up for a free Trustiics account to get access to some of China’s top-rated lawyers who can help.