An increasing number of foreign companies are signing contracts to provide products and services to, or to make investments in, China. Although China's Contract Law, which took effect on October 1, 1999, is based on internationally recognised commercial contract principles, many pitfalls remain for companies unfamiliar with practice and law in China.
Article 126 of the Contract Law permits parties to a contract with a 'foreign element' to choose the law for handling disputes. The parties may choose Hong Kong law, for example, as the governing law of a contract that is mainly performed in China. However, mandatory provisions of Chinese law still will apply, such as the requirement that certain contracts be approved by a government agency to take effect. For example, contracts to establish a joint venture or to import restricted technology into China still do not take effect until approved by the Ministry of Foreign Trade and Economic Cooperation or its local counterpart.
Article 126 requires some contracts, including Chinese-foreign joint-venture contracts, to be governed by Chinese law. Moreover, Chinese law may apply because a foreign party agrees to use Chinese law to close the deal or the parties have not designated a governing law and China has the closest connection to the contract.
A foreign party may be exposed to liability under China's Contract Law even before a contract is formed. Article 42 subjects a party to liability for damages for losses caused to the other party for negotiating in bad faith under the pretext of concluding a contract. Tactics such as tying up a potential joint-venture partner with a noncompete clause while talking to other potential partners may lead to a suit for damages.
Article 42 also creates liability for deliberately concealing an important fact from the other side that is relevant to conclusion of the contract or for providing false information. Few negotiators are fully candid about all circumstances relevant to a proposed contact. Indeed, a degree of vagueness may be essential to concluding the deal. But withheld information should be carefully weighed in light of Article 42.
Article 43 creates liability for disclosing or improperly using trade secrets that a party learns during the course of concluding a contract. While this opens a welcome new avenue of protection for proprietary information, a foreign party should be aware that it could be subject to a claim by the Chinese party that it improperly used technical secrets or confidential market information gleaned during negotiations.