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Posts from blogs about Law in China

• Must Read of the Month: Subject of the Emperor Filed Enhanced Nutcracker Patent in U.S. and Canada
• Toyota on a Chain: Creatively Challenged Art or Parody?
• Microsoft Applies Doctrine of Landlord Liability To Software Piracy
• Dr. Clarisse von Wunschheim On Arbitrating Your China Disputes, Part II. Inside Or Outside China?

  This is part II of Dr. Clarisse von Wunschheim’s series of guest posts on China arbitration. I asked to write this series because arbitration is of such crucial importance to so many China transactions and she literally wrote the book on China arbitration: Enforcement of Commercial Arbitral Awards in China.

  More from Dr. Von Wunschheim:

  PART 2:         Pros & Cons of Arbitration Inside and Outside China

  In my previous post, I tried to establish that though the question of whether to arbitrate in or outside China may seem to be primarily relevant for so-called ‘foreign-related’ contracts, it actually concerns all kinds of China-related contracts.  Today’s post aims to determine the main pros and cons of each option, as well as the current trends which they give rise to.

  Referring to the arguments most often invoked by the supporters of each option, the main pros and cons can be summarized as follows:

  ARBITRATION OUTSIDE CHINA
  PROs	CONs
  -         Neutrality of the forum, and thereby better assurance of independence of the arbitrators and the arbitration institutions -         Higher level of professionalism, ethical standards and competence of international arbitrators -         Increased flexibility and party autonomy, especially with regard to (i) choice of the arbitrators and (ii) conduct of the proceedings	-         Expensive -         Slow -         Complicated -         Lack of availability of interim measures for protection -         Difficult enforcement of foreign awards in China -         Western Bias against Chinese companies

   

  ARBITRATION IN CHINA
  PROs	CONs
  -         Faster -         Cheaper -         Some availability of interim measures for protection -         Easier enforcement	-         Lack of independence of the arbitrators and/or the arbitration institution -         Limited party autonomy regarding selection of arbitrators and design of the arbitration proceedings -         Lack of professionalism among arbitrators -         Restrictions regarding representation by foreign lawyers -         Lower ethical standards of lawyers and arbitrators -         Complicated

  Though the above lists give a good overview of the most common ‘selling points’ of each option, they do not distinguish:

  (i)            the weight of each individual pro or con compared to the others;

  (ii)          what makes the difference at the end of the day, the pros of the chosen option or the cons of the opposite option.

  With regard to the individual weight of each pro or con, this can be quite different if looking at the problem from the perspective of a Chinese company/lawyer or from the perspective of the foreign company/lawyer.

  • With regard to the position of Chinese lawyers/companies, most of them seem to favor arbitration in China for the following main reasons:
    • They believe arbitration outside China is too expensive, takes too much time and is too complicated;
    • They believe Western arbitrators and arbitration institutions are biased against Chinese companies;
    • The Chinese arbitration system works just fine.

  While there is merit in some of these arguments, I also think that they are partly misplaced:

  -            Regarding the costs: There is no doubt that arbitration according to international standards and with the involvement of international specialists is generally more expensive than arbitration in China under a local arbitration commission and with local experts. However, there is a reason why, and the list of pros and cons listed above already gives a hint of these reasons. In addition, many companies and especially Chinese companies, misperceive the real cost items and ignore that there are ways to control and limit these costs. They often believe that the main cost item are the fees of the arbitrators and arbitration institution, while it is actually the lawyers’ fees (which are estimated to represent over 80% of the total costs related to an arbitration). They will also often tell you that prices in Geneva, London or Stockholm are far too expensive and they can’t afford to travel there. This argument ignores that the place of hearings does not need to be at the place of arbitration (actually a lot of lawyers ignore that too…). The place of arbitration is a virtual place determining the applicable legal framework to the arbitration, and while they may need to hire lawyers from that region, parties do not need to go there. Hearings can be held in Hong Kong, or even somewhere in China, while the place of arbitration can be anywhere outside China. 

  -            Regarding the time: It is also true that the deadlines provided in Chinese arbitration rules are usually shorter than in international arbitration rules, and that arbitration proceedings in China usually take less time than in international arbitration proceedings. However, firstly, while speed is good, it is rarely a virtue per se. If it is at the expense of quality it is useless, and even detrimental given the final and binding character of the award. Secondly, let’s not forget that in international arbitrations the parties are the masters of the proceedings, and therefore also of the timeline. In many cases, the problem does not lie with the arbitrators or the rules, but with the parties and their counsel. As busy as famous arbitrators may be, the same is true for high profile arbitration counsel… Here again, there are ways to control this issue, by choosing appropriate arbitrators and counsel. Many arbitration institutions now also provide for fast-track arbitration proceedings.

