by Alexandra Damsker

As we discussed in our last entry, arbitration is gaining steam as a method of dispute resolution in both the PRC and Hong Kong. As a refresher, arbitration is legally binding, and comes in two (or three) basic "flavors" in the PRC. First are local PRC disputes, which go through either the China International Economic and Trade Arbitration Commission and China Maritime Arbitration Commission. Second are international disputes, which generally - but not always - includes US companies (see the final paragraph for this warning). International disputes can be broken down further into disputes regarding "foreign awards" (from a non-Chinese arbitration institute), and those regarding "foreign-related awards" (from a domestic arbitration body involving a foreign party). The distinction between "foreign" and "foreign-related" will be seen in the section regarding enforcement.

In any event, parties with international disputes relating to the PRC generally choose to arbitrate in Hong Kong. Hong Kong has a long and well-established legal history, particularly with international disputes (especially with those involving Western nations) and is easier to predict in many ways than PRC outcomes. Also, unlike the PRC, but similar to the US, Hong Kong is subject to principles of common law. Accordingly, along with Singapore, Hong Kong is the main venue of arbitration in the region. The primary arbitration center is the Hong Kong International Arbitration Center (HKIAC), which increased the number of disputed resolved 35% in 2008 over 2007 (compared to 14%increase in 2007 over 2006). As noted previously, the increase is likely due, in part, to the declining economy, as the decreased cost and increased speed both serve to facilitate the speed and profitability of business.

Hong Kong announced in February of this year that it expected to create a single regime for international and local arbitration, based on the UN Commission on International Trade Law Standards (UNCITRAL), without rewriting them. (Interestingly, if both parties are PRC citizens, the arbitration is considered "international" in Hong Kong, just as the Hong Kong arbitration ruling is considered "international" by the PRC government for the purposes of enforcement, discussed below). The use of UNCITRAL is being interpreted as permitting the use of UNCITRAL interpretation for interpretation of the new Hong Kong ordinance, bringing new clarity to arbitration proceedings (and, presumably, negotiations prior to arbitration), filling gaps in Hong Kongʼs court system. The ordinance will also contain limits on court redress of arbitral awards.

Arbitration procedures are gaining popularity among unlikely followers. For example, arbitration tends to typically be less attractive to financial institutions for both the tendency to "split the baby" and their lack of summary judgment. However, the HKIAC recently announced that it is resolving investor disputes related to sales of US $2.03billion in financial products (mostly mini-bonds) associated with Lehman Brothers (see http://www.asialaw.com/Article/2068790/Search/Results/A-new-solution.html?Keywords=Civil+Justice+Reforms) - yet another signal in arbitrationʼs new popularity.

In addition, on April 30, a key case, A v. R, was resolved in Hong Kongʼs High Court, further enforcing the finality of arbitration decisions and encouraging enforcement of the award payment. In that case, the court concluded that mounting an unfounded challenge to an arbitration award fails to comply with a partyʼs obligation to further the objectives of the Civil Justice Reforms (introduced April 2, 2009), particularly the duty to assist the court in the just and efficient resolution of a dispute. Further, and most importantly - it added indemnity costs, considering heavier than usual costs fair, adding further penalty to those wishing to challenge arbitral awards in Hong Kong.

But how enforceable are the judgments reached in these proceedings? Sonia Chan writes an excellent article for AsiaLaw.com regarding the enforceability of arbitration proceedings, http://www.asialaw.com/Article/2023082/Search/Results/Protectionism-is-stifling-Chinese-arbitral-awards.html?Keywords=Arbitral%2bawards, which is briefly summarized (in conjunction with additional research): Basically, unless your defendant is in Beijing, Shanghai or Guangzhou - it can be tough, but it’s getting somewhat easier.

