Select the Right Forum for Business Disputes in China By Lefan  GONG 2009-09-16

In cross border transactions, it is not uncommon for parties to struggle over the dispute resolution clause. However, these negotiations often miss the important points. Some counsels are inclined to select forums that are more familiar to themselves; others insist on choosing locations that appear “neutral” to all parties (i.e., Switzerland). In neither situation is counsel adequately considering the ultimate enforceability of rights, timing and convenience of the dispute resolution process.

Drafters of commercial agreements should consider the following true story: A joint venture company in Shanghai (the “JV”) owed a significant amount of account payables to each of a Chinese domestic company (the “China Co.”) and a multinational corporation (the “MNC”). The sales agreement with the China Co. chose the CIETAC in Shenzhen for dispute resolution, while the agreement with the MNC selected Singapore as the arbitration venue.

The China Co. filed the claim first, and then successfully sought a prejudgment remedy from the local court in Shanghai by attaching the JV’s primary bank account. After having learned of the attachment, the MNC initiated arbitration in Singapore. However, the MNC soon learned that its Singapore dispute resolution process would take much longer than the China Co’s CIETAC arbitration. Moreover, because PRC law does not allow prejudgment attachment when arbitration is to be conducted outside of the PRC, the MNC was unable to attach any assets.

CIETAC in Shenzhen quickly reached an award in the China Co’s favor. After the China Co enforced the award, the JV was left with an amount of cash that was less than one quarter of the amount the MNC was seeking. The MNC’s only hope of obtaining full satisfaction would be to force the JV into bankruptcy. However, involuntary bankruptcy is difficult for a creditor to initiate in the PRC, and the process allows other creditors to come forward with possibly competing claims.

If the MNC’s counsel had a little more foresight in selecting the right forum, the MNC could have wound up in a much better situation. Unfortunately, in preparing PRC-related dispute resolution clauses, there are many myths about the process that make such mistakes common. In most cases, these myths are supported by compelling logic; however, believing in these forum selection myths may cause you to make costly mistakes.

Myth #1 – Convenience is Paramount

Most drafters hopefully resist the temptation to choose a forum based on what is convenient for them (although the large number of New York-based resolution clauses calls this assumption into question).
When considering forums, drafters should try to envision what types of disputes would likely arise, and in what forms. Then, they should compare the pros and cons of a given forum in each situation.

Counsel should give special consideration to the following issues:
? Whether the assets concerned are largely located in China?
? In what forums would key witnesses be most readily available?
? Might prejudgment relief be important?
? How might the risk of each particular forum jeopardize your client’s interests?

Myth #2 – Anywhere but China

Perhaps out of fears of bias, foreign companies tend to try to avoid CIETAC and other Chinese arbitration commissions; while Chinese companies often prefer China forums. Often after excruciating negotiations, parties meet in the middle and choose a “neutral” location for dispute resolution, such as Singapore.

Lawyers should carefully consider the procedural advantages and disadvantages of conducting arbitration overseas. As shown in the real case above, Chinese arbitration can offer a significant procedural advantage by allowing the plaintiff’s to obtain prejudgment attachments.

A new judicial cooperation agreement between Mainland China and the Hong Kong SAR recently entered into force. Under such arrangement, a petition for prejudgment relief by a Hong Kong arbitration tribunal may be entertained by Chinese courts; however, this is yet to be tested in practice.

Myth #3 – Binding Arbitration Agreements are always Enforceable

Properly executed binding arbitration agreements are enforceable; however, procedural defects may void an arbitration agreement. A common mistake is plugging in boilerplate dispute resolution language without review. It is not that uncommon for such boilerplate language to violate the law, given the circumstances in which it is used.

For instance, PRC law provides that parties may select foreign arbitration if the agreement involves one or more foreign factors, such as party and performance of the contract. Some courts in China might refuse to enforce arbitration rulings from foreign panels if they deem the subject matters to be entirely domestic and without the presence of any foreign factors. As a result, if a domestic Chinese company enters into a contract with a Sino-foreign joint venture company (which is considered to also b a Chinese company), and the agreement does not have other foreign factors, the choice of a non-Chinese arbitration could be subject to court challenge in China.

Other considerations include the selection of choice of law. China requires certain matters, such as disputes relating to Sino-foreign joint ventures, to be governed by the PRC law. Violating this law may also render the clause and the resulting arbitral award unenforceable.

Beyond enforcing the arbitration awards, another important consideration for enforcement is how to build mechanisms into the agreements to allow for quick and effective protection of clients’ interests, such as injunctive relief and prejudgment remedies. This is related to the myth #4 below.

Myth #4 - Arbitration and Court Relief Are Mutually Exclusive

At first glance, it is true that a valid binding arbitration clause proscribes court adjudication and arbitration when disputes arise. However, there are important exceptions to the rule. A valid arbitration clause does not prevent the parties from being able to seek injunctive relief, which is an important form of recourse when the dispute involves intellectual property, and the damages may be imminent and irreparable.

It is therefore important to allow for injunctive relief and similar remedies in the agreements aside from the arbitration clause. In a situation where a U.S. company’s intellectual property rights are at stake, the drafter may consider including language to allow parties to seek injunctive relief in both U.S. and PRC courts.

The mistakes or misconceptions discussed above are not uncommon in cross border transactions. However, prudence dictates that drafters do not blindly use boilerplate language. For good measure, they are well-advised to draft the agreements with the view to being able to effectively enforce them when necessary. Relative to the future litigation costs and expenses that could otherwise be saved, such cautionary measures are worth the time and effort.