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Emerging market/China outsourcing issues. A speech.

By Dan Harris in 'China Law Blog'

Last week, I gave an hour long talk before the Pacific Northwest Chapter of the International Association of Outsourcing Professionals (IAOP). My talk was entitled, “The Legal Myths, Realities, Traps and Benefits to Outsourcing to an Emerging Market,” but I should have called it everything you need to know about the law of outsourcing, crammed into an hour.

The following is the written version of the speech I gave. Please realize this was a speech and not a paper and read it accordingly. I would ordinarily break something like this up into a series of posts, but there really was no logical way to do that with this and so I am giving you the whole (very long) thing in one fell swoop.

INTRODUCTION

I am going to start by telling you a little bit more about me so you can better understand where I am coming from when I talk about international outsourcing and, more particularly, outsourcing to an emerging market.

I am an international lawyer and what that means is that I focus on legal matters involving multiple countries.

In the last ten years, about 50% of my work has involved China, about 10% has involved Russia, 10% Korea and 10% Vietnam, with the remaining 20% percent involving mostly India, Turkey, Thailand, Indonesia, Malaysia, and various countries in Eastern Europe and in Latin America.

So as you can tell, the bulk of my work has been with emerging market countries.

My clients have been a fairly even mix of tech, service and manufacturing companies and I have written and reviewed countless international outsourcing agreements for all three types of business. I have represented both companies that were contracting for outsourcing and companies that were contracting to provide outsourcing. I have been at this long enough to have taken part in what I see as the evolution of outsourcing from the United States. This means I started out mostly dealing with contract manufacturing of goods and then started working on the contracting of technology services and BPO outsourcing. In the last few years, I have been handling an increasing number of outsourcing contracts involving medical clinical trials and professional services.

For the last five years, I have also written a blog on China, which has put me in touch with hundreds of companies involved in doing business internationally, many involving international outsourcing to emerging market countries, especially China. This has given me a much wider perspective than I would have received from my law practice alone.

My talk today is going to be based in large measure on my experiences and on what I have learned from talking with clients and other businesses that are engaged in international outsourcing with emerging market countries.

I am going to focus more on how things really are than on what the law says about how things should be. The distinction between what a country’s laws say and how those laws are actually enforced in the real world is a very important one, particularly when dealing with an emerging market country where the laws are often very good, but the enforcement of them is often very poor.

My goals will be to highlight the legal issues related to outsourcing to an emerging market country and to provide approaches and methods for dealing with those issues.

DEFINITIONS/SCOPE

What exactly is international outsourcing?

For purposes of my talk today, I will be defining it as using another company to provide your company with a service or a product. I am intentionally being very broad and simplistic here because the legal issues involved in international outsourcing typically apply across the board to most “outsourcing” situations and I do not want to get bogged down in making fine distinctions between the various types of outsourcing.

The “international” part of “International outsourcing” simply means that at least two of the companies involved in the outsourcing be from different countries. International outsourcing does not include a contract between a US company and the US arm of a foreign company when all of the outsourcing work will be done in the United States, because in that situation, no international law issues are likely to be implicated.

I am going to give my own intentionally broad definition of what constitutes an emerging market country because I tend to disagree with most lists and definitions of emerging market countries, both because they so often include what I see as developed countries, like South Korea, Poland, and Chile, and because they so often fail to include a country like Viet Nam, which has been one of the fastest growing countries over the last five years and will, I am convinced, be one of the fastest growing countries over the next five years as well.

In broad and simple terms, my definition of an emerging market country is any country that is growing fast, is able to feed its people, and is not yet highly developed.

Now, I fully realize that all or nearly all of you here today are primarily or exclusively involved in technology outsourcing, so when possible, I will focus on international technology outsourcing. However, from a legal perspective, the big picture issues involved in outsourcing the manufacturing of a shirt button in China are surprisingly similar to the legal issues involved in outsourcing the writing of complex software code to India.

In both cases, the primary issues usually revolve around:

RISKS/BENEFITS

In choosing whether or not to outsource, U.S. companies typically weigh the perceived benefits of outsourcing versus the perceived risks.

The perceived benefits typically are one or more of the following:

  • Reduced Costs
  • Having an outside company handle the non-core aspects of the business
  • Better quality/operational performance
  • Around the clock work force

All of these benefits can be realized by outsourcing to an emerging market country, particularly the lower costs and the 24/7 work force.

