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Contract law, the “rule of law” and Guanxi - doing business in Hong Kong and the People’s Republic of China - Part 3
Tuesday, December 27th, 2005

This is part 3 of the reprinting of an article written based on research in 2000 and a trip to China. This part discusses contract laws in China and the United States. Please consult appropriate advisors. This is especially important when doing business in a foreign jurisdiction. Go here for part 1 of the article.
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How do the contract laws of China compare with the contract laws of the United States?

In 1999, the National People’s Congress of China passed a unified contract law, “Contract Law of the People’s Republic of China” (the “Contract Law”). Contract Law replaced three prior statutes, “Law of PRC on Economic Contracts,” “Law of PRC on Economic Contacts Involving Foreign Interest,” and “Law of PRC on Technology Contracts” (Xuanjun, Wang). The new law was intended to provide parties with more freedom to contract and to make the form more flexible. To accomplish these objectives, the Contract Law was more detailed and more comprehensive than prior laws (U.S. Embassy - China 1999). It also recognized certain forms of agreements that had not been recognized previously.

In order to compare contract laws of China and the United States, four areas will be discussed. The first area is the jurisdictional type (common law or code). Next, the relative certainty business can have about legal interpretations will be considered. The third issue is the rule of law and enforcement of court decisions. Finally, the contract law of China will be compared with those typically found in the United States.

Jurisdiction type

China’s legal system is based on a code of laws (Mo, John S. 1999 at 2). While France and Germany base their laws on codes, most of the United States still recognizes the common law. (Louisiana is the exception.) As is characteristic of common law jurisdictions, courts in the United States can look at prior court decisions and long-standing societal expectations to resolve unanswered questions and define terms in agreements. In code jurisdictions, this option is not available.

To the extent that China adheres to the code approach, its courts will not look beyond the agreements and applicable laws and regulations in interpreting agreements. Consequently, the Contract Law is more detailed than similar laws in the United States. One manifestation of this is found in the explicit categorization of the kinds of agreements that are recognized in China (Contract Law 1999 at 9-27). If a type of agreement is not included in the Contract Law’s list, in theory, it is not recognized.

Certainty

Contract laws have existed in the United States since its inception. Contract law is one of the oldest types of law. Many branches of law in the United States, including family law and criminal law, originated in medieval England using contract and property law principles.

In contrast, when modern contract laws were developed in China in the 1970s and 1980s, they were not developed based on a systematic scheme (Mo 1999 at 3). After all, there is little need for laws regulating contract between private companies and governments in an economy where the government decides the items and the quantities to be produced (Jianhua, Kong and Yu Guanghua 1999 at 3).

Courts in the United States will enforce any agreement that is not contrary to public policy. Since contract laws in general and the Contract Law in particular are extremely new, it is unclear how undefined or ambiguous terms in the law will be interpreted. In addition, in many cases, the Contract Law may not apply because other laws control if they are not consistent with the Contract Law (Contract Law 1999 at Article 10).

One risk associated with contract in China is that companies do not know if courts will recognize agreements that may not fit into the categories listed in the Contract Law. Another risk is that commercial terms may not be applied, or may be applied differently, by Chinese courts than they would be applied in most other countries. Finally, China’s legal system places relatively little emphasis on precedent, which makes it difficult to ascertain how issues will be resolved in subsequent cases (U.S. Department of State - China 2000 at 70).

The Rule of Law and enforcement of court decisions

In the United States, there is a strong belief in the “rule of law.” The “rule of law” refers to the idea that judges are to treat litigants fairly, all litigants receive justice, and that laws should be interpreted and administered in the same manner, regardless of the parties and judges involved. Many US companies expect similar standards in other countries. In the case of Hong Kong, it may exist. However, it does not yet exist in the case of China.

United States’ standard

While it does not necessarily occur in practice, legal systems in the United States are based on the idea that the court should reach the same decision in the same jurisdiction, regardless of the judge hearing the case. To help ensure this, judges and juries cannot hear cases if they have a relationship with a party or a witness that may influence their impartiality. Judges cannot preside over a case if their relationship with any participant (attorney, witness, or party) in the case creates even the appearance that the judges may not be impartial.

If a company wins a court case, the next step is enforcing the decision. In the United States, courts are the final arbiter of statutes and agreements. If Congress or a state legislature disagrees with a court decision, there are only five options. First, the legislative body can reverse some decisions by enacting statutes or pursuing constitutional amendments. Second, the legislative body may be able to remove or limit the court’s ability to hear further cases involving the situation in question. Third, in some cases, a government entity may appeal the court’s decision even if the government entity was not a party to the original litigation. Fourth, the government may be able to file a separate lawsuit seeking to prevent implementation of the decision. The final option is for the government to enforce the decision.

