China, Contracts

Don't Misunderstand Your China Memorandum Of Understanding

Don't sign any contracts in China before consulting an attorney. Here's why.

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Just about every month, an American businessperson contacts one of my firm’s China lawyers to request we draft a contract based on a “just signed” Memorandum of Understanding with a Chinese company. And just about every month, we tell an American businessperson that the “memorandum of understanding” they just signed likely constitutes a binding contract under Chinese law and is almost certainly viewed that way by their Chinese counterparts.

In common law countries like the United States, MOUs typically mean little; only the signed deal really counts. This is not typically true in civil law countries which hold to a much stronger concept of good faith negotiation. Under that concept, it is not acceptable to simply walk away from an MOU if that would constitute “bad faith.” Since the traditions are so different, you can see where conflicts may arise.

What is bad faith under Chinese law? The standard example is signing an MOU with one Chinese company and then entering into a deal with another Chinese company. Under the common law, the party cut out under this scenario usually has no claim. Under Chinese law, the party cut out has a claim under the bad faith doctrine.

When an American businessperson asks one of our China lawyers to draft a contract based on a signed MOU, we usually suggest they first alert their Chinese counterparty of this plan. The Chinese counterparty usually responds by insisting that there is no need for another contract. The American signed the MOU thinking its nothing and planning to come back and turn it over to their attorneys to draft the final agreement while the Chinese side signed it thinking that it embodied the deal.

If the American company then insists on drafting a new contract, the Chinese party will view the American company as having acted dishonestly. Now you have a situation where what could have been a good relationship starts off poorly or fails to start off at all. If we go ahead and draft a contract that differs at all from the MOU — or even just from how the Chinese party views the MOU — more problems arise.

American companies often need to sign an MOU to keep their China deals moving along, but in doing so, it is important that what you sign does not take you beyond where you wanted to go. You should treat an MOU with a Chinese company just as you would a binding contract. In other words, next time, call us before you sign one, not after.

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Dan Harris is a founding member of Harris Moure, an international law firm with lawyers in Seattle, Chicago, Beijing, and Qingdao. He is also a co-editor of the China Law Blog. You can reach him by email at firm@harrismoure.com.

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