But of course, there are risks to outsourcing as well, including the following:

  • Your vendor will do a bad job
  • Your vendor will do a bad job, yet still expect full payment
  • Your vendor will steal your data
  • Your vendor will steal your Intellectual Property
  • Your vendor will steal your trade secrets
  • Your vendor will sell your data or IP or trade secrets to one of your competitors
  • Your vendor will use your data or IP or trade secrets to compete with you
  • Your vendor will cost more than expected in the short term due to transition costs
  • Your vendor will cost more than expected in the long term
  • Your company will lose its innovation edge because someone else is doing its key work
  • Your vendor’s personnel tomorrow will be different from your vendor’s personnel today
  • Your company’s morale will be negatively impacted by your outsourcing
  • Suing and collecting meaningful damages from your vendor may be difficult
  • Politics will impair the project
  • The price will change due to currency fluctuation
  • An inability to secure visas will impair the project
  • Crime will impair the project
  • You might face export control issues
  • You might face Foreign Corrupt Practices Act issues (FCPA)
  • You might get snared in your vendor’s labor/employment law issues
  • You might get snared in your vendor's bankruptcy

Nearly all of the above risks are present even when you outsource domestically, but nearly all of these risks will be greater when you outsource overseas and nearly all of these risks will be even greater still when you outsource to an emerging market country.

Let’s look at a few of these risks and how going to an emerging market country makes them even greater.

Let’s take the first one: your vendor doing a bad job. If you are outsourcing to a country with a really different language and culture, the chance of a miscommunication is greatly increased and bad communication can cause your vendor to do a bad job.

I can give you a very real example of how this can easily happen, even if your company has strong language skills. A few years ago, my firm was handling a lawsuit in China. We were representing a United States company owed money by a Russian company and we knew the Russian company would be shipping its product to Dalian, China. My firm has two U.S. trained lawyers who are completely fluent in spoken and written Chinese (one here in Seattle and one in China) and a Chinese lawyer who speaks pretty good English, so we were pretty much covered.

We put our lead China lawyer on the case and he and I were handling the matter together. His Chinese is so good that he at one time taught law at China’s best law school -- in Chinese. We then brought in a really good Dalian lawyer to assist us on the case and we asked her, both in English and in Chinese, whether we would need to post a bond to seize the Russian company’s product when it hit China and she said “no.” I passed this information on to my client and we thought we were done with that issue. Then, a few weeks later and only a few days before we were to file our complaint, the Chinese lawyer told us that our client would need to come up with around $200,000 for “counter-security.” We simply had not realized that our Dalian lawyer would consider a bond to be different than a counter-security because the word “bond” is usually used to cover all sorts of required payments in this sort of situation. And on the flip side, our Chinese lawyer just assumed we knew all along that we would need to post a “counter-security” because she just assumed that those were required everywhere.

So even though both parties spoke the language of the other quite well and even though both parties were international lawyers, a miscommunication occurred.

Can miscommunications occur domestically? Of course they can…. But they are more likely when the language and the culture are very different.

Let’s talk a bit about the fourth one on this list: theft of Intellectual Property (IP). Emerging market countries do not respect IP as much as developed countries. There is no getting away from that.

In the 1800s, the United States, which could be said to have been an emerging market country at that time, was notorious for its IP infringement. IP enforcement tends to correlate very closely with income because countries do not tend to enforce IP laws until their own native companies have started building up their own IP and pushing hard for IP enforcement.

Each year, the U.S. Trade Department comes out with a list of countries it believes to be the worst IP scofflaws and the following countries made its Priority Watch List and its Regular Watch List:

PRIORITY WATCH LIST

  • Argentina
  • Canada
  • Chile
  • China
  • Costa Rica
  • India
  • Indonesia
  • Mexico
  • Philippines
  • Russia

WATCH LIST

  • Poland
  • Ukraine
  • Vietnam

As you can see, China, India, Indonesia, Mexico, the Philippines and Russia are all on the priority list. IP protection in Vietnam is no better than any of the countries on the priority list and I think the only reason it didn’t make the priority list is because it is newer to the international marketplace and because it is not as economically developed as some of the countries on the Priority Watch List. Canada is obviously a very interesting one. It is on there because it is such a developed country and it is our neighbor, and it has a few really strange IP laws, including, I believe, that it is not a crime to import clearly counterfeit goods. The point of my showing you these lists is to highlight how virtually all of the outsourcing powerhouse countries are on these lists; and if they are not, they should be.

So turning over your IP to an outsourcing company in an emerging market country means you will likely be taking on risks that you would not be taking on if you were turning that IP over to a company in Fargo, North Dakota.

REDUCING THE RISKS

How then can you protect your company from the risks of doing business with a company in an emerging market country?

There are three main ways and all are critically important.

  • Due Diligence on the company you are thinking of using
  • A good contract with the company you end up using
  • Quality Control monitoring every step of the way

Note how only the second of these three is explicitly legal. I am going to talk about the first two. I am not going to talk about Quality Control (QC) because I figure you all are much more knowledgeable about that than I am.

Let’s first talk a bit about Due Diligence.

It is absolutely critical.

I have already done a fair amount of talking about various countries, but to a large extent it is not the country that matters, but the company with which you are doing business.

First off, countries do not tend to be monolithic. Take China, for example. Shanghai is in most respects more like New York than it is like a tiny city in a remote Chinese province. If you have to sue a Chinese company in China, you will be far better off suing in Shanghai where your judge will likely have a law degree from a top university and view his task as ruling fairly. If you sue a Chinese company in a remote province, your judge’s “legal” credentials might consist of a fourth grade education and a prestigious war medal.

The same is true of Russia, where Moscow is more like New York than it is like Magadan. I was once stranded in Magadan in January when the city had no heating oil, so you are going to have to trust me on this.

Second, and even more importantly, the reputation of the particular company with whom you do business should trump the reputation of the country in which that company is based. I am always telling my clients that no matter how good a contract I write and no matter how good the court system is of whatever country is going to enforce that contract, if you enter into a contract with a crook, you are all but guaranteed to face major problems. Conversely, if you enter into a contract with a company that wants more than anything to do a good job for you so as to build up its reputation worldwide, things will almost certainly go well for you, no matter in what country that company is based.

So what due diligence should you do?

The quick, pat answer is whatever is appropriate in terms of the value of the contract. Your due diligence on a 30 thousand dollar outsourcing deal should be very different from your due diligence on a 30 million dollar deal.

You have to be serious about your due diligence, or don’t even bother. For example, if your potential outsourcing company says it did good work for some other company, don’t just believe it. Check it out.

A few years ago, an American company came to me wanting to sue a Chinese company for having provided bad product. When I asked this American company why it had gone with this particular Chinese company in the first place, the American company told me that it had picked this Chinese company because “so and so” had used them. The funny thing was that “so and so” had come to me maybe six months earlier wanting to sue this same Chinese company for bad product as well.

So I then asked the American company if it had ever checked with the first American company regarding its satisfaction with the Chinese company and they told me “no.” They had just assumed that the first American company was happy with the Chinese company simply because they were using them. The second American company lost about a million dollars because of this assumption.

I always recommend going over and visiting the company with whom you are contemplating doing business. Business is business and many of my clients have told me how surprised they were at how easy it was for them to distinguish good companies from bad companies by going and visiting them, even in countries where they did not speak a word of the language.

And don’t be afraid to push for the information you think will be helpful to you. American companies are oftentimes reluctant to be seen as pushing too hard for fear of indicating mistrust. In my experience, the legitimate foreign company actually welcomes the opportunity to prove it is bona fide and it will usually bend over backwards to get you the information you seek. On the other hand, the illegitimate foreign company will usually claim that what you are seeking is “never done” in their particular country.

This means that the way the foreign company reacts to your requests for information can be one of the best and cheapest indicators of the kind of company it really is.

The same is true of Non-Disclosure Agreements (NDA), which you should pretty much always require your foreign counterparty to sign before you reveal anything to them of any real importance. How your prospective outsourcing company handles your request for them to sign an NDA can tell you volumes about who they really are.

My law firm has done hundreds of non-disclosure agreements for China and we know what is acceptable to companies there. So when we draft one for our clients and their Chinese counterpart claims “this is not how we do things in China,” we tell our clients that this is how things are done in China and the only reason we can think of for why the Chinese company would be claiming otherwise is that it does not want to be tied down by a non-disclosure agreement because it plans to steal some of your information.

