A couple weeks ago, an American company contacted us about representing them before the China International Economic and Trade Arbitration Commission (CIETAC) in Beijing.  The American company claimed to be owed hundreds of thousands of dollars by a Chinese company that had failed to make final payment on a large piece of industrial equipment.  The Chinese company was contending the equipment did not work as it should.

The American company was absolutely convinced that if we brought the arbitration, the Chinese company would settle quickly.  We insisted the exact opposite would likely be the case.  I know we are right, and here is why:  Chinese companies almost never settle their in country litigation matters.

In the United States, something on the order of 97% of all cases settle.  Indeed, Houston based mega-firm, Fullbright & Jaworski concluded that 60% of the cases it took to trial settled before a verdict could be reached.  I actually think the settlement numbers are even higher on business litigation matters, but I am not aware of any study on this.  The reasons usually given for nearly every case settling are the huge costs of litigating and that both parties usually have a pretty good idea of how the court is going to rule.  I agree with both these reasons and neither usually apply in China.

Chinese lawyers often complain to us how cases in China almost never settle.  They attribute this to the newness of so many of China’s laws and so few Supreme Court decisions on them.  Without clear and established law, nobody knows how a court will rule.  We hear that around 90% of the business cases filed in China actually go to trial.

Adding to the problem is that many cases in China do not require an outside lawyer (this is also true of CIETAC arbitration) so Chinese companies can and do fight their lawsuits without having to pay anything at all.  Because Chinese courts rarely award the winning party its attorneys fees and are slow to award much in interest, there is little incentive to settle quickly.

So using the American company’s breach of contract case as an example, one can quickly see a smart Chinese company defendant in this case being very reluctant to settle.  First off, the Chinese company will probably choose to handle the case without a lawyer, so its costs will be minimal.  The American company, on the other hand will, ideally, use an American lawyer who speaks Chinese.

Secondly, it is likely the Chinese company will either fully prevail or lose entirely, depending on whether it can convince the arbitrator(s) the product was bad.  If the Chinese company prevails, it will owe nothing.  If it loses, it will almost certainly owe the full amount of the claim.  But, is it not better to fight until the bitter end and at least gain the time value of the money?

Thirdly, even if the American company prevails, there is still the very sticky matter of collection.  The Chinese company might shut down and form a new company.  The Chinese company may just shut down.  And, even if it keeps operating, it very well might take a lot of time and even more money on legal fees to get them to pay.  In the meantime, if it wishes, the Chinese company could initiate settlement discussions.

The Hoaran blog [link no longer exists] recently did a post commenting on the thrills and the agonies of how everything in China is “in progress”:

living in china is like peeking behind the scenes of how things work. nothing is finished and everything is “in progress”. because of this, you get to see the infrastructure of a society and see how it functions – its built environment and transportation infrastructure, its economy, its legal system, its workplaces and schools, its shopping malls.

on the surface, you are confronted first with endless construction. in fact, i don’t think there is a person living in Beijing who is not within a block of a building site. so if you observe, you see how a field is cleared for construction, how the foundation is laid, the concrete structure established, the scaffolding erected, the worker’s temporary housing built, etc.

at the workplace, you see basic filing systems and h.r. policies being set up. management strategies, business processes and procedures, consistency between offices and other basic systems are still being figured out.

The Hoaran blog is written by an attorney and he sees this same “in progress” situation in the legal arena as well:

in the legal system, practicing judges, lawyers and customs authorities are being trained in basic legal issues. laws are being adjusted all the time. cases are constantly being tried for the first time with no predictable outcome because there is no precedent, no body of legal theory, and no previous experience to rely on

Parties in the United States can settle cases because they essentially agree on the likely outcome.   There is always a 10% chance of an aberrant verdict either way, but within the 80% of expected rulings, the numbers are usually close enough so that both sides can reach agreement at some number near the top of the bell curve.  But since China cases have no bell curve and no 80%, settlement is as much of a gamble as trial.  Since going to trial often costs only marginally more than not going to trial, there is little incentive to do anything but see the case through.

Bottom Line: A good contract can not only help prevent the need to litigate, but it can make settlement of any dispute more likely.  A contract that is so clearly written that both sides will have an easy time predicting how the court will rule increases your chances of an eventual settlement.  A contract that requires the losing party pay the winning party’s attorneys’ fees also helps, but may not always make sense.  A contract calling for mandatory arbitration without appeal and requiring the posting of a bond will often also make sense.

  • There are other factors. Chinese courts tend to be much faster and much more informal than American courts. Judges can and use the power to act as informal mediators between parties. Fighting a case to the end in American courts is painful.
    The other big social factor is that it is consider an *EXTREME* loss of face to settle a case. Settling a case, in China, implies that you didn’t have a good reason to bring or defend the lawsuit in the beginning. If you settle a case, then your social reputation goes way down. There is a lot of room for quiet informal mediation before a formal lawsuit gets filed, but once one gets filed, it is impossible for either party to back out without losing face.
    Even if the judgement is extremely adverse, you can claim that judge was corrupt or incompetent, and keep your face. If you admit fault, then you lose everything.
    I should mention that its not clear to me that the Chinese system is better or worse than the American system. The trouble with the American system is that it works really well when you have two equally matched large companies working out a dispute. It works much less well when the parties have different amounts of resources. It’s also not clear the degree to which either the United States or China can copy each others systems, because a lot of this involves underlying social attitudes about law.

