Written contracts with Chinese companies are of little value if their dispute resolution clause precludes enforcement.
Foreign company distrust of China’s legal system often leads to contracts that provide for disputes to be subject to foreign law and resolved outside China. The problem with this choice of law and dispute location is that it can make the contract practically or legally unenforceable.
1. China dispute resolution disasters
My law firm’s international dispute resolution lawyers often see the following China dispute resolution disasters:
Disaster 1: Exclusive jurisdiction in a foreign court. A Chinese supplier has shipped defective goods to its foreign customer. The contract’s dispute resolution clause provides for disputes to be resolved by litigation in the United States. The Chinese supplier never shows up in the U.S. court and the American plaintiff is thrilled to obtain a favorable U.S. judgment. But joy turns to despair when the plaintiff discovers its judgment is worthless. If the Chinese party has no assets in the U.S., the only way to enforce the U.S. judgment is usually to proceed against the Chinese company’s assets in China. But because Chinese courts virtually never enforce U.S. judgments, the U.S. judgment is meaningless. See China Enforces United States Judgment: This Changes Pretty Much Nothing.
Disaster 2: Foreign arbitration required. A Chinese manufacturer has been using its foreign customer’s molds to make goods for a competitor. The foreign customer seeks a Chinese court order requiring that the Chinese manufacturer immediately return its molds. The Chinese court refuses to hear the request because the dispute resolution clause mandates arbitration in Hong Kong. The Chinese supplier continues manufacturing the infringing product and the foreign company goes out of business before it has time to prevail in the Hong Kong arbitration and take that arbitration award to a PRC court to seek a Chinese court order mandating the return of the molds.
Disaster 3: Foreign law governs. A foreign party learns that its Chinese partner is improperly using trade secrets in violation of a trade secrecy agreement. The foreign party seeks a Chinese court order requiring that the Chinese side immediately terminate the activity. Chinese law permits this sort of interim relief. However the dispute resolution clause provides that United States law governs. Unfamiliar with the United States legal system, the Chinese court requires every element of U.S. law be proved before it will take action. This makes the Chinese litigation action so expensive and time-consuming that it renders any emergency relief ineffective.
Ironically, the foreign party caused all three of the above disasters by choosing the dispute resolution clauses.
2. How to draft China dispute resolution clauses that work
The following basics can help you avoid the wrong dispute resolution clause in your China contract:
1. Foreign arbitration can be a good option when potential disputes are likely to amount to nothing more than calculating damages to be collected in China. China is party to the New York Arbitration Convention on the Recognition and Enforcement of Foreign Arbitral Awards and it has a decent record of enforcing monetary awards.
2. You should seek to avoid foreign court litigation because China generally does not enforce foreign court judgments. This is especially true when there is no treaty requiring it do so. China does not have such a treaty with the United States, nor does it have one with many other countries.
2. If your core dispute issue will likely require a Chinese court require your Chinese counter-party act or terminate an action, foreign arbitration will probably be too slow and expensive. In these cases, access to a PRC court with jurisdiction over the defendant is usually essential, and your dispute resolution clause should provide for litigation in China under Chinese law. If your dispute will be in a Chinese court, suing a Chinese company over a Chinese law contract, your contract should be in Chinese as well. See Using English-Language Contracts in China: My Q&A with China Law Blog.
Mapping out dispute resolution clauses is nearly always complicated. For this reason, our international contract lawyers often consult with our international litigators on these clauses.
3. Key factors to consider when drafting China dispute resolution clauses
There is no one-size-fits-all solution for China dispute resolution clauses. The right dispute resolution clause usually depends on the following factors, at minimum:
- The location of the Chinese company within China
- The nature of the transaction
- The goals of the parties
- The most likely dispute issues
- The most important dispute issues
- The type of dispute issues
- The languages of the documents and potential witnesses
- The law of the contract
For more on arbitration versus litigation, check out Chinese Litigation: Why We Like It.