Dispute Resolution in China: Putting the House in Order

In recent years, however, PRC officials seem more reluctant to "knock heads together" and settle the matter. Some are too busy handling the flood of unprecedented foreign direct investment. Some worry that their vigorous efforts to settle a dispute may lead a disgruntled party to bring suit against them seeking compensation under the PRC State Compensation Law.¹ And finally, some sincerely believe that China's arbitration and judicial institutions are now capable of effectively resolving disputes and should be utilized to do so, thereby further strengthening the legal system.

Is this realistic? Let's first look at arbitration.

Arbitration

For many years PRC contract negotiators were under orders to try to persuade foreign parties to accept arbitration in China under the auspices of the China International Economic & Trade Arbitration Commission (CIETAC), but not to lose the deal as a result of their insistence. Thus, many foreign negotiators who went down to the wire on this issue were rewarded for their patience by obtaining arbitration abroad, in places such as Stockholm, London, Singapore or Hong Kong. Foreign parties often sought to avoid arbitration before CIETAC (and even more so before the many PRC local arbitration commissions) because of their desire to have any dispute tried by a trio of arbitrators no more than one of whom was from the PRC. Foreign arbitration, they also believed, might enhance the uncertain prospects for enforcing the panel's arbitration award in China's courts. The reasoning was that this strategy would bring into play the United Nation's 1958 New York Convention on the recognition and enforcement of foreign arbitration awards.

Lately, however, especially in major transactions, PRC negotiators have been more determined in their demand for CIETAC arbitration. Just a few weeks ago, for example, negotiations for a large financial investment in China by a foreign company seemed on the brink of failure because neither party would give in on the place of arbitration. One possible compromise discussed was mediation in China and arbitration, if necessary, abroad. Another called first for CIETAC arbitration and then, if either party requested it, arbitration in Singapore. I favoured the first option but the Chinese side resisted. The second option seemed a nightmare to me, even if the PRC investment authorities and CIETAC deemed it valid, which seemed questionable. If a major CIETAC arbitration case can drag on for two or three years and cost the foreign party several hundred thousand US dollars, think of what doing it a second time abroad might mean!

Finally, I suggested a compromise that worked: CIETAC arbitration but only with the explicit understanding that the presiding arbitrator, although chosen from CIETAC's list of available experts, must be from a country other than China and the country of the foreign investor. This means probably that each of the three arbitrators will be from a different country, as usually occurs in International Chamber of Commerce (ICC) arbitration, and many other arbitrations outside China.

I warned our client that accepting CIETAC bore other risks. CIETAC procedures and evidence rules need to be strengthened. Moreover, would CIETAC staff keep the proceedings confidential? Would the Chinese arbitrator be insulated from outside pressures and external, off-the-record communications? One cannot take for granted the existence of legal ethics in either arbitration or litigation in China. But I also told the client that CIETAC was constantly seeking to improve and was aware of the need to meet foreign criticisms of existing defects.

Unfortunately, CIETAC has not yet come to grips with the problem of compensating its arbitrators. Foreign companies that appoint a foreign arbitrator are often surprised to discover that they must pay CIETAC an additional fee. This fee is ostensibly collected in order to cover the cost of the foreign arbitrator's travel from abroad and his or her need to stay in a hotel in China. In fact, it is collected even in cases where the foreign arbitrator is a long-term resident of China and incurs no such travel and local expenses. More fundamental - at least to the foreign arbitrators - is the very poor compensation that CIETAC provides, which makes at least some seasoned foreign arbitrators on CIETAC's list reluctant to serve once the novelty of the CIETAC experience has passed.

Yet CIETAC is the world's busiest international business arbitration institution, and it became number one in case volume by trying to meet the needs of the parties for speedy, less costly dispute resolution. One recent unpublicized example is worth noting. When a Chinese claimant invoked CIETAC jurisdiction and the Hong Kong respondent, before the arbitration panel was established, pointed out that the contract's arbitration provisions were self-contradictory and/or unintelligible, CIETAC might nevertheless have required each party to appoint its own arbitrator and go through the process of confirming the presiding arbitrator so that the panel could decide the jurisdictional issue. This is how most arbitration institutions would have handled the problem, but to do so would have delayed the decision and added considerably to the expense of the proceedings. Instead CIETAC itself reviewed the matter and promptly decided that it lacked jurisdiction because the arbitration clause was invalid.

