January 2008

International Arbitration as a Means for Dispute Resolution With Chinese Exporters

Holland & Knight Newsletter
A Andre Hendrick

With U.S. public perception of Chinese goods deteriorating at an alarming rate, and recalls of allegedly defective Chinese goods forcing U.S. importers like Foreign Tire Services out of business and into bankruptcy, many importers are weighing the risks associated with importing goods from China.1

Among the top concerns for U.S. companies when importing goods from China is the threat of a recall. As it stands, the National Highway Traffic Safety Administration (NHTSA), the Food and Drug Administration (FDA) and the Consumer Product Safety Commission (CPSC) lack the authority to force Chinese companies to recall such products, and the recall burden falls squarely on American companies.2 During the last eight months alone, Fisher Price and Mattel have recalled millions of allegedly defective products that were imported from China. A U.S. importer of Chinese products has little recourse when confronting such a situation. Obtaining a U.S. court judgment against a Chinese supplier has limited or no practical value unless the Chinese supplier has significant assets in the United States, because the U.S. and China do not have a mutual judicial enforcement treaty and Chinese courts generally do not enforce judgments from foreign courts. Consequently, what options are available to U.S. importers seeking to enforce product liability claims against Chinese suppliers?
Bringing Lawsuits in China
One option is to bring a claim against a Chinese supplier in a People’s Republic of China (PRC) court. This is sometimes the only practical recourse available to a U.S. importer, particularly if the relevant supply or sales contract does not contain an enforceable arbitration clause. However, most foreign companies tend to avoid resorting to litigation in PRC courts due to perceived shortcomings in the level of professionalism, independence and impartiality of the Chinese judicial system. Moreover, the level of damages awarded by PRC courts tends to be significantly less than those customarily awarded by U.S. courts for product liability claims. Faced with these realities, U.S. companies are well advised to seek alternative methods of dispute resolution when dealing with PRC exporters.

Opting for Arbitration

U.S. importers should consider arbitration to be an alternative to litigation in resolving problems that may arise when importing Chinese manufactured goods. As described below, there are three viable options for obtaining an arbitration award that would be enforceable in China, and each has its respective advantages and shortcomings.

Arbitration Outside China: The New York Convention
The first and clearly preferred option for U.S. importers is to provide for U.S. law (more properly, the law of a designated state) to govern the supply or sales contract and for the arbitration to be held outside of China. Both China and the United States are parties to the Convention on the Recognition and Enforcement of Foreign Arbitral Awards, commonly called the New York Convention.3 Article 3 of the New York Convention states that “[e]ach contracting State shall recognize arbitral awards as binding and enforce them in accordance with the rules of procedure of the territory where the award is relied upon…” Theoretically, an arbitral award rendered in any of the more than 130 countries that are parties to the New York Convention must be recognized and enforced by other contracting states. Singapore, London, Paris, Geneva and Stockholm (the latter due to its role as a center for East-West trade and dispute resolution during the Cold War Era) are some of the more popular venues.

Often, the primary obstacle to arbitrating under the New York Convention is persuading the Chinese party to agree to arbitration outside of China. This is sometimes difficult to achieve as a negotiating point, but it is not impossible. It is not uncommon for Chinese parties to argue that Chinese law must be the governing law or that dispute resolution must occur within China with respect to supply or sales contracts. It is important to note, however, that under PRC law governing international sales contracts between a Chinese party and a foreign party, the parties are free to choose non-PRC law as the law governing the contract and to provide for arbitration outside of China as the forum for dispute resolution.

Once a company has received an arbitral award from a jurisdiction that is a party to the New York Convention, it must apply to the Intermediate People’s Court to have the judgment recognized and enforced.4 After receiving the application, the Intermediate People’s Court is required under Article 267 of the Civil Procedure Law to recognize and enforce the award.5 However, the award can be challenged on procedural grounds, such as the validity of the arbitration clause, lack of fair opportunity to be heard6 and sufficiency of notice. For example, in Guanghope v. Mirant,7 the Chinese Supreme People’s Court found that an arbitration clause was invalid because the parties had not expressly identified an “arbitral commission.”

Companies trying to enforce arbitral awards in China should be aware that there is a significant loophole under the New York Convention. Article V(2)(b) of the Convention8 allows Chinese courts to refuse to enforce a judgment based on the “public policy of the forum.” PRC courts have historically interpreted this language very broadly and have allegedly succumbed to pressure exerted on them by local interests, local businesses and governmental bodies. This was a particular problem in the 1990s, when there were instances of PRC courts refusing to enforce foreign arbitral awards for reasons that seemed to conflict with China’s treaty commitments under the New York Convention. In the face of growing international concern, the PRC Supreme People’s Court addressed this issue in a circular issued in 1995 that required lower PRC courts to seek the approval of the Supreme People’s Court, China’s highest court, before refusing enforcement of a foreign arbitral award from a New York Convention member jurisdiction. Since the issuance of the 1995 Supreme Court circular, PRC courts have generally enforced arbitral awards obtained in New York Convention member states.

Arbitration in Hong Kong
The second option a U.S. importer may consider is arbitration in Hong Kong. Because Hong Kong is part of China, a Hong Kong arbitral award would not be entitled to the benefits of the New York Convention. However, the PRC central government and the government of the Hong Kong Special Administrative Region have entered into an arrangement that provides for the enforcement in China of arbitral awards obtained in Hong Kong.9 One advantage in selecting Hong Kong as the forum for arbitration is that Chinese parties are typically more receptive to such an arrangement than they might otherwise be to arbitration forums outside of Mainland China. Furthermore, there may be situations where Hong Kong will be perceived as a reasonable compromise to arbitration in Mainland China.

Arbitration in China – CIETAC

The third option is to provide for arbitration in China itself. Although it is now possible for local PRC arbitration commissions to handle foreign-related arbitrations, the China International Economic and Trade Arbitration Committee, or CIETAC, is still probably the best known. Established in 1956 and originally named the Foreign Trade Commission, CIETAC includes more than 1,000 arbitrators, approximately 25 percent of whom are non-residents of mainland China.10 CIETAC now handles more international arbitration cases than any other arbitral body and offers MED-ARB (mediation-arbitration) as an alternative to traditional arbitration.11 Typically, Chinese parties prefer CIETAC arbitration – among other reasons, because they perceive it as being less expensive than offshore arbitration. While this might be true for arbitrations where relatively small sums are at stake, CIETAC’s fee scale can result in it being a relatively costly alternative when large sums are involved. The CIETAC fee scale provides for fees equal to RMB 610,000 plus 0.5 percent of the amount in controversy for arbitrations with an amount in controversy of RMB 50 million or greater (approximately $6.9 million at current exchange rates). This fixed scale can result in higher fees than might otherwise be the case if other international arbitration organizations are used where the amount in controversy is large.12 For example, the ICC also has a fee scale but caps its fees at $75,800, regardless of the amount in dispute.

Foreign parties should exercise care when drafting a CIETAC arbitration clause, both to ensure its enforceability and to avoid certain perceived institutional biases.13 For example, if the clause states that disputes may be submitted either to an arbitration commission or to litigation, or if it only gives one party the right to choose arbitration, Chinese courts will deem it invalid.14 Additionally, there are certain requirements that, if omitted, will void an arbitration clause. Most importantly, an arbitration clause must state that all disputes will be submitted to CIETAC. