China Law Blog

Co-blogger Steve Dickinson recently wrote a column for the China Economic Review on the plusses and minuses of arbitration provisions in contracts with Chinese companies. The article is entitled, "Overseas arbitration and enforcing contracts in China," and, not surprisingly, it says that decisions on whether to arbitrate should be made on a case by case basis.

Steve's article starts out by noting that written contracts are "essential" for protecting the rights of foreign companies doing business in China, but such contracts are of no value if they cannot be enforced. Steve then notes how foreign company distrust of China's legal system too often leads them to insist that any dispute be subject to foreign law and resolved outside of China even though doing this sometimes renders the contract
"practically or legally unenforceable."

Steve then sets out "three common dispute resolution disasters":

Disaster 1: Exclusive jurisdiction in a foreign court. A Chinese supplier has shipped defective goods to its foreign customer. The claim is undisputed, the contract provides that the sole remedy for enforcement is litigation in the US and the plaintiff is thrilled to obtain a favorable judgment. But joy turns to despair when the plaintiff discovers that the judgment is worthless. If the Chinese party has no assets in the US, the only way to enforce the judgment is to proceed against the assets of the Chinese party in China. However, US judgments are not enforceable in China and so the foreign customer is unable to recover its losses.

Disaster 2: Foreign arbitration required. Contrary to the terms of the agreement, a manufacturer of outsourced products in China has been using its foreign customer’s molds to make goods for a competitor. The foreign customer seeks a court order requiring the molds be immediately returned. However, the court refuses to hear the request because the contract provides that all disputes must be submitted to arbitration in Hong Kong. The Chinese supplier continues to manufacture the infringing product and the foreign party goes out of business before it has the chance to complete the arbitration in Hong Kong.

Disaster 3: Foreign law governs. A foreign party learns that its Chinese partner is improperly using trade secrets in violation of a trade secrecy agreement. Since the damage is immediate and cannot be repaired, the foreign party seeks an order from a Chinese court requiring the Chinese side to terminate the activity immediately, prior to the final resolution of the dispute in the Chinese court. Under Chinese law, such interim relief is available, but the contract provides that US law governs in the case of a dispute. Unfamiliar with the US system, the Chinese court requires that every element of US law must be proved before it will take action – an expensive and time consuming process. As a result, the remedies available under Chinese law to deal with these emergency issues are rendered ineffective and the contract is virtually useless.

Steve then points out how "ironic" it is that in these three common circumstances, "the disaster is caused by contractual provisions inserted by the foreign party itself." Steve sets out the following basics for avoiding the wrong enforcement/choice of law provision:

Avoiding falling into this trap requires an awareness of what type of enforcement the dispute resolution process will throw up.

If it amounts to nothing more than calculating damages that must be collected in China, then foreign arbitration is a good alternative. China is a party to the New York Convention on the enforcement of arbitration awards and has a good record of enforcing lump sum monetary awards. Litigation, however, should be avoided since China generally does not enforce judgments from foreign courts.

Where the issue requires an order from a Chinese court instructing the Chinese party to act or terminate an action, foreign arbitration tends to be too slow and too expensive. In these cases, access to a PRC court with jurisdiction over the defendant is essential, and potential plaintiffs are therefore well-advised to provide for litigation in China subject to Chinese law. This is true even where the provisions of Chinese law are not favorable or where there is suspicion concerning the impartiality of the Chinese court. While these concerns may be well-founded, there is simply no practical alternative.

It is best to face reality rather than to imagine that foreign proceedings or law will provide some magical form of relief.

For more on whether to arbitrate against your Chinese counterparts, check out the following:

-- "So Ya Say You Wanna China Arbitration, Well You Know"

-- "Chinese Litigation: This Is The Way (Uh Huh) We Like It"