In fact, for every 100 non-disclosure Agreements we have done for China, I would say that around 50 of them are accepted without any changes, 45 are accepted with reasonable changes and 5 are rejected as not the “Chinese way.”  We actually like it best when the Chinese company comes back with suggested changes because we view that to mean that it is very concerned about not signing a contract that it cannot fulfill. When a company like this does sign a contract it does so with every intention of abiding by it.

The best way to protect yourself against many of the risks I enumerated earlier is to deal with those risks in your contract. The differences between a foreign and a domestic outsourcing contract lie more in the way the contract should be written than in the issues that need to be resolved. In other words, the issues are mostly going to be the same, whether you are outsourcing domestically or internationally, but the big differences in the laws will usually necessitate that your international contract be written very differently from your domestic one.

What is the benefit of having a written contract with another company?

The most common reason given for having a contract is so you have something you can use to sue on if something goes wrong.

In most instances, if you get into a lawsuit over a contract or over someone having taken your IP, you have already lost. This is particularly true of litigation involving outsourcing agreements.

The second reason for having a contract is so you have a mutually agreed-upon blueprint setting out what is expected of the parties. This means that a well-written contract not only positions you to prevail in the lawsuit you hope never happens, it also helps you avoid problems with your foreign outsourcing company. The contract therefore helps the project go smoothly and that works to decrease the chances of a dispute requiring litigation.

So what should you be looking at in terms of your international outsourcing contract?

The first thing you should do is to make sure that what you are planning to do is legal. I am not kidding. What is legal here may not be legal there and you need to know that. We had a very sophisticated American company come to us after having spent half a million dollars on a market research firm that had told them the Chinese market was ripe for exactly what this American company planned to do in China. This American company was now coming to us to help them with their outsourcing agreement with a Chinese company that would be setting up and hosting their Chinese website and also to have us form their company in China.

They were very unhappy when we told them that China forbids foreign companies from operating on their own in the very business they were planning to start.

When it comes to the contract itself, I am always stressing how international contracts almost always require much greater specificity than domestic contracts. Courts in emerging market countries tend to be good at enforcing simple, clear contracts where the standards for default are objective and where the penalty requires little analysis. They tend not to be good at making contracts for the parties, as is common in the U.S. legal system. In the United States, suing on an oral contract or a contract written on a napkin can work out just fine. Don’t think that will be the case in an emerging market country where your not having your contract sealed may preclude you from suing on it.

It is therefore essential that you draft your contract with an emerging market company in such a way that it will produce a good result for you in whatever court you may find yourself. You do not want to base your court case in an emerging market country on a complex set of emails, oral communications and practice over time.

Not only does greater specificity in your contract make sense for foreign courts, it also makes sense for your outsourcing project itself. The cultural and linguistic differences between you and your foreign outsourcing company only increase the likelihood that the two of you will have different understandings about what is implicit in your deal.

For these same reasons, I usually try to avoid words like “reasonable” or “best efforts” in the contracts I draft for foreign countries. What is “reasonable” in Saigon might be very different from what is “reasonable” in Seattle. This is particularly true when it comes to quality. In China, you can pay 25 cents for a t-shirt that will be ruined when washed once. That being the case, it is pretty clear that what constitutes reasonable quality for a t-shirt differs between China and the United States, and there is no reason to think there will not be similar differences with other products and services.

Many years ago, I heard a story of an American who was renting an apartment in Shanghai. Whether this story is true or apocryphal, it is such a good illustration of how Chinese judges and arbitrators view contracts that it really doesn’t matter whether it happened or not. And, by extension, it is also a good story to illustrate how emerging market judges and arbitrators might view your contract.

The apartment this American was renting was a really nice apartment and it had a really nice expensive office chair -- high-end apartments in China are virtually always rented out fully furnished. One day, the really nice office chair broke and became unusable and the American tenant kept asking his Chinese landlord to replace it. But that wasn’t happening.

The lease on the apartment eventually came up for renewal and the American refused to renew it unless the landlord put in writing that he would replace the really nice office chair. The landlord agreed and after the new lease was signed, he came by and put in a $2 metal folding chair.

