The Last Resort: dispute settlement for SMEs

co-workers-294266_1280According to a recent survey of the world’s largest corporations by law firm Hogan Lovells, China is now the fourth most common location for cross-border commercial disputes worldwide. Whereas large companies can afford whole teams of seasoned lawyers to prepare their legal strategy for China, small and medium-sized enterprises (SMEs) tend to lack these resources and are therefore keen to prevent any conflict with their business partners. A guideline on dispute settlement with Chinese companies, published by the EU SME Centre, aims to disperse anxieties by providing a clear overview of the options available when legal action can no longer be avoided. Jonas Rasch provides a summary of the guideline, which is available for free download on the Centre’s website.

The perks (and drawbacks) of being a ‘foreign element’

When it comes to dispute settlement in China, the first question to be answered is whether the accused party has assets that can be used for compensation. Only if this is the case is it worthwhile to think about taking action. The second question revolves around whether or not one of the parties involved is considered a ‘foreign element’, since Chinese Contract Law and Civil Procedure Law offer special regulations for legal disputes involving ‘foreign-related contracts’. Only companies registered abroad fall into this category. Any foreign-invested enterprise registered in China (e.g. wholly foreign-owned enterprises or joint ventures) is regarded as Chinese and Chinese law applies as a consequence. Chinese law also applies exclusively to disputes among joint venture partners, even if the foreign party is not registered in China, as well as any business concerning real estate or the extraction of natural resources in the country.

If a foreign company is involved, the parties are free to choose the applicable law, the jurisdiction and (if applicable) the domestic or foreign arbitration commission. It is important to note, however, that enforcement of decisions made by foreign courts or arbitration institutions can become an issue in China. Only if a treaty on judicial assistance or a reciprocity agreement is in place will a Chinese court recognise foreign awards. Several European countries have signed such treaties on commercial law with China—among them France, Spain and Hungary. Many others have not, including the UK and Germany, and decisions made in these jurisdictions will therefore be of no consequence in China.

Which law and jurisdiction applies to any individual ‘foreign-related contract’ will have to be decided between the parties involved, most likely during contract negotiations. For obvious reasons, Chinese companies are reluctant to accept anything else than Chinese law, Chinese courts and Chinese arbitration commissions. Whereas this might have represented a deal breaker in the past, this should no longer be the case as the Chinese legal environment has come a long way since.

exchange-of-ideas-222790Hope for the best, prepare for the worst

Regardless of whether a dispute involves foreign elements or not, the parties are free to choose between litigation and arbitration to resolve the issue. Both result in legally binding rulings that can, in most cases (see above), be enforced in China. However, only if the contract between the two parties includes a well-drafted arbitration clause can arbitration become a mandatory stage of dispute settlement. Whether litigation or arbitration is preferable depends very much on the details of each case and is a matter of discussion even among experienced lawyers; some of the factors include the most likely type of dispute, the desired remedies, the location of the assets, or the amount of money involved. In general, the advantages of arbitration include:

  • its flexibility regarding the servicing of the necessary documents;
  • the right to choose an arbitrator from a pre-selected list;
  • the right to pick the preferred arbitration institution (within China in case of domestic disputes, globally in international cases);
  • the fact that foreign attorneys are allowed to represent foreign clients (however, they are not allowed to make statements and interpret the law if the governing law is Chinese); and
  • the fact that the language does not necessarily have to be Chinese.

Chinese courts: reputation and reality

According to Hogan Lovells’ survey, the Chinese legal environment is currently regarded as the second most challenging by international businessmen and business lawyers of multinational corporations—only the United States’ is considered as more difficult. Common preconceptions suggest that local courts might favour local companies, that cases in China take too long, that corruption is widespread or that the actual enforcement leaves much to be desired. However, much has been done in recent years to remedy the situation. After all, China has a strong interest in keeping and attracting further foreign investment in the country.

That these efforts are bearing fruit becomes evident in a recent comparison of the ease of enforcing contracts in 189 economies worldwide, published by the World Bank. Outperforming the UK, Denmark or Italy, China ranks nineteenth when taking a look at the time, cost and procedures involved in resolving a standardised commercial lawsuit between two domestic businesses. However, things might become more difficult when foreign parties are involved, and even more so if the Chinese party happens to be a state-owned enterprise or the dispute revolves around technologies or information deemed politically sensitive. Tellingly, China ranks ninety-eighth on the World Bank’s list concerning the protection of foreign investors.

Besides the lack of a clear-cut division between politics, vested economic interests and the law, the unpredictability of Chinese courts worries many foreign entrepreneurs and managers. The Chinese legal system is not based on case law, thus previous rulings are not regarded as examples for the future and similar cases can have completely different outcomes. In addition, some Chinese regulations are vague and imprecise, providing judges with a wide range of latitude.

Another major concern for foreign parties is the fact that Chinese courts base their rulings almost exclusively on documentary evidence and the burden of providing such evidence lies solely with the complainant. Strict rules apply to these documents as well as the timing of their provision, which can become especially difficult if evidence from abroad is involved.

Even though the Chinese court system might be very different from what foreign companies and lawyers are used to, it is easier to navigate than some might assume. Foreign companies can, and do, win cases in Chinese courts on a regular basis.

EUSMEcentre_logo_2000_1060This article is based on a guideline entitled Dispute Settlement with Chinese Companies, which provides much more detailed information on the topic and is freely available after registration on the website of the EU SME Centre. Related resources include guidelines on sales contracts when exporting to China, due diligence for joint ventures, mergers and acquisitions and negotiating with Chinese business partners as well as recordings of webinars on managing contract terms to reduce risk and finding the right Chinese partners and protecting your company’s assets. Should you have any questions concerning the legal framework for doing business in China, please contact our in-house expert team.