Arbitration Preferred Over Litigation by Chinese Lawyer from Law Firm

Written contracts are vital to doing business in China. The Chinese legal system has undergone massive improvement due to which a properly prepared Chinese contract by a Chinese lawyer can now provide solutions to various problems including breach in contract. The Chinese business folk have also realized the importance of a properly drawn agreement to conduct business in their country. They have also realized the advantages regarding the same making the improvements tangible. Earlier people used to rely on parties to resolve disputes but now with an improved legal system, both the Chinese manufacturer and the foreign business party can depend on the judiciary.

The fact however is that a contract is valid as long as it can be enforced by law. Foreign companies generally insist on incorporating certain provisions in their contract. However, this is not important in the Chinese business as well as legal context. They do not make the contracts enforceable. The point of being enforceable is extremely important in China and any Chinese law firm will stress on a kind of contract that can be made enforceable in the country. Foreign business counterparts generally in their want of proper guidance end up with an agreement that much to the amusement of Chinese manufacturers are not binding and absolute legally.

Making a contract effectively enforceable in China has 3 fundamental rules:

  • Enforcement is done through litigation in Chinese court
  • Chinese law governs the litigation
  • Chinese language is used in the court and for documents

Generally, the contract drafted by the US party contains provisions according to the US law from the homeland. In such a contract, the language in which the contract is drafted is English and the enforcement can be done in English court outside the Chinese context. In fact, the provisions can only be enforced in the state court of the home state for the US party.

Why this Situation is a Disaster?

This kind of agreement is not valid because it flouts the basic rule of preparing a contract enforceable under Chinese law. Hence, discussing about the other 2 rules is not even necessary. The Chinese court will never enforce US court judgements. Therefore, any kind of judgement obtained at the US court remains invalid in the Chinese court and judiciary. Moreover, if the Chinese organization does not have any asset in US, the judgement is rendered worthless.

There are some attorneys who have spotted this issue and they argue that China is a signatory to the New York Convention on the Enforcement of Arbitral Awards and hence will provide for arbitration in the court of law. According to them, the Chinese courts shoudl take into account US Arbitration Awards; in fact, they are obliged to do so. However, in reality it does not hold true. US Arbitration Awards are totally worthless in Chinese context. There are quite a few reasons for this. They are:

  • China belongs to a group of Asian nations which have strong cultural aversions to enforce any foreign arbitration. The courts thus find various reasons for not enforcing foreign enforcing awards. This is practically true for local court cases; sometimes there is a chance of prevailing on appeal. However, the biggest problem with this is that the process is uncertain and hence takes long time. The Chinese court has another way of not issuing any ruling at all just to avoid foreign arbitration.
  • The Chinese party may not participate in the entire process in order to avoid the verdict altogether. This might make the award a default award. Chinese courts do not recognize default awards and hence the chance of enforcing a foreign default from an arbitration tribunal is very low.
  • Precisely, Chinese courts usually do not heed orders from foreign arbitrators. Many arbitration concerns company management or or intellectual property disputes. These issues require some kind of injunctive relief. The Chinese perceive such orders as an insult to their sovereignty and hence they ignore such orders by an unwritten rule.

This practically means that China is a modern country with a reasonably well developed legal system. Receiving any kind of favor from the court should be done through the legal system only and not resorted the legal system of other countries. This is especially true for arbitration from foreign courts. Though some foreign organizations stick to rule number one, they often flout the second and third rule and use English as the court language. They argue that Chinese law allows for the foreign companies to choose their law as well as choose the language to sue the Chinese organization. Of course the law must be related to the business or the transaction made between the parties. The reason being that Chinese civil law drafters believe in party autonomy which empowers business parties to take decision pertaining to the business. However, the the real world such decisions make even a written document unenforceable.

Chinese effective litigation entails fats and decisive action especially in terms of property seizure and pre-judgement relief. Now employing Chinese arbitration instead of litigation is preferable due to the delay in the entire litigation process because of foreign law and language. In case of governing law, the Chinese court will always require the foreign party to prove that this is the relevant foreign law. Now proving law is expensive and time consuming. Same delay is applied to foreign language because the court will appoint an incompetent translator to translate the document drafted in foreign language. This only adds to the existing complication.