Ignoring or refusing to follow a court decision is seldom a viable option for a government official in the United States. Unless the government official is authorized by a court or a statute not to enforce a court decision or the court clearly lacked jurisdiction to hear the case or make a decision, government officials almost always enforce and follow the court decision. Severe penalties can be imposed against officials or governments that refuse or fail to follow a court order. For example, government officials who ignore or refuse to follow court decisions can face criminal prosecution in some situations. A second penalty is that the government officials can be removed from office for failure to follow the law, including applicable court decisions. Finally, financial penalties can be available when a government acts illegally. In some cases, the individual officials can be personally obligated to pay the penalties and the legal fees of the individuals who were harmed. When judgments are entered against officials in their individual capacities, government entities generally cannot reimburse the officials for the money they were required to pay.

Part 4 of the article continues the discussion of contract law.

Posted in Business Articles, Cultural Issues | 1 Comment »



Contract law, the “rule of law” and Guanxi - doing business in Hong Kong and the People’s Republic of China - Part 2
Tuesday, December 27th, 2005

This is part 2 of an article written based on research in 2000 and a trip to China. This part discusses how commercial activities in China compare with those in the United States. Please consult appropriate advisors. This is especially important when doing business in a foreign jurisdiction. Go here for part 1 of the article.
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How do commercial activities in China compare with those in the United States?

Beginning in the early 1980s, China began to move towards a market-driven economy (Folsom 1996 at 4). This has increased the similarities between commercial activities in China and those in the United States. However, there remain surprising similarities and striking differences between the commercial activities in China and the United States. Three areas will be considered. First, the approach to guanxi will be discussed. Second, the role of attorneys handling business transactions will be considered. Finally, the paper will review the availability of information relating to the economy and the companies in China and the United States.

In both China and the United States, establishing relationships with other companies is very important. “Guanxi” is a Chinese term that refers to the use of special connection and relationships to gain an advantage or accomplish a desired result (Johnson, Vincent 1999 at 720). Guanxi obligates people, who may or may not be friends, through the exchange of favors (Chen 1995 at 53). Logically, businesses would try to limit their reliance on guanxi while increasing the other party’s reliance on it.

Chinese companies may grant favors in order to obtain the right to a favor in the future. US companies tend to focus explicitly on the exchange nature of relationships. Typically, US companies discuss the benefits and expectations associated with relationships. This prevents misunderstandings about the nature of the parties’ obligations to each other. According to one US businessman based in China, businesses in the United States identify business opportunities that are legal, develop plans for pursuing the opportunities, and establish any required relationships. He said that, in China, the process was reversed and the first requirement is to establish the relationships, then one develops the plans, and finally, one determines if the opportunities contemplated are legal. (Rosen 1999 at 45).

Companies in both China and the United States rely on attorneys’ assistance in the area of commercial transactions. In the United States, attorneys expect their clients to consult with them from the beginning of the transaction. When the clients can afford it, they often rely on attorneys or professional negotiators to handle the negotiations. In contrast, the advice given to people trying to enter China’s market through joint ventures is to try to develop a personal relationships with the joint venture partner and to consult attorneys only at the end of the negotiations (Laws Contracts & Arbitration 1). Including attorneys at earlier stages would be seen as an expression of distrust of the other company. This advice may be equally applicable to wholly foreign-owned enterprises and other entities.

In the United States, it is relatively easy to gather market information and information about competitors. Commercial services, including Dun & Bradstreet, collect and compile information about many companies. In addition, the US government collects data on markets, regions, trends, and industries that, normally, can be obtained at little or no cost. While economic indicators are available for China, the information relating to Chinese markets and trends is more limited and less accurate than what US firms usually deal with (U.S. Embassy-China, 1999). Until recently, private reporting of economic information has been discouraged by the Chinese government (Rosen 1999 at 30).

Part 3 of the article deals with contract law in China and the United States.

Posted in Business Articles, Cultural Issues | 1 Comment »



Contract law, the “rule of law” and Guanxi - doing business in Hong Kong and the People’s Republic of China - Part 1
Tuesday, December 27th, 2005

Introduction

Recently, a businesswoman in Houston failed to take culture into consideration in dealings in Bahrain. US firms considering business in China may wish to review this article that I wrote as part of my MBA program in May 2000. Please confirm the accuracy and currency of the information. You should consult an attorney who specializes in international transactions with expertise in China if you are considering undertaking operations in China. It is always a good idea to consult appropriate advisors in connection with any business undertaking. This is especially important when doing business in a foreign jurisdiction.

