The current wave of foreign investment in the People's Republic of China (PRC) is seeing an increasing number of laws promulgated within a very short period of time. These new laws, which aim primarily to lay down guidelines for the orderly conduct of China's market reforms, have been enthusiastically welcomed not only by foreign investors already in the PRC but by the international business community as well.
Unfortunately, the effectiveness of Chinese legislation governing business transactions is often thrown into doubt when a dispute arises and business relationships turn sour. The effectiveness of . Chinese laws is often affected by the legal institutions that are in place, the members who make up such legal institutions and the attitudes of the Chinese people as a whole and the Communist Party in particular towards the concept. of law. Only by an understanding of these factors can the weaknesses in the Chinese legal system be mitigated.
Unlike countries in the West, direct confrontation by way of litigation in the courts when dispute arises is neither normal nor the preferred system in the PRC. Its foreign economic laws in fact offer several options for the resolution of disputes in an effort to discourage courtroom litigation.
The Chinese resolve disputes through friendly mediation or conciliation by a third party, and there are opportunities for the parties to settle their disputes in this way even after the initiation of a suit. An attempt at pre-arbitration or pre-court conciliation hearings may also be required under the PRC's Civil Procedure Laws. Only when the parties are unwilling to go through conciliation or mediation or if such conciliation or mediation proves fruitless, may the parties resort to litigation in the courts or refer the case to the Arbitration Commission.
The arbitration referral must be made in accordance with the arbitration clause already existing in the contract or with a written agreement to refer the dispute to arbitration made after the dispute has arisen. As a practical matter, it is advisable to include an arbitration clause in the contract, since the parties are unlikely to agree to an arbitration hearing once the relationship has broken down, especially if one of the parties is likely to be able to exploit the weakness of the present court system to its unfair advantage.
Under the PRC arbitration rules, the parties are permitted to appoint one arbitrator each and a third arbitrator, who performs the role of presiding arbitrator, is appointed by the Chairman of the Arbitration Commission. The rules allow the parties to challenge the appointment of the arbitrators and to request their withdrawal in cases where conflict of interest arises.
Much emphasis during the arbitration hearing is placed on examination of the facts underlying the claims and the defenses raised. No specific evidentiary rules are imposed by the tribunal and the arbitrators may make investigations and collect evidence of their own. The arbitrators may also consult specialists and appoint experts. If the parties wish, they may be represented by counsel, either foreign or local. An arbitration award must be rendered by the tribunal within 45 days of the close of the final hearing.
Developments in arbitration
As the PRC becomes more and more involved in foreign trade, arbitration tribunals have played an increasingly important role in the country in resolving international economic disputes in a way which foreign investors find more acceptable than the court system. Based on caseload alone, the PRC is now the second largest international commercial arbitration centre in the world. The Beijing branch of the State Economic Arbitration Commission is reported to have heard around 196 cases last year of which about 20 per cent involved foreign investments.
To meet the growing importance of arbitration and the increasingly difficult issues that are referred to arbitration, the China International Economic and Trade Arbitration Commission (CIETAC) appointed 200 more arbitrators in April this year, amongst whom there are 40 foreign specialists from Hong Kong, the United States, Singapore and countries in Europe.
Arbitration tribunals in the PRC combine arbitration with conciliation. The tribunals will often help the disputing parties to reconcile and even make an arbitration award based on the voluntary settlement agreement between the two parties. This is an important service because conciliation agreements will not be accepted by the courts as legally binding. Conversely, once an arbitration agreement has been signed, the court system loses jurisdiction over any re-examination of the facts and may concern itself only with the issue of enforcement.
Unfortunately, it is only when a party applies to the courts to enforce the arbitration award that the cracks in the system begin to show. CIETAC considers its job finished once an award is rendered. Applications for enforcement must therefore be made to the court where the arbitration body or the property concerned is located. There is however little coordinated enforcement mechanism between the arbitration commissions and the courts, with the end result that enforcement is often time-consuming and frustrating. The courts have been frequent targets of criticism for failing to follow up with enforcement actions against companies within their jurisdiction against whom an unfavourable decision has been made.
Chinese law does not require the parties to submit their disputes for arbitration before Chinese arbitral bodies. Rather the parties are free to choose arbitration in either China or some other country. Where arbitration outside China is acceptable to the Chinese party, a third country is chosen. Foreign arbitral awards are enforceable in China, pursuant to the terms of the New York convention of which China is a member.
As mentioned above, arbitration is preferable to litigation in the PRC not only because court room litigation is discouraged but also because, for cultural and historical reasons, the parties to a court hearing have no choice as to the selection of the judge, nor can they presume that the judge will have had much experience of even basic commercial law issues.
Where legal proceedings have to be instituted, they are in practice often instituted in the locality where the Chinese party is situated so as to alleviate the problem of getting the Chinese party to appear in the court proceedings and also to facilitate the enforcement of the judgements subsequently issued. Unfortunately, while in most major cities such as Beijing, Shanghai and Guangzhou, impartial court hearings are the norm, this may not necessarily hold true for courts situated in remote or less prosperous cities.
Enforcement of court judgements
In PRC litigation, the responsibility for the enforcement of a court judgement rests with the court of first instance. Enforcement however may be stayed if a third party raises an objection to enforcement and such an objection is reviewed favourably by the president of the court.
Where a judgement is secured against a Chinese party located in a remote part of the PRC, it is also often necessary to notify the local authorities of the of the claim against the Chinese party and particulars of the court order prior to enforcement. This is because the local authorities generally exercise greater influence over the Chinese party than do the courts and can provide assistance in ordering compliance with the court order. Failure to notify the authorities may be construed as an attempt to bypass their authority in the locality, or a rack of respect for it, and may result in their refusing to intervene or cooperate if the Chinese party chooses to ignore the court order.
Debt settlement options
Where a claim is made against a Chinese seller for damages or compensation on account of failure to deliver, late delivery or the supply of unmerchantable goods, the Chinese seller will often propose by way of settlement the supply of further quantities of the goods at a discounted price. In the past, most foreign buyers or sellers who were anxious to continue their business relationships with the Chinese party or with the PRC would often opt to settle for such terms. Their reasoning was that such an alternative was preferable to initiating arbitration or court proceedings which, as well as being protracted and costly, ran the risk of severely damaging the relationship between the parties.
Guarantees under loan agreements
A word of caution should be offered about the legal status of guarantees which often form part of such deals. Under PRC law, a guarantee can only be a secondary obligation and the creditor enjoys no greater rights against the guarantor than it does against the original debtor. Furthermore, under Chinese law a guarantor will be released from its obligations if any modifications to the terms and conditions of the contract under the
guarantee are made without the consent of the guarantor. As the terms of the underlying contract under a guarantee are often subject to some form of variation or modification to suit the nature of the project as it progresses, it is almost inevitable that the guarantor will use this legal provision to try to find grounds to be released from its obligations if the debtor defaults on a loan.
In practice, with guarantee cases, if a debtor defaults on a loan, rather than taking action against the guarantor, the loan repayment schedule is restructured for the benefit of the debtor. This is especially so if a syndicate involving a Chinese lender is involved in the loan. Another possible solution is to use standby letters of credit or bank guarantees of the first demand without proof variety which oblige the guarantor to pay on written demand from the beneficiary or against presentation of a document without the need to prove the nature or extent of any default by the principal debtor.
Foreign parties who wish to avoid resolving their disputes in the PRC by instituting proceedings abroad are faced with two basic problems. One is the highly complicated and time-consuming service of process through diplomatic channels, and the second is the inability of successful claimants to enforce their foreign judgements in the PRC.
The Civil Procedure Law of the PRC does provide for other easier forms of service of process. However, whether such forms of service are valid will depend on the foreign court. Even if service of process has been validly effected, a foreign claimant will still face difficulty in enforcing the foreign judgement. An application must be made to the PRC court which will examine the judgement for compliance with relevant international treaties and reciprocal treatment. Only if the foreign judgements do not infringe the basic principles of PRC law, state sovereignty and security, or the public interest, will they be enforced. Most foreign judgements are enforceable if there exists a judicial assistance treaty between China and the foreign country. Unfortunately China has entered into very few judicial assistance treaties, and at present they exist only with France, Poland and Belgium.
It is hoped the PRC will take active steps to remedy the anomalous position regarding Hong Kong, which will in 1997 become a special administrative region (SAR). At the present moment court judgements obtained in Hong Kong or the PRC are not mutually recognised and therefore not enforceable. There is an obvious and urgent need for both the Hong Kong and the Chinese authorities to work together in this direction.
While litigation in the PRC is still far from international standards, the Chinese authorities have begun in earnest to develop and improve the court system. In 1988 experimental courts were set up in the special economic zones to meet the PRC's rapid economic growth, and recently the Intermediate People's Court divided its criminal court into two, one to hear criminal offences such as murder and robbery and the other economic offences of a criminal nature such as fraud and extortion.
In recent months the central authorities have also been operating a scheme designed to educate the general populace about the importance of laws in the process of bringing about Deng Xiao Peng's 'Socialism with Chinese Characteristics'. Such a campaign has even included a message about Communist Party officials not being above the law. Witness the latest film by the mainland's most famous director Zhang Yi Mou, "Qiu Ju Goes to Court", where a peasant woman successfully sues the village leader and local Communist Party Secretary for assaulting her husband. Such a scheme has been applauded by foreign observers and before long should bear fruit for the benefit of foreigners and Chinese citizens alike. *
Lovell White Durrant, Office 5D CITIC Building, 19 Jianguomenwat Dajie, Beijing 100004. Telephone: 506 3588, 500 2255 ext 568/3569. Fax: 500 1972.