Although CIETAC has become a spirited and successful competitor for the world's business arbitration market, it has recently shown a willingness to accommodate the needs of rival foreign institutions to hold hearings in China. Foreign parties that insist on arbitration outside of mainland China may now obtain the best of both worlds by providing, for example, for Singapore, Stockholm, ICC or Hong Kong as the place of arbitration, thereby obtaining the benefits of such an organization's superior rules, and greater freedom in selecting arbitrators and enforcement of the award in accordance with the New York Convention. At the same time, they can provide in their arbitration clause for any arbitration hearings to be held in mainland China to the extent that either party or the arbitration panel deems desirable. CIETAC has offered the use of its physical facilities in such cases for "a nominal charge".

We need to consider one final point about arbitration. When two PRC domestic legal entities conclude a contract, even if they are both wholly foreign-owned companies, can they validly include a clause calling for arbitration outside China? Would a PRC court refuse to enforce an award from such an arbitration on the ground that two domestic PRC companies are not legally free to go abroad for arbitration even though no PRC law explicitly prohibits this? Can the domestic companies nevertheless achieve their desired result by designating Hong Kong as the place of arbitration rather than, say, Singapore, since Hong Kong is a Special Administrative Region of China? We are awaiting clarification of this question.

The Courts

There is continuing uncertainty concerning whether PRC courts will enforce either foreign or domestic arbitration awards. But what about their suitability to decide international business disputes on the merits? Formerly it was taken for granted that in most disputes foreigners would be unwise to prefer Chinese courts to arbitration. Should the experience of recent years plus the PRC's entry into the WTO lead to a reconsideration of that position?

China's courts are gradually improving their reputation. Since 1978 they have had to be reconstituted from scratch. In addition, as is well known, they have suffered from a lack of sufficient professional competence and training, corruption, guanxi,² local protectionism, Communist Party control and command influence within each court. The frank annual reports of the able Supreme Court President recognize most of the problems, and the President of the Beijing High Court, often a model for the country, recently acknowledged that many litigants doubt the fairness of Chinese judges because some courts appear to have abused their authority.

Spurred by the WTO's requirement that its members must provide an independent, impartial institution for the review of administrative actions alleged to violate trade and investment-related legislation, China's judicial leaders have undertaken intensive educational programmes for judges at every level of the court system and in this effort they have increasingly requested the cooperation of international organizations and foreign governments, charitable foundations, university law schools, judges and law firms. I have just finished a two week tour of several major cites in China, meeting with court officials, prosecutors, lawyers and law professors and was tremendously impressed by their ability, knowledge and determination to bring further crucial reforms to the judicial system. China is plainly in the midst of major ferment concerning the reform of its commercial dispute resolution institutions. This will be profoundly significant not only for the handling of commercial matters but also for the entire system of dealing with civil, administrative and even criminal matters. For example, the WTO's transparency requirements, in addition to its judicial review requirements, are already stimulating courts to be more open in their work and to publish more of their judgments.

All of this will take time. The September 2001 Supreme Court circular mandating postponement of shareholder suits until "necessary legal and judicial preparations" have been made is only one of many recent reminders that raising the courts' professional competence to an international level will take time. Similarly, China's belated recognition of the need for an evidence law and for procedural reforms such as the pre-trial conference to promote both justice and efficiency will take years to implement. Not surprisingly, prospects for improvement are better in the courts of the more sophisticated eastern coastal areas than in the vast interior of the country, although the recent PRC campaign to develop the western areas has brought with it awareness that without court reforms this campaign will be limited in impact.

Will China's younger, emerging leaders realize the importance of implementing radical judicial restructuring to eliminate local protectionism, Party control of individual cases and other problems that make going to court a game of roulette and a political struggle? Unless they do, their ambitious plans for attracting much greater foreign investment, for restructuring state-owned enterprises and the banking, insurance and tax systems, and for fostering capital markets and intellectual property rights will not succeed.

This article is an edited version of a speech delivered by Jerome Cohen to the American Chamber of Commerce in Hong Kong, November 13 2001.

Jerome A. Cohen is Professor, New York University School of Law, Senior Fellow, Council on Foreign Relations (N.Y.), and Of Counsel, Paul, Weiss, Rifkind, Wharton & Garrison.

Endnotes

1 The Compensation Law was promulgated on May 12 1994 and became effective on January 1 1995. Recourse to the law has been frequent by parties aggrieved by official violation of their rights.

2 Guanxi, though lacking an exact English equivalent, is often translated as "personal connection". In Chinese, the term has a negative connotation, implying exploitation of a personal relationship, with a government official for example, for one's own benefit. The word has come to imply any informal, personal method (such as friendly relations with a judge presiding in a commercial case) to further a business aim, rather than adherence to institutional mechanisms or the rule-of-law.