This creates number of disadvantages for the prosecutor which can be turned into advantages for the defendant. The delay becomes limitless and hence it is always better to opt for arbitration instead of litigation in China ground.

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Pitfalls of Chinese Manufacturing Binding Agreements

An effective Chinese manufacturing agreement must address various issues out of which the most vital part is the one constituting terms for purchase of the manufactured item. Three things are critical to a business establishment, quantity, price and date of delivery. Since these are the key factors, these must be addressed right at the beginning of preparing a contract. A Chinese lawyer is required to draft a contract by clearing explaining these terms right at the beginning.

Incorporating these fundamental terms right at the onset can be done in 2 ways. The ways are:

  1. The manufacturing contract drawn for purchase of goods is a binding one for a particular quantity of product to be delivered within a stipulated time frame and a fixed price. The outstation purchaser has an obligation to purchase while the manufacturer is compelled to sell. Failure in any of these will be considered as a breach of agreement. A letter of credit is often attached to this kind of agreement.
  2. A contract stating the purchase of goods is formed only after the foreign purchaser submits the purchase order which is also accepted by the Chinese manufacturer for which the terms and conditions are laid earlier. This contract is however not formed when the foreign buyer does not provide a purchase order and the Chinese manufacturer does not have anything to accept it. In case there is no submission of order or there is a rejection of order these are not considered as breach of contract. This type of agreement comes without a letter of credit.

The first option is opted by the multinationals ordering large quantities of products from Chinese firms. It comes with 2 advantages:

  • The risk of price fluctuation is absent because it is locked for a particular period. However, in case of any cost changes, both the parties bear it equally.
  • The delivery date for product is fixed and hence the buyer can plan for any kind of seasonal variation. The only risk involved in this is that the buyer might get stuck with a full inventory of products.

The second option is more viable for start-ups or for companies launching new items with an undetermined sales market. It allows the foreign buyers to test the waters before launching the new produce in the new market. Moreover, the buyers do not face any loss regarding failure of products and being stuck with unsold inventory.

The basic disadvantage integral to this arrangement is that the Chinese factory can deny any business terms anytime because there is no documentation of contracts. In fact, this is a tool used by Chinese manufacturers to raise price by rejecting the purchase order. They also reject if they are unable to provide required quantity and also unable to meet the delivery deadline. The toughest part is that the buyer really does not have much choice apart from accepting the rejection from the Chinese counterpart.

In a nutshell the situation is not in favour of the foreign buyer because the Chinese company can negotiate any price for producing the products. It is also not possible to force them to deliver products on time. Just imagine the kind of trouble a start-up will land into with a single new product. A start-up receives sustainable orders after lot of effort and it requires fulfilling the deadline in terms of time and delivery. The start-up is obligated to perform because the US and EU buyers stress on binding contract.

Now, the real trouble begins when the start-up submits their purchase order and the Chinese manufacturer rejects it asking for a price hike. The start-up can be subjected to a lawsuit in its home land due to failure of on time delivery of products and it is considered as a breach of contract. It suffers from bad reputation and also from financial loss and can only recover if it has financial backing; sad news is that, these companies generally do not recover from this blow. They realize late that they were working under the illusion of a binding contract with the Chinese manufacturer come product supplier.

China lawyers receive calls all the time from EU or USA retailers who get trapped into this “no business terms”. However, there is no solution expect from being careful the next time. The ‘business terms’ issue must be addressed properly for every manufacturing contract because it is confined to this only but spreads to other issues as well. For instance, the Chinese manufacturer you are working with is supposed to provide a certain type of packaging along with the product. However, it decides at the last moment not to do it but the price is included in it. Under the second option, the manufacturer will reject the purchase order expecting to negotiate which means that the original condition was illusory because the manufacturer has no obligation to perform.

It is only after the tide has passed that you discover who has been swimming naked. This adage is true for companies from EU and US working with Chinese manufacturers. It is often late when business owners realize that their Chinese manufacturers have left them with no clothes. The moment you decide to work with Chinese manufacturers, you also need to decide which option will be applicable to the contract that incorporates those terms that legalize your decision. Otherwise operating under an illusion will lead you towards unpleasant consequences.

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