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. Issues of capacity are sometimes overlooked when dealing with Chinese parties. If a contract contemplates the import or export of goods or cross-border transfer of rights in technology (including licensing), then China's Foreign Trade Law requires that the Chinese party have 'foreign trade rights' in order to enter into the contract. If the Chinese party does not have such rights (and many do not), then it probably lacks capacity, and an authorised foreign trade company with such rights should sign the contract as a primary or additional party. Although foreign companies typically are authorised to engage in a broad range of activities, a Chinese enterprise is required to operate within an approved scope of business, which is usually quite narrow. Article 10 of the Interpretation of the Supreme People's Court on 'Several Issues Concerning Application of the Contract Law of the People's Republic of China,' issued on December 19, 1999, states that a contract will not automatically be invalid because a party exceeds its business scope in concluding the contract. However, the Chinese enterprise may not have the ability to carry out obligations under a contract that are outside its business scope, and a People's Court may declare the contract invalid if it violates regulations restricting or prohibiting the business that is the subject matter of the contract. The prudent course is to examine the Chinese party's business scope (included in its business license) before entering into the contract. China's Contract Law has made it much easier to form a contract, to the point that a party may find itself inadvertently bound. Article 9 makes oral contracts valid, unless other provisions of law require a writing. The contract also may be embodied in one or more facsimiles or e-mails, and, under Article 33, an executed letter of confirmation is optional. Offer and acceptance rules generally look familiar to lawyers from common law jurisdictions, but no consideration is required. An offer must be definite, but only the parties, subject matter and quantity must be specified; the parties can supplement other provisions after the contract is concluded. A contract is formed when the acceptance becomes effective, and only a 'written instrument' must be signed or sealed. Article 12 'generally' requires a contract to provide for quality, price, time, place and method of performance, liability for breach and method of dispute resolution. In the absence of agreement by the parties, the court may supplement such terms by reference to other terms in the contract or local trade practice, which may lead to a result that differs from the foreign party's expectations. What if the acceptance contains modified terms? If the terms affect the required provisions listed in the previous paragraph, they are considered material modifications that make the acceptance a new offer. Otherwise, modified terms become part of the contract. Article 39 has created substantial uncertainty about standard or 'boilerplate' clauses. The party using standard clauses must abide by the principle of fairness, draw the attention of the other party 'in a reasonable manner' to the clauses and explain them if requested. Article 39 defines 'standard clauses' as clauses prepared in advance for repeated use, which are not negotiated when concluding the contract. Examples of drawing attention in a reasonable manner include placing standard provisions in a prominent place, using eye-catching fonts, identifying appendices with standard provisions in the body of the contract and completely attaching them to the contract. A contract with standard provisions may include a declaration that it has been explained to the other party. However, in the event of a dispute, it is unclear whether such measures will meet Article 39's requirements. In the event of a dispute, a standard clause is interpreted against the party that drafted it. Under Article 40, a standard clause is void if it exempts the party that drafted the clause from liability, increases the liability of the other party or deprives the other party of a major right. Terms such as 'major right' are not defined, but Article 40 on its face is quite broad and calls into question the validity of disclaimers of liability and limitations of damages in standard-form terms and conditions attached to sales and licensing contracts. Article 99 permits one party to a contract, by notice to the other party, to set off its matured obligations, such as a debt that is due and payable, against matured obligations of the same 'type and quality' of the other party. Other obligations can be set off by agreement. Although the effect of a setoff is not spelled out in the Contract Law, it apparently serves as a satisfaction of the obligation up to the amount that is set off. Setting off obligations facilitates settlement of debt, but it raises other issues of general concern when dealing with Chinese parties. First, a Chinese party that earns foreign currency from sales or services abroad is required by China's Regulations on Foreign Exchange to remit such foreign currency back to China. Although receipts and payments of foreign currency for current account items do not require approval by the foreign exchange authority and, in principle, may be made on the strength of transaction documents, setoffs of foreign currency require approval because foreign currency receipts are not remitted back to China. Such approval generally cannot be obtained. Second, Article 73 provides that a creditor can petition a Chinese court to be subrogated in its own name to the right of its debtor to collect a matured claim from a third party, if the debtor's failure to collect injures the creditor. Some companies in China have little net capital and owe money to their suppliers and bankers in a 'triangular debt' situation. Any waiver of a claim by one of such companies will injure the others. If a Chinese company in such situation agrees to set off a receivable owed to it by a foreign party for less than full value or to set off such receivable against a payable owed by its own affiliate to the foreign party, the Chinese company's creditors may assert that the company has failed to pursue a matured claim against the foreign party and petition the court to be subrogated to such claim. The foreign party may find itself in a Chinese court answering to an unfamiliar creditor for a debt it believed to have been set off or settled. Article 94 sets out conditions for unilateral termination of a contract, including failure of the other party to perform its main obligations and a delay or breach that makes the objective of the contract unachievable. The parties also may agree on conditions for termination and, when a foreign party wishes to be able to terminate the contract upon the occurrence of a specific event, such as upon an unauthorized disclosure or use of confidential information, whether that event should be set out in the contract. Article 128 allows parties to a contract with a 'foreign element' to apply to a Chinese or foreign arbitral institution for arbitration on the basis of their agreement. China is a signatory to the 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards. Arbitration awards rendered in member countries can be enforced in China in accordance with this convention. Hong Kong awards are enforced in accordance with The Arrangement between the Mainland and the Hong Kong Special Administrative Region concerning the Mutual Enforcement of Arbitral Awards. On the other hand, in practice, judgments of courts of most countries (currently also including Hong Kong judgments) generally are not enforceable in China. A provision in a contract vesting exclusive jurisdiction in the courts of a country that does not have a treaty with China for the mutual enforcement of judicial decisions, for example, may not be of practical value unless the Chinese party has assets outside of China. A final point sometimes overlooked by both foreign and Chinese parties is that China is a member of the United Nations Convention on the International Sale of Goods. Under Article 142 of the General Provisions of the Civil Law of China, an international treaty to which China has acceded takes precedence over the civil law, and the Convention on the International Sale of Goods will apply to a sale of goods between foreign parties from countries that have acceded to the Convention and Chinese parties unless the parties have expressly disclaimed it.