  -            Regarding the argument of ‘complicated’ proceedings, I believe this argument confuses ‘complication’ and flexibility. Chinese arbitration does not provide lawyers and parties with a lot of autonomy, and most things are decided by the arbitrators in a fairly expedited manner. Thus, when Chinese companies and lawyers are involved in international arbitrations, they do not know how to deal with the autonomy given to them and they see that as being ‘complicated’. Due to their lack of exposure to arbitration abroad, many Chinese companies and lawyers do not feel confident in their ability to efficiently conduct such proceedings. And, let’s be honest, no one likes to have to get external help…

  -            Regarding the argument of bias against Chinese companies, I believe it is closely linked to the previous argument. It is normal that Chinese parties feel safer at home, the same is true for any party from anywhere. However, this concern has recently been alimented by a survey from CIETAC according to which Chinese companies involved in arbitrations abroad lost in 9 out of 10 cases. Unfortunately, only the result of this survey was published without any information on the reasons for the loss or the methodology or scope of the survey. Thus, while some believe that this survey confirms Western arbitration is tainted by a general bias against China, others (myself included) prefer to explain the figure of 9/10 losses (if at all representative - I am still skeptical about this figure) with the lack of experience and familiarity of Chinese lawyers and companies with international arbitration, which leads them to make the wrong choices. Also, let’s remember that splitting the world into the West vs. China does not really reflect the current world map, be it in terms of geography, economic interests, culture or political power…

  In summary, I believe most concerns of Chinese companies and lawyers arise from misperceptions concerning the real functioning of international arbitration. This is understandable to the extent that, except for a handful of mostly big Chinese law firms and their clients, most Chinese lawyers and companies have not yet been exposed to international arbitration.

  However, I should also stress that I have noticed in recent years an increased willingness of Chinese companies and lawyers to arbitrate their dispute outside of China, though they often insist on places such as Singapore or Hong Kong. Chinese parties choose these venues because they feel culturally close to them and believe that the risk of a bias against them is limited. From an outsider’s perspective, since these regions having both adopted the UNCITRAL Model Law on International Commercial Arbitration, they are attractive options compared to arbitration in China. However, what the parties often do not realize is that these jurisdictions have common law legal systems, which means that the way that lawyers work and the manner in which the case will be pleaded may be very unfamiliar to them and different from the spirit in which their contracts were drafted. I am thus not sure that this is necessarily the best way to go for Chinese parties, and in particular I am not sure it will help them feel more confident with international arbitration.

  • With regard to the position of foreign lawyers/companies, there is no unanimity and the two schools of thought find supporters. With regard to each of these options, the most common arguments I hear are the following:
    • From supporters of ‘Arbitration outside China’: Arbitration in China is unpredictable. Arbitrators have too much power and the risk of lack of independence and impartiality reduces the chances of fair proceedings;
    • From supporters of ‘Arbitration in China’: Arbitration outside China is not always efficient. After all, winning the arbitration is only half the battle, and enforcing foreign awards in China is more difficult than enforcing Chinese awards.

  Again, I remain partly unconvinced by most of these arguments for the following reasons:

  -       Regarding the argument of unpredictability of arbitration in China: I agree that arbitration in China is often unpredictable. However I am not sure whether this is really due to the alleged lack of independence and impartiality of the arbitrators or the arbitration institution, as opposed to the general unpredictability of the Chinese legal system. In addition, one cannot deny that international arbitration always shows a certain degree of unpredictability, in particular when the case involves arbitrators from different backgrounds, lawyers and parties from different backgrounds and legal cultures, various laws applicable to various aspects of the dispute, etc.  Who can honestly pretend to be able to predict the outcome?  What must be predictable is the process; arbitration must provide the guarantee of a fair process according to pre-determined rules, and this brings me to the argument of lack of independence or impartiality of the stakeholders.

  -       Regarding the argument of lack of independence and impartiality of arbitrators: I have no doubt that this argument is justified in some cases. But this is also true on the international arbitration scene. Let’s not forget that the maxim: ‘the arbitration is only as good as the arbitrator’. In other words, your arbitrator can kill your arbitration, and this is true everywhere, not just in China. While it is true that the choice of arbitrators is more limited in China due to the system of panels of arbitrators, this limitation has been widely relaxed in recent years: Firstly, the current panels of some arbitration commissions, such as BAC or CIETAC, now list many foreign candidates, and secondly, these arbitration commissions now allow the parties to choose arbitrators outside the official panels (with regard to party-appointed arbitrators). In other words, when drafting their arbitration clause, parties have sufficient room to limit risks relating to the background and personality of potential arbitrators.

  -        Regarding the argument of enforcement: This is the argument that convinces me the least.

  Firstly, why should enforcement of a Chinese arbitration award be easier than enforcement of a foreign award?  While it is true that a Chinese award does not need to be first recognized before being enforced, this recognition phase consists in the review of the existence of grounds for non-recognition/enforcement. Such a review is also applicable to Chinese awards and they are subject to a similar system, though it is not called ‘recognition’.  In addition, I am not sure that the end result of enforcement is more optimistic for Chinese awards than it is for foreign awards.  Most of the difficulties encountered in enforcement proceedings are of a practical nature (finding the defendant, locating the assets, etc.) and apply generally to both types of awards. As to local protectionism or lack of independence of the courts, it can just as easily affect a Chinese award (rendered in favor of a foreign company) as a foreign award. In addition, numbers do not seem to support the theory that Chinese awards are easier to enforce (see a survey conducted by WunschARB).

  Secondly, even if one was to assume that it is easier to enforce Chinese awards (which I do not believe), this can only be deemed an advantage if the award is the result of a fair process, which meets and corresponds to the parties’ expectations. And in this regard, in view of the cons listed above, many would say that the chances of getting a fair process is more difficult in a Chinese arbitration…

  I draw two main conclusions from the above:

  • It seems to me that what makes the difference at the end of the day is often not the pros of the option eventually selected, but rather the cons of the other option.
  • This, together with the lack of persuasiveness of many of the cons, in turn indicates that the way parties choose between arbitration inside or outside China is still largely directed by their fear and ignorance of the other system and is not made in due regard of the specific needs and possibilities of the case at hand. And this will be the topic of my next post.

   

  

  

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

  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:

  1. 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.
  2. 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.

  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.

  

  

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