Whenever
one of our China lawyers drafts an agreement for a client doing business in China, one of the first things we ask is the identity of the
Chinese counterparty. It’s a deceptively simple question.
The
typical Chinese manufacturer (for example) is composed of multiple
entities, with complicated lines of ownership. One entity may run the
factory, another entity may run the office, and a third entity may serve
as a holding company – and is probably based in Hong Kong. Overseeing
the entire operation is a controlling shareholder who could care less
which entity is the contracting party. And every single person on the
Chinese side ignores corporate formalities and behaves as if all the
entities are interchangeable.
But
the entities are not interchangeable, and the counterparty matters. How
it matters depends on your goals and the Chinese side’s corporate
structure.
One
basic rule is that the counterparty should have financial resources. No
rational company should sign an agreement with a counterparty that is
effectively judgment-proof. But many holding companies, especially those
in Hong Kong, conduct no business other than receiving payments, and
their bank accounts are emptied every few days.
Another
rule is that the counterparty should be the entity that you pay. In the
face of a stack of wire transfer receipts and a signed contract, it’s
hard to argue that a business relationship doesn’t exist. This rule is
considerably less compelling, however, when the Chinese side insists
that payments be made to its holding company.
Meanwhile,
if you have any hope of stopping IP infringement, the counterparty
should be the entity most likely to steal your IP – the factory. But the
factory may be an otherwise impractical choice if it has neither
financial resources nor English-speaking personnel.
Similarly,
you will need to consider dispute resolution, especially if the holding
company is a Hong Kong entity. Where do you want to litigate (or
arbitrate)? And where do you need to enforce the judgment?
Regardless
of the named counterparty, any contract should reflect the reality of
your relationship with the Chinese side. If the factory handles
manufacturing and shipping, the office handles communication and orders,
and the holding company handles all payments, then the contract should
make that clear. The ideal situation, of course, would be for one
Chinese entity to handle everything. But reality rarely matches the
ideal.
