When a foreign company signs a commercial contract in China, it usually starts with a template. Sometimes the template comes from the Chinese counterparty, sometimes from the foreign company’s home office. Either way, the document gets passed around, someone translates it, someone reviews it, and eventually both sides sign.
The problem is that commercial contracts in China work differently than they do in most Western jurisdictions. A clause that is standard and enforceable in one legal system can be meaningless or even counterproductive in another. I have reviewed enough contracts between foreign and Chinese parties to see the same mistakes repeat across industries, company sizes, and deal types. Here are the six that cause the most damage.
Governing Law and Dispute Resolution
The governing law clause gets the most attention and still goes wrong surprisingly often. The basic principle is simple: if your contract involves a Chinese entity and performance happens in China, Chinese law will almost certainly apply regardless of what the contract says. Chinese courts will apply Chinese law to contracts performed in China, and foreign arbitration awards that contradict mandatory Chinese law provisions may face enforcement difficulties in Chinese courts.
What you should actually be negotiating is not the governing law — accept that Chinese law applies — but the dispute resolution mechanism. A Chinese court judgment is generally faster and cheaper to obtain than an international arbitration award, but it is harder to enforce outside China. An arbitration award from HKIAC, SIAC, or CIETAC is enforceable in most countries under the New York Convention, but the arbitration process is slower and more expensive.
For most foreign companies, the right answer is CIETAC arbitration seated in a neutral location, with the proceedings conducted in English. CIETAC is China’s primary international arbitration institution, its rules are well-developed, and its awards have a strong enforcement track record both within China and internationally. The key is to specify these details in the contract — the institution, the seat, the language, and the number of arbitrators. An arbitration clause that simply says “disputes shall be resolved by arbitration” without these specifics creates as many problems as it solves.
Termination Rights
Chinese contract law does not give parties the same default termination rights that many common law systems provide. In particular, the concept of termination for convenience — the right to end a contract without proving a breach, simply by giving notice — does not exist as a default rule under Chinese law.
If you want the ability to terminate a contract for convenience, you need to write it into the contract explicitly. The clause should specify the notice period, whether compensation is payable upon termination, and what happens to work in progress, prepayments, and confidential information after termination.
Equally important is the termination for cause provision. Under Chinese law, a party can terminate a contract if the other party’s breach makes it impossible to achieve the purpose of the contract. But what constitutes “impossible to achieve the purpose” is a factual determination that can be litigated. A well-drafted contract lists specific events that constitute material breach and explicitly states that each such event gives the non-breaching party the right to terminate. Late payment beyond a specified number of days, failure to meet specified quality standards after a cure period, change of control of the counterparty, insolvency — these should all be listed.
Intellectual Property Ownership
This is one of the most litigated areas in China commercial disputes, and it is almost always because the contract was silent or ambiguous.
If a Chinese manufacturer develops tooling, molds, or production processes specifically for your products, who owns that intellectual property? Under Chinese law, if the contract does not specify, the answer may not be what you expect. The default rule for commissioned works under the Chinese Copyright Law and similar principles under the Patent Law is that the creator owns the IP unless otherwise agreed in writing. If you commissioned the work and paid for it, you might assume you own it. Chinese law does not make that assumption.
The contract needs to state, with specificity, who owns what. Every category of IP that might arise from the relationship — patents, utility models, designs, copyrights, trade secrets, technical know-how — should be assigned to the appropriate party. The assignment should cover both the IP itself and the right to apply for registration. Pre-existing IP brought to the relationship by each party should be identified as remaining the property of that party. Improvements and derivative works should have clear ownership rules.
One drafting note: under Chinese law, an IP ownership clause that is buried in the back of a long contract may not be sufficient to transfer patent rights. For patents specifically, the transferor may need to execute a separate assignment document that can be recorded with the patent office. This is something your Chinese counsel should flag, but it is often missed when the contract is drafted by the foreign company’s home office legal team.
Liquidated Damages
Chinese contract law allows liquidated damages, but with a significant caveat: a court can adjust the amount if it finds the liquidated damages to be excessive relative to the actual losses suffered. Article 585 of the Civil Code and Article 114 of the Contract Law before it both provide that if the agreed liquidated damages are more than 30 percent above the actual losses, the court may reduce them upon the request of the party in breach.
What this means in practice is that a liquidated damages clause that seems protective on paper may not hold up if it is enforced. Chinese courts regularly reduce liquidated damages to amounts closer to actual proven losses, even when the contract explicitly states the amount is a genuine pre-estimate of damages and not a penalty.
The better approach is to use liquidated damages for situations where actual losses are reasonably predictable — late delivery, for example, where the daily cost of production downtime can be calculated — and to supplement with specific performance remedies or other contractual mechanisms for situations where losses are harder to quantify. A well-drafted contract also includes a waiver by the parties of the right to request judicial adjustment of liquidated damages, though Chinese courts do not always honor such waivers.
Force Majeure
Force majeure clauses became a topic of intense interest during the COVID-19 pandemic, but they matter well beyond pandemic scenarios. China’s legal framework for force majeure — now set out in Article 180 and Article 590 of the Civil Code — is relatively developed, but the default rules may not give you the outcome you want in specific circumstances.
Chinese law defines force majeure as objective circumstances that are unforeseeable, unavoidable, and insurmountable. A party that cannot perform due to force majeure is partially or fully exempted from liability, depending on the impact. The affected party must notify the other party promptly and provide evidence of the force majeure event.
For foreign companies, the practical issues are threefold. First, what happens to prepayments if a contract cannot be performed due to force majeure? The default rule is that payments already made should be returned, but only to the extent that the recipient has not incurred costs in reliance on the contract. A well-drafted clause addresses this specifically. Second, at what point does an extended force majeure event give either party the right to terminate rather than merely suspend performance? Without a contractual deadline, the parties are left in limbo. Third, natural disasters in southern China — typhoons, flooding — are not uncommon, especially in Guangdong province from June through October. A force majeure clause that specifically references these events, including the procedures for invoking them, avoids disputes over whether a particular tropical storm rises to the level of an “unforeseeable” event.
Language
This is not a legal doctrine, but it is the single most common source of disputes I see. Many contracts between foreign and Chinese parties are drafted in English only, sometimes with a clause that says the English version prevails. That clause is binding between the parties, but it does not help when a Chinese court needs to interpret the contract or when a Chinese regulator needs to review it.
If the contract will be performed in China and is likely to be examined by Chinese authorities — tax bureaus, customs, foreign exchange regulators — it should have a Chinese version. The two versions should be equally authentic, or the contract should specify that if there is a discrepancy, the Chinese version prevails for purposes of interpretation under Chinese law. The reason is practical: a Chinese judge or regulator reading an English-only contract through a translator may interpret terms differently than the parties intended, and the “English prevails” clause will not help if the judge finds the translation ambiguous.
The better practice is to negotiate the contract in both languages simultaneously, with the Chinese and English texts side by side, and to have both reviewed by bilingual counsel. This takes more time upfront and costs more in legal fees. It is still cheaper than litigating the meaning of a clause that was clear to one party in English but reads differently in Chinese.
This article is provided by Dan Young Business Consultancy for general informational purposes only and does not constitute legal advice. For assistance with contract drafting, contract review, or dispute resolution for your WFOE or subsidiary in Shenzhen, Guangzhou, Foshan, or Dongguan, please contact us directly.
