Case Study: Commercial Contract Examination and Advisory in China

As part of our mission to provide business intelligence on the legal, tax and operational issues of doing business in China, China Briefing presents the next installment in a series of case studies based on the practical experience of professionals at Dezan Shira & Associates.

Scenario

A foreign company engaged in China’s heavy equipment manufacturing industry purchased certain specialized machinery from a Chinese supplier to coat its equipment in a protective paint for the manufacturing process. The company’s supplier insisted on the contract being signed based on their template, but the client company wanted to thoroughly examine the commercial contract provided by its supplier, as the purchase was a major capital expenditure. The company did not have any specialized legal or tax resources to do this, and thus approached Dezan Shira to ensure that the company’s interests were adequately protected.

As requested by the client, Dezan Shira’s Business Advisory Services team checked the contract template and provided alternative terms and text in any areas that could be improved, which the client’s purchasing manager would then negotiate with the vendor. Simultaneously, Dezan Shira conducted a due diligence/credit check on the Chinese supplier to protect the client in case the products couldn’t be delivered on time after the first payment.

In the course of our Business Advisory Services team’s investigation, we discovered that there were problems between the Chinese and English language text in the contract template. The main weakness in the contract related to the warranty for the machinery, and the circumstances under which the vendor would take responsibility for problems arising in its performance. Furthermore, the terms in the contract were rather vague and therefore meaningless. In particular, the language relating to the period of time necessary for the manufacturing and installation of the machinery was inadequate.

After working with the client’s purchasing team and helping the client understand the potential risks that might be incurred from the transaction, the following changes and improvements were made to the contract:

• The supplier further clarified the scope of the problems that could be caused by improper operation of the equipment;
• The definitions of “commencement” and “completion” were improved and penalties for non-completion were introduced. Certain unreasonable terms within the template relating to cost over-runs on the supplier’s side were eliminated;
• The contract clarified payment terms and specified that the supplier was required to issue invoices/fapiao upon the completion of each phase of the work and before demanding payment. It was also considered necessary to include a definition of the type of fapiao which the supplier should issue, as the VAT treatment would have a considerable effect on the total net cost of the machinery to the client; and
• Additional terms were added to directly refer to machinery specifications and operational methodology – these were originally contained in a separate set of documentation.

The credit check result was acceptable and provided the client with the confidence that the payment for the machinery could be made without any further risks.

Conclusion

In this case, our client was able to substantially reduce the risks that a big project would potentially lead to during its implementation. Specifically, the transaction risks were identified and reduced in the areas of machinery warranty, project completion, project payment, and taxation. The foreign general manager of the client felt in control of the project throughout, as the Dezan Shira team were handling all the coordination work with his team and made the changes to the contract in both English and Chinese.