China Law Blog

Dr. Clarisse von Wunschheim On Arbitrating Your China Disputes, Part I. The Legal Context.

Dan — Thu, 02 Feb 2012 20:08:25 -0800

We are always writing on the importance of China contracts having a well-crafted dispute resolution provision. My favorite line about this is the following, from the post, "Arbitration In Your China Contract. Adult Supervision Required":

With sushi restaurants, it's the yellow-fin.
With new houses, it's the windows.
With international contracts, it's the dispute resolution provision.

The "it" I am talking about is the one easiest, fastest, most accurate, way to judge whether something is good or not. And the way I judge international contracts is by heading straight to the dispute resolution provision. The well crafted provision is, above all else, unambiguous. If it calls for litigation, it says where it will be and what law will apply. And it says who will pay for it and under what circumstances. If it calls for arbitration, it says where it will be, how many arbitrators will be required, how the arbitrators will be chosen, the language of the proceedings, the rules that will be used for the proceeding, and the law that will apply. And it says who will pay for what.

The above are minimums.

Because arbitration is of such mainline importance to contracts with China, I asked China arbitration expert, Dr. Clarisse von Wunschheim to write a series of guest posts on China arbitration and she has agreed to do so. I asked Dr. von Wunschheim because she literally wrote the book on China arbitration: Enforcement of Commercial Arbitral Awards in China. Dr. von Wunschheim presently heads up WunschARB, "a boutique advisory firm created in Zurich in 2010, with the Beijing branch opening in April 2011. It provides advice and practical assistance preventing, managing and resolving cross-cultural commercial disputes, with a particular focus on international arbitration and China related disputes."

So without any further ado, Part I of Dr. von Wunschheim on China arbitration.

Introduction

One of the biggest bones of contention among lawyers and business people when it comes to negotiating and drafting arbitration clauses in China-related cross-border commercial contracts is whether it is better to arbitrate inside or outside China, and there are two main schools of thought:

Avoid China as place of arbitration and try to agree on a place of arbitration outside China. Focus first on winning the arbitration, and worry then about enforcement.
Avoid complications due to arbitrating abroad and keep your place of arbitration in China. Overall, you will be better off, especially when it comes to enforcement.

I believe that both of these approaches miss the point, and that the question of where to arbitrate is intimately linked to the parties’ expectations and needs and should therefore depend on a series of case-specific factors.

Before dealing with the pros and cons of each option (post no. 2), and determining which should – in view of the pros and cons and of the parties’ expectations - be the relevant criteria for selection (post no. 3), let me briefly set out the (legal) context of the issue.

Premise – Legal Restrictions on Choice of Forum

Under Chinese law (see in particular Art. 242 PRC Civil Procedure Law and Art. 128 Contract Law), only parties to a ‘foreign-related contract’ may choose a foreign dispute resolution forum. The corollary of this is that parties to a purely domestic contract must keep their dispute and its resolution in China.

Based on this, the debate about a foreign or a Chinese place of arbitration would seem to be limited to ‘foreign-related’ contracts.

However, this statement does not fully reflect reality and raises two main questions:

1. When is a contract deemed foreign-related?

The term ‘foreign-related’ can be misleading and the perception of foreign companies as to what counts as ‘foreign-related’ is therefore often wrong.

In 1992, the Supreme People’s Court defined a ‘foreign-related’ case as a case showing one of the following features:

(i) one or both parties are of foreign nationality or stateless, or a company or organization is located in a foreign country;

(ii) the legal facts that establish, alter or terminate the civil legal relationship between the parties occur in a foreign country; or

(iii) where the subject matter of the dispute is situated in a foreign country.

Unless one of these three circumstances is present, the case will be qualified as domestic.

While the official definition of what counts as ‘foreign-related’ seems to be quite broad, the practice of the Chinese courts is very restrictive: When determining whether a case is ‘foreign-related’ they rely exclusively on the first criteria, i.e. the nationality of the parties involved.

In summary, for a case to be considered foreign-related, at least one of the parties involved must be of foreign nationality. In this regard, foreign companies too often overlook the fact that their Chinese subsidiaries, including joint ventures or wholly owned entities, are considered to be Chinese entities established under Chinese law. Therefore, disputes involving such subsidiaries will mostly be considered domestic, which means that the contracts entered into by such subsidiaries may not provide for a foreign place of arbitration.

2. What happens if notwithstanding the domestic nature of your contract, you select a foreign place of arbitration?

If, notwithstanding the domestic nature of the contract, the parties opt for a foreign place of arbitration, they breach Chinese law and in particular Art. 242 PRC Civil Procedure Law and Art. 128 PRC Contract Law.

It is however not totally clear what the consequences of such breach are.

One argument could be to say that the arbitration clause is invalid because it breaches Chinese law.

