10 September 2014

Disputes in China: choice between arbitration and court can be crucial

Disputes cannot always be prevented. Contracts must therefore provide for an effective means of dispute resolution. An important consideration in that respect is the choice for arbitration or court proceedings. This is especially true in China, where a tailored approach is a must because standard clauses rarely lead to practicable solutions. In choosing a forum, foreign investors will therefore have to consider a number of important issues.

Dispute resolution is rarely a walk in the park, with many foreign investors feeling most comfortable choosing one of the various paths available in their home countries. China also offers a wide range of paths, but since these are still very much under construction, it is easy to get lost without detailed guidance. This article aims to offer some initial guidance, distinguishing between arbitration and court proceedings, both outside and within China.

When contracting with a Chinese counterparty, many foreign investors are not comfortable with selecting a Chinese forum for the resolution of any conflicts that might arise. The initial thought might be to look for a forum in the home country or on neutral ground.

  1. Court proceedings outside China

Court proceedings in the home country of a foreign investor obviously provide a home advantage. However, PRC courts only recognise foreign court judgments on the basis of a bilateral agreement with the relevant country – and there are not many. For example, China does not have agreements with the US or the Netherlands, meaning that enforcement of a court judgment from these countries in China is impossible. Court proceedings outside China can therefore only be recommended in cases where there is a bilateral agreement with the relevant country. But even then, some PRC courts have been reluctant to enforce foreign arbitration awards. Such reluctance may stem from illegitimate grounds, but they nevertheless pose an actual risk for foreign investors.

  1. Arbitration outside China

International arbitration institutes such as ICC, HKIAC and SIAC offer popular arbitration proceedings that can be tailored to all needs. As China is a signatory to the New York Arbitration Convention, PRC courts are obligated to enforce foreign arbitration awards. The only grounds for refusal are of a procedural nature. This makes arbitration outside China an interesting option for many foreign investors. However, the general reluctance of PRC courts to enforcing foreign arbitration awards is a risk here as well (in this case resulting in a mere deadlock rather than in a refusal of the arbitration award, which would require the approval of the People’s Supreme Court). Also, PRC law does not provide for the enforcement of interim measures from foreign arbitral tribunals. Arbitration outside China is therefore primarily recommended when there is a non-Chinese party involved, for example, in cases where the Hong Kong parent company of a Chinese subsidiary, and the claims are more related to compensation for damages rather than to the taking of specific actions.

An important consideration is that PRC courts generally do not recognise foreign dispute resolution regarding conflicts between two domestic parties. This includes wholly foreign-owned entities, such as wholly foreign-owned entities through which a foreign investor may operate in China. For this reason, and because of the limitations to foreign proceedings as set out above, one may want to consider a Chinese forum.

  1. Court proceedings in China

Although PRC courts are becoming increasingly professional, especially in China’s major cities, PRC courts are still generally considered unpredictable. The mandatory use of Mandarin adds an additional barrier to foreign investors. PRC courts are consequently often not the preferred route, yet they are in the best position to enforce judgments against PRC companies. This is especially true when it comes to interim measures, because the power to order interim measures under PRC law lies exclusively with the courts. PRC courts may be worth considering when the availability of quick actions is an important selection criterion.

  1. Arbitration in China

We previously reported on the developments at CIETAC, showing that the road along which arbitration in China is developing is not always a smooth one. But while the dust of that dispute is settling, PRC arbitration institutes are becoming more professional and better equipped. Various institutes offer a broad range of competent arbitrators and the possibility to have proceedings in English. Arbitration in China is considered domestic arbitration if it involves only PRC parties. A domestic award does not need to be recognised in order to be enforced. When a domestic award is challenged before the courts, however, the courts have the power to review the award on its merits. This is a major risk. Arbitration involving non-PRC parties, on the other hand, is considered foreign-related arbitration. Foreign-related awards can only be refused on the basis of procedural errors, do not require recognition from the PRC courts before they can be enforced, and provide access to interim measures. For these reasons, arbitration can be an interesting option.

After obtaining an arbitration award and, if needed, court recognition, the execution of a judgment requires the prevailing party to notify the local court of the other party’s domicile, which then has the responsibility to enforce the judgment. Such execution may be complicated by local politics, especially if it involves multiple localities as it will likely require the cooperation of multiple courts.

All in all, there is no easy route to dispute resolution in China. Our key message is that when contracting with Chinese counterparties, foreign investors should not rely on their boilerplate arbitration clauses, but should carefully consider a tailored approach.