What would happen in the United States if this tenant were to sue the landlord over the landlord’s failure to replace the office chair with something pretty comparable?

The tenant would almost certainly win because the court would essentially write into the lease contract the provision that the replacement chair had to be a good office chair like the one it was replacing. What would happen if the tenant sued the landlord in a Chinese court?

The Landlord would almost certainly win because if you want something in your contract in China, you had better put it in there.

Why is this chair story relevant? It’s relevant because American companies too often fail to put enough into their contracts with foreign companies. Instead, they just assume that the courts or arbitrators will know what the parties intended and re-write their contracts accordingly. But it doesn’t work that way in China. And it doesn’t work that way in Russia or Vietnam or Korea or Turkey or just about every emerging market country of which I am aware.

Not so long ago, an American company came to me after having received a large shipment of laptop bags that weren't strong enough to hold a laptop. We called the Chinese company to ask about getting a refund, and they told us that if our client had wanted a bag strong enough to hold a laptop, they should have paid 50 cents more per bag for one that could actually do that. The American company should have specified in its contract that they wanted a bag that could hold x number of kilograms.

Damages are another difference between the United States and the typical emerging market country and, therefore, another matter you should consider addressing in your contract.

My eldest daughter is studying in Saigon right now and when she takes a taxi, she makes it a point to talk with the taxi drivers so as to improve her Vietnamese. The taxi drivers always talk of their desire to go to Los Angeles where they will make $2000 a month instead of the $200 or so a month they are making in Saigon. When my daughter explains to them that a studio apartment in Los Angeles will cost them $1000 a month and lunch out costs $10, they literally don’t believe her. They just can’t grasp those numbers.

When my daughter goes to the Ben Than market in Saigon to buy a purse, the vendor typically starts out asking $100 for a purse my daughter ends up buying for 5 or 6 dollars. Why does the vendor ask for $100? Because every once in a while a Western tourist will buy it for $50.

If you go to court in Vietnam or in a typical emerging market country, you will be dealing with something very similar when it comes to your damage numbers.

Let’s say you are a bank and you hired a Vietnamese company to write some software for you. You paid that Vietnamese company $500,000 and the software comes back three months late and it works, but is buggy. So you sue the company in Vietnam and you seek $3 million in lost profits and in the time your company had to spend fixing the software to make it work perfectly.

What is likely to happen to your case in a Vietnamese court?

The judge is almost certainly not going to award you the $3 million you seek. He or she will view that number as the equivalent of the $100 purse, and why not? On top of that, the judge is going to think you have already having saved a fortune by having done the work in Vietnam, so it is unlikely that he or she is going to have much sympathy for you. But the judge is likely to have sympathy for the Vietnamese company if he or she believes it tried its best but is just learning how to handle such big projects. The judge is likely to have sympathy for the Vietnamese company because he or she will likely think that you have not sought hard enough to resolve your issues with the Vietnamese company before suing. And working it out with the Vietnamese company would entail giving the Vietnamese company a lot more time to fix the problems.

In the United States we are always saying “time is money.” They don’t think that way in places like Vietnam and China where time is just an opportunity to throw more really cheap workers at the problem.

So your $3 million dollar case in Vietnam might be worth maybe only $30,000 when and if you win it.

So what can you put in your contract to help you get more in damages?

How about putting in your contract that you can sue your Vietnamese vendor in the United States? You’d get your $3 million from them easy if you could sue here, right? Wrong. If you sue here, you might very well get a U.S. judgment for $3 million, but will you ever collect on it? Vietnam, China, Russia, even Japan: none of those countries will just take a U.S. judgment and turn it into a domestic judgment in those countries such that you will be able to enforce it against your vendor there.

My firm constantly gets calls from American lawyers wanting to retain us to collect on a U.S. judgments they have received against Chinese or Russian companies. The American lawyers have usually charged their clients a pretty fair sum and they think all that is left for them to do is to take that judgment to a Chinese or Russian court. There, they think, they will get their U.S. judgment automatically converted into a Chinese or a Russian judgment and then they will get their money.

But it doesn’t work that way. Your United States judgment pretty much has zero value in either China or Russia, and in most other places in the world as well.