However, this argument is not necessarily convincing, mainly for the following reason:

The law applicable to the validity of the arbitration agreement may not necessarily be Chinese law. Under most modern arbitration laws, the law applicable to the arbitration clause is the law chosen by the parties, and in the absence of an explicit choice, it is the law of the place of arbitration.

In other words, where the parties choose a place of arbitration abroad, let’s say in Switzerland, Swiss arbitration law will apply to the question of the validity of the arbitration agreement. Since there are no restrictions under Swiss arbitration law with regard to the place of arbitration, an arbitral tribunal constituted under Swiss arbitration law will have no reason to consider the arbitration agreement invalid.

The restriction imposed by Chinese law on the place of arbitration may therefore in principle not prevent the arbitration from taking place in another country.

However, the party seeking to enforce the arbitral award in China may encounter serious problems.

From the outset, I should say that I am not aware of any decision of Chinese courts refusing enforcement of a foreign award in relation to the breach of the legal restriction concerning foreign forum selection. In addition, the breach of legal provisions is – as such – not a ground for non-enforcement of foreign awards under the New York Convention.

However, I believe that Chinese courts would very likely consider such a breach to trigger the ground for breach of public policy under Article V(2)(b) New York Convention: Though it is true that the Supreme People’s Court has made it clear that a breach of – even mandatory – legal provisions does not necessarily amount to a breach of public policy (see e.g. ED&F Case 2003; Mitsui Case 2005; GRD Minproc Case 2009), it has also made it clear that a breach of China’s jurisdictional sovereignty will in principle amount to such breach thereby justifying to refuse enforcement (see the Yongning case 2008).

Since Art. 242 PRC Civil Procedure Law and Art. 128 PRC Contract Law are meant to allow China to keep control over certain contracts and disputes, I anticipate that a breach of these provisions would be regarded as a breach of China’s jurisdictional sovereignty.

Consequently, I believe that enforcement of a foreign award rendered based on an arbitration agreement which disregards the forum selection restrictions set by Art. 242 PRC Civil Procedure Law and Art. 128 PRC Contract Law run a serious risk of being refused enforcement based on Article V(2)(b) New York Convention.

Does this mean that parties should refrain from entering into such arbitration agreements? Not necessarily. This ultimately depends on the importance given to the issue of enforcement, within the entire context of reasons why parties would want to choose arbitration abroad.

In this respect, it is my contention that the role of enforcement is often overemphasized and this will be the topic of the next two posts.

The End Of Cheap China, Part IV. More On How YOU Must Prepare For It.

Dan — Wed, 01 Feb 2012 07:38:17 -0800

By: Steve Dickinson

In my previous post in this series on the end of cheap China, I noted that the risks relating to purchases from Chinese manufacturers are rising in the export sector in China's Eastern provinces. Given the risks, it surprises me that I still see many buyers who continue to use the worst payment system possible in their dealings with Chinese manufacturers. The standard (terrible) system for payment in most of the export sector is: 30% down payment on signing of contract with the remaining 70% payable prior to shipment.

Why is this a terrible system for the Buyer? Let's consider the deposit system first. It is common for a Buyer to learn that the manufacturer is not able to make the product, makes the product with excessive defects or substantially delays in delivering the product. If the Buyer has paid a 30% deposit, the Buyer is basically "stuck" with the manufacturer and is not able to go elsewhere even after these problems are discovered. I have seen many Buyers who find themselves trapped in this way.

More important, the need for deposits reveals weakness of the manufacturing sector. Many foreign buyers naively believe the deposit is retained in a special account or is at least reserved for their own project. This is not the case. The 30% deposit is not used as any sort of security. Rather, the deposit is used as a financing tool for the manufacturer. Most raw materials for production are purchased with these deposits without regard to the specific project or buyer. Other costs are paid from the same general deposit fund.

As a result, when there is a problem, the deposit is almost never returned. There are two reasons for this. First, the manufacturer has already spent the money on costs and simply does not have the funds available to pay a refund. Second, the manufacturer knows that the amount of the deposit is so small that there is little risk of the foreign buyer filing suit for a refund. Indeed, normally there is not contract so the basis for requiring a refund is not clear. Thus the Buyer is forced to negotiate a price reduction or an extension or some other make-do remedy with a manufacturer that has already revealed ts clear weaknesses.

Now consider payment of the 70% upon shipment and prior to delivery. Under this approach, if the Buyer does not inspect in China, the Buyer only discovers what has actually been shipped after the payment and after the product has been delivered to the buyer. To consider the risks, consider these stories that have come into my law firm over the years:

Buyer purchases carrying cases for its notebook computer. Computer is 8 inches wide. The cases arrive. They are beautiful, except for one "minor" problem: they are all seven inches wide.

Buyer purchases jewelry bracelets with clasps that are to be mounted on the left side. The bracelets arrive. They are beautiful, except for one minor problem: the clasps are all mounted on the right side.

Buyer purchases hand blown glass Christmas tree ornaments. The ornaments arrive just in time for holiday sales. The are beautiful except for one minor problem: the ornaments do not include a ring on top for mounting on the tree.

