Hong Kong Arbitration for Chinese Contracts: I Don’t Think So

Hong Kong ArbitrationEvery month or so, a lawyer will write me out of the blue with a “quick question” about a draft contract. Without a doubt, the most common “quick question” I (and the other China lawyers at my firm) get is asking me to “confirm” that Hong Kong arbitration would make the most sense for such and such type of contract. I usually respond to this question by explaining that for me to be able to confirm or disagree with their having chosen Hong Kong arbitration I would need to review the entire contract and know a ton more information. About half the time, the lawyer responds by asking like what? I then respond by saying that when the lawyers at my firm are trying to figure out the best venue (location) and method (arbitration versus litigation) to put into an international contract, we typically consider the following:

  1. Who the parties are.
  2. Where the parties are located.
  3. Applicable law.
  4. Contract language.
  5. The goals of the client. Money? IP protection? Something else?
  6. The likelihood that the client would breach the contract as compared to the likelihood the other side would breach the contract.
  7. The sort of disputes likely to arise.
  8. The language(s) spoken by the client and the other side
  9. The client’s wealth as compared to the wealth of the other side.
  10. The need to engage in discovery if there is a dispute.
  11. The need to bring in third parties to any dispute.
  12. The complexity/simplicity of likely disputes
  13. Appeal concerns.
  14. Confidentiality concerns.
  15. Concerns regarding speed of dispute resolution.
  16. Enforcement of judgment/award concerns.

Contracts cannot be reviewed in a vacuum.

Let me explain.

A very long time ago, a large manufacturing company client contacted me to help with an international product recall. This companies product had a faulty and potentially dangerous part that had been provided to it by one of its smaller suppliers. My first thought was that my client should seek reimbursement of the recall costs from this small supplier and its insurance company. Towards that end I asked for a copy of the supply contract as between my client and its supplier.

Unfortunately, the contract protected the small company in every respect. This surprised me because usually big companies impose its terms on their small suppliers. I explained to my contact at the company (an excellent international compliance person, but not a lawyer) why his company had allowed such an unfavorable contract to be used and now it was his turn to be surprised. He told me that his company had believed this was a really well drafted contract and they had recently stared using it with all of their new suppliers. My response was that it was one of the best drafted supply contracts I had ever seen and that was part of its problem; it had been incredibly well drafted but entirely in favor of the small supplier, not in favor of my client who was the recipient of the parts. I then asked who had drafted this contract (I was especially curious because I thought my firm had a lock on this company’s international contracts). His response was that no lawyer had drafted it; a non-lawyer high up in supply chain management had seen this contract when their largest supplier had required they sign it and he just figured it would be a really good contract because it came from XYZ company. My response was, yes, it is a great contract, but a great contract for a parts supplier, NOT for a parts recipient and when XYZ company required you sign this contract it was acting as a supplier. The client ended up paying every dollar of the recall.

What would happen if a lawyer were handed this contract for a one or two hour review from another lawyer without being provided with the context behind this contract? The lawyer would review it and say this is a great contract and I don’t see anything that needs to be changed.

Context can be equally crucial for dispute resolution clauses.

Over the years, our China attorneys have dealt with the following situations, the facts of which have been modified so as to negate any possibility of anyone recognizing the specific matter:

1. Tokyo Jurisdiction. An American company comes to us after learning that its Chinese manufacturer has started manufacturing and selling  the American company’s newest version of its core product. I read a provision in the contract to expressly state that any future iterations of the core product would belong to the Chinese company and I mention this to the potential client. The potential client then tells me that when it complained to its Chinese manufacturer about IP theft, the Chinese manufacturer cited to the same provision and said the product now belonged to them.

To make matters worse, the contract called for all disputes to be resolved in “Tokyo Superior Court.” I asked the potential client how it was decided Tokyo Superior Court would be the venue for any disputes and the potential client explained it as follows:

The Chinese company asked for disputes to be resolved by arbitration in Beijing and my lawyer said that we wouldn’t stand a chance there and so we refused. The Chinese company then proposed Singapore or Hong Kong arbitration and my lawyer countered with Tokyo Superior Court because it was the opposite [both with respect to the type of forum — arbitration versus court — and the location] of what the other side wanted.

Ugh. I then explained how no country other than China will allow for a lawsuit in its courts that has zero to do with its country and because this case would involve a US-based company going up against a China-based company on an issue with zero relevance to Japan, there is no way a Japanese court will allow itself to be a free (or nearly free) public forum for this dispute. I did not even bother to mention that there is no such thing as the Tokyo Superior Court or that even if the US company were to sue in Tokyo and get its case heard in Tokyo (which will never ever happen) and then win in Tokyo, no court in China would ever enforce the judgment because the Tokyo court never had any jurisdiction over the matter. The US company might be able to convince a Chinese court to take the case, but I doubt it, simply because China very much tends to enforce contracts no matter how silly they may be and I most Chinese courts would likely just toss the case for not having been filed in Tokyo as per the contract.

2. Toronto Jurisdiction. This is one of my favorites. I get an angry email from someone that essentially says as follows:

I read your blog regularly and carefully and you were wrong about Canada and that makes me wonder what else you have been wrong about. I read one of your posts where you talked about how you like to propose Canada for disputes because Chinese companies often will agree to that. Well the Chinese company we work with did agree to that but when it came time for us to actually sue them there, all of the Canadian lawyers told us that we couldn’t.