The tools are all there: The PRCʼs Civil Procedure Law of 2007 lays out the basic principles of recognition and enforcement of foreign arbitral awards, which includes both institutional and ad hoc (proceedings conducted by someone other than an "arbitral institution") arbitration proceedings conducted in Hong Kong, both of which are recognized in the PRC. It also lays out a two year time limit for enforcement (an improvement over the previous law’s one year limit), which helps creditors.

However, arbitral awards cannot be enforced unless they have been recognized by the local PRC courts as being enforceable, and local protectionism has been a problem. Although, in 1995, the PRC Supreme Court declared its solitary supremacy in its right to refuse to recognize both foreign awards (from a non-Chinese arbitration institute) and foreign-related awards (from a domestic arbitration body involving a foreign party), that hasn’t solved the problem. There is no time limit on the Supreme Court’s decision, so getting through the procedural red tape can drag on for years - which can also be due to some local protectionism. Enforcement is further hampered by Chinese interest, local or otherwise, in the defendant - and, as anywhere, whether or not the defendant is even solvent.

Finally, it is important to note that domestic arbitral awards may not be enforceable at all! Unlike foreign and foreign-related arbitral awards, Chinese courts can review the arbitration tribunal’s findings of both fact and law. The mere fact that one party is a wholly foreign-owned entity will not normally render the award foreign or foreign-related. So the winning party in arbitration may be pronounced the loser by the court. Consider this when considering domestic arbitration - you may end up in litigation anyway...

Is arbitration the answer? Perhaps - it depends on where you and your partners are located, the interests the PRC has in your and your partners’ business, and the solvency of your partners’ business should the situation decline. Once again, this cannot be overstated: CONSULT YOUR ATTORNEYS. THIS SHOULD BE CONSIDERED BEFORE A MATERIAL BREACH OCCURS. Once disaster strikes, these questions can certainly be revisited, but you are never stronger in negotiating that when you are still at the contracting stage, particularly as the mood is still congenial and terms are much easier to set. An ounce of prevention is worth ten pounds of cure when it comes to dispute resolution mechanics. At the USA China Law Group sound prevention is sound business - please feel free to contact us.

Wishing you good counsel - and good health!

LITIGATORS AND MEDIATORS AND ARBITRATORS - OH, MY!

by Alexandra Damsker

You are coasting along, manufacturing products in China, beginning product development there, as well as opening up your European and Asian markets when - something goes disastrously awry. Despite the best of intentions between you and your Chinese suppliers, a shipment is missed, a major contract term goes unfulfilled, and negotiations are getting you nowhere. “But I have a contract!” you say? As our friends at www.chinalawblog.com have explained so well, Chinese contract law is far from clear(see, for example, http://www.chinalawblog.com/2009/06/china_gets_all_new_on_contract.html, discussing the Explanations of Contract Law released by the PRC Supreme Court, effective May 13, 2009).

What are your options? Well, as in the US, you have the courts, mediation, and arbitration.

The benefit of the court system is that all decisions, including mediation and arbitration,are subject to the ruling of the courts. In that respect, if you start with the courts, youare more likely to get a final ruling. However, as Chinese law is based on Civil Law rather than common law, there is no system of stare decisis (“like cases are determined alike”)-therefore, there is little to no predictability in ruling. Determinations can only besurmised by hints from the Supreme Court, and most would wish just a bit more to on which to base the outcome of their business. Without the principle of predictability to buoy up one sideʼs argument - and thus speed up negotiations and settlement – the odds that a dispute will end up in the fickle and byzantine Chinese court system is discouragingly high.

Mediation is an alternative, and may work better for those who merely need assistance negotiating the relationship or one or two issues. As a less adversarial and often cheaper process, disputes can be resolved quicker and with relationships more likely to remain intact. However, mediations are non-binding, and issues may end up in the courts and/or arbitration in the end - with additional costs, delay, and possible antagonism. If, however, you merely require “lubrication” in your relationship to restart your negotiations, “conciliation centers,” as they are know, are not uncommon, and your legal counsel can refer you to a good source of knowledgeable, independent mediators.