In fact, Chinese and Russian companies love it when you put a United States litigation requirement in your contract with them because they know that their own courts won’t enforce against them whatever judgment you may get. And even if you later realize that suing in the United States is not the way to go and you choose to sue the Chinese or Russian company in its home country, the court there will almost certainly toss your case out for being in the wrong jurisdiction because you signed a contract agreeing to sue in the United States.

So you have to be very careful not to write a contract that essentially blocks you from ever suing on it. And of course, on the flip side, if you put the United States in your contract as the jurisdiction for disputes, the foreign company can easily sue you right here.

Arbitration is oftentimes your best option and should in many cases go into your contract. Almost every country is a signatory to the New York Convention on Arbitration Awards, which means it will enforce U.S. and other foreign arbitration awards.

But arbitration has its shortcomings and sometimes you are better off putting a foreign court as your venue for resolving disputes. For example, if your biggest fear is your outsourcing company running off with your IP or your trade secrets, the fastest and best way to stop that is usually through the courts in the country in which your outsourcing company is based. Choosing the venue oftentimes comes down to figuring out the worst thing that could happen to you and then choosing the best venue for dealing with that.

Another possible solution to the bank software problem I described above is to put a liquidated damages provision in your contract, specifying exactly what the damages will be if the software is late and also what the damages will be if it is buggy – though you will need to define what late and buggy mean. But don’t put three million dollars as the liquidated damages amount; if you do, the court will probably bend over backwards to avoid having to issue a judgment in that amount. Put in $300,000 and you just might get it. Better yet, if your foreign outsourcing company believes you just might get $300,000, you will have positioned yourself well to get the software on time and bug free.

It oftentimes makes sense to put personnel requirements into your overseas outsourcing contract. Emerging market countries have rapid growth and with that growth it is common to see rapid job changing, which likely will not be good for your outsourcing project. One way to try to deal with this is to put in the contract a percentage retention rate that your foreign outsourcing company must meet to avoid a penalty or to get a bonus. You can get even more specific by listing out maybe the ten key people and setting a penalty if some number of those ten leave.

You should also consider the possibility of future currency fluctuations and think about what you should put into your outsourcing contract to protect you from that.

In 1995, a very sophisticated American client of mine sold a very expensive product to a Korean company for three yearly payments of “3.5 million dollars/2.7 Billion Korean Won.” By the time the Korean company was to make its final payment in 1998, its 2.7 billion Korean Won payment was worth only around about 1.7 million dollars, not the $3.5 million dollars the American company had expected. The American company (who had used its in-house counsel, not my firm to draft this contract) came to me to see if it could assert a claim against the Korean company for the approximately $2 million dollar shortfall it had experienced due strictly to the devaluation of the Korean Won, mostly during the Asian crisis of 1997. Since the contract was silent on whether the payments had to be in dollars or in Won, and since it seemed to provide for the Korean company paying in either currency, we determined that the best course of action for this American company would be to chalk this deal up to experience.

One common way to handle currency issues in international outsourcing agreements is for the outsourcing fee to be raised or lowered by half of the percentage change in the currency. In other words, the two parties split the fluctuation down the middle. But if you are going to do this, you need to have clear benchmarks in terms of what the currencies are worth and in terms of when their worth will be measured.

The key here though is that you think about the currency issues before you draft your contract and that you put something in the contract to provide for that – or not, depending on what is most likely to work in your favor.

Protecting your Intellectual Property is always important, particularly when your IP is either going overseas or will be created there. Every country has its own laws governing intellectual property rights within its borders and those laws can run the gamut both as between countries and as between patents, trademarks and copyrights.

Every type of IP asset -- trade secrets, trademarks, industrial designs, patents, copyrights -- may be involved in your outsourcing relationship and the best to protect those assets is to keep them right here in the United States.

But that isn’t always practical and that doesn’t always make business sense.

If you are going to “loan” your IP to a foreign company you should make it clear in the contract what belongs to you. It is not going to work for you to claim a few years from now that “everyone knew it belonged to us.” You should also think about registering that IP in the country to which you are sending it. Registering it here in the United States is not registering it “there”, particularly when it comes to patents and trademarks.

You are going to have to know and understand the IP laws of the country with which you are dealing. Putting in your contract that IP developed by your foreign outsourcing company belongs to you is not going to help you much if under the laws of the country with which you are dealing, the developed IP actually will belong to the employees or independent contractors who worked on it, rather than the company with which you have a contract.

