A foreign company that signs a contract with a Chinese counterparty needs a dispute resolution clause that works in practice, not just in theory. The choice of governing law and the choice of dispute resolution forum determine whether a contract dispute can be resolved efficiently, whether the judgment or award can be enforced, and ultimately whether the contract rights are worth the paper they’re written on.
Too many foreign companies default to their home country’s law and their home country’s courts, only to discover that a judgment from an English or American court is not enforceable in China and that the Chinese counterparty’s assets are all in China. Here’s how to get the dispute resolution clause right.
Governing Law: Chinese Law vs Foreign Law
The governing law of a contract is the law that the court or the arbitration tribunal applies to interpret the contract and to determine the rights and obligations of the parties. The parties are free to choose the governing law in most international commercial contracts, subject to the mandatory rules of the forum and the public policy of the jurisdictions involved.
For a contract with a Chinese counterparty that’s performed in China — a manufacturing agreement, a distribution agreement, a service agreement where the services are performed in China — Chinese law is the natural governing law. The contract is performed in China, the counterparty is Chinese, the assets are in China, and the enforcement will be in China. Applying a foreign law to a contract that’s entirely connected to China creates practical problems — the court or the tribunal must receive expert evidence on the foreign law, the foreign law concepts must be translated into Chinese legal concepts, and the counterparty can argue that the foreign law clause should not be enforced because the contract has no connection to the foreign jurisdiction.
Chinese courts apply the principle of the closest connection — if the parties haven’t chosen a governing law, or if the choice of law is disputed, the court applies the law of the jurisdiction that has the closest connection to the contract. A contract that’s performed entirely in China by a Chinese company has the closest connection to China, and a Chinese court may apply Chinese law regardless of the foreign law clause.
For a contract where the foreign company’s performance is significant — a technology license agreement where the foreign company provides technology and support from abroad — the contract has connections to both jurisdictions, and the choice of foreign law is more defensible. But even in this case, the practical enforcement of a foreign law judgment in China is challenging, and the foreign company should consider whether the foreign law choice is worth the enforcement difficulty.
The practical choice for most contracts with Chinese counterparties is Chinese law, with a dispute resolution clause that provides for arbitration rather than litigation. Chinese law is the law that the Chinese counterparty understands, the law that the Chinese arbitration tribunal applies comfortably, and the law that’s enforced against the Chinese counterparty’s assets.
Litigation vs Arbitration
Litigation in a Chinese court is the default dispute resolution mechanism for a contract that’s governed by Chinese law and that doesn’t have an arbitration clause. The Chinese court system is hierarchical — the basic people’s court, the intermediate people’s court, the high people’s court, and the Supreme People’s Court — and the parties can appeal a first-instance judgment to the next higher court.
Litigation in a Chinese court has several advantages for a foreign company. The court fees are low — the filing fee is a percentage of the amount in dispute, typically 0.5% to 2.5% — and the court process is relatively fast — a first-instance judgment is typically issued within six to twelve months of filing. The court has the authority to grant interim measures — asset preservation orders that freeze the defendant’s assets before the judgment is issued — and the interim measures are enforced by the court’s enforcement department.
But litigation in a Chinese court has significant limitations for a foreign company. The judgment is in Chinese, and the foreign company must translate the judgment into its own language and must understand the Chinese legal reasoning. The court process is document-based — the parties submit written statements and written evidence, and the oral hearing is a supplement to the written record, not the primary forum for presenting the case. A foreign company that’s used to common law litigation — oral advocacy, cross-examination, discovery — will find the Chinese court process unfamiliar and constraining.
More importantly, a Chinese court judgment is not automatically enforceable outside China. The foreign company must bring a separate proceeding in its home country’s court to enforce the Chinese judgment, and the home country’s court applies its own rules on the recognition and enforcement of foreign judgments. A Chinese judgment that’s recognized and enforced in the United Kingdom under the bilateral enforcement arrangement between China and the UK is enforceable. A Chinese judgment that’s brought to a country without an enforcement arrangement may not be enforceable at all.
Arbitration is the preferred dispute resolution mechanism for international commercial contracts in China. The arbitration award is final and binding — there’s no appeal from an arbitration award to a court — and the award is enforceable internationally under the Convention on the Recognition and Enforcement of Foreign Arbitral Awards — the New York Convention — to which China is a party. An arbitration award rendered in China by a Chinese arbitration institution is enforceable in more than 170 countries under the New York Convention, and an arbitration award rendered outside China by a non-Chinese arbitration institution is enforceable in China under the same Convention.
