By Steve Dickinson
The Chinese press has been very excited to report this week on an increase in foreign litigants making use of the Chinese courts. Under the somewhat misleading title of “Commercial disputes with foreign nation [sic] flood Chinese courts,” the reports state that the PRC Supreme People’s Court reports the following statistics:
? Through November of 2010, 13,131 cases involving foreign elements were heard by the Chinese courts. This is a 15% increase over the previous year.
? Companies from the United States were the most numerous litigants, followed by Japan, South Korea, Germany and Britain. This group accounted for 40% of the foreign related cases.
? The vast majority of cases were commercial, with only 4% of the cases concerning criminal matters.
Though 13,000 cases is hardly a “flood” of litigation, this report does show an increase in foreign acceptance and use of the Chinese legal system for resolution of commercial disputes.
Why would any foreign litigant want to make use of the Chinese courts? The most common reason is that there is often no alternative. Take a typical example. A U.S. company has a contract with a Chinese factory to manufacture a product. The Chinese manufacturer has no assets outside China and no contacts with the U.S. other than this one contract. The Chinese manufacturer delivers defective product and delivers late. The U.S. company as a result suffers substantial damage.
What legal recourse is available to the U.S. company? As a practical matter, the only recourse is litigation or arbitration in China. Why is this the case? Because if the U.S. company sues the Chinese company in the U.S. and wins, its judgment will be worthless because Chinese courts will not enforce it. Say the U.S. company thought ahead and provided for arbitration in China. China is a signatory to the New York Convention on the enforcement of arbitral awards. China should therefore enforce an arbitration award in favor of the U.S. company. Right? Not necessarily. China is one of a group of Asian countries (including Indonesia and Thailand) that do not have a very good record of enforcing foreign arbitration awards. In particular, Chinese courts rarely enforce foreign default arbitration awards obtained when the Chinese company fails to show up to contest the arbitration. This means that all the Chinese company has to do is refuse to participate in the U.S. arbitration and it will probably never need to pay on the default award.
All of this means that in the situation I described above, the best and perhaps only recourse will be to pursue legal action in China. Note that concerns about fairness of Chinese courts and arbitration panels are simply irrelevant in this situation. A legal action in China is the only course of action. So the rational foreign business will work to ensure that it makes the best possible use of the Chinese legal system to maximize their prospects of success. Our firm (always working in tandem with licensed Chinese lawyers/litigators have had excellent success pursuing litigation in China when the foreign company we are representing has used a contract that well-prepared it for a China lawsuit. ??
The most common mistake we see by foreign companies is using a contract that is not enforceable in China. By doing this, they ensure the contract is not enforceable anywhere in the world. How does this happen? They do this by writing a contract with these features:
? The contract is governed by U.S. law.
? The exclusive forum for dispute resolution is litigation in a U.S. court.
? The language of the contract is English.
Foreign companies are frequently quite proud that they have “forced” the Chinese side of the contract to accept these onerous terms. Apparently they think the terms protect the foreign side because it forces the Chinese side to file a lawsuit outside of China and subjects them to foreign law and procedure. However, this is an illusion. How many times does a Chinese manufacturer file a law suit? The party that will normally want to file a law suit is the buyer of the product, not the seller.?
The Chinese side is usually happy to sign a agreement with these dispute resolution terms because it fully understands 1) that if it wants to sue the foreign company, it will need to sue it in their home (foreign) country since very few countries enforce Chinese judgments and 2) it also knows that it will have now ensured that it is nearly free of any risk that an enforceable judgment will be entered against it. In other words, the Chinese company knows that it has just been "forced” by the foreign side to execute an unenforceable contract. Since the terms of the contract cannot be enforced, the Chinese side can then be quite relaxed about the contract terms.
Why does this happen? The reason is that at the start of litigation, a Chinese court will first look at the dispute resolution provisions of the contract. If the contract provides for dispute resolution (litigation or arbitration) outside of China, the court will refuse to hear the case. There are no exceptions to this. With respect to arbitration, as with most countries, Chinese courts will only allow arbitration in China if there is an explicit, exclusive China arbitration provision. A common trap is a contract that provides for an alternative of litigation outside of China or arbitration inside China. In that case, the Chinese courts have traditionally refused to honor a Chinese arbitration award because the arbitration provision is not exclusive.
It is therefore critical for every company that does business in China to ask a fundamental question: if there is a dispute under this agreement, am I most likely to be a plaintiff or a defendant. If your company will be a plaintiff, then you must ensure that your contract is fully enforceable in China. It is a complete disaster to close the door to the Chinese litigation and arbitration by insisting on litigation outside of China. The next step is then to draft your contract to maximize the chance that you will get a good result in China.
Even though this all seems obvious, I find that almost every week I have to give a potential client the bad news that their contract is unenforceable through their own efforts. When I get a call from a client who wants to collect on a debt or resolve a business dispute with a Chinese company, the first thing I ask about is the dispute resolution provisions in their contract. The client then emails me the contract and I discover that the contact is governed by Arizona law with exclusive jurisdiction in the Arizona courts. I then ask: does the potential defendant have any assets in the U.S. The answer to this question is nearly always "no," at which point I then have to tell them that their contract is unenforceable and they will have to consider another method for resolving their dispute. This is usually a conclusion that causes distress for the client, because this kind of provision is often included at the tail end of a long and detailed (and expensive) 50 page contract. Needless to say, it is much better to have a 7 page contract that you can enforce than a 50 page contract that is waste paper.
In a future post I will discuss the most important ways to make a commercial contract enforceable in Chinese courts under Chinese law.
In the meantime, if you wish to read more about pursuing claims against Chinese companies, check out the following:
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Did you think Avatar was going to settle for being the highest grossing movie of all time and then just fade away quietly? No way! This record-breaking juggernaut is also the most pirated film of 2010. On one hand, this makes no sense at all since Avatar seemed like the last film you would want to download, given that its visual, 3-D experience was the main selling point. On the other hand, I guess the hype behind any movie making that much money is hard to ignore, even for internet pirates. In any case, while 20th Century Fox is probably okay with this distinction since the film already killed it at the box office, a few other films on the top ten list probably aren’t so happy.