This article is being shared to emphasize the importance of understanding the situation before making business decisions and to highlight the differences one may encounter between one’s own culture, and the culture in other countries. To a lesser extent, one may find significant differences in culture even within a country. Within the United States, there are significant differences between how one does business in California, Texas, Illinois, and New York, for example.

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Contract law, the “rule of law” and Guanxi - doing business in Hong Kong and the People’s Republic of China

The People’s Republic of China represents a tremendous potential market for many US companies. Relatively few US companies have entered the Chinese market. For some, such as telecommunication providers or US defense contractors, regulatory restrictions by either the Chinese government or the US government may explain the absence. In other cases, US companies have made a conscious decision not to expand into China.

Many companies that could do business in China have chosen not to expand into China, at least at this point. One must wonder why companies would decide not to expand into China, especially since it represents such a large potential market. In domino fashion, this question leads to many other questions. How do commercial activities in China compare with those in the United States? How do contract laws in the two countries compare? What relative importance are the laws and regulations regarding contracts given in the two countries? Finally, the paper will look at how these factors affect business transactions. Through both research and personal observations, the author was able to draw some conclusions on each of these questions. This paper will briefly discuss each of these question in an effort to provide a deeper understanding of the opportunities and obstacles that US companies face relating to business activities and transactions in China.

Why would companies decide not to do business in Hong Kong or China?

A company may decide not to do business in Hong Kong or China for many reasons. These reasons include lack of a market for the products or services, little disposable income, corporate resources, growth potential in current markets, as well as the firm’s internal and external environment.

Absence of a market

While Hong Kong and China are home to a large percentage of the world’s population, this does not guarantee the existence of a market. Some US companies are very successful in selling pet food and treats, pet beds and grooming items, and pet beds as well as other pet furniture.

Many dogs were seen during the trip to Hong Kong and China. This does not mean that there is a viable market for pet items. Most of the dogs were emaciated and seemed feral as they ran around and away from people and scrounged for scraps. Of all the dogs observed, only three appeared to be pampered pets. Two were seen on an apartment balcony in a wealthy part of Hong Kong. The third was seen at Digital Lighting’s villa in Chan An.

Based on these observations, there did not appear to be a significant market for pet food, treats, beds, toys, or shampoos. According to information gathered by the Foreign Commercial Service, there are 100,000 registered pets in Beijing (Foreign Commercial Service - American Embassy, March 24, 2000). By US standards, this is a low number of pets for a city of ten million inhabitants. Consequently, the market may be too small to attract a company like PetsMart.

Little disposable income

Although the population of China is very large, according to US government estimates, two-thirds to three-fourths of the population is too poor to be able to afford anything but the most basic consumer products (U.S. & Foreign Commercial Section 1999 at 10). This absence of disposable income would prevent the majority of Chinese people from purchasing many goods that are produced by US companies. Consequently, China may not represent a viable market for US companies that market foreign luxury cars, gourmet restaurants, art, jewelry, and similar products and services. To the extent that such companies do enter China’s markets, they may need to market products differently and use different operating models than they use for their US operations.

Corporate resources

The resources required to do business in China may exceed the assets of many small US companies or may not be available in China. Small companies may not be able to afford the cost of transporting raw materials that cannot be produced in China from the United States. Conversely, the companies may be unable to afford the cost of exporting goods made in China back to the United States or other overseas markets. In some arras, the labor pool may lack the skills, background, training, or credentials. Many parts of China are isolated. In those areas infrastructure required for many of today’s businesses may not be present.

Entering foreign markets can require considerable expense to develop relationships, establish distribution channels, obtain qualified workers, and overcome cultural hurdles. If the companies are able to expand within current markets, deciding not to expand into Hong Kong or China may be a smart business decision. Businesses considering entering the Chinese markets may decide not to do so because of language and cultural barriers, the effort and expense required to create and maintain relationships, prejudice against foreigners, and difficulty locating suitable workers. When faced with these requirements, many companies that have adequate expansion potential in their current markets are unlikely to expand into the new markets.

Legal and regulatory factors

Each of the preceding factors should be considered by US companies when they consider doing business in China. The factor that prevents the greatest number of US companies from entering China is the regulatory and legal environment in China. Legal and regulatory factors will be discussed in the sections that follow.

Part 2 of this article will compare the commercial activities in China and the United States.

Posted in Business Articles, Cultural Issues | 5 Comments »



Pendulum Theory in the context of customer and supplier relationships
Tuesday, December 27th, 2005

In this blog, I discussed Pendulum Theory.

Pendulum theory applies to the relationships between customers and suppliers as well. Let’s look at Pendulum Theory in the context of decentralization by a customer.