Arbitration, on the other hand, is legally binding, and is gaining prestige and steam in both the PRC and Hong Kong. Local disputes in the PRC usually go through the China International Economic and Trade Arbitration Commission and China Maritime Arbitration Commission. However, most disputes with any international aspect, including those involving US companies, go through Hong Kong which, unlike the PRC, is subject to principles of common law, and, along with Singapore, is the main venue of arbitration in the region. The primary arbitration center is the Hong Kong International Arbitration Center (HKIAC), which announced that it resolved 605 disputes in 2008,compared to 448 in 2007 and 394 in 2006. The increase is no doubt due, in part, to the declining economy, as the decreased cost and increased speed both serve to facilitate the speed and profitability of business. Arbitration is expanding as a method of dispute resolution, and will be discussed further in our next blog entry.

So, what to do? Regardless of which path you choose - make sure you clearly indicate your chosen venue (litigation, mediation, arbitration) and body IN YOUR CONTRACTS. This cannot be overstated - an ounce of forethought will keep you from pounds of medication for your ulcers and heart...and isn’t that what good lawyers are for? Good health comes with good counsel - so keep your counsel informed of events in your company, and let them protect you. The attorneys at the USA China Law Group have years of experience in keeping you protected, so contact us at your earliest opportunity.

You’ve gone through a thorough analysis to determine that outsourcing works for you, and China is the place to go (our team can help you out with this). Now you need to know how to get started - and, unlike many of our blogging friends, we’ll just put this up front. You need really good business and legal advice for this. China’s economic and legal dealings have changed a great deal in the past year, and you don’t want to leave your company’s future at risk because you didn’t plan well enough. So, what’s in the plan? There are five main issues to consider.

First, how much work are you going to do in China?

Second, if you are farming out cost-heavy functions, such as manufacturing (as many are), are you able to get financing? According to David Drayton, author of the wonderful Silk Road International blog (Steps for Effective Sourcing) and this excellent article on Chinese outsourcing, (New Opportunities) financing is a hit-or-miss enterprise these days.

Technically insolvent Chinese banks are cash-rich due to government funded injections, and they’re loaning out money like your favorite grandmother,yet they seem to be targeted towards specific industries, such as technology, education, logistics, green tech, health care, infrastructure, and transportation. In addition to these sectors, local governments and connected entities are getting cash. It may be difficult for an unconnected factory to get access to those funds. Factoring is an option in the short term, but long term will eat away your profits. Otherwise, China is littered with unused inventory, cancelled product and cheap labor. Cash flow, orders, deposits, guarantees and creativity in your terms will get you far. And understand their wariness - foreign cancellations completely changed the industry, so they are a bit more circumspect on foreign orders. Whatever you do, make sure you’re steering clear of the Foreign Corrupt Practices Act - Asia tends to be a red flag for this law. More on the FCPA can be found here: at the Justice Department's official web site.

Third, are you protecting your intellectual property? We can’t emphasize enough good use of counsel familiar with Chinese courts on this one. The intricacies of the Chinese legal system moves us on to our next point.

Fourth, have you considered product liability issues? In addition to US liability issues, China doesn’t have a network of national insurance providers for product liability, and factories end up going bankrupt in the wake of liability issues (e.g., the Sanlu milk issue). The ongoing Epic Kayak case will give us a glimpse of the Chinese court position on outsourced product liability - look for US product liability insurers to keep a close eye on the outcome of this case, too. You may also want to consider a product test service to keep quality assurance as high as possible.

Finally, you’ll want a local agent to oversee the process and provide onsite troubleshooting. Our affiliate attorneys in the USA China Law Group have offices in Hong Kong, Guangzhou, Shanghai, Beijing and Nanjing.

The engine of China is huge, and you may be able to harness China’s energy to power your company’s bottom line, thriving in the midst of recession. But failing to plan is planning to fail - so be smart and plan wisely!