Buyer purchases candle lamps. Lamp must be made from inflammable safety materials. Buyer pays extra for use of this material. The lamps arrive. They are beautiful except for one minor problem: they are made from normal, flammable paper and plastic and explode into flames at the touch of a match.

In each case, the Buyer received a full container of 100% defective product. The defect was so obvious that it would have been discovered by even the most rudimentary inspection prior to shipment. By failing
to inspect, the buyer suffered a total loss. So much for the China price.

Of course, the more common thing is finding a smaller number of defects that result in damages ranging from 10% to 30% of the delivered product. Since the money has been paid, if these defects are discovered only after delivery to the buyer, then the buyer is entirely at the mercy of the manufacturer and is virtually without an effective remedy. The manufacturer knows that the amount at issue is too low to justify a lawsuit on the part of the buyer. If the manufacturer is looking for repeat business, the most common result is that the manufacturer will admit there are defects, refuse to pay a refund or damages and will instead offer a "credit" (typically 5% to 10%) against future purchases.

As with advance deposits, the "credit for defects" system is also a terrible system for the buyer that virtually always ends in failure. Let's take a look at how this works. In order to obtain the credit, the buyer must purchase from a manufacturer who has already shown that it will make a defective product and not give a refund for having done so. Buyers then get locked in a downward spiral. Each shipment has defects, and the amount of the credit grows. The manufacturer knows that the price for the subsequent shipments will be discounted, so the manufacturer gets even sloppier. So defects increase and delays become common. Finally, the buyer just gives up and writes the whole thing off or simply goes out of business due to the lack of adequate product.

Some buyers have finally understood that making payment prior to inspection is an invitation to disaster. Many buyers now perform inspections in China prior to shipment. This is an excellent trend and is basically required for protection of the buyer. However, this approach is still not as safe as inspection after delivery in the home country of the buyer. The basic reason is that we are aware of many times where Chinese manufacturers deceived inspectors and shipped non-conforming product.

As I mentioned in my previous post, some really bold manufacturers will substitute an entire container of non-conforming product by replacing a sealed container with an alternative. More often, manufacturers will rig the container so that conforming product is easy to find, with non-conforming product hidden deep in the container or in alternative locations on the loading dock. The only way to avoid these deceptive practices is to inspect at the place of delivery in the home country of the buyer and to make payment after that inspection is complete. Most Chinese manufacturers will strenuously resist payment only after nspection upon delivery. Buyers should therefore at a minimum inspect in China prior to shipment and then take into account the inherent risk in this practice. The price the buyer pays is actually substantially higher than its face value since this inherent risk is built into the price.

In part V of this series, I will discuss payment options that can reduce your risks.

The End Of Cheap China, Part III. How YOU Must Prepare For It.

Dan — Mon, 30 Jan 2012 09:58:45 -0800

We have been writing frequently regarding the end of cheap China because we are just about every day seeing how this impacts our (mostly American) clients. This post by Steve Dickinson is on how buyers of manufactured product from China's Pearl River Delta are going to be impacted by the end of cheap China. Here is Steve's post:

The excellent Chinese financial journal Cai Jing recently published an article, entitled, Dire Straits in the Pearl River Delta, detailing the financial problems facing export-oriented manufacturers in the Pearl River Delta region of Guangzhou Province. The article includes the standard lament that these businesses are not being adequately supported by the central government. However, the truth is that these manufacturing businesses are under financial pressure simply because they are no longer competitive. These manufacturers of toys, clothing, shoes, furniture and housewares are standard high volume, high employment, low technology and low margin operators.

The Chinese government has decided to let them go for three very good reasons. First, they do not represent the high technology manufacturing that China wants for the Pearl River Delta. Second, they are largely controlled by foreigners, mostly from Hong Kong, Taiwan Korea and Singapore. Third, and most important, these manufacturers are simply no longer competitive. It is well known that wages in China have increased greatly. However, other costs have also increased substantially in this region: raw materials, utilities, rent and taxes have all dramatically increased over the past five years. When all of these costs are combined, the Pearl River Delta manufacturers simply can no longer compete with their competitors in Asia and elsewhere in the world.

What these manufacturers want are subsidies from the Chinese government that will allow them continue to operate when normal economics would force them to shut their doors. The answer from the Chinese government has been clear. Financing will be made available to domestically owned manufacturers that can show that they have a viable business. All others will need to shut down. There will be no “hand outs.”

Many buyers are convinced that the central government will eventually step in and save these failing businesses. They believe that the need to create jobs will trump any other concerns. This belief is misguided. It is a central theme of the 12^th Five Year Plan that the Pearl River Delta manufacturing region will be transformed from low value added to high value added manufacturing. The government does not want to provide jobs for migrant laborers in this region. It wants the migrant laborers to return home and take jobs in Sichuan and Henan and other central provinces. The government encourages low value added manufacturing to move to those regions and it is providing numerous incentives for such moves. In parallel, the Chinese government has no intention of preserving these Pearl River Delta businesses with subsidies when such a practice is directly contrary to government policy.

It is therefore certain that over the next two years we will see a major change in the whole export manufacturing sector that extends from Wenzhou down to Zhuhai. During this period, many companies will fail. Many of these companies will have a long and excellent track record of performance. But they will still fail because their business model no longer works.

In this environment, there are substantial risks that foreign buyers must prepare for with great care:

Many buyers pay an advance deposit for products. Many failing manufacturers will collect these deposits with no intention of ever manufacturing the product.

If a manufacturer is struggling, the level of defects will rise to a shockingly high level. Manufacturers that owe a credit or refund from prior defects will not pay. There is also tremendous pressure for the manufacturer to substitute low quality or non-conforming components to save money. Lead content paint on toys or low quality fasteners on clothing are examples.

Many buyers pay for their product at the time of shipment without doing an inspection of the product. This leads to a great risk of fraud in dealings with a manufacturer who is going to go out of business in a short time. Some standard frauds are as follows:

- The manufacturer simply does not ship the product. Sometimes the manufacturer will convince the buyer to make a payment to a new bank account. Often this bank account is in the wrong name or even in a different country. When the buyer complains that there has been no shipment, the manufacturer claims the buyer is the victim of fraud by someone other than the manufacturer. We are seeing this one a lot, with the "new" bank account being a personal (rather than a business) one.

- The manufacturer takes payment, and then ships an entirely different product or a non-conforming product. For example, a container of frozen fish will turn out to have one layer of fish and the remainder of the container is bricks. Or a container of a frozen food product when unfrozen will turn out to be entirely rotten product. We had a client receive a shipment of frozen salmon that was so rotten that the container was declared a hazardous waste site right on the dock.

- Even where the buyer inspects, we have recently seen a number of cases of outright fraud. In these cases, the buyer watched the product be loaded and the container sealed. The manufacturer then switched the container on the dock and sent an entirely different product to the buyer.

In all these cases, the manufacturer is relying on two things:

First, due to the low value of any single container, no foreign customer will bother to sue in China.

Second, since the manufacturer plans to go out of business and “disappear,” the manufacturer simply is not worried about legal liability.

Note that past history with a manufacturer is no guarantee that these problems will not occur. As I noted above, even “good” companies will fail when the business model no longer works. Often, these “good” companies are the cleverest at extracting the most funds from their long term foreign customers. These owners are smart, and they apply their considerable intelligence in making the best of their difficult situation.

Given the current economic hardship in the southern coastal region, all buyers must take particular care to guard against these risks. Those of us who have been in China for a while have seen all this before. It always happens during an economic shift or slowdown in China. Previous examples are the late 1980's when SOEs were forced to stand on their own and then again in the late 1990s when the effects of the Asian financial crisis were felt in China. We also saw some of this in 2008. This period will be no different.

Buyer beware.

Learn Chinese For Business? The Pros And Cons

Dan — Sun, 29 Jan 2012 19:58:19 -0800

The following is a guest post by Jonathan Poston. Jonathan is the Editor-in-Chief of the Learn Chinese Business Blog and Chinese Carolinas. Though learning Chinese well is obviously helpful for doing business in or with China, actually accomplishing can be so difficult that many a learner has given up or just pondered whether it is worth it. I asked Jonathan to write a post on the pros and cons of learning Chinese for business because his Learn Chinese Business blog so often delves into issues relating to China's business culture. Here's Jonathan's post:

If you Google “When will Chinese economy overtake US,” you will notice how many of the top results spit back a year that is closer than five years away: 2016. Though no one can predict the future, consider that China is already the second greatest economic power in the world, which begs the question as to when learning Mandarin-Chinese will be mandatory for aspiring international business people worth their mettle. Let’s take a look at the pros (beyond China’s massive economy) and cons to determine whether it pays to learn Mandarin-Chinese for business.

Pros

Government Subsidies for Mandarin Language Training. The Chinese government is making it easier for foreigners to learn Mandarin, as part of a highly organized campaign to strengthen their “soft power” abroad. U.S. high schools and universities are already recipients of Chinese government subsidized Mandarin learning initiatives, which usually operate under the sometimes controversial Confucius Institute marquee.

Mandarin is the Most Popular Language on Earth. Mandarin is the official language of the most populous country on Earth: China. That means Mandarin easily ranks as the most widely used language among native speakers. There are also millions of other native Chinese speakers living in Taiwan and around the world, who use the language to conduct their regular business affairs.

Stronger Relations. Developing a strong relationship with Chinese business partners usually precedes meeting at the official negotiating table, and is in many ways paramount to the deal itself. Learning to speak with Chinese business partners in their native tongue always imparts a special advantage to anyone willing to learn a language for the sake of business. It shows respect, and who wouldn’t appreciate that? Furthermore, foreigners who end up doing business with the Chinese may have a partner or translator who speaks the language, but relying on them too much can undermine crucial “bonding” experiences with important Chinese decision makers.

