Western companies doing business with Chinese counterparts are often nervous about how any disputes which result from their contracts will be resolved. Few have experience of the Chinese court system, and fewer still have confidence in it. Chinese parties will likely feel the same way about foreign courts, especially those in the U.S. - whose punitive damages, juries and plaintiffs' bar strike as much fear into foreign hearts as do the cost and duration of U.S. litigation.
International arbitration is designed precisely for this sort of situation, where both parties to a cross-border contract are keen to avoid playing on the other's home turf. An international arbitration typically takes place in a neutral third country, follows procedures which are broadly acceptable to both parties, and will lead to an award which is enforceable - at least in theory - in the opponent's home jurisdiction and in over 140 other countries around the world. Even if a party's negotiating leverage does not allow it to reach agreement on arbitration in a neutral locale, that party will likely be better off with arbitration in the counterparty's home nation rather than litigating in the local courts. This is certainly true, in our view, with respect to both China and the U.S.1
There is a movement today towards the worldwide harmonization of international arbitration rules and laws. This means that in many cases an arbitration clause drafted for a deal on one side of the world can be deployed without substantive change, and still be effective, in an entirely different transaction on the other side of the world. However, China's international arbitration rules and laws contain a number of features peculiar to China, which drafters of international contracts involving Chinese parties need to recognize and work around in order to achieve a suitable agreement to arbitrate. In this article, we highlight some of the pitfalls, and suggest how parties can navigate their way through them and arrive at an effective dispute resolution mechanism for China contracts.
Arbitration With Chinese Parties Outside China
Perhaps the best way for a foreign party to avoid the pitfalls of international arbitration in China is to avoid arbitration in China in the first place. The seat of arbitration ( i.e. the place where the arbitration is held from a legal perspective) is important because, in most countries at least, the arbitration laws of the seat will govern the arbitration procedure. The courts of the seat have supervisory jurisdiction over the arbitration and will enforce those laws and will also hear any action to set aside (or vacate, in U.S. parlance) the award made in the arbitration. Selecting a seat of arbitration outside China will mean that Chinese law does not govern the arbitral procedure, that the Chinese courts do not supervise the arbitration, and that Chinese courts will not be entitled to set aside any awards issued in the arbitration. As indicated earlier, it is common for parties to cross-border contracts to choose a seat of arbitration in a third, neutral country, and a non-Chinese party with leverage will frequently be able to persuade its Chinese counterparty of the merits of arbitration in a third country.
Where should parties agree to hold their arbitration, when one of them is Chinese but both agree that the seat should be outside China (and, in the name of neutrality, outside the home nation of the non-Chinese party)? Traditionally, Chinese companies contracting with Western companies would agree to arbitration held in Stockholm, Sweden, which was considered during the Cold War era to be neutral territory between East and West. More recently, Asian cities such as Hong Kong and Singapore have equipped themselves with strong arbitration infrastructure: modern international arbitration laws, strong pro-arbitration courts and reputable arbitration institutions. These two cities are also geographically and culturally close to China. For all these reasons, Chinese parties today routinely agree to Hong Kong or Singapore as the seat of their international arbitrations, and the two cities now attract many China-related arbitrations, which in earlier times would have had their seat in Stockholm. That said, Chinese parties still regularly agree to arbitration in Stockholm and other traditional seats that are further afield from China, such as Geneva, London and Paris.
Is there anything to choose between Hong Kong and Singapore as a seat of arbitration for China-related disputes? Clients ask arbitration practitioners in Asia this question day-in, day-out, and a cynic would say that the answer will depend on where the practitioner is located. This practitioner, who is based in Singapore, believes the two cities allow for equally effective arbitration of China-related disputes. However, Singapore is further from China than Hong Kong in every sense, which makes it a little less attractive for Chinese parties and a little more attractive for non-Chinese parties. Many U.S. clients, in particular, have difficulty with the notion that Hong Kong can be a neutral seat of arbitration when - despite its autonomous status and independent legal system - it is part of China.
One unusual feature of Chinese law is that it will not allow parties to agree to arbitration outside China unless the dispute is "foreign related." Where the foreign party is not incorporated in China, this is not an issue. But where the foreign party is a foreign investment vehicle incorporated and operating in China, it may be considered a domestic company for these purposes, and therefore cannot validly agree, under Chinese law, to arbitration in an offshore seat with another Chinese-incorporated company. Although Chinese law would not govern the offshore arbitration, it would be likely to prohibit enforcement in China of the resulting award. To avoid this risk, foreign-owned companies incorporated and operating in China should agree to arbitration in China with other companies, Chinese or foreign-owned, incorporated and operating in China. This may, in any event, be the preference of the "local" company, even if foreign-owned, as it will be more comfortable with arbitration in China than would be a foreign company with less experience of doing business in China.
Parties agreeing to international arbitration in their contracts should, in addition to specifying the seat of the arbitration, select a reputable arbitral institution to administer the arbitration. The alternative is unadministered, or "ad hoc," arbitration, which has little to recommend it. This is especially true in China-related disputes, as Chinese law does not recognize ad hoc arbitration, and Chinese courts may therefore be reluctant to enforce ad hoc awards made outside China (although some recent court decisions suggest otherwise). The Hong Kong International Arbitration Centre (HKIAC) and the Singapore International Arbitration Centre (SIAC) are reputable arbitration institutions that are well suited to China-related arbitrations. Other leading arbitral institutions are those of the International Chamber of Commerce (ICC), the London Court of International Arbitration (LCIA), and the Stockholm Chamber of Commerce (SCC).
The elephant in the China arbitration room is enforcement of awards in China. Suppose a non-Chinese party obtains a money award in arbitration outside China against a Chinese party, and the Chinese award debtor declines to pay the award. Unless the Chinese party has accessible assets outside China, the foreign award creditor will need to enforce the award through the Chinese courts, the avoidance of which may have been the driver for agreeing to arbitration in the first place. Although China has ratified the 1958 New York Convention, which facilitates cross-border enforcement of arbitral awards, a foreign award creditor will often find it challenging in practice to enforce an award in the Chinese courts. This may be because of weaknesses of the Chinese courts, especially outside major cities, or because award debtors in China succeed in making themselves judgment-proof with impunity.
However, the consensus among practitioners is that the enforcement environment in China has greatly improved in recent years. This is notably the result of a reporting system that requires China's highest court, the Supreme People's Court, to endorse any lower court decision not to enforce an arbitral award that is foreign related. Also, special arrangements allow for the facilitated enforcement in China of awards made in Hong Kong and Macau. Still, the situation is uncertain enough for a non-Chinese party for whom enforceability of a monetary award against a Chinese counterparty may be important to seek robust commercial protections in its contract to mitigate the enforcement risk.
Arbitration Between Foreign And Chinese Parties In China
If a non-Chinese party agrees to arbitration with a Chinese party in China, Chinese law will govern the arbitration, and Chinese courts will hear any action to set aside the resulting award. The law distinguishes between these "foreign-related" arbitrations and domestic arbitrations (where there are no foreign elements), with the courts granted greater powers to set aside and refuse to enforce domestic awards. Enforcement in China of awards issued in both forms of arbitration held in China are still exposed to the uncertainties affecting enforcement in China of awards made outside China, as described earlier.
Foreign parties should take certain precautions to cater to the particular characteristics of Chinese arbitration law and practice. The first is to agree to administered arbitration, as ad hoc arbitration is not recognized under Chinese law. The second is to select a major Chinese city as the seat of arbitration. The third is to select a Chinese arbitral institution to administer the arbitration, as it is still uncertain whether arbitral institutions based outside China, such as the HKIAC, ICC or SIAC, may validly administer arbitrations in China.
The leading Chinese arbitral institutions for international arbitration are the China International Economic and Trade Arbitration Commission ("CIETAC") and the Beijing Arbitration Commission ("BAC"). CIETAC is better known and has administered more international cases than the BAC, but the BAC is now perceived as a credible rival for the more established institution. Either institution is likely to be a respectable choice. However, a foreign party should tailor its arbitration clause to bring any CIETAC or BAC arbitration under that clause in line with standard international practice. Recommended adjustments include:
• specifying that the language of the arbitration shall be English, if the party is not comfortable with arbitration in Chinese - Chinese being the default language in CIETAC and BAC arbitrations. The foreign party should remember that even if it is comfortable with Chinese as the language of arbitration, this will limit in practice the pool of non-Chinese arbitrators and counsel. It is possible to agree to conduct arbitration in two languages ( e.g . English and Chinese), but this adds significant cost and inconvenience;
• requiring a tribunal of three arbitrators, rather than one. While this increases the cost of arbitration, it will also allow the foreign party to nominate an arbitrator (see below), giving it more confidence in the tribunal and reducing the risk of clearly incorrect decisions;
• stipulating that each party shall appoint one arbitrator, and that the parties shall appoint the chair by agreement, failing which the chairman of the institution shall appoint the chair;
• allowing parties to appoint arbitrators who are not members of the institution's panels of arbitrators (to overcome common restrictions to that effect);
• requiring the chair (or sole arbitrator) to be of a nationality other than that of the parties, as CIETAC, for example, may appoint a Chinese chair in cases where one of the parties is Chinese, and even if that Chinese party has itself appointed a Chinese arbitrator; and
• incorporating rules of evidence and procedure such as the International Bar Association's Rules on the Taking of Evidence in International Arbitration. These Rules allow, in particular, a degree of discovery and witness evidence which is unlikely to be available in most arbitrations held in China.
Arbitration Under Investment Treaties
A final note concerns the benefits offered to foreign investors by China's broad network of over 120 investment treaties. These instruments offer covered investors significant protection from mistreatment of various sorts by the state or its agencies. These treaties allow the investor to enforce these protections by suing the Chinese state in international arbitration outside China, even if the investor has no prior arbitration agreement with the state. Foreign investors may even be able to sue under these treaties if the mistreatment they have suffered is the failure by Chinese courts to enforce the investor's arbitration agreement or an arbitration award in its favor.
There is currently no investment treaty between China and the U.S., but U.S. investors may still be entitled to protection by investment treaties - including the right to start arbitration offshore - if they invest in China using subsidiaries in third countries, such as the Netherlands. However, investment treaties are a last resort, and the better course for foreign investors in China is to do their homework before entering into their contracts, and to draft an arbitration clause specifically tailored for maximum effectiveness in the Chinese arbitration environment.
Published December 6, 2010.