International IP issues are almost always very complicated and it does not help that they can vary so considerably from country to country.

What if you do end up needing to sue your outsourcing provider in its home country? Is all lost? Maybe not.

Earlier this year, The World Bank came out with its 2010 Country Rankings regarding handling of Commercial Disputes, based on “procedures, time and cost to resolve a commercial dispute”:

  • China 15
  • Russia 18
  • Vietnam 31
  • Ukraine 43
  • Poland 77
  • Philippines 118
  • India 182

How can China have done so well? Because cases there move much faster and cost far less to bring than in most other countries. The same is true for Russia and Vietnam. Whereas US courts grant extensive time for information-gathering, or discovery, almost all emerging market countries pretty much forgo discovery altogether. It bears mentioning that these rankings did weigh corruption.

Corruption is a much bigger factor in emerging market countries than in the U.S. and is something your company is going to have to address, particularly since the U.S. government has really stepped up its enforcement of the Foreign Corrupt Practices Act (FCPA) in the last few years.

You will need to be particularly careful in dealing with companies in Communist countries. The United States’ Foreign Corrupt Practices Act applies to payments to government officials and there are a lot of government officials embedded in companies in China and Vietnam and Cambodia due to the nature of their economic systems. Paying off a non-governmental employee could also land your company in hot water -- or you in jail -- because most countries have their own laws forbidding this sort of thing.

I am not aware of any country in the world that has a “but everybody else was doing it too” defense.

I often hear people say that contracts in such-and-such a country are not worth the paper they are printed on due to corruption. This is pretty much always wrong.

Take Russia for example. Among the countries with which I frequently deal, I see Russia’s judges as being the most corrupt. But even there, corruption has very definite limits. I have a lawyer friend in Russia who tells me that about half of the judges in his city are corrupt (and he knows exactly which ones are and are not). So is it worth having a good contract if your odds of getting someone who will enforce it are only 50%? Yes, and here’s why.

First off, I am going to assume that you are not going to want to get into the business of paying bribes. And on that, my only advice is never ever do that.

My friend’s Russian city is probably more corrupt than most other Russian cities with strong outsourcing and even if your chances of getting a fair hearing on your case in Russia are only 50%, that is high enough to warrant having a real contract.

But even if you do end up with a corrupt judge, you will still be far better off with a good contract on your side. Let me explain.

Let’s say you are suing your Russian counterparty for a million dollars. Should you go forward with the case if you get assigned one of the corrupt judges? Absolutely yes. If you have a great contract and you should clearly prevail, it is going to cost your Russian counterparty a lot of money to pay off the judge for a ruling in its favor. Even corrupt judges in a country with endemic corruption do not want to be seen as corrupt. If you clearly should have won the case, the lower court judge will be very worried about appearing to the appellate court to have been bought and paid for.

So now you are probably saying, “well that’s great, he is telling me to sue so that the Russian company will have to pay some Russian judge a lot of money, but I am still going to be out my $1 million.” Not so fast. If the Russian company is going to have to pay the judge $300,000 to avoid paying you $1 million, and if the Russian company is going to have to risk going to jail for bribery on top of having made the payment, and perhaps most importantly, if the Russian company is going to have to risk losing the case at the Court of Appeals level (and that court is usually made up of at least 3 judges and is usually in another city), don’t you think it would rather pay you $500,000 than pay $300,000 to a judge and risk paying the million on top of that if it loses on appeal?

And I know $500,000 is not the million you were owed, but it is a lot better than zero. In other words, even where corruption is rampant, you are better off having a good contract.

Here is how some of the more prominent countries for outsourcing fared on the most widely cited and probably most highly regarded corruption index, Transparency International:

  • Poland 41
  • China 78
  • India 87
  • Indonesia 110
  • Vietnam 116
  • Ukraine 134
  • Philippines 134
  • Russia 154

I hope I haven’t scared you too much.

 

 


Dan Harris is founder of the Harris & Moure law firm, a boutique international law firm focusing on small and medium sized businesses that operate internationally. China is the fastest growing area for the firm. Dan writes ChinaLawBlog.com as a source of China legal and business information.

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