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Before Negotiating Deals in China, Plan Carefully for Dispute Resolution

August 25, 2006

The contemplation of dispute resolution at the negotiation stage of contracting is an essential element of any good agreement between business partners. Although this axiom is obvious in the domestic context, the factors to be considered in dispute resolution planning become far more complicated when one is entering an international agreement. Distinct cultural expectations as well as different laws about dispute resolution complicate planning for potential disputes when transacting business across national borders. Because disputes can represent friction, we naturally wish to avoid thinking about such possibilities when we are in the midst of a positive and potentially fruitful negotiation. However, failure to plan for possible disputes is an invitation to frustration and failure of the relationship, especially when transacting business in countries with very different cultures and laws.

Many people are aware that Asian cultures approach business relationships differently than in the United States. Asian societies tend to avoid confrontation and do not feel comfortable with planning for disputes between business partners, much less litigation. However, this type of avoidance is usually the result of either strong pre-existing personal relationships and/or a recognition that power often resolves disputes. Most foreign parties have neither of these. Therefore, at the beginning of a business relationship with an Asian business partner it is important to recognize that planning for potential disagreements can avoid some pitfalls neither party will want if conflict arises later. Familiarity with both cultural expectations about dispute resolutions and the legal avenues for redress can avoid unnecessary confrontations and facilitate a better resolution of disputes with Chinese partners. Remember, both parties must have a common understanding of all the provisions. Make sure the contract in all its provisions has the same meaning in English and in Chinese (Mandarin).

Three Ways to Resolve Commercial Disputes in China
There are three primary ways to resolve commercial disputes in China: negotiation, arbitration, and litigation. Although these same mechanisms are common to resolution of disputes in most countries, the choice of mechanisms in China is influenced significantly by the nature of Chinese society.

  1. Negotiation is usually the best method of dispute resolution because it is less expensive, more direct, and more likely to preserve the relationship after the dispute is resolved. In China, a number of other factors also play a role in encouraging negotiation as the first and best method to use. First, unlike in the United States and other western countries (e.g. European Union states), arbitration and litigation suffer from significant disabilities. Second, preserving the business relationship between the parties is often a goal greater than the dispute. Indeed, both parties have entered a relationship that has involved extensive investments of time and money that would be far too costly to replace. Moreover, negotiation gives both parties an opportunity to “save face,” which is very important to Chinese parties and to you in the context of their society. Your ability to find substitute suppliers or buyers will be dependent upon how you operated in the context of saving face. Although saving face can take negative forms such as not “buckling under” when the foreign party makes threats, saving face can work to your benefit. Fears of losing a contract, having government officials criticize the Chinese managers and developing a reputation as unreliable puts unseen pressure on the Chinese company to work out the problems before greater disruption occurs. To avoid the personal conflicts that may arise in these situations, Chinese parties are quite amenable to clauses in the contract calling for mediation of disputes as part of the negotiation process.

  2. If negotiations reach an impasse, parties should be prepared to use arbitration. In China, arbitration offers many advantages over litigation. A major advantage is the finality of arbitration rulings. Decisions by Chinese courts are subject to appeal and consequently, litigation may continue for years. An arbitration panel can be made up of experts, and the proceedings and rules of arbitration are more transparent than litigation. Conversely, judges in China are poorly qualified and may be more likely to be influenced by local politicians and other government officials .

    New York Convention
    In 1987, China acceded to the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York Convention). Under the New York Convention, arbitral awards rendered in another signatory country must be recognizable and enforceable in China and Chinese arbitrations are enforceable in other signatory countries. Since it is rare for the parties to agree on arbitration after the dispute has arisen, the underlying contract or separate agreement must expressly provide that disputes will be resolved through arbitration. Moreover, a valid arbitration agreement must reflect a clear intent to use arbitration as the exclusive means of dispute resolution available under the contract. Failure to state that arbitration is exclusive will leave the dispute to the Chinese courts.. Because arbitration in China may be conducted only by officially recognized arbitration institutions it is best to declare in the underlying contract or separate agreement that the parties agree to use arbitration exclusively the choice of a foreign arbitral body that will supervise the arbitration in a foreign locale. Because it will be difficult to convince a Chinese party to use the United States, it is better to select a neutral site (e.g. the International Chamber of Commerce a/k/a the ICC) and arbitrators from the pre-selected group of arbitrators approved by this body.

