We continue to see contracts rendered unenforceable because the American or European party seeks to avoid application of Chinese law and enforcement in Chinese courts. By their own actions the foreign party guarantees the contract it drafted will be of absolutely no value to them. This is what is called “to be hoisted with one’s own petard.” (Hamlet Act III, Scene 4,).

Making Hong Kong your jurisdiction in your contract with a PRC company is a really big mistake that cannot be erased
Making Hong Kong your jurisdiction in contracts with PRC companies is a really big mistake that cannot be erased.

Consider a contract between a U.S. technology company and its PRC licensee. 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 reverse: 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 agrees and the contract is signed.

Why did the Chinese side agree? It is because the Chinese side knows that under this “compromise” it 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. The Chinese company is amused. I know this from my Chinese lawyer friends.

Of course, there is the 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. It comes as a surprise to many in the U.S. 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 China has no connection to Hong Kong. It is therefore entirely possible the Hong Kong court will refuse to further crowd its docket and will refuse to hear the case.

For purposes of this post, however, we will make a leap of faith and assume the Hong Kong court hears the case and renders a judgment. Consider what happens. If the plaintiff is the Chinese company, then the judgment against the U.S. defendant is easily enforceable in the U.S. 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 that they would do so in this situation as well.

If the plaintiff is the U.S. company seeking to enforce in the PRC, the situation is quite different. On the surface, it appears enforcement of the judgment should not be an issue. In 2008, China and Hong Kong entered into a reciprocal enforcement agreement. Thus, in accordance with law, judgments from Hong Kong courts should be enforceable in China. However, the fact is that Chinese courts simply ignore this statute and they do not enforce Hong Kong judgments. I am aware of only one case where such enforcement was successful. In every other case of which I am aware, enforcement did not succeed. This is the same result as for arbitration. China is a signatory to the New York convention on the enforcement of arbitral awards, but Chinese courts regularly fail to enforce such awards.

Chinese courts avoid enforcement in two ways. The most common way is they simply refuse to act. They do not openly reject the demand for enforcement. They 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 the foreign award was based on grounds that violate of 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. The following are the most common public policy grounds Chinese courts use to reject enforcement:

a. Often, the Chinese party does not appear in the foreign 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 nearly zero. Knowing this, Chinese lawyers typically instruct their Chinese clients not to appear when sued in Hong Kong.

b. 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 chose a law with no connection to the underlying transaction, Chinese courts typically deem this to violate public policy.

But like I said, the Chinese courts oftentimes do not even rule in these cases; they simply let them sit until they die out, using one or both of the above reasons to justify their doing nothing to enforce. Whether the Court issues a written ruling or simply does nothing, the effect is the same: no action taken and no enforcement of the judgment.

I cannot emphasize enough how harmful using Hong Kong in this sort of situation can be for the U.S. company. The U.S. company 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. 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, when it finally receives its judgment, the U.S. company learns the hard way that this 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 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.

A very sad result, all because the U.S. company would not face the simple truth of what is required for enforcement of a judgment in China. It is not a pleasant thought to consider enforcing a judgment in China against a Chinese company. But dreaming about an alternative that makes matters worse is not a solution. Facing the facts and designing a practical plan is the solution.