Customers sometimes reorganized from a centralized to a decentralized structure. As part of that, many customers, move from centralized ordering to decentralized ordering. What might that mean from a supplier’s perspective? Let’s look consider what might happen if a customer decentralizes in terms of three factors: staffing, cost, and relationship.

Staffing

When suppliers are accustomed to a single person or single group placing orders, the suppliers may have fewer orders for larger quantities of products and services. Bills are likely to be processed consistently.

In a decentralized model, suppliers may receive more orders for smaller quantities. Bills may be processed by multiple people. As a result, some bills are likely to be processed quickly and others are processed more slowly.

In a decentralized model, suppliers sometimes have more direct contact with the functional business unit involved than they do when a centralized group is placing orders.

Cost

Centralization of the customer can reduce the supplier’s cost if the customer is able to aggregate many small orders into a smaller number of large orders.

Centralized bill payment is more likely to reduce the number of calls that suppliers must place to check on status of the payments. It is also likely to result in more consistency with regard to the need for such calls. This makes it easier for suppliers to plan for costs.

In a decentralized situation, suppliers may incur higher administrative costs because they have to stay in contact with more people through out the process.

Relationship

At times, customer decentralization allows suppliers to develop stronger relationships with the actual users of the products and services.

When the relationship is working well, this can be a good thing. If the relationship is rocky, the absence of an objective intermediary can result in the supplier receiving more feedback about opportunities for improvement and some of the feedback can be quite heated.

Questions to consider

When a customer decides to reorganize, it is important for suppliers to ask customers how the customers would like to interact with the supplier with regard to ordering, billing, reporting, and other elements. By asking such questions, suppliers are better positioned to meet customer expectations.


Kauai, Hawaii 2003

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Pendulum Theory… Haven’t we tried this before?
Monday, December 26th, 2005

Pendulum Theory has been used for many years to explain political shifts. Pendulum Theory views the world as a place of continuous change between two extremes, just like a pendulum of a clock.

As the pendulum swings, there is a broad range where behavior is acceptable. Once the pendulum goes outside the range, the resistance increases and, eventually, the pendulum swings back the other direction. To maximize the time that the pendulum is in the acceptable range, one should align interest and obtain buy-in.

Pendulum Theory tries to explain many phenomena in an organizational context. Here are two examples…

AMR Example

Diversification is a tool that firms use to manage risk. Diversification strategies can involve investing in similar operations, expanding into other countries, or investing in operations that are unrelated to one’s core business.

At one time, AMR invested heavily to create Worldwide Flight Services and develop an alliance with Bombardier. In the 1998 timeframe, AMR moved away from those initiatives. Worldwide Flight was sold and AMR negotiated a corporate divorce from Bombardier.

SBC Example

I am told that before SouthwesternBell purchased Pacific Bell, contract managers in Southwestern Bell had authority to sign their own contracts, up to a certain dollar value. There was no company-wide standard for client communications, negotiation, approval, or archiving documents. This was standard in the corporate world at the time, by the way. The downside of not having formal processes is that contract managers were unable to quickly transition to other projects. In addition, contract could not always be located. There was a perception that there were insufficient checks and balances on contract managers’ actions.

As it consolidated operations, SBC selected and retained “best practicse” from Southwestern Bell and Pacific Bell. Procurement policies used by Pacific Bell favored standardization of process, documentaiton, and checks and balances. This approach was deemed a best practice, and was retained by SBC. SBC used ISO 9000 to standardize the functions and implement a system of checks and balances through documented reviews and compliance. Through th eprocuedures adopted to obtain ISO 9000 certification, SBC required its contract managers to complete separate forms that:

  1. Documented the stakeholders’ agreement with the proposed approach,
  2. Demonstrated the stakeholders’ agreement to pay for the item or service being purchased,
  3. Authorized procurement to sign the contract,
  4. Explained how the decision to contract with the vendor was reached, and
  5. Demonstrated the contract manager’s adherence to procruement procedures.

There was quite a bit of resistance to such a high level of structure, especially from clients. To increase compliance, contract managers were “graded” for every contract and demerits were assessed for each deviation from the standards. In response, contract managers began leaving procurement for other jobs within the company and for other companies. For a period of time, contract managers were not able to sign contracts.

During the early years of my tenure with SBC, the pendulum shifted back to a more moderate position. Forms were combined and alternatives to contract-by-contract documentation, such as blanket authorization to sign all contracts were implemented.