Catching Bad Translations. Knowing a bit of Mandarin in most cases won’t mean there isn’t going to be need for a translator, but it can help non-native speakers catch some mistakes during negotiations.

Getting Around Easier. American businessmen often make the mistake of believing that everyone in China learns English and that everything comes with an English translation. This might be somewhat true in tier 1 cities like Beijing and Shanghai, but more business opportunities are becoming available in tier 3 and 4 cities, where English is more of a rarity. Even with a translator, what business thought-leaders want someone to order everything for them, or even escort them to the public bathrooms at a tradeshow?

Cons

Takes Forever to Learn. The argument has been made over and over again that Mandarin-Chinese is too difficult for foreigners to learn, when weighed against the “business” benefits the learner stands to gain. Many who seriously tackle Mandarin with the gusto that it takes to become truly fluent do so for personal reasons, rather than strictly for business. Though it’s relatively easy to take high school Spanish coursework abroad and actually make some use of it for business purposes, it’s almost impossible to expect a similar use-outcome from the same amount of time spent learning Mandarin. It takes many years of study and practice to begin to peel back and process through the layers of complexity of a four tone, fifty-plus thousand character language.

You’ll Never Be “Chinese.” When you do business in China, you are, for all intents and purposes, an outsider (There’s even a term you’ll probably hear yourself referred to as: Wai Guo Ren -外国人). No matter how much Mandarin you know, you’ll still never be seen as Chinese. That means you may be missing out on inside talks and preferential treatment the Chinese government has been known to reserve for Chinese-owned companies. So, while knowing Mandarin can give international business people some advantages, it can only take you so far.

Regional Dialect Differences. “Standard Mandarin” is what most Chinese language learners study. It’s what’s officially spoken in Beijing, and supposedly in the rest of China as well. But the further you travel from the capital city, the less likely your standard Mandarin will “work.” So what might pass for good Mandarin in Beijing might not be intelligible in Shanghai, much less in some of the more rural areas where Mandarin is amalgamated with the local dialect (which might not even be Mandarin-based at all). This author saw where tour bus drivers from one region had trouble asking for directions in another.

Unlikely to be the Next English. Though many extol the virtues of learning Chinese to prepare for the new global economic reality of China's dominance, because Mandarin is currently primarily used only by native Chinese speakers (because it is so difficult to effectively learn and standardize), it is unlikely to supersede “English” as the preferred language for global business communications.

With the above “pros and cons” in mind, readers might still be left wondering what to do. Do you learn Chinese for business or not? For businesspeople currently living in China or those planning to spend a considerable amount of time working with the Chinese, it’s definitely worth it. For those planning to do a deal or three over a lifetime, it’s just not feasible. For personal purposes of tourism, ex-pat retirement escape plans, making international friends, or just expanding your world view (imagine how much Chinese you would know if you spent the same time learning the language as you do reading the Economist), learning Mandarin is just as rewarding as mastering any other skill, and well worth the time spent. It all just depends on your goals.

China Rep Offices, Bankruptcies And The Perils Of Being Chief Representative

Dan — Thu, 26 Jan 2012 05:55:15 -0800

I know I keep reading how China's economy is just fine, but my firm just keeps getting more inquiries and more work relating to shutting down offices and companies in China.

Of those, the most heartbreaking are coming from Chief Representatives of China Representative Offices who are concerned about their own liabilities when their China Rep Office closes.

Typically, the Chief Representative tells the Rep Office employees that the Rep Office is going to be shutting down. Naturally enough, the employees ask about their getting paid. The Chief Representative usually tells them not to worry, which causes them to worry more and go to their local government. A local government official then comes by and informs the Chief Representative that he or she is PERSONALLY responsible for paying the Rep Office's employee salaries AND all outstanding taxes.

The Chief Representative then contacts my firm and we tell him or her that he or she does indeed run a very real risk of being on the hook for any and all Representative Office debts and so they had better make sure their home office pays. What can happen to a Chief Representative if the home office refuses to pay? We've heard of all sorts of things, ranging from the Chief Representative being held at a hotel for weeks until all debts are paid, to Chief Representatives sneaking out of town and then out of China, under fear of being put on a list that will prevent them from ever returning.

But what happens when the head office/owner of the China Representative Office files for bankruptcy in the United States?

In those situations, we recommend that the Chief Representative hire a US-based bankruptcy lawyer to file a claim against the bankruptcy estate on his or her own behalf. The Chief Representative could claim that the US company owes him or her the amount owed to the Chinese employees and the Chinese tax authorities because the Chief Representative assumed that debt on the home office's behalf. Will this work? We don't know. Yet.

