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China Contracts: Your Dispute Resolution Clause
More lawyers are catching on to this and we are seeing fewer contracts that call for US court jurisdiction. But we are now starting to see contracts that are getting too specific about the Chinese court in which disputes will be resolved.
And that itself can be problematic.
The reason for our concern about overly specific Chinese court jurisdiction provisions is that the Chinese courts tend to ignore any attempt by contracting parties to dictate where a matter will be litigated. Instead, Chinese courts typically determine the proper jurisdiction for a dispute based on the nature of the claim, the amount of the claim, the location of the parties, and the location of the witnesses to the dispute.
If your choice of Chinese court jurisdiction is wrong, the Chinese court will — at best — ignore it. But at worst, your mistake could raise questions about the validity of Chinese Court jurisdiction or create other confusions. The whole reason for putting in a dispute resolution clause is to avoid the expense, the time, and the uncertainty of where and how to resolve any disputes. There is therefore no reason to add language that appears to increase certainty, but which in practice will have exactly the opposite effect.
For more on positioning yourself to be able to collect from a Chinese company in litigation/arbitration, check out the following:
- How To Sue A Chinese Company. Part I. Jurisdiction And Service Of Process
- How To Sue A Chinese Company. Part II. Discovery
- How To Sue A Chinese Company. Part III. Litigation Strategies And Enforcing Judgments
- How To Sue A Chinese Company. Part IV. Arbitration In The U.S. And Suing In China
- Taking Judgments To China (And Korea), Let’s Not Sue Twice
- Why Suing Chinese Companies In The US Is Usually A Waste Of Time
When my firm’s China lawyers draft a contract concerning China, we nearly always use a simple and clear dispute resolution provision:
- The contract is governed by Chinese law.
- Chinese language controls.
- Disputes will be resolved in China.
On the third point, we work with our client to choose either litigation in the PRC courts or arbitration in China. We point out that the client must pick one method: litigation or arbitration, but not both. What is known in logic as the exclusive or.
In discussing the dispute resolution clause, clients often propose a flexible dispute resolution provision such as the following:
- Plaintiff has the option to choose arbitration or litigation. Once plaintiff chooses, defendant must comply.
- Litigation or arbitration will occur in defendant’s home location; the Chinese party must be sued in China and the U.S. party must be sued in the United States.
In the 80s and 90s, most U.S. entities were reluctant to allow themselves to be sued in China. As a result, many contracts from that era included such “flexible” dispute resolution provisions. However, with the growth of sophisticated court litigation and arbitration in China in the post 2000 era, it quickly became clear that such a flexible approach is a mistake. In many cases, U.S. parties using such provisions have found themselves with no remedy of any kind. In other cases, working through the issues has resulted in substantial delay.
It is for these reasons that we write our China contracts to provide for one (and only one) method of dispute resolution and one forum for that process. We reject flexibility in favor of certainty. When the time to pursue dispute resolution arises, we want to be able to move quickly and decisively. In addition, during contract negotiation we do not want to waste time on these issues when the legal and practical best practice is already clear.
PRC Arbitration Law requires that the agreement to arbitrate must include, among other things, the parties’ intent to arbitrate and the arbitration institution where they will arbitrate. A dispute resolution provision is likely to be viewed as invalid if it lacks either of the above. If the dispute resolution provision gives the plaintiff a choice of the dispute resolution method, there is substantial risk that the provision will be held to be fatally vague. For example, pursuant to Article 7 of the Interpretation of the Supreme People’s Court Concerning Several Issues on the Application of the PRC Arbitration Law (最高人民法院关于适用《中华人民共和国仲裁法》若干问题的解释), an optional provision like this will mean that the agreement to arbitrate is invalid.(第七条当事人约定争议可以向仲裁机构申请仲裁也可以向人民法院起诉的，仲裁协议无效).
Of course, this rule only comes into effect if the respondent objects. If a party submits an application with the arbitration institution to arbitrate the matter, and the respondent does not object before the first arbitration hearing, then the arbitration may proceed. (第七条但一方向仲裁机构申请仲裁，另一方未在仲裁法第二十条第二款规定期间内提出异议的除外) This may not happen often in the real world. Chinese lawyers are masters of delay. Once the defendant/respondent has lawyered up, it become almost a certainty that it will object to arbitration on the grounds that the arbitration agreement is invalid.
In the early 2000 era, this result often meant that the plaintiff was simply denied a remedy. The situation in this regard has improved. Most recently, PRC courts have taken the reasonable position that even though the arbitration agreement is considered invalid, the plaintiff will still have access to the court. However, this result comes after substantial delay, which places the plaintiff in a weak position at the start of litigation.
Given this result, most experienced Chinese litigators agree with our position that a flexible dispute provision like this is almost meaningless because the very reason to have a dispute resolution provision is to clarify what will happen should any dispute arise. Choosing a dispute resolution provision that is not clear defeats the purpose of drafting such a provision.
The approach that provides that the place of dispute resolution as the location of the defendant is legal and enforceable in both China and the U.S, but it is impractical. The first issue concerns governing law and language. It is not very practical to litigate a Chinese language/Chinese law contract in a U.S. court. Chinese parties have become quite sophisticated and they are aware of this issue. For this reason, Chinese parties typically refuse to accept such a provision which then results in a lot of fruitless and costly discussion over a provision that made no practical sense from the beginning.
We also do not like the provision that prohibits an actual lawsuit unless and until the parties have spent 30 days “amicably” trying to resolve their dispute and then mediated their dispute. Nine times out of ten this sort of provision only drives up costs and increases delay. If your Chinese counter-party has breached your contract with it, do you really want to be required to have to spend 30 days trying to work it out and then another 6-8 months seeking agreement by mediation? No, you don’t, especially since you can always propose such actions after the breach in the rare case that it would make sense for you to do so.
