Identical Text, Different Legal Substance

Hidden legal risks in Chinese–Hungarian business contracts

As globalisation continues to expand its reach day by day, it is becoming ever more common for European businesses to enter into partnerships and conclude contracts with Asian companies. In these legal relationships, the parties are often inclined to underestimate the effect that cultural differences have on the legal system – that is, in the European and Asian, and in particular the Hungarian and Chinese, legal environments, individual contractual practices and the enforcement mechanisms associated with them may differ significantly. A contractual structure that is customary in the European Union will not necessarily be able to operate effectively in China – and, conversely, a contractual structure customary in China will not necessarily be able to operate effectively in the European Union.

This article sets out the hidden legal risks that may arise from contracts that have not been properly adapted.

The limits of freedom of contract

The legal systems of the Member States of the European Union fundamentally strive for the fullest possible realisation of freedom of contract: the parties are free to decide whether they wish to conclude a contract with one another, and they may shape the content of the contract relatively freely, provided that it does not offend good morals or conflict with mandatory legislation. Mandatory rules in this respect appear only rarely, chiefly in the fields of consumer protection and competition law.

In this regard, Chinese legal regulation appears, on the face of it, to coincide with that of the European Union; in Chinese law, however, mandatory rules restricting freedom of contract arise in a number of areas (e.g. import and export, data-protection rules, certain questions of liability, certain sector-specific requirements), and in the application of the law by the courts, considerable weight is given to public and state interests as well as to economic-policy considerations.

The key role of governing-law and jurisdiction clauses

In our practical experience, in cross-continental contractual practice the most common source of problems relating to the use of contract templates is that the parties use an existing template drawn up for a similar legal relationship, but then, in the course of the contractual negotiations, alter the provision on the governing law.

In such cases, improperly chosen clauses on the applicable law or on jurisdiction may cause significant difficulties in the subsequent application of the contract – particularly in disputed situations.

The reason for this is that many contractual stipulations permitted under the laws of the EU Member States and routinely applied in business practice are invalid under Chinese law (e.g. the exclusion of liability, the capping of the amount of damages), or else carry an entirely different meaning (e.g. the principle of good faith and fair dealing, the principle of expectable conduct) than they do under the laws of the Member States.

Although both the laws of the EU Member States and Chinese law treat the principle of partial invalidity as the general rule – so that a single invalid provision does not render the entire contract invalid – this may nonetheless cause problems for the contracting parties: on the one hand, because the provision in question may have been precisely a provision that was critical for them; and on the other, because, once the (partial) invalidity has been recognised, the parties’ earlier trust in their partner and in the business relationship concerned may be shaken, which – should the situation escalate – may in the longer term even lead to the termination of that business relationship.

Contractual clauses frequently applied in business contracts that are affected by interpretive difficulty falling short of invalidity – such as the requirements of “good faith” and “best efforts” – may, when incorporated into international contracts, cause difficulty (where the governing-law or jurisdiction clause has not been negotiated with sufficient care), because they are interpreted differently in the judicial practice both of the individual EU Member States and of China. As regards these principle-level requirements, it can be said in general terms that the interpretive practice of each European state is, within that state, uniform, consistent and supported by a substantial body of case law, whereas Chinese legal interpretation in this area is far less coherent, and the individual courts interpret these requirements differently.

It is therefore by no means a matter of indifference which country’s law is designated as governing in which contract, and what contractual provisions are set out therein. In the course of the contracting process – when examining the drafts and agreeing their final version – economic operators must clearly bear in mind which law governs which contract, what specific content a given item of terminology has under that law, and whether that content corresponds to the contracting party’s actual contractual intent.

Conclusion

The same contract does not carry the same legal risk in every legal system.

On the basis of the foregoing, it can be established that a contract which works well in a given legislative environment, between particular business partners, and which may even have proven itself in practice, will not necessarily be properly applicable to a legal relationship concluded with a new international partner – or where, in respect of the same contract, the law of a business partner domiciled in another state is designated as the governing law.

The conscious and active management of the differences between individual legal systems, as the governing laws of contracts, calls for great care and extensive background legal knowledge. Contract templates – although in many cases they can support the smooth conduct of business – must in all cases, but especially in cases that carry international elements, be treated with reservation, and their use is advisable only after appropriate legal review tailored to the individual transaction.

Carrying out this kind of legal review effectively is impossible without proficiency in several legal systems and international cooperation. A law firm with the appropriate background can provide substantive support not only in the preparation of the contract but also in its performance and in the resolution of any legal disputes that may arise – whether before Chinese or EU courts or arbitral tribunals.