Local Protectionism a Sword Rather than a Shield
May 02, 2001 | BY
clpstaff &clp articles &Foreign investors are all too familiar with local protectionism in China. In particular, they are well aware that it is often difficult to enforce court…
Foreign investors are all too familiar with local protectionism in China. In particular, they are well aware that it is often difficult to enforce court judgments and arbitral awards because local governments and courts protect local parties. In such cases, local protectionism serves as a shield to protect the local company.
Yet local protectionism may also serve as a sword. The biggest obstacle to enforcement is the insolvency of the party against which enforcement is sought. Naturally, companies that win a large judgment will be frustrated if they are not able to enforce the judgment because the losing party is insolvent or because it is protected by the local government or courts. In some cases, the winning company will need the money from the judgment to survive or to take advantage of fleeting market opportunities. In such cases, winning companies will frequently beseech their local government and courts to assist in compulsory enforcement. Under tremendous pressure to aid their own local companies, local governments will pressure local courts to take enforcement measures, including seizure of the assets of third parties usually located outside the region, in flagrant violation of PRC laws and regulations and the rights of such parties.
Two Illustrative Cases
The Chinese party (Company A) to a joint venture (JV) contributed buildings, land use rights and equipment as its registered capital contribution. The foreign party contributed cash. In addition, Company A sold certain equipment to the JV.
Company A, a Hebei company, became involved in a contractual dispute with a Heilongjiang company. An Intermediate Court in Heilongjiang decided in favour of the Heilongjiang company, and awarded damages in excess of US$1 million. Unfortunately, Company A was insolvent at the time the judgment was made. The Heilongjiang company, itself in dire economic straits and barely able to pay its employees, applied for compulsory enforcement at the Intermediate Court.
Discovering that Company A had no unencumbered assets, the Court decided to seal the buildings and equipment that Company A had contributed as registered capital or sold to the JV. The JV immediately submitted a written protest to the Court along with documents such as the JV Contract, the Assets Purchase Agreement and the Certificates of Title for the buildings.
The Court not only completely disregarded the protest and legal arguments of the JV, but without any legal basis whatsoever ordered the JV to pay the Heilongjiang company the amount owed by Company A. Then, adding insult to injury, the Court froze the JV's bank account.
By coincidence, the JV was the sacrificial victim of another illegal enforcement action, arising out of a loan agreement between Company A and its bank. The High Court ordered the JV to pay the amount owed by the JV to Company A along with the annual profit accrued by Company A to the bank. The JV objected. First, Company A also owed the JV money. According to Article 99 of the PRC Contract Law (中华人民共和国合同法), the JV had the right to apply the amount Company A owed the JV to offset the amount the JV owed Company A. Second, while the JV did show a profit in the year in question, in previous years the JV suffered losses. According to Article 88 of the PRC, Sino-foreign Equity Joint Venture Law Implementing Regulations, the JV was not permitted to distribute any profits prior to making up the losses from the previous years.
Third, Article 63 of the Supreme Court's Regulation Judicial Interpretation Work Tentative Provisions (Enforcement Regulation) provides that a court should not take compulsory enforcement measures against the assets of a third party (whose debts to the original party against which enforcement is sought have come due) if the third party objects within the stipulated time period. Brushing aside the Supreme Court's requirement, the High Court demanded that the JV pay the amount owed or else the Court would subpoena the JV's general manager to appear before the Court.
Under protest, and reserving its rights and objections raised previously, the JV had no choice but to make payment.
The Rights of Third Parties
According to the Supreme Court's Regulation, if a third party objects to enforcement, the court shall consider the objection in accordance with Article 208 of the PRC, Civil Procedure Law. If the court decides against the third party, it
shall proceed with enforcement. The court's decision cannot be appealed under Article 140 of the PRC, Civil Procedure Law. In such circumstances, third parties can only ask the court at the next higher level to exercise its power of adjudicative supervision to correct the enforcement order. However, the likelihood of success is low.
Even if a court agrees that a mistake has been made and that the assets should be returned or the injured third party otherwise compensated for its losses, the court will often find it difficult or impossible to rectify the situation because of local protectionism or because the assets will have disappeared and the company will have no other unencumbered assets.
The injured third party could seek compensation under the PRC, State Compensation Law. However, the third party must first apply to the same court that issued the incorrect order for a written confirmation that the court acted incorrectly.1 Needless to say, the chances of persuading the offending court to admit its error is low.
By Shirley Xu and Feng Jinwei,
Yiwen Law Firm, Beijing
Endnotes:
1 The Supreme Court Interpretation on Several Questions concerning Judicial Compensation Arising from Civil and Administrative Litigation (effective as of September 21 2000), Art. 8.
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