Will the bankruptcy court hold that the Chief Representative is owed anything by the home office in bankruptcy? And even if the bankruptcy court does hold that the bankruptcy estate owes the Chief Representatve the amount the Chief Representative (and the estate) owes in China, is there any basis for the Chief Representative to claim entitlement to any higher percentage on his debt than any of the other unsecured creditors? In other words, will the Chief Representative get anything more than the usual pennies on the dollar creditors usually get? I rather doubt either the employees or the tax authorities in China will cut the Chief Representative much slack simply because his or her home office has filed for bankruptcy in the United States.

Quite the ugly situation. Bankruptcy lawyers (and others), what do you know?

China Product Quality Problem? Here's My Template Answer.

Dan — Tue, 24 Jan 2012 09:18:31 -0800

Because I receive countless emails every day and because so many of them involve the same questions, I have developed various templates to respond.

Here's the template I use when a US company writes me with a China product quality problem and the contract they have provided me is not good at all. Much of the time the US has no contract at all, but usually when they do have one, it is usualy so bad as to work against them. Here's my "stock" answer in that situation.

This is our template response when the contract calls for arbitration in a US city but is pretty much silent on everything else (a far too common scenario when non-lawyers draft a contract).

It's a tough case and your contract does not help matters at all.

What you probably will need to do is begin arbitration in [US City] and serve [the Chinese company] via the Hague Convention. This will require translating the complaint into Chinese and serving it through the Chinese court system, which takes months. We write our arbitration contracts to say that service can be done by email/fax/personal delivery so as to avoid this sort of situation.

Your contract is silent regarding the arbitration panel to be used and the choice of law. I hate to tell you this, but we had a case with a similar arbitration provision and it cost our client $50,000 to get the case into arbitration in the first place because the other side used the vagueness of the provision to stall. And that was just the arbitration panel alone. It could cost $10,000 easy to figure out what law should apply here and in the end, I am very worried it will be Chinese law. I'm worried about that because under Chinese law, terms like "highest quality" and "best workmanship" can be very different from the US. Very different.

In the end, the arbitrator will probably use US standards (without saying so explicitly) but you've opened yourself up for a whole lot of argument in the meantime. If your complaints are based on the Chinese company's failure to build your product according to ____ standard or to meet _________ certification, your case becomes a bit simpler because there is at least something clear cut against we can measure the product you received. You may need an expert to testify regarding the quality problems and that is more cost.

So now that I've told you the many issues that you may need to confront just to get the case into arbitration and then to win in arbitration, I'm going to tell you that even if you win in arbitration, you are only about 60% of the way there. Because after you win in the US, you will need to take your US arbitration award over to China and then convert it into a Chinese court judgment and that is going to take a while and will likely involve its own set of fights. Once you have a Chinese court judgment, trying to collect on it will be the next difficult and expensive task.

Here is how I suggest you proceed:

1. If you are ever going to buy product from China again, you should hire us or some other law firm experienced in writing Chinese OEM Agreements. We typically write the official contract in Chinese (with a Chinese court dispute clause) and the translation in English. A good contract scares Chinese companies and your threat of a lawsuit thus has a lot more force. Most importantly, a good contract is much more likely to make it worth your Chinese manufacturer's while to do things right from the get go.

2. I am very skeptical that it will be worth your while to pursue arbitration in the United States, but that seems to be the only litigation/arbitration route you have.

3. One other option you have is to have us write a demand letter to [Chinese company] in Chinese to stating that if it does not resolve and pay for the product quality issues, we will pursue arbitration in [US City] pursuant to the contract and then take that arbitration award to China and turn it into a court judgment. We would act like all of that will be easy. We have a decent (but not great) success rate with these letters in that we do sometimes get real money back for our clients by writing them, even when the litigation/arbitration option is gloomy.

If you have any questions, please feel free to write or call.

What do you think? Part II of this will be the letter we write when the contract calls for litigation in a US city (which is even worse than arbitration, BTW).

China Grammar Wiki. What A Great Idea!

Dan — Sun, 22 Jan 2012 14:08:04 -0800

I think (and hope) this is the first time we have used an exclamation point in a blog post title and I assure you that this will not become common. I just am so impressed by the idea and the ingenuity and the hard work and the sheer helpfullness of the AllSet Chinese Grammar Wiki. I first learned of the Wiki from Ryan over at Lost Laowai, who in his post, "Chinese Grammar Wiki: Learning Chinese grammar just got easier," had this to say about it:

AllSet Learning, the Shanghai-based language learning consultancy founded by long-time China blogger John Pasden, has just released what is surely a boon for mandarin learners who aspire to achieve better Chinese grammar — the Chinese Grammar Wiki....

As an on-again, off-again Chinese learner, I’m pretty excited for the resource. Few people I’ve met have spent as much time as John thinking about language learning, particularly as to how it relates to Chinese. His blog and various resources at Sinosplice have been extremely helpful over the years, and I have to imagine that with his ambition and love for the language behind the wiki, it’s sure to be fantastic.

