Thinking long term

2. What have been the most important cases that you have worked on this year and why were they challenging? What precedents, if any, did they set for litigation and arbitration in China?

In the past year, we successfully acted as counsel in several disputes the cause of which lay in contracts for the long-term supply of industrial products. The biggest case involved an amount approaching Rmb10 billion. Notwithstanding the fact that these cases do not have guiding significance as precedents, the experience we gained from them is nevertheless worth sharing.

Firstly, these types of disputes have some features in common that are distinct:

• the party wishing to extricate itself from the contract will often make its claim for rescission on the grounds of “material misunderstanding” and “marked lack of fairness”;
• the disputed subject amount tends to be rather large, and regardless of the outcome of the trial, the parties and, at times, even third parties are certain to incur a significant loss;
• the focus of the dispute will usually be the core commercial terms of the contract; and
• because the interests involved in the cases are huge, it is difficult for the parties to reach a settlement.

We would like to put forward the following recommendations in respect of these types of disputes:

A party that wishes to extricate itself from a contract has to take full advantage of the long-term nature of the contract. With respect to its interpretation of the terms “unfair” and “misunderstanding”, it cannot limit itself to the provisions of the contract themselves, but needs to take into consideration the contract term to vividly reflect more specific figures e.g. how large the burden would be were it to fully perform a certain obligation for a certain number of years, or how large a loss it would incur were performance to be carried out at the specified price for a certain number of years.

A party wishing to maintain a contract must first duly keep records of the contract negotiation and conclusion stages. This information could serve as important evidence in a future dispute. Secondly, it needs to maintain a high degree of vigilance for a claim by the other party to terminate the contract, and respond to any such claim in strict accordance with the law. Thirdly, communication with its lawyers needs to be given high priority and best efforts made to have them gain a full understanding of the economic factors underlying the relevant commercial terms so that the lawyers can fully explain the economic basis specified in the contract to the judges or arbitrators outside the court debate. Lastly, the boundaries between concepts such as commercial risk, force majeure and change in circumstances need to be strictly delineated so as to establish a robust defensive position for one's claims.

3. Clients are often concerned that court judgments are not effectively enforced. How do you respond to these concerns and what measures do you recommend to ensure enforcement?

We have noticed that the amended Civil Procedure Law implemented from January 1 2013 has bolstered the enforcement of judgments and rulings. In the section on enforcement procedures, the amended Civil Procedure Law has made numerous improvements at the technical level, e.g. a court can not only make inquiries about the deposits of the person subjected to enforcement, but can also make inquiries about their financial assets; entities that are the subject of verifications are no longer limited to banks, and have been expanded to financial institutions such as securities companies. These changes will bring the enforcement work of courts closer in line with current social reality and enhance the effectiveness and practicability of enforcement. Furthermore, the new law further strengthens the measures involved in the enforcement of judgments and rulings, not only expanding the scope of entities required to assist in enforcement, but also greatly increasing the fines imposed for refusing enforcement. These measures will further increase the compulsory nature of enforcement.

We believe that the amendment of the Civil Procedure Law provides more robust legislative support for the enforcement of judgments and rulings. However, whether the courts at the various levels will fully implement the new legislation and duly promote the enforcement of judgments and rulings remains to be seen.

4. The CIETAC dispute has over the past year cast a shadow over dispute resolution in China. Can you provide an update of the current situation? In addition, how have you been advising your clients during this dispute?

We have noted that at the end of 2012, the Intermediate People's Court of Shenzhen City rendered a ruling in a case in which an application was made for the vacation of an arbitration award rendered by the South China Commission of the China International Economic and Trade Arbitration Commission. One of the parties in the case claimed that the procedure employed by the South China Commission was illegal on the grounds that the Commission did not apply the new arbitration rules implemented by the China International Economic and Trade Arbitration Commission (Beijing) from May 1 2012. The Intermediate People's Court of Shenzhen City ultimately determined that the South China Commission was an independent arbitration institution and, as such, could apply the arbitration rules that it formulated, and dismissed the application to vacate the arbitration award.

However, at the beginning of 2013, it was rumoured that the Intermediate People's Court of Suzhou City rendered a determination on the validity of an award rendered by the Shanghai Commission of the China International Economic and Trade Arbitration Commission that was completely the opposite of that of the Intermediate People's Court of Shenzhen City. Based on the doubts as to the status of the Shanghai Commission, the Intermediate People's Court of Suzhou City rendered a ruling denying enforcement of its award.

To date we have not been able to secure the original of the Suzhou court's ruling through public channels. However, based on the currently available information, both this case and the Shenzhen case are domestic arbitration cases. Based on the requirements of the Supreme People's Court, if a lower-level people's court wishes to vacate or deny enforcement of a foreign-related arbitration award, it must submit the award level by level up to the Supreme People's Court, which will render the final decision. Based on the domestic arbitration nature of the two cases, for the time being we feel that neither of the rulings in either of the cases reflects the judicial attitude of the Supreme People's Court.

According to reports, a party to the Suzhou case has filed an appeal with the Supreme People's Court. The final ruling of the Supreme People's Court can be expected soon. At that time, the dust will finally settle in the CIETAC dispute and a clear division of the territories in China's arbitration sector will be made.

5. During the past year, which judgments rendered by the PRC's court system have had the most significance, and what effect will they have on future litigation?

We would like to bring the outcomes of three cases to the attention of readers; the final judgment rendered in Haifu Investment v Gansu Shiheng by the Supreme People's Court, the final judgment in Chinachem v China Small and Medium Enterprises rendered by the Supreme People's Court and the judgment at first instance in Fosun International v Soho China et al rendered by the First Intermediate People's Court of Shanghai Municipality.

The Haifu Investment v Gansu Shiheng case is also known as the first valuation adjustment agreement case. In 2012, in its judgment at second instance, the Gansu Provincial Higher People's Court found that a valuation adjustment agreement had the nature of a guaranteed payment and, as such, was invalid in accordance with the law, attracting great attention in the industry for a time. In its final judgment, the Supreme People's Court stated that because the valuation adjustment mechanism between the investor and the target company was inimical to the interests of the target company and the debtors of the target company, it was invalid in accordance with the law. But the court stated that the valuation adjustment mechanism between the investor and the shareholder of the target company, because it did not harm the interests of others and did not violate mandatory provisions of laws, should be recognised as lawful and valid provided that the expression of intent was genuine and valid. This judgment not only soothed the nerves of the investment world that had been stretched taut for some time and recognised the legality of reasonably planned valuation adjustment mechanisms, but the legal analysis may also provide direct guiding significance for other related legal issues. For example, there has been a long debate over the validity of punitive damages clauses specified in contracts but, based on the analysis of the Supreme People's Court in this case, the validity of relevant arrangements should be recognised so long as the expression of intent is genuine and the interests of others are not harmed. For this reason, we would advise readers to pay close attention to how, in future similar cases, judges of courts at every level render extended interpretations based on the legal basis in the judgment of this case.

Notwithstanding the fact that the backgrounds to, and the focuses of, the disputes in Chinachem v China Small and Medium Enterprises Investment and Fosun International v Soho China et al are different, the judgments nevertheless both find their basis in Item (3) of the second paragraph of Article 52 of the Contract Law: “it conceals an illegal objective by giving it a legal form”, both resulting in judgments finding the disputed contracts invalid on this basis. For a long time there was no uniform definition of “it conceals an illegal objective by giving it a legal form”, making it impossible for parties to accurately assess the risk of the invalidity of contracts. With the recent appearance of a large number of disputes over the validity of large or long-term contracts, this shortcoming has become more apparent.

Furthermore, the Chinachem judgment has also made the investment world extremely wary, believing that this case could introduce new uncertainty as to the legality of variable interest entity (VIE) frameworks. This is the second round of massive debate on the legality of VIE after the CSRC VIE internal report incident rumoured in 2011. In 2010, the author served as counsel in an arbitration case involving a dispute over the validity of VIEs and successfully secured an arbitration award declaring the relevant agreements invalid (according to reports, this is the only VIE dispute to date in which a juridical outcome has been obtained). However, looking at the legal analysis of the Supreme People's Court in the Chinachem case, based on the high degree of uncertainty of the above mentioned Item (3) of the second paragraph of Article 52 of the Contract Law, this in fact signifies that the negative attitude of the Supreme People's Court towards VIEs, entrusted investment and other such attempts to circumvent the law is more extreme than that of the arbitrators above, and should make investors very wary. The author would advise readers to continue to watch whether new disputes over the legality of VIEs appear in the litigation and arbitration fields later.

Author biography

Vincent Mu

Vincent Mu is a senior associate at Martin Hu & Partners. His practice areas are shareholder and management dispute, commercial contract disputes, labour and employment disputes, corporate, M&A and labour.

He graduated from Wuhan University where he received his Doctor of Law. He is a member of Corporate Law Committee of Shanghai Bar Association. His working languages are Chinese and English.