Future communications revealed that this company had — based on my having extolled the virtues of proposing Canada for arbitrations — believed it could list the Toronto courts as the jurisdiction for disputes between its US-based company and its Chinese counterpart. Just as would have been true in the Tokyo instance above, there is no way a Toronto court will hear a dispute between two foreign companies on a matter that has no relevance to Canada. Fortunately, the Canadian lawyers to whom this company went realized this and chose not to waste the US company’s time and money pursuing litigation in Toronto. I had to point out that we constantly emphasize that dispute resolution provisions must be fact and situation specific and that there is a big difference between what can be done in arbitration and what can be done in a foreign country’s courts. I didn’t — but I should have — pointed out the disclaimer here on our website:

The China Law Blog is for educational purposes and to give a general information and a general understanding of Chinese law. It is not intended to provide specific legal advice…. You should not use the China Law Blog as a substitute for competent legal advice from a licensed attorney.

3. Split Jurisdiction.  We get this one fairly often. The contract provides that the Chinese company must sue the United States company in a U.S. court and the U.S. company must sue the Chinese company in a Chinese court. The thinking behind this is logical but its execution is so flawed that we avoid these provisions like the plague.

These provisions initially seem to make sense because this sort of split jurisdiction appears to favor the U.S. company. If the Chinese company seeks monetary damages from the American company, it must go through the trouble of suing the American company in a U.S. court where the U.S. company will presumably get a fair trial. And on the flip side, the American company can sue the Chinese company in a Chinese court, which is (90 percent of the time, anyway) exactly where the U.S. company should want to be. For why this is the case, check out China Enforces United States Judgment: This Changes Pretty Much Nothing and China Contracts: Make Them Enforceable Or Don’t Bother.

But Chinese courts typically hold that this sort of split jurisdiction clause means there is in fact no jurisdiction in China. So if you really want jurisdiction to be in China, your agreement should be 1) be governed by Chinese law, 2) be written in Chinese and 3) provide for exclusive jurisdiction in China. This is not black letter law. This is just what actually happens on the ground in China’s courts and this is why our firm’s China attorneys provide for all three of these in all contracts where it is critical our client be able to sue in China.

But once again there is no clear answer as to what might be best for any given company’s specific situation. To properly evaluate whether you go with Chinese law in a Chinese Court (which is what we usually end up choosing to do), you need to consider your most important concerns. Is it more important you have an effective remedy against the Chinese company with which you are contracting or is it more important you make it as difficult as possible for the Chinese side to sue you? If your primary goal is to be able to enforce the contract against a Chinese company, you usually will want to provide for exclusive jurisdiction in China with Chinese law applying and the contract being in Chinese. But if your primary goal is to prevent the Chinese side from suing you, you should consider providing for exclusive jurisdiction in the United States. But if you do this, you must realize that because China does not enforce U.S. judgments, you may never be able to enforce it against your Chinese counter-party. It is these preferences that should help you decide the best jurisdiction provision for your contract. In any event, the split jurisdiction approach generally does not work.

4. Geneva Chamber of Commerce Arbitration. A very good client of ours came to one of our international litigators with a contract calling for arbitration before the “Arbitration Institute of the Geneva Chamber of Commerce.” Problem was the Geneva Chamber of Commerce did not have an Arbitration Institute nor did it handle international arbitration. Our client had taken a contract my law firm had written for them and made a few changes and simply re-used it on another deal. The contract my firm had written had called for disputes to be resolved before the Arbitration Institute of the Stockholm Chamber of Commerce, which is a very common forum for resolving disputes between Russian and American companies. So when my client went off and did an agreement with a Spanish company and the Spanish company refused to have the contract disputes resolved in Stockholm, my client just switched “Geneva” for “Stockholm” and called it a day. But then when it came time for my client to pursue arbitration we had to conduct massive research to determine how even to commence arbitration before an arbitral body that did not exist. We ended up deciding to file with the Swiss Arbitration Association in Geneva, and the opposing side vigorously contested our choice of forum. We actually were able to keep the case there, but only after incurring a large amount in fees fighting to do so.

5. South Carolina Arbitration in Chinese Under British Law. Yes you read it right and if you are not stunned by this, you should read it again. This is my all time favorite. U.S. company comes to us with an arbitration clause mandating arbitration in South Carolina in Chinese under British law. When I talked about how much it would cost to get three Mandarin-speaking arbitrators to South Carolina (assuming the other side doesn’t argue for some other Chinese language) and and the added costs of researching and arguing British law, the U.S. company — wisely — chose not to pursue the case. When I asked the company how it had chosen this particular dispute resolution provision they explained that they had taken it from one of their previous agreements. I didn’t say a word, but what I will say now is that a provision like this is a great way to discourage arbitration and sometimes that can make sense, but such a provision is a disaster if you are the one that ends up needing to sue. Again, context is everything.

Every once in a while when I say that I cannot opine about their having chosen Hong Kong arbitration for their specific contract, the attorney will write me back asking for “my general opinion regarding Hong Kong arbitration”. My response is that there are plenty of excellent arbitrators in Hong Kong but arbitration there is generally very expensive and, most importantly, it is seldom the most effective forum for enforcing a contract with a Chinese party.

Frankly, the biggest issue I have with Hong Kong arbitration is that far too often attorneys choose it not because it is the best forum for their client’s disputes, but simply because they are comfortable with it because it has a common law system very similar to the United States, Great Britain, Canada and Australia and the contracts and the arbitration can easily and logically be in English. Like everything else, whether these reasons make sense will depend on the entire context.

This article was written by Dan Harris and published on China Law Blog. Original Post: https://www.chinalawblog.com/2018/07/hong-kong-arbitration-for-chinese-contracts-i-dont-think-so.html      

View the original article here.

Dan Harris

Dan Harris is internationally regarded as a leading authority on legal matters related to doing business in China and in other emerging economies in Asia. Forbes Magazine, Business Week, Fortune Magazine, BBC News, The Wall Street Journal, The Washington Post, The Economist, CNBC, The New York Times, and many other major media players, have looked to him for his perspective on international law issues.