I second that emotion. What do you think?

UPDATE: A reader sent me an email regarding a "wiki-ish" site he likes called Wordbuddy:

It is wiki-ish because it is a dictionary that anybody can add to (slang, etc). Other sites can do this, but this one is interesting because people can also add 'memory tricks' for learning words which everybody can share. For example:

书 (shū): The librarian will 'shoot' you if the is not returned on time.

东西 (dōng xi): In old times, a "donkey" was one of a person's most basic .

讨 (tao3): The purpose of a (讠) is to slowly inch(寸) toward an agreement.

独 (du2): A dog(犭) with flees(虫) will be shunned by humans and other dogs. He'll become a "dude".

These are just off the cuff examples that users have entered. The site also integrates flashcards, radicals, translation, study lists, forums, etc, and makes a very good training tool for learning vocabulary.

Having spent part of last night helping my youngest daughter memorize Latin American capitals, I can vouch for the value of using memory tricks. Does anyone have a good way to remember that the capital of Uraguay is Montevideo, the capital of Paraguay is Asuncion, and the capital of Ecuador is Quito?

China. The Full On Harvard Course.

Dan — Sun, 22 Jan 2012 06:48:42 -0800

Malcolm Riddell at China Debate just did a post noting how Harvard University has posted online (for free!) a 37 class course on China.

The 37 lectures were filmed as they were given as part of a course entitled, China: Traditions and Transformations. The course was/is taught by William C. Kirby and Peter K. Bol.

Here is the course description:

Modern China presents a dual image: a society transforming itself through economic development and social revolution; and the world’s largest and oldest bureaucratic state, coping with longstanding problems of economic and political management. Both images bear the indelible imprint of China’s historical experience, of its patterns of philosophy and religion, and of its social and political thought. These themes are discussed in order to understand China in the modern world and as a great world civilization that developed along lines different from those of the Mediterranean.

This course is part of Harvard's open learning initiative so you can view (again, note that it is free) via either streaming video or audio.

I know of very few people who would not benefit from a course like this and my goal is to complete it within the year. Would love to hear back from anyone who watches at least a few of the lectures.

The End of Cheap China. Part II.

Dan — Sat, 21 Jan 2012 13:28:18 -0800

Last week, we did a post enttitled, "The End of Cheap China, With A Giant Caveat." The point of that post was to pick up on the widespread discussion regarding the end of cheap China, but to highlight how this "end" has, and will continue to, impact foreign companies very differently. Our initial "end of cheap China" post was based mostly on a "Made in America, Again: Why Manufacturing Will Return to the United States, a Boston Consulting Group study that jump-started the end of cheap China discussion.

Yesterday, i was alerted to two very recent and very good articles addressing the end of cheap China issue. The first is a post by Michael Zakkour over at the China Business Blog and Podcast, entitled, "The End of Cheap China. But Not China Manufacturing."

Michael starts by positing that "the cheap China era is over, but China manufacturing isn't." He goes on to note the following, all of which he contends portend just fine for Chinese manufacturing:

China is not going to be able to build a service and consumer driven economy within the next five years.

China’s interior provinces are still a viable alternative for manufacturing, as compared to the more expensive and saturated coastal cities. China's 12th Five Year Plan "makes clear that more equal development and sharing of wealth is a priority." This equalizing of wealth will mean a continued and increased push to move manufacturing inland.

"America will not win back the "low value-add, commodity based manufacturing jobs it once had." These jobs are going to SE Asia and South America.

"China is working toward moving commodity based manufacturing inland, but is also developing higher value-add and higher technology manufacturing in the coastal areas. It is NOT abandoning manufacturing and it has the money to support and subsidize it where needed. In other words China will move from selling toothpicks to the machines that make them (formerly bought from Germany)."

China's has "stellar" manufacturing infrastructure, which makes it very difficult for other countries to compete.

Western companies are shifting manufacturing to China to create and manufacture products for China.

Chinese manufacturers are improving in terms of efficiency and quality and this will provide a new advantage for China.

I think Michael is right and his explanation above provides support for the fact that we have not really seen much of a slowdown in terms of our clients' manufacturing in China, other than on the very low end.

The other article is an Economist article, entitled, "The End of Cheap Goods?" This article focuses on what Bruce Rockowitz, CEO of Li & Fung, calls the phases of Asian manufacturing:

He [Rockowitz] argues that Asian manufacturing has gone through a number of phases, each lasting about 30 years. When China was isolated under Mao Zedong, companies in Hong Kong, Taiwan and South Korea grew expert at making things. When China reopened in the late 1970s, after Mao’s death, these experienced Asian operators converged on southern China. With almost free access to land and labour, plus an efficient port and logistics hub in nearby Hong Kong, they started to make things ever more cheaply and sell them to the whole world.