The New York Convention is the reason arbitration is the standard dispute resolution mechanism for international commercial contracts. A Chinese court judgment may not be enforceable in the foreign company’s home country, but an arbitration award is enforceable — the Convention provides a uniform framework for recognition and enforcement that the contracting states are required to apply. A foreign company that obtains an arbitration award against a Chinese counterparty can enforce the award against the counterparty’s assets in China and against the counterparty’s assets in other Convention countries.
Choosing the Arbitration Institution
The arbitration clause must specify the arbitration institution — ad hoc arbitration is not generally recognized in China — and the arbitration rules that will apply. The choice of the arbitration institution affects the cost, the speed, the quality of the arbitrators, and the enforceability of the award.
The China International Economic and Trade Arbitration Commission — CIETAC — is the leading Chinese arbitration institution for international commercial disputes. CIETAC has a panel of arbitrators that includes Chinese and foreign arbitration specialists, and its rules are modeled on the UNCITRAL Arbitration Rules. A CIETAC arbitration award is enforceable in China and internationally under the New York Convention, and CIETAC’s reputation for fairness in international disputes is well-established.
The Shanghai International Arbitration Center — SHIAC — is a newer institution that’s increasingly used for international commercial disputes, particularly disputes connected to Shanghai and the Yangtze River Delta. SHIAC’s rules are similar to CIETAC’s, and its panel includes international arbitrators.
The Hong Kong International Arbitration Centre — HKIAC — and the Singapore International Arbitration Centre — SIAC — are the leading international arbitration institutions in Asia, and they’re widely used for China-related disputes. A HKIAC or SIAC arbitration award is enforceable in China under the New York Convention and under the special arrangements between mainland China and Hong Kong and between mainland China and Singapore. The HKIAC and SIAC arbitrations are more expensive than CIETAC arbitrations — the arbitrators’ fees and the institutional fees are higher — but the quality of the arbitration and the enforceability of the award justify the cost for significant disputes.
The arbitration clause should specify the seat of arbitration — the legal jurisdiction where the arbitration is deemed to take place. The seat determines the procedural law that applies to the arbitration and the court that has supervisory jurisdiction over the arbitration. A CIETAC arbitration with the seat in Beijing is governed by Chinese arbitration law, and the Chinese courts have supervisory jurisdiction. A HKIAC arbitration with the seat in Hong Kong is governed by Hong Kong arbitration law, and the Hong Kong courts have supervisory jurisdiction.
The arbitration clause should also specify the language of the arbitration. A Chinese-language arbitration is cheaper and faster — the documents and the testimony don’t need to be translated — but the foreign company’s management can’t follow the proceedings without translation. An English-language arbitration is more accessible to the foreign company, but the Chinese-language documents — the contract, the correspondence, the financial records — must be translated, and the translation cost is a significant component of the arbitration cost.
The Enforcement Reality
The best dispute resolution clause in the world is only as good as the ability to enforce the judgment or the award against the counterparty’s assets. A foreign company that wins an arbitration award against a Chinese counterparty must enforce the award against the counterparty’s assets in China — the counterparty’s bank accounts, the counterparty’s real estate, the counterparty’s receivables — through the Chinese court’s enforcement procedures.
The enforcement process starts with an application to the intermediate people’s court in the jurisdiction where the counterparty is located or where the counterparty’s assets are located. The court reviews the arbitration award for compliance with the New York Convention and for the absence of grounds for refusing enforcement — the counterparty was not given proper notice of the arbitration, the arbitration exceeded the scope of the arbitration agreement, the composition of the tribunal was not in accordance with the arbitration agreement, or the enforcement would be contrary to Chinese public policy.
The court’s review is not a review of the merits — the court doesn’t re-hear the case — and the grounds for refusing enforcement are narrow. The Chinese courts have generally been supportive of the enforcement of international arbitration awards, and the enforcement rate is high for awards that comply with the procedural requirements.
But the enforcement is only as effective as the counterparty’s assets. A counterparty that has transferred its assets before the award is rendered — or that has no assets in its own name — is a judgment-proof defendant. The foreign company should consider interim measures — an asset preservation order from the court or an emergency arbitrator order from the arbitration institution — at the start of the dispute to prevent the counterparty from dissipating its assets during the arbitration.
