Enforcing contracts with Chinese partners is often difficult for foreign business owners in China. However, many foreign business owners hesitate to enter litigation in China because they assume that the legal process in China is a time consuming nightmare filled with red tape and corruption.
This is a myth.
The impression portrayed above is the result of misunderstandings, weak cases, poor strategy, and careless implementation, not the fault of the Chinese legal system itself. In fact, the World Bank Group ranks China 7th among all countries in terms of contract enforcement, while the United States, Canada, and Italy sit at 21st, 49th, and 111th, respectively. In this article, we provide a brief introduction to the Chinese legal process to give foreign business owners the confidence to enter into litigation or arbitration in China.
Compared to western litigation, Chinese litigation has unique characteristics. Lawyers in China require an official power of attorney in order to represent a client, and any documents needed must be notarized, legalized, and translated into Chinese before they can be used in court. Moreover, Chinese litigation focuses on written evidence and adheres to strict evidence rules.
On the other hand, China has been plagued by inconsistencies in the litigation process, especially in lower tier cities. In lower tier cities, the litigation process is often handled by phone, deadlines are flexible, written pleadings are limited, parties are able to access the judge without the other being present, and legal/technical arguments are not given the same patience and attention as they are in Western courtrooms. Chinese litigation also differs because there is no real negative consequence for lying during the litigation process. In cases where investors are involved in a lawsuit the opposition might deny whatever they can, whether it is true or not.
China vs. Abroad
Foreign business owners have more confidence in the legal and arbitration processes abroad than in China. The consistency and transparency of a western legal system is comfortable for western business owners. However, foreign business owners settle their legal disputes in mainland China whenever possible because doing so is more enforceable. Generally, foreign court judgements are not enforceable in China unless the Chinese side has a significant amount of offshore assets or the foreign court is in a jurisdiction with an applicable bilateral treaty such as Hong Kong. As for foreign arbitration outcomes, it remains unclear if they are officially enforceable in China. While China is party to the New York Convention (Convention on the Recognition and Enforcement of Foreign Arbitral Awards), numerous exceptions have been made related to Chinese public policy and due process. If a Chinese court refuses to enforce the outcome of a foreign arbitration, the outcome can be enforced by the Intermediate People’s Court in the specific province or in the four cities directly under the central government: Beijing, Shanghai, Tianjin, and Chongqing. Should this not prevail, the final option is to take the case to the Supreme Court in Beijing. Unfortunately, the case may not be accepted or may be endlessly delayed.
To settle a legal dispute as a foreign business owner in China, the best option is to use Chinese litigation or arbitration in a tier-1 city. By entering into the process in China, investors will retain the ability to immediately freeze assets, judgements are directly enforceable, and enforcement will be assisted by local courts. Notably, when taking a case to the court, a connection with the dispute is required, and there must always be a written agreement or contract. Arbitration can only be conducted with official institutes such as China International Economic and Trade Arbitration Commission (CIETAC) or Shanghai International Economic and Trade Arbitration Commission (SHIAC); ad hoc arbitration is not allowed.
Seizure of Assets
When foreign business owners are in the midst of a legal dispute, they may ask the court to help freeze the opposition’s assets. Essentially, the court has the power to restrict the opposition’s ability to liquidate certain assets as a means of preserving them for eventual compensation. This tactic is used to pressure the other side to settle, especially when trying to receive payment from a delinquent account or customer.
In Chinese litigation, the most commonly seized properties include bank accounts, machinery, inventory, ships, and company stock. Pre-trial preservation (freezing) of assets is allowed, but seldom granted. If you are seeking pre-trial preservation you must apply at the court where the defendant and assets are located, the court must make a ruling within 48 hours, and litigation must be initiated within 30 days after the court adopts the preservation measure. Additionally, a deposit equal to 100 percent of the claim must be provided as security for the defendant in case the seizure is unjustified.
Preservation during trial is usually granted. It is advised that the party wishing to preserve assets work with the judge to ensure the defendant receives notice of proceedings and asset seizure at the same time. The required deposit is at the discretion of the judge and can be anywhere between 10 to 100 percent of the claim, though in practice the minimum deposit is around 30 percent.
Preservation during arbitration is only possible in domestic arbitration. This can be tricky because it requires coordination between the court and the arbitration institute. In this case, the defendant may receive arbitration notice several days before the notice of seizure.
There are specialized companies in China who can provide the deposit guarantee on one’s behalf for a fee of about 0.5 percent to four percent of the claim. Some courts admit such companies, while others require at least part of the deposit to be paid in cash. Investors should check the local court’s policy regarding third party deposit guarantee for more details.
Enforcement and Prevention
Successful litigation or arbitration is only half the battle in China. The real victory in contract enforcement comes when the opposition complies with the ruling. At every step of the litigation process plaintiffs are advised to assume that the counterparty will not pay, no matter what the outcome might be. While every local court does have an enforcement division with broad powers to seize, freeze, appropriate, or auction assets, they are often understaffed and slow to act. In fact, Chinese courts consistently encourage parties to reach a court settlement, rather than continue the litigation.
Even after winning a court case, investors should once again attempt to reach an out of court settlement. While the resulting compensation may be lower, the money is much more likely to be paid in a timely manner. Courts are seldom willing or able to use their power to find assets for seizure, so investors may need to conduct their own investigation of the company’s website or financial statements.
In other words, investors need to create other effective incentives to ensure payment. Political pressure, controlling resources, limiting market access, and other kinds of “arm twisting” have proven to be successful strategies. In the event of a business dispute, foreign investors should not summarily dismiss engaging with Chinese courts. However, investors must have a thorough understanding of China’s legal system to benefit from its utility and avoid leaving empty handed.
This article was first published on China Briefing. Since its establishment in 1992, Dezan Shira & Associates has been guiding foreign clients through Asia’s complex regulatory environment and assisting them with all aspects of legal, accounting, tax, internal control, HR, payroll and audit matters. As a full-service consultancy with operational offices across China, Hong Kong, India and emerging ASEAN, we are your reliable partner for business expansion in this region and beyond. For inquiries, please email us at [email protected]. Further information about our firm can be found at: www.dezshira.com