Later in my tenure, as the telecommunication bust continued and Sarbanes-Oxley was enacted, there were multiple pendulums headed in opposite directions for contract managers. Here are three data points:

  1. Restrictions on signing contracts for new software increased dramatically. IT had to “bless every proposed purchase of software
  2. Contract managers were given more signature authority for the contracts.
  3. Every certificate of insurance was audited and contract managers were graded on whether the certificates of insurance contained the required coverage in each category.

Strategies for dealing with change

When one is making changes, redefining a single large change as several smaller changes can reduce resistance to change. This strategy can allow increased acceptance and allow greater monitoring of results.

Mandating something less than the major change that had been planned is a second strategy for allowing the desired result to be achieved.

Creating employee teams to look at issues can reduce resistance and increase employee buy-in. One of the mistakes that firms often make in this context is that they focus on employees who are high performers or employees that are respected by leadership, rather than their peers.

Conclusion

At SBC, employees were included in all stages of the decisions. Some firms overlook this step and, as a result, employees may not “buy-in_ to the need for the change or the change being implemented.

Most major change faces resistance. companies often respond by trying to force employees to comply with new expectations. When this occurs, the most skilled meployees seek new positions, or comply without questioning the approach. Either response can be detrimental to companies.

Companies, like individuals, should be careful what they ask for because they may get it. Understanding Pendulum Theory can help companies avoid asking for too much, or asking for the wrong thing.

By the way, Pendulum Theory also applies in the context of supplier and customer relationships. Tomorrow, one of the postings will deal with Pendulum Theory in that context.

Posted in Planning Tips, Sourcing | 1 Comment »



People make the place… or do they
Monday, December 26th, 2005

What makes organizations behave as they do?

Some argue that organizations behave as they do because of the people who belong to the respective organizations. People who accept this view are suggesting that external factors are not as relevant in understanding organizational behavior as the people. This is the same flaw made by scholars in the debate over whether individual behavior is the result of nature (genetics) or nurture (the environment in which the individual is raised).

People are important in determining organizational behavior. However, other factors are also important. If and tothe extent that an orgnaization survives and is successful over time, t must be more than merely a compilation of the knowledge, skills, and personalities of the individuals comprising the organization.

Factors determining orgnizational behavior

An organization’s ultimate success over the long-term requires one to:

  1. Identify or create a market,
  2. Communicate effectively with customers,
  3. Develop products and services in a cost-effective manner,
  4. Comply with legal requirements, and
  5. Acquire sufficient funding to produce, deliver, and improve the products and services.

Airlines example

Do people gravitate towards organizations who have leaders that are like the individuals themselves?

If so, one may wonder how the cultures of American Airlines and Southwest Airlines remained so different during the lengthy tenures of Herb Kelleher and Robert Crandall.

Herb Kelleher and Robert Crandall were both intense, highly competitive, cost conscious, and successful in an industry with very little profit margin. Both were even similar in gender, race, age, and personality according to contacts who had met both of them.

Hypothesis

Speculation on my part suggests that the diversity of the workforce tends to prevent organizations in the US from becoming too reflective of leadership.

How would this be manifested?

Assume that two identical employees were hired. One went to work for Southwest Airlines. The other went to work at American Airlines. Suppose that the employees were the same age, had the same degrees, attended the same universities, had the same family background, and even had the same political and religious views. In short, as far as one can know from the outside, the two people are not very diverse.

What would happen? At some point, one or both people may marry and have children. Their interactions with their spouses might be different. Their interactions with their children might be different. Their children’s interactions with them might be impacted by peer pressure or knowledge gained at school. Parents, children, or relatives might suffer different illnesses. Family members might move to other parts of the country. The employees may hear news stories and react differently. They may move to other parts of the country and interact with people who think differently than they have in the past. In short, the people would deal with the hills and valleys of life and those hills and valleys infuse diversity.

The diversity that could grow among employees based on experiences over time is likely to impact the employees’ decisions, including hiring decisions and decisions about whether to stay with their respective employers or seek employment elsewhere.

Conclusion

People are important in determining an organization’s behavior. People are not the only factor that contributes to or detracts from the organization’s behavior. To be successful over time, an organization’s behavior must consider external factors and the diversity of life experiences that employees at all levels of an organization experience over time.

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Considerations in planning training and knowledge transfer acquisitions
Monday, December 26th, 2005

This posting provides a high level view of the sourcing process for training and knowledge transfer acquistions.

The first element of the process was to define the need. Defining the need involves answering the following four questions:

  1. Who is the team that defines the need and the process?
  2. What is needed?
  3. What are the characteristics of the solution?
  4. Who are suitable suppliers for this project?

One may wonder what factors play into the answers for these questions. The diagram below shows some of the factors that may be considered.

Posted in Sourcing, Training | No Comments »



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