    China International Economic and Trade Arbitration Commission
    The China International Economic and Trade Arbitration Commission (CIETAC) is the Chinese government-sponsored arbitration body. (There also are local arbitration commissions in some Chinese cities.) For many reasons it is advisable to avoid CIETAC, if possible. Although CIETAC will allow a contract between a foreign party and a domestic party to specify the nationality of some of the members of the arbitration panel, and CIETAC maintains a list of arbitrators from which parties may choose, this choice is sometimes hollow because the pay to foreign arbitrators is so low by international standards that few foreign arbitrators will participate. Where CIETAC deems the dispute a domestic one (i.e. the foreign party to the dispute is technically domestic because the foreign party has a business status in China), arbitrators must be chosen from a special list that excludes foreign arbitrators. Another concern is that procedurally CIETAC permits itself a much greater role than most international arbitration institutions that leave most procedural decisions to the arbitrators. CIETAC decides issues such as the existence and validity of an arbitration agreement and fixes the dates for hearings. In addition, the arbitrators are empowered under CIETAC rules to make an award on the basis of the “principles of fairness and reasonableness” (ex aequo et bono) in addition to the applicable facts, contractual terms and law. Such consideration of equity is usually used in international arbitration only when the parties expressly empower the arbitrators to do so. Once a domestic arbitral award is issued, securing payment is beyond the powers of the CIETAC arbitration commission. As a result, the prevailing party must apply to a court to have the award recognized and enforced. While this is the same procedure on the surface as that which is followed in other countries for recognition and enforcement, the Chinese courts are more willing to perform a review of the substantive proceedings in the domestic arbitration. (Chinese courts sometimes even perform an extensive review of “offshore” arbitrations.) Further, the problems of the Chinese courts such as local protectionism, the influence of local and national party officials, lack of professional ethics and inadequate authority to decide may complicate enforcement.

    Unfortunately, it may be difficult to convince a Chinese party to agree to offshore arbitration. In addition, there may be actual or perceived foreign travel and monetary transfer restrictions. Finally, although the offshore arbitration award may be recognized and enforced in China (it appears that China’s enforcement record is poor), the ability to take the offshore arbitration award to another country for enforcement under the New York Convention may be greatly restricted by the lack of presence and/or assets of Chinese parties in other countries.

  3. Litigation is the third way to resolve commercial disputes in China. Like Chinese citizens and companies, foreigners and companies may bring actions in the Chinese trial and appellate courts. As noted above, Chinese courts are well below the standards of developed industrial societies. Judges have minimal or no legal training, court officials are susceptible to corruption and regional and local protectionism, and concepts of professional ethics and judicial independence have little foundation in Chinese society. The independence of Chinese judges is further undermined because local governments fund the Chinese courts and judges, and judges are subject to removal by the electorate and by local officials within short time periods. Avoidance of Chinese courts is a reasonable goal.

Enlisting the Aid of the United States Department of Commerce
A last consideration is the situation where a dispute arises with the Chinese government, a Chinese state-owned enterprise or a government-subsidized project. After quietly raising the issue with the entities involved it may be appropriate to enlist the aid of the United States Department of Commerce. Because China is a member of the World Trade Organization (WTO), it has certain obligations to the other sovereign members of the WTO. Prior to beginning the negotiations with the entity involved, it is essential that you are aware of the Chinese domestic laws and international trade agreements that govern the matters in dispute. Depending on the issues in dispute, American parties may file complaints before U.S. and international trade bodies as well as U.S. courts. However, the rupture of business relations that these actions represent should be carefully considered before threatening, much less acting on them.

Preparation for dispute resolution is often seen as the caboose of the budding business relationship. However, careful dispute resolution planning can avoid conflicts, and like the caboose, keep the train of business on track when problems arise. If you have any questions or would like assistance with addressing dispute resolution in Chinese business agreements, please contact a member of our China Team.

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