By Art Dicker, Limeng Yang
Often the elephant in the room on any discussion of doing business in China is the enforceability of contracts. Navigating the legal landscape of contract enforcement in China can be a complex and often daunting endeavor. China’s legal system and economic dynamism in particular pose hurdles for foreign entities seeking to enforce contracts. The decision to initiate a lawsuit or arbitration case can be costly and cumbersome, especially when it involves cross-border disputes.
From drafting a contract with enforceable clauses to maneuvering with foreign-sourced evidence, there are many potential pitfalls. A lack of mutual recognition between national courts and the logistical challenges associated with enforcing judgments and arbitration awards further complicates the matter. In this article, we will explore these challenges in detail, and provide insights and strategies to help navigate the often-misunderstood world of contract enforcement in China.
Enforcement Strategy in China
Enforcing contracts in China presents unique challenges, like many other high-growth economies. The decision to initiate legal proceedings, whether through a lawsuit or arbitration, especially as a foreign entity, requires grit, determination, and strategic thinking.
The key lies in careful preparation when dealing with cross-border trade, licensing, or investment contracts involving Chinese and foreign parties. It is essential to draft contracts with a clear understanding of the enforcement landscape in China and to keep potential legal scenarios in mind during the drafting process, not as an afterthought.
We often encounter clients where the other side has breached their contract, who have arrived with agreements executed without prior legal review, brimming with confidence about having an airtight case. Their certainty is understandable but frequently misplaced. Our role then shifts to managing expectations and outlining the real-world complexities of enforcing their contract in China.
One major hurdle is the enforceability of the dispute resolution clause, along with the process and expense of presenting foreign-sourced evidence. Such challenges can suddenly make pursuing smaller claims seem unviable. This reality is not exclusive to China but is particularly pronounced when engaging in a cross-border dispute with a Chinese company.
For more sophisticated transactions, it is crucial to create a well-crafted dispute resolution clause, as claims may be substantial. This clause will serve as the primary means of enforcing your contract. This dispute resolution clause should specify how any disputes must be resolved, whether through litigation, arbitration, or other means, and where the proceedings should take place. Further elaboration on the dispute resolution clause will follow, particularly as we recommend considering jurisdiction in China.
Legal actions often become a delicate game of strategy, where each side tests the other’s resolve. However, even if you decide against proceeding with a lawsuit in China, possessing strong arguments that reference both the contract and relevant laws will provide leverage in potential settlement discussions. Sometimes, conveying an unshakable determination to seek justice, regardless of the cost, might be the very thing that brings the other party to close at the negotiation table.
Enforcing Foreign Judgements in China
Should you bring a case in a US court, you might find it more straightforward to secure a judgment either on the merits or by default, particularly if the Chinese party neglects to dispute your claim. However, you then face the task of enforcing that judgment, meaning you must identify assets to attach to that judgment.
One of the key barriers for US-to-China claims specifically is the absence of a treaty recognizing mutual enforcement of each other’s court judgments. You might have a judgment in the US for a lawsuit, but there is no requirement for courts in China to honor that judgment, and in most instances, they will not. In such a case, you still have the option to file another lawsuit in a Chinese court. However, there is no guarantee of receiving the same outcome or remedy.
Arbitration presents a more favorable landscape. Since China is a party to the New York Convention on Enforcement of Arbitration Awards, Chinese courts must enforce that arbitration award within China. Achieving this remains a logistical challenge though – local courts frequently seek any conceivable avenues to evade enforcing an arbitration award. To combat such local favoritism, the Supreme People’s Court of China has even instituted a reporting system, requiring lower courts refusing enforcement of an arbitral award to refer the case to a higher court for review.
Alternatively, as a third option, you may have your US judgment enforced in a third country if that country maintains a bilateral treaty with the US. For instance, if the Chinese party possesses significant assets in Korea, you might bring the judgment there and attempt to enforce it against those assets.
Choosing Jurisdiction and Venue
Owing to the challenges associated with enforcing judgments and arbitration awards in China, an increasing number of foreign companies are incorporating dispute resolution clauses that proactively choose jurisdiction in China. If there is a precise dispute resolution clause within the original contract, this approach is generally more practical to enforce than instinctively defaulting to the jurisdiction of your home country, such as the United States.
A major benefit of opting for Chinese jurisdiction lies in the availability of provisional remedies, such as injunctions. These interim measures can often compel the opposing party to settle, potentially resolving disputes much earlier.
If your company is situated in a major city such as Beijing, Shanghai, Shenzhen, or Guangzhou, you might want to consider using Chinese courts. These courts tend to be more experienced in handling litigation involving foreign parties, and generally demonstrate proficiency in enforcing commercial contracts. However, if your Chinese counterpart is in a smaller city, where there might be concerns about the court’s favoritism towards local business, then arbitration in one of the major cities mentioned above might be a more suitable option. Arbitration panels from institutions like the China International Economic and Trade Arbitration Commission (CIETAC) are known for their impartiality.
It is worth noting, though, that arbitration might not provide access to certain provisional remedies that are available through litigation. Nevertheless, according to Chinese law, you retain the option to seek an injunction in a Chinese court to address breaches of confidentiality or ongoing infringement of intellectual property. This remains applicable even if the dispute resolution clause exclusively references arbitration as the avenue for resolving conflicts.
For those without a subsidiary presence in China, it will be necessary to designate a representative through a power of attorney, such as a local law firm, to initiate legal action on your behalf in the local Chinese court. This arrangement can streamline the process and even eliminate your need to travel to China.
