Companies look to arbitration to solve enforcement woes

A recent global survey conducted by Hogan Lovells found China to be the most common jurisdiction for cross-border disputes, but also the most challenging.

The results aren't surprising; China invests all over the world and Chinese parties increasingly realise that litigation can be used both offensively and defensively. However, the Chinese court system has a poor reputation when it comes to enforcement, professionalism, education and independence.

“There's no way to completely avoid the court system in China,” said Eugene Chen, a Hogan Lovells partner. “One big solution is international arbitration, but the difficulty here is that even an arbitral judgment needs to be enforced by the local courts.”

China's court system problems

“Enforcement is a major problem, especially enforcement of an international court judgment in China, which is almost unheard of,” Chen noted. “We have a client asserting such papers in China right now, and we're telling them to be aware that any foreign judgment they get will most likely not get recognised there.”

The difficulty in enforcement is not just specific to foreign entities. Chinese parties also face the same problem, explained Benjamin Miao of Fangda Partners. “There are many differences in the practices and levels of practice among provinces, and judges in remote provinces are simply inexperienced in cross-border matters.”

The judicial system's lack of independence adds to the challenge. Although China is increasingly adopting a market-oriented economy, the court system is not entirely independent from political interference and thus subject to many external influences that can interfere with judgments.

“Unlike many western jurisdictions where judiciaries are independent, lawyers are well-trained, and in many cases judges have received additional schooling, Chinese courts often have judges with no legal experience, and whose decisions are influenced by political favours,” said Chen.

Local protectionism, for instance, prevents courts from enforcing rigorous judgments that can have potentially calamitous effects to local society or the economy. Miao emphasised the difficulty in pushing for bankruptcy proceedings for these reasons: “We represented a solar energy company that suffered a loss due to a market downturn and many companies went bankrupt. The entire proceeding was tightly controlled. The choice of liquidator, new investor, everything was controlled for.”

Arbitration offers a smoother and fairer alternative, but faces similar limitations. “Progress is blocked, especially when the issue is politically sensitive,” Chen explained. “We've had cases where the judge refused to enforce an arbitral award even when the contract contained an arbitration clause.”

However, such instances “should be more the exception than the rule”, he said. In principle, international arbitration judgments should be enforced in China pursuant to China's status as a signatory to the New York Convention, provided the arbitration clause is legal and valid.

Strategy is critical

Miao advised foreign clients to be sensitive to particularities in China's legal system: “Finding a local partner is very important for strategic investors. [You need] someone that you can trust and work with in the long run, because many disputes arise from contracts, M&As and relationships between foreign investors and local management.”

Chen added, “We've had clients who fully rely on US or EU counsel for these deals. They put in dispute resolution clauses favourable to the western party without considering what the enforceability will really be in China.”

A specific dispute resolution clause is a big part of a well-defined exit strategy.

“Typically, we recommend an arbitration clause because an international arbitration judgment is easier to enforce than a foreign court judgment, and arbitration can be more predictable than Chinese court litigation,” he explained.

Arbitration has always been popular for cross-border disputes. “Chinese parties are increasingly amenable to accepting arbitral proceedings outside China. Before, they would only want CIETAC [China International Economic and Trade Arbitration Commission] or local official rulings, but now they have become open to arbitration centres like Hong Kong,” said Miao.

Matthew Townsend of the China Britain Law Institute also recommended arbitration and said that despite some problems, companies can for the most part expect their foreign arbitration awards will be enforced. In fact, he said that China has a pro-enforcement culture for foreign arbitral awards: “Foreign awards are subject to a special reporting mechanism. The court can't refuse enforcement until it has checked with a superior court, and ultimately the refusal has to be cleared by the Supreme People's Court.”

However, fundamental issues with enforcement continue to shroud the seemingly inconsistent treatment of international arbitration awards. “The courts just need more education at the local level,” Townsend stated.

“If a court wishes to refuse enforcement and its reasons are not based in good law, the Supreme People's Court has to overturn that judgment, which is based on the quality of judges in Beijing. Wrong decisions made at the initial stage at the lower level can lead to a delay in enforcing awards,” he said.


By Katherine Jo