  • Mr. Wang —
    Thanks for checking in and thanks for mentioning additional reasons why Chinese companies are so reluctant to settle cases. You are absolutely right to mention how Chinese cases go so much faster than U.S. cases. Chinese cases not only go faster, they have way less discovery and, therefore, way less cost. I also agree with you that it is not clear whether one system is better than thte other. I have written on this previously. The American system values accuracy over speed, and the Chinese system is the opposite.
    I really like your comments on loss of face because I had not thought of that, but it does make complete sense. Interestingly enough, “face” can sometimes be a reason cases do not settle over here.
    I remember a fairly small case around ten years ago that a client had against a bank. The bank was clearly at fault, as it had pulled a loan from the client AFTER approving it because the President had a tiff with the client. The client had to cancel an order and damages were incurred. The bank would not settle and the opposing lawyer told me (off the record)that the President insisted he had done nothing wrong and that they had no choice but to try it. The case was tried, the bank lost and the client got paid. The President, apparently, maintained some face.

  • That story illustrates another difference between Chinese and American corporate practices in that Chinese companies tend to be very centralized with the leader taking things very personally. If they bank had settled that would have been an admission that the President had done something *personally* wrong. By contrast if Citibank settles a case, that doesn’t impact the CEO personally.
    This has some good and bad points.
    One thing that this behavior results in very rapid decision making, which is sometimes good and sometimes bad, in that the decisions made are sometimes questionable.
    In the case of Foxcomm suing the reporters, I don’t doubt that what happened was that the CEO of Foxcomm was personally offended by the reporters and wanted to regain his face by suing in court, and Chinese companies being what they are, there wasn’t anyone in a position to make him think twice, and so what happened was that he ended up losing even more face.

  • Mr. Wang —
    You are right to note the managerial differences between US and China companies and I agree with you as to what probably happened at Foxconn.
    I have written previously how Westerners often make the mistake of failing to realize that in the typical Chinese company, the very bright, English speeking person with whom the Westerner is dealing very likely has little to no influence on the company. Corporate power is far more concentrated in China than in the West.

  • John Hafen

    I find it curious that the post compares apples (international arbitration before CIETAC) to oranges (domestic litigation in China). I am not well-versed in CIETAC’s arbitration rules, but I do know that CIETAC now allows parties to appoint non-Chinese arbitrators. That alone, I would think, must add a different level of analysis to the question of whether a foreign company is wise to pursue arbitration in an attempt to hasten settlement.

  • John —
    Thanks for checking in. Yes, on one level, comparing China’s courts to CIETAC is comparing apples to oranges, but for purposes of this discussion, it is comparing peaches to peaches (nobody is going to beat me in the use of fruit metaphors!)
    If you look at the reasons for why the Chinese do not settle, including the additional reasons given by Mr. Wang in his comments, all of them apply to the same degree (or at least close) to arbitration as well as to litigation.

  • John —
    Thanks for checking back in. You raise some really good points, each of which I will address.
    1. You are right to raise the issue of the cost of the arbitrator. I missed that and that is a factor that should “add at least a small degree of deterrence to arbitration.”
    2. I too find it “hard to believe that a Chinese company faced with the unfamiliar prospect of international arbitration would not hire legal counsel to help navigate the unfamiliar waters of international arbitration” but it is very often true. I find it hard to believe that Chinese companies come to the United States, form a new company using a sister in law or somebody like that, never file a tax return, never hire a lawyer for a contract…. but I often see that sort of thing as well.
    3. I do not think the confidential nature of the arbitration proceeding does all that much to influence the loss of face issue. It is settlement that causes the loss of face and that loss of face is presumably internal within the company and perhaps also with respect to the opposing party.

  • John Hafen

    Hey Dan, I’m glad to see the China Law Blog is going strong. I’m amazed at your ability to keep up with everything.
    At the risk of pretending to have a good understanding (I do not) of Chinese culture and Chinese legal culture in particular…I understand that all of the stated reasons apply, to some degree, to arbitration just as they do to domestic litigation. My point is that international arbitration before CIETAC brings additional considerations.
    For example, you mention that the Chinese company would likely represent themselves and not incur legal fees. However, an arbitral tribunal before CIETAC would likely be composed of three arbitrators, whose fees and reasonable expenses are paid for by the parties. So the Chinese company must include those fees and expenses in its cost benefit analysis. I would assume this would add at least a small degree of deterrence to arbitration.
    I also find it hard to believe that a Chinese company faced with the unfamiliar prospect of international arbitration would not hire legal counsel to help navigate the unfamiliar waters of international arbitration.
    Also, contrary to litigation proceedings, arbitration proceedings are generally confidential. I assume this would reduce the “loss of face” risk to some extent.
    That said, I wish I knew more about the Chinese legal culture. Their approach to business disputes sounds completely distinct from what we know in the United States.