CIETAC Arbitrations: U.S. Companies Can Win
You have to be smarter: If you’re doing business in a place that is perceived as being corrupt, have disputes decided somewhere else. Specify that the law of some other country governs your contract (so long as local law permits this). Provide that your arbitration hearing will be conducted somewhere outside of the corrupt place, which will give you a shot at a fair hearing. Specify, if you can, that the arbiters cannot be residents of the corrupt country. If you’re going to permit an appeal, specify the fair, trustworthy tribunal to which the appeal must be taken — not a court in the corrupt country. In short, get out of Dodge.
It is far more complicated than that, as shown by the following examples:
- Does it really make sense to apply United States law to a shareholder dispute involving a Chinese company? I am not even sure what a case like that would look like. What if it involved a type of share that does not even exist under U.S. law?
- What if your contract is to have pharmaceuticals manufactured to Chinese FDA standards? Would it really make sense to litigate that issue in the United States without any of the arbitrators being residents from China?
- What if your Chinese product distribution company keeps distributing your product in China after you want that to cease? Do you really think a US-based arbitration panel will be well-positioned to stop that?
- What if a Chinese licensee of your trademark refuses to stop using your trademark in China after the contract period has expired? Do you really think a US-based arbitration panel will be well-positioned to stop that?
- What if the company is in a country that does not enforce US (or other foreign) arbitration awards? Does it really make sense to call for US arbitration in your contract when whatever arbitration award you receive will not be enforced against the company with which you are doing business in what may be the only country in which that company has any assets? I cannot resist noting that of the five countries the post highlights for their corruption (Cambodia, Zimbabwe, Myanmar, North Korea and Somalia), only two have signed on to the New York Arbitration Convention. This means that the odds are overwhelming that three of these countries would completely ignore any US arbitration ruling. Even in corrupt countries that have signed on to the New York Convention, you should find out what their record is in terms of enforcing foreign arbitration awards before deciding whether you will be better off with a foreign arbitration or not.
It took me five minutes to come up with the above and I am quite sure I could come up with countless additional examples if I had spent more time. My point is simple. There is no one best way to write a dispute resolution provision in a contract with a company in a corrupt country. The same holds true for China, where we generally look at a whole host of factors to determine what to put in our dispute resolution provisions.
We concluded our post, Arbitration In Your China Contract. Adult Supervision Required, by noting that “arbitration provisions often end up being the most important provision in your contract so give them the strategic thought and consideration they deserve.” If you want a truly in-depth analysis of when to go with foreign arbitration in your China contract, check out the following series of posts:
- Dr. Clarisse von Wunschheim On Arbitrating Your China Disputes, Part I. The Legal Context
- Dr. Clarisse von Wunschheim On Arbitrating Your China Disputes, Part II. Inside Or Outside China?
- Dr. Clarisse von Wunschheim On Arbitrating Your China Disputes, Part III. Is Enforcement Overemphasized?
Standing alone, our having done a three part series on arbitration provisions ought to tell you that there is no “always” or “one size fits all” solution to something as complicated as where to have your disputes, corrupt country or not.
Interestingly enough, China Law Insight just did a post, entitled, “Post-Award Settlement for International Arbitration,” that, among other things, nicely sets out how complicated it can be to get a foreign arbitral judgment enforced in China.
What do you think?
Got an email the other day from a very savvy client of ours for whom we are working on a China product distribution agreement. The client wanted to know whether it would make sense to have a dispute resolution provision that included an additional sentence stating that both parties agreed that the Chinese courts would be able to enforce any foreign court judgment. Client wanted to know whether we thought the Chinese courts would enforce the “agreement to enforce” portion of this.
One of our China lawyers responded as follows:
Very interesting idea, we simply do not know whether this additional language would increase the odds of a Chinese court enforcing a foreign country court judgment. On one hand, it seems like it would/should, since it is just a contract and Chinese courts generally do abide by freedom of contract by enforcing contract provisions. But I really have my doubts because the Chinese court would also likely be concerned about relinquishing some aspects of China’s sovereignty to a foreign court. There was a short period where we wrote contracts calling for arbitration in Singapore/HK/NYC of monetary disputes but litigation of IP disputes in Chinese courts. By doing this we were choosing one of the best methods for resolving monetary disputes (foreign arbitration) while also leaving it open for our clients to be able to stop IP infringement via the Chinese courts — usually the best method for stopping China IP infringement as quickly as possible. But we started hearing about and reading Chinese cases where Chinese courts were rejecting such dual-venue provisions and just ruling that everything needed to be arbitrated. Chinese courts are not terribly flexible.
The other concern I have about your contracts is that one of the main reasons to have a Chinese court be the venue for disputes is to be able to stop the Chinese company from using your IP. When drafting our contracts, we typically try to figure out the worst thing that can happen to our client and then figure out the best place to deal with that worst thing. Most of the time, the worst thing that can happen to our clients is the Chinese company running away with our client’s IP, in which case a China court is almost always the best place to deal with it. If you have a liquidated damages provision in your China contract, you can effect a pre-judgment seizure of the Chinese company’s assets relatively quickly and easily and that tends to almost instantly get Chinese companies to stop messing with someone else’s IP.
So though I find your idea interesting, I have my doubts as to its overall efficacy. Let’s talk more about your goals and your concerns on this particular contract and then we will talk more about the venue specifics that will make sense for it.
We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.
Source: http://www.chinalawblog.com/2016/12/china-contracts-your-dispute-resolution-clause.html