Governing Law: Foreign vs Chinese
In line with China’s Foreign-Related Civil Relations Application Law of 2010, parties typically have the liberty to opt for a foreign governing law in cross-border contracts between a Chinese and foreign party, such as California or Singapore law. Nevertheless, this freedom is subject to exceptions, particularly when a mandatory provision of Chinese law applies to the issue or if the use of foreign law contradicts the social and public interests of the People’s Republic of China. Despite this allowance, we strongly recommend the selection of Chinese law as the governing legal framework. This preference is rooted in the aim to streamline contract enforcement procedures in China.
Chinese courts treat foreign laws as extraterritorial evidence. Consequently, the proper authentication of foreign laws, legal precedents, or reports becomes necessary. Furthermore, the opposing party’s legal representative can cross-examine the foreign legal evidence submitted. In the case of contracts governed by foreign law, both parties are compelled to provide substantiation for every pertinent element of that foreign law. This complicated and financially demanding process involves the engagement of legal experts and rigorous scrutiny of foreign jurisprudence. These requirements inevitably lead to considerable delays and financial burdens, blocking the smooth progression of legal proceedings. The defense may endlessly contest any interpretation of foreign laws.
Adding to these challenges, Chinese judges frequently harbor skepticism regarding the precision of submitted foreign legal research reports, thus fostering uncertainties in their judgments. It is not uncommon in practice for courts to directly apply Chinese law when the determination of applicable foreign law proves difficult or uncertain, if the judge deems it warranted.
Choosing Chinese law as the governing legal framework effectively circumvents these potential delays and disputes. Chinese commercial law, on balance, is remarkably consistent with commercial law in Western jurisdictions. Chinese law provides avenues such as the preliminary seizure of assets and other pre-judgment relief mechanisms that can significantly expedite issue resolution. These strategic advantages, which might not be as accessible under foreign legal systems, harmonize with local customs and practices.
While Chinese law permits contracts to be drafted in foreign languages, it places an explicit requirement that all evidence submitted to a court, including contracts, must be in the Chinese language. This alone strongly encourages the use of bilingual contracts where one of the parties is a domestic Chinese entity.
The importance of having a Chinese version of the contract is further underscored by the risks associated with translating the contract after a dispute has arisen. Such translations are often carried out by court-appointed translators, whose proficiency is not guaranteed. This leads to potential errors in translation and an associated risk of misinterpretation of the contract’s original intent.
Furthermore, the Chinese courts tend to place heavy weight on the Chinese version of a contract. Even if the English version prevails in a bilingual contract, the court will still likely consider the Chinese text significantly in its interpretation. It would be desirable if you were diligent in understanding the Chinese version and not merely relying on the English text. Translations of contracts should be reviewed by Chinese lawyers to ensure that the precision of the Chinese text aligns with the intent of the English version.
We believe it is sensible to draft your contract in Chinese in addition to English. This will facilitate a clear understanding by the court of the terms, including unequivocal descriptions of the goods, the method of payment, and basic representations and warranties regarding the quality of the product. Additionally, remedies for breaches should be articulated clearly, furthering the contract’s clarity and enforceability.
Authentication of Evidence
Another important consideration to keep in mind is that evidence obtained outside of China might encumber your efforts towards contract enforcement through litigation or arbitration. We will illustrate the process of authentication of evidence using an example involving faulty products.
Consider a contract for purchasing personal protective equipment (PPE) from a Chinese supplier - a common practice in recent years. In some cases, the PPE fails to meet product standards, and the foreign party wishes to take legal action against the Chinese party for breaching the contract. You will require clear evidence of the defective product, achieved through testing the unsealed product and presenting results that demonstrate non-conformity with the contract specifications. This approach applies similarly to technology and other products.
Naturally, many of these specifications, particularly during the early stages of PPE procurement, may not be explicitly defined in the contract initially. Assuming you overcome this hurdle, your subsequent step involves having the testing or any other evidence translated into Chinese and then authenticated. This authentication is necessary for the evidence’s acceptance in a Chinese court. Chinese courts have dealt with extraterritorial evidence that lacks proper authentication or certification in diverse ways. Some have outright deemed the evidence incapable of proof, while others may assess its probative value case by case.
These processes are time-consuming, and the associated costs accumulate at each stage. Despite completing these steps, you find yourself in a situation where you are disadvantaged in a Chinese court. Particularly, if the time needed for these procedures surpasses the court’s set deadline, you will need to request an extension, which the court might not be patient about.
Even if you present the authenticated evidence in court, the opposing party could still question its credibility. The authentication can only verify the authenticity of the documents, not their contents. Ultimately, the Chinese court retains discretion in assigning weight to extraterritorial evidence.
An alternative approach is to gather evidence within China. You could have the faulty PPE examined by a Chinese institution. Even for evidence generated abroad – for instance, email records stored on foreign servers with both sender and receiver located outside of China – it is still possible to obtain notarization within China by accessing the email account over the internet. These measures significantly expedite the evidence-gathering process and mitigate the risk of the opposing party challenging its credibility. To navigate through these procedures, you can seek assistance from a local law firm.
In conclusion, the complex landscape of contract enforcement in China, riddled with potential pitfalls, demands a thoughtful and strategic approach. The very cornerstone of successfully doing business in China lies in crafting a clear and enforceable contract at the outset. Key elements include choosing Chinese jurisdiction and venue, using Chinese law as the governing framework, and drafting bilingual contracts. This not only facilitates smoother legal proceedings but can also provide significant leverage in negotiations and potential settlement discussions.
R&P China Lawyers is a full-service law firm with a strong commercial & contracts practice that is closely integrated with our dispute resolution team. The teams include experienced litigators, representing international and domestic companies in disputes all over China. For more about our practice, please email Mr. Art Dicker (firstname.lastname@example.org), Ms. Limeng Yang ([email protected]) or your usual contact at R&P China Lawyers.
A significant contribution to the writing of this article was also made by Yvan Pan during his time at the R&P Shanghai office.