Chinese lawyers
Just say no to Hong Kong jurisdiction.

Hong Kong courts are world class and few foreign companies would not rather have their disputes against their Mainland China counter-parties resolved in Hong Kong as opposed to in Yiwu or in Harbin. Hong Kong as the jurisdiction of choice is very alluring. But for all sorts of reasons, it’s a trap.

Let me explain.

Back in 2008 China and Hong Kong entered into a reciprocal enforcement agreement to make judgments from Hong Kong courts enforceable in China, and vice-versa. Foreign lawyers (usually those not experienced with China contracts or China courts) see this and think having their clients disputes resolved in Hong Kong is the way to go. But as is so often true of China, what is on paper does not correspond so well with the real world and most of the time calling for disputes with Mainland Chinese companies to be resolved in Hong Kong is a terrible idea.

Consider a contract between a U.S. technology company and its PRC licensee. [Though our example is of a U.S. company, what we say below holds true for nearly all Western countries/companies as well.] The U.S company seeks to avoid Chinese law by providing for English as the contract language, U.S. law as the applicable law, and enforcement in a U.S. court. The Chinese side refuses and insists on the opposite: Chinese language, Chinese law and enforcement in a Chinese court. As a compromise, the U.S. side proposes the following: English language, Hong Kong law and enforcement in a Hong Kong court. The Chinese side readily agrees and the contract is signed.

Why did the Chinese side agree? It agreed because it knows this “compromise” has created the worst possible situation for the U.S. company. The contract is NOT enforceable against the Chinese company, so the Chinese company is off the hook for any liability. On the other hand, the contract IS enforceable against the U.S. company, giving the Chinese company substantial power in the event of a dispute. The U.S. company has placed itself in the worst possible position. I have Chinese lawyer friends who brag about setting up foreign lawyers with this “trick.”

There is though a chance both parties will be disappointed because there is a risk the Hong Kong court will refuse to hear the case because the matter has no connection to Hong Kong. Remember that Hong Kong is an entirely separate jurisdiction from China. For this reason, a contract between a U.S. company and a Chinese company governing conduct that will occur in the PRC has no connection to Hong Kong. It is therefore entirely possible the Hong Kong court will refuse to further crowd its docket and will simply refuse to hear the case.

But let’s just assume the Hong Kong court hears the case and renders a judgment. What then will happen? If the Chinese company is the plaintiff and if it prevails, its judgment against the U.S. defendant will be easily enforceable in the United States against the assets of the U.S. company. Hong Kong is a common law country with laws and legal procedure based on the laws of England. U.S. courts regularly enforce such common law judgments and the odds are overwhelming they would do so in this situation as well

But If the plaintiff is the U.S. company and it prevails and then seeks to enforce its Hong Kong judgment in the PRC, the situation is quite different. On the surface, it appears enforcement of the judgment should not be an issue under China and Hong Kong’s  reciprocal enforcement agreement of 2008 which on its face makes judgments from Hong Kong courts enforceable in China. However, Chinese courts regularly ignore this statute by not enforcing Hong Kong judgments.

Chinese courts avoid enforcement in two ways. Sometimes they simply refuse to act. They do not openly reject the demand for enforcement. They instead accept the demand and then do absolutely nothing. This is the most common technique.

The other approach is to find technical reasons to reject the demand for enforcement. Usually the Chinese court will reject the Hong Kong judgment based on a claim that award was based on grounds that violate Chinese public policy. Since Chinese civil law and Hong Kong common law come from an entirely different legal background and legal procedure, it is generally easy for a Chinese court to find a public policy issue.

Often, the Chinese party will not appear in the Hong Kong action. In this case, the U.S. side will obtain a default judgment. Like many Asian courts (and European and U.S. ones as well), Chinese courts are reluctant to enforce any form of default judgment. When the default judgment is from a foreign jurisdiction, the likelihood of enforcement is very low. Knowing this, good Chinese lawyers instruct their Chinese clients not to appear when sued in Hong Kong.

As noted above, a contract between a Chinese entity and a U.S. entity has no factual or legal connection with Hong Kong. Chinese law allows the parties to a contract to chose the applicable law, but when the parties choose a law with no connection to the underlying transaction, Chinese courts typically deem this to violate public policy.

Whether the Court issues a written ruling or simply does nothing, the effect is the same: no enforcement of the Hong Kong judgment against the Chinese party defendant.

So what this all means is that by writing a Hong Kong jurisdiction provision into the U.S. company’s contract with its Chinese counter-party, the U.S. company (or its lawyer) has placed itself in the worst of all positions. First, it must convince a skeptical Hong Kong court to hear a case with no connection to Hong Kong. And since Hong Kong has a loser pays system, the U.S. company usually must post a substantial monetary bond to cover the risk that it will not prevail on its claim. Then it must pay the very high attorneys’ fees and court costs demanded by the excellent Hong Kong legal system. Then it must wait as the Hong Kong court takes what can be a substantial period of time to render judgment when the facts and parties are all foreign to Hong Kong. Then, if and when it finally receives its Hong Kong judgment, the U.S. company will likely learn the hard way that its judgment has no value since it is not enforceable in China. Or even worse, the Chinese party prevails on its counterclaim and the Chinese party is free to enforce its judgment against the American company in the United States. And to top it all off, the U.S. company loses its bond, which goes to pay the Chinese company’s legal fees.

Hong Kong as the jurisdiction for disputes with Chinese companies? Great on paper, but really bad in real life.