Hong Kong Arbitration for Chinese Contracts: Why Context Matters

Approximately once a month, a lawyer suddenly writes to me with a 'little question' about a draft contract. Without a doubt, the 'little question' that I (as well as the rest of the Chinese lawyers in my firm) receive most frequently is whether Hong Kong arbitration would be suitable for a particular type of contract. I usually respond to this question by saying that to confirm or disagree with the idea of choosing arbitration in Hong Kong, I would need to review the entire contract and have more information. Half the time, the lawyer responds by asking: What kind of information do you need? Then I reply by saying that when the lawyers in my firm try to determine the best site (location) and method (arbitration versus litigation) to include in an international contract, we usually consider the following criteria:

1. Who the parties are.
2. Where the different parties are located.
3. The applicable law.
4. Language of the contract.
5. Client's objectives. Money? Intellectual property protection? Anything else?
6. The likelihood of the client breaching the contract compared to the likelihood of the other party doing so.
7. The type of disputes that may arise.
8. The language spoken by the client and the other party.
9. The client's assets compared to the other party's assets.
10. The need to know the opposing party's claims in the event of litigation.
11. The need to bring third parties to the trial (e.g. witnesses or experts).
12. The complexity or simplicity of the disputes that may arise.
13. Appeal of cassation.
14. Confidentiality
15. Concern about the speed of conflict resolution.
16. Enforcement of resolutions.

Contracts cannot be reviewed without any context.

Let me give you an example.

A long time ago, a major industrial company hired me to help with an international product recall. The company's product had a defective and potentially dangerous part introduced by one of its smaller providers. The first thing I thought was that my client would have to claim the cost of the product recall from this small supplier and its insurer. To that end, I requested a copy of the supply contract between my client and its supplier.

Unfortunately, the contract protected this small company in all these aspects. I was surprised because, generally, large companies impose the contract terms on their smaller suppliers. I explained to my contact at the company (a person with a strong international profile but definitely not a lawyer) the reasons why their company had such an unfavourable contract, which left them very surprised. They told me that their company thought it was a very well-drafted contract and that they had just used it with all their new suppliers. I commented that it was one of the best-drafted contracts I had ever seen and that was part of the problem; it was incredibly well-drafted but entirely in favour of the small supplier, rather than my client, who was the recipient of the parts. Then, I asked who had drafted that contract (I was very curious because I thought my firm was the only one handling this company's international contracts). Their response was that no lawyer had drafted it, but a senior production chain manager without a legal background. He had seen that contract when their major supplier asked them to sign it and simply thought it would be a great contract because it came from such a company. My response was that yes, it was a great contract, but a great contract for suppliers, NOT for the buyers of the parts. I added that when that company had asked them to sign the contract, it was acting as a supplier. The client ended up paying for all the costs of the product recall.
What would have happened if a lawyer had reviewed the contract for an hour or two without knowing the contract's context? The lawyer would have read it, stated that it was a great contract and saw nothing that needed to be changed.

Similarly, context can be essential in the case of clauses relating to dispute resolution.

Over the years, our Chinese lawyers have had to handle the situations described below. The facts have been modified to prevent anyone from recognising themselves in a particular matter:

1. Tokyo jurisdiction.

An American company came to see us after learning that Chinese manufacturers had started to produce and sell the new version of their main product. I read a provision in the contract that expressly stated that future versions of the main product would belong to the Chinese company and mentioned it to the potential client. The potential client then told me that when they complained to the Chinese manufacturer about the intellectual property theft, the Chinese manufacturer cited the same provision and said that the product now belonged to them.
As if that wasn't enough, the contract stipulated that all disputes would be resolved in the Tokyo Supreme Court. I asked my potential client why the Tokyo Supreme Court had been chosen as the place of arbitration for any dispute. Their response was as follows:

The Chinese company requested that all disputes be resolved in Beijing, and my lawyer said we wouldn't stand a chance there so we refused. The Chinese company then proposed arbitration in Singapore or Hong Kong. My lawyer insisted on the Tokyo Supreme Court because it was the opposite (both in terms of the type of arbitration—arbitration versus litigation—and the location) of what the other party wanted.

Wow. Then I explained that no country apart from China would accept a lawsuit in its courts that had no connection to the country. As the process would involve an American company litigating against a Chinese company over an issue that has no relevance to Japan, there is no way a Japanese court could afford to be a public, free (or almost free) court for this type of dispute. I didn't bother to tell them that there was no such thing as the Tokyo Supreme Court, or that, even if the American company had sued in Tokyo and managed to have the trial held (which would never have happened) and won, no Chinese court would have enforced the judgment because the Tokyo court has no jurisdiction over such a matter in China. The American company might be able to convince a Chinese court to accept the case. However, I doubt it, simply because in China there is a strong tendency to enforce contracts regardless of how foolish they may be. Most courts in China would have rejected the case because the lawsuit was not filed in Tokyo, as stipulated in the contract.

2. Toronto jurisdiction.

This is one of my favourites. I have received some angry emails telling me more or less the following:

I usually read your blog very carefully and you were wrong about Canada, so I wonder how many other things you are wrong about. I read one of your blogs where you propose Canada for dispute resolution because Chinese companies will usually agree to it. Well, the Chinese companies we worked with agreed to that, but when we had to resort to Canadian justice, the Canadian lawyers told us we couldn't.

In further communications, I learned that this company had thought—based on my praise for the advantages of proposing Canada as an arbitration location—that it could establish the Toronto court as the jurisdiction for disputes between their American company and their Chinese counterpart. Just like in the previous example, there would have been no way for a Toronto court to accept mediating in the dispute of two foreign companies over an issue that has no connection to Canada. Fortunately, the Canadian lawyer the company had consulted knew this would be the case and chose not to waste the American company's money and time seeking the jurisdiction of the Toronto courts. I had to point out that we always emphasise that dispute resolution always depends on each situation, and that there is a big difference between what can be done in arbitration and what can be done in a foreign court. I didn't point out—but should have—the disclaimer agreement (in English) that you will find here on our website:

The content of the China Law Blog is for educational purposes and aims to provide general information and understanding of Chinese law. It is not intended to offer specific legal advice... The China Law Blog should not be used as a substitute for competent legal advice from a licensed attorney.

3. Mixed jurisdiction.

This occurs quite frequently. The contract states that the Chinese company must sue the American company in an American court and the American company must sue the Chinese company in a Chinese court. The thinking behind it is logical, but its execution is so flawed that we avoid this type of clause like the plague.

These clauses seem sensible because this type of mixed jurisdiction works in favour of American companies. If the Chinese company sues the American company for damages, it will have to sue the American company in a American court where it will get a fair trial. On the other hand, the American company can sue the Chinese company in a Chinese court which is (90% of the time) exactly where American companies should want to be. To see that this is the case, check China Enforces United States Judgment: This Changes Pretty Much Nothing and Chinese Contracts: Make Them Enforceable or Don't Bother.

But Chinese courts usually interpret mixed jurisdictions as if there is no jurisdiction in China. For this reason, if you really want your jurisdiction to be in China, the contract should 1) be governed by Chinese law, 2) be written in Chinese and 3) establish China as the exclusive jurisdiction. But this is not a law written in black and white. It is what actually happens on the ground in Chinese courts and is why our Chinese lawyers specify these three points when it is crucial for our client to sue in China.
However, once again, there is no definitive answer to what would be best depending on the specific situation of a company. To properly assess whether you are interested in having your contract governed by Chinese law under a Chinese court (which is what we usually choose), you need to consider what is really important in your situation. Is it more important to have an effective remedy against the Chinese supplier or is it more important to make it as difficult as possible for the Chinese company to sue you? If your primary goal is to enforce the contract against the Chinese company, you are usually interested in exclusive jurisdiction in China and the contract written in Chinese. However, if your primary goal is to prevent the Chinese from suing you, you should consider the exclusive jurisdiction of your home country. If you do choose the latter, you ought to keep in mind that China does not enforce judgments from the US or other countries, so you may never be able to enforce the contract in case of a breach by the other party. Those are the criteria that should help you decide the best jurisdiction for your contract. In any case, the mixed jurisdiction strategy rarely works.

4. Geneva Chamber of Commerce Arbitration.

One of our very good clients presented one of our lawyers specialising in international litigation with a contract requiring arbitration before the 'Geneva Chamber of Commerce Arbitration Institute'. The problem lay in the fact that the Geneva Chamber of Commerce had no Arbitration Institute nor did it handle any international arbitration. Our client hired our law firm to draft a contract, made some subsequent changes and quietly reused it in another deal. The contract my firm had drafted had specified that disputes had to be resolved before the Stockholm Chamber of Commerce Arbitration Institute, a very common solution for resolving conflicts between Russian and American companies. When my client went and signed an agreement with a Spanish company, it refused to resolve any dispute in Stockholm. So my client changed 'Geneva' for 'Stockholm' and left it at that. When it came time for my client to resort to arbitration, we had to make a great effort to determine how to initiate arbitration before a non-existent arbitration body. We ended up deciding that we would have to file the arbitration with the Swiss Arbitration Association in Geneva, the other party challenged our choice. In the end, we managed to proceed with the case there, but only after incurring a great expense to achieve it.

5. South Carolina arbitration in Chinese under British Law.

Yes, you read that right and if it doesn't baffle you, you should read it again. This is my favourite case since I heard about it. This US company asked us for an arbitration clause in Chinese in South Carolina under British Law. When I discussed how much it would cost to bring three Mandarin Chinese mediators to South Carolina (assuming the opposing party didn't request another Chinese dialect) as well as the added costs to research and litigate under British law, the American company wisely decided not to proceed with the case. When I asked the company how they had chosen that peculiar way of resolving conflicts, they explained that they had taken it from one of their previous agreements. I kept quiet, but what I will say now is that such a clause is a great way to discourage arbitration, which can sometimes make sense. However, a clause like this is a disaster if you are the one who needs to sue. Again, context is everything.

Occasionally, when I say that I cannot comment on choosing Hong Kong as a place of arbitration for a specific contract, a lawyer writes to me asking for 'my overall opinion on Hong Kong arbitration'. My response is that there are a lot of excellent mediators in Hong Kong, but arbitrations are generally very expensive and, more importantly, it is rarely the most effective way to enforce contract provisions on the Chinese party.

Honestly, my biggest problem with Hong Kong arbitrations is that most of the time lawyers choose it, not because it is the best way to resolve clients' disputes, but simply because they feel comfortable with it. Indeed, it is a common law system, very similar to that of the United States, Britain, Canada, Australia, and contracts and arbitration can simply be in English. As always, whether this is convenient will depend on the context.