For the next 30 years manufacturers in China helped to keep global inflation in check. But that era is now over, says Mr Rockowitz. Chinese wages are rising fast. A wave of new demand, especially from China itself, is feeding a surge in commodity prices. Manufacturers can find some relief by moving production to new areas, such as western China, Vietnam, Bangladesh, Malaysia, India and Indonesia. But none of these new places will curb inflation the way southern China once did, he predicts. All rely on the same increasingly expensive pool of commodities. Many have rising wages or poor logistics. None can provide the scale and efficiency that was created when manufacturers converged on southern China.

Rockowitz, like Zakkour, does not see manufacturing leaving China. He just sees it getting more expensive:

Nothing can replace the Chinese miracle. “There is no next,” says Mr Rockowitz. Prices will now start to rise by 5% or more each year, with no end in sight. And that may be optimistic. So far this year, Mr Rockowitz says, Li & Fung’s sourcing operation has seen price increases of 15% on average. Other sourcers of Asian toys, clothes and basic household products tell similarly ominous tales.

At the same time, according to the Economist, China is "shifting to more sophisticated products, such as electronics:"

Some of the more striking offerings at the [Computex] fair were ultra-cheap versions of global hits. A company named BananaU advertised tablet computers with Google’s Android operating system for $100. Another pushed Windows-based thin computers looking much like MacBooks for under $250. E-Readers were everywhere and available for a song.

Whether these products can be produced or sold in developed markets is unclear. The quality may be “B” for Banana rather than “A” for Apple. The intellectual property embedded in some devices may not, ahem, have been paid for. But still, the booths were packed.

Amazingly enough, prices for these electronics goods are "falling sharply" and this is attributed to Chinese manufacturers "learning how to get more from fewer hands." The article concludes by saying that "Li & Fung may be sounding the closing bell on one era of production, but the Taipei [Computex] computer fair suggests that another is emerging."

What are you seeing out there? What exactly does "the end of cheap China" really mean for manufacturing and overall?

China Joint Ventures Tips. You Have Been Warned.

Dan — Thu, 19 Jan 2012 11:28:27 -0800

The Foreign Entrepreneurs in China blog is in the midst of a very worthwhile three part series, entitled, "A China Joint Venture Survival Guide. 22 Facts and 22 Practical Tips." The series is now at tips 9 through 15 and I like all of them. Not only are they good tips for those contemplating doing a China Joint Venture, most are are good tips for those contemplating or doing business in or with China as well.

Here is a summary of each tip, followed by my own analysis of it in italic font.

9. Your Potential Partner is Well Connected … Maybe Good, Maybe Bad. "Do not be dazzled by your partner’s connections …They will not necessarily be used for your benefit. The fact that your partner is well connected is good (you obviously don’t want to end up with a nobody), but it is also a fact that at times those connections are only used for their own benefit." Absolutely true. Whatever "power" your China joint venture partner has to help the joint venture, it likely has equal power to shut you out and keep you out should the tide turn. And trust me when i say that I have seen that happen far too many times.

10. Financial Reports: “I can’t live with or without you.” "Be aware that reports can easily be falsified, and a lot of relevant information may be missing." Absolutely true. Check out "Buying A Chinese Company? Why China Deals DON'T Get Done," for more on this.

11. Tax Planning: “Tax Breaks. Do not believe all you hear.” "Tax breaks are a common tool to lure you into a location that needs to be developed....We were promised tax exemptions on all those tools and parts required for our product manufacturing. It did not happen. Not even once....Your investment should make sense regardless of the tax exemptions or other promised benefits." Again, absolutely true. Unlike even five years ago, legitimate tax breaks in China are actually few and far between. You will be promised tax breaks that do not exist. You will be promised tax breaks that are not legal. You will be promised long term tax breaks that disappear. If the deal does not make economic sense without the tax breaks, do not do the deal. It really is that simple.

12. Let me guess: your Chinese partner wants to contribute the land to the joint venture.
"The Chinese partner always wants to contribute his own properties to the joint venture." But it will usually be worth a lot less than claimed. it not only may end up being worth a lot less than claimed, it may not even be owned by your potential JV partner. Verify, verify, verify.

13. Does your land have a license to have a factory built on it? "You need to watch out for this one. Chinese companies often ignore this step. You may find sizeable companies operating (100 employees, tax bureau number, social security …) without the license to legally operate a factory/company on their land. So true. For more on this, check out "Cracking Down On Illegal Land Use In China. Do You Really Still Feel Lucky, Foreign Punk?" and "Eight Big Mistakes To Avoid In China."

14. Building the Factory- Oh Nightmare. This is another potential source of conflict. You will probably trust your partner to lead the factory construction works. You will need to monitor this closely and have good contracts in place. Indeed.

15. Check Company Operational Manuals. Very often there is nothing written on how operations should function. When you land there and try to organise things you do not even know where to start. And what is worse, your Chinese partner is not interested in changing anything as he feels it has been working for him for years before you arrived. Just assume you are going to have to start over on this front.

I urge all of you to read the full post here.