Why China's arbitration scene is busier than ever

----By Mark Godfrey

In many partnerships between Chinese and foreign companies, negotiating, drafting and signing a contract is the easy part. Agreeing on what the contract actually means - or whether it even applies - is another story. When the points of contention pile up and no compromise can be reached, it may be time to arbitrate. Thus French drinks company Danone and its Chinese partner Wahaha, whose fractious joint venture imploded earlier this year, are now in Stockholm working out their differences.

But the trend extends beyond a handful of high-profile cases. Restrictions on foreign entry in key industries is causing a resurgence in arbitration in China. Joint ventures, regarded by some as obsolete after WTO-driven economic liberalisation in China, are back in vogue in lucrative sectors such as financial services and telecommunications.

A recent "regulatory frenzy' in China, while within the boundaries of the country's WTO commitments, means foreign investors entering joint ventures are using arbitration to settle disputes, says Susan Munro, counsel at the Shanghai office of the law firm O'Melveny & Myers.

The wholly foreign-owned enterprise (WFOE) has not, as some predicted, reduced the need to settle disputes. Most of the 700-plus cases filed at China's largest arbitration body, the China International Economic and Trade Arbitration Commission (Cietac) in 2006 involved a Chinese and foreign party, according to a spokesman for the state-run organisation. According to foreign lawyers' estimates, up to 80 percent of arbitration cases in China involve foreign and local parties.

Arbitration options are usually written into the original contracts between two parties to offer an exit when difficulties arise. Danone and Wahaha had stipulated in their joint venture agreement that disputes would be arbitrated at the Stockholm Arbitration Institute in Sweden.

Foreign firms prefer to arbitrate offshore, says Munro, where damages are generally higher, and "there's a perception of a more level playing field'. The Hong Kong International Arbitration Council is preferred for its proximity and reputation for a sound, transparent legal tradition. Mainland arbitration councils, by comparison, lack both the established British-style common law tradition which has existed in Hong Kong for a century and a half, and its long experience in resolving commercial disputes. "They don't have a lot of guidance to rely on," says Munro.

Though foreign investors may prefer to go overseas, most cases end up being heard in China, says Clarisse von Wunschheim, an associate at DLA Piper's Beijing office - though she admits that it is impossible to know how much Sino-foreign arbitration goes on beyond China's borders.

Differing opinions

That's partly because Chinese law remains vague on where arbitration involving Chinese companies can be held. Commercial and operational disputes between two domestic companies must be heard in China, according to a 2006 interpretation by the Supreme People's Court on the application of the arbitration law. Under that ruling, a foreign-invested enterprise is regarded as a local entity.

There is a clash between China's contract law and the local arbitration law on the opportunities for foreign arbitration in disputes between locally incorporated companies, including foreign-invested enterprises. A WFOE incorporated in China is considered a Chinese entity and any contract it makes with a Chinese company will be considered a "non-foreign related' contract governed by Chinese law, explains Mary Utterback, a partner at Thelen Reid Brown Raysman & Steiner.

"The losing party could argue against enforcement of the judgment on the basis of the contract law that a non-foreign related contract should be submitted to Chinese arbitration only. The successful party will however argue that the PRC Arbitration law does not prohibit off-shore arbitration."

The confusion can be frustrating, yet companies are better advised to play it safe, says Utterback. "In the past when we have informally consulted with the local courts, we have been told that the foreign award between two PRC entities would likely not be enforced. Accordingly, we usually recommend that two PRC entities opt for a domestic arbitration body in their contracts."

Aside from complexities in local arbitration law, foreign investors who prefer to seek arbitration abroad often find it difficult to persuade local partners to accept such a provision. "It depends on your leverage," says Utterback. "If your partner is a state-owned enterprise, they will have a lot of clout in the partnership, and will probably be unlikely to want to go abroad. But a private Chinese company is usually much more amenable."

Chinese companies that are listed on local or foreign stock exchanges are often more amenable to offshore arbitration, since the dispute may in any case have to be disclosed to shareholders. "This may give more leverage to the foreign party," explains Susan Munro.

Enforcing awards from mainland rulings remains difficult. Foreign arbitral institutions' awards are enforceable by local Chinese courts if the country which made the award is - as China is - a signatory to the 1958 New York Convention, an international agreement on arbitration law.

Local protectionism, however, means lower-level courts will frequently find fault with an arbitration award, particularly from a foreign arbitration process. "This is particularly common in a town where the Chinese company is the largest employer locally," says Munro. "It's very hard to get a judge to enforce that."

For example, an award from an arbitration council in Germany, also a signatory to the convention, which was rejected when the German company took the case to Wuxi court for enforcement. "They ruled that it did not meet the requirements of Chinese law," says Munro.

Enforcement of awards, foreign or local, can take up to two years. The speed of enforcement varies according to the region. The process is much easier in wealthier coastal cities. "There's a recognition that they have to have the rule of law, or foreign investors are deterred," says Mary Utterback. But it can be sluggish in smaller cities, where there is more pressure on politically appointed local judges.

Yet China does have a mechanism in place to prevent local protectionism. Foreign judgements which are not enforced must be referred from the local court to the Supreme People's Court. "As the ultimate court in the land it's rare that it would get it wrong," says Munro.

Enforcement of awards, local or foreign, can take up to two years. The speed of enforcement often varies according to region. Enforcement is easier in wealthier costal cities, says Mary Utterback. "There's a recognition that they have to have the rule of law or foreign investors are deterred."

Signs of improvement

Arbitration panels in China are improving, if slowly. Cietac arbitration panels usually comprise three members from an approved list, one selected by each party, and a chair appointed by Cietac. Ironically the laws of commerce may be driving improvements. Within China there are now several arbitration bodies now in competition with the Cietac; there are several in Shanghai alone. "These are growing in sophistication," says Mary Utterback.

Foreign arbitral institutions like the International Chamber of Commerce (ICC) are technically allowed to sit in China, but sittings are rare and outcomes are not necessarily final. A 2006 award reached by an ICC arbitration council sitting in Shanghai has been rejected by local courts, which refused to enforce the ruling on the grounds that the body was operating outside its jurisdiction.

"The rules of arbitration are similar in China, even if local practitioners often do things their own way," says von Wunschheim. Training abroad helps widen the horizons of local arbiters. "Unlike common law traditions arbitration it's the practitioners who develop arbitration. The more experience and training China's legal personnel get, the more comparable their practices become to those of the EU and US."

Foreign lawyers also seek more transparency in China's arbitration process. "The publication of arbitration awards would be a way forward," says Von Wunschheim. Cietac has claimed that publication would endanger companies' trade secrets. While approval of higher courts has helped prevent local protectionism the process is not transparent. "It all happens behind closed doors, the parties can't participate," adds von Wunschheim.

Arbitration practitioners are busier than ever in China. But sometimes arbitration is not the best way to resolve a dispute. In some cases on-shore litigation is a better option, says Munro, particularly in non-disclosure cases against former employees where a speedy resolution is vital. "A year may have passed before you get a foreign arbitration judgement enforced & If it's a completely commercial structure where damages are a priority then you'd go to arbitration, offshore."

China's arbitration market is "huge', says Munro, but as the number of cases pile up she also sees the emergence of a settlement culture. "Domestic and foreign parties are starting to prefer to settle before the arbitration runs its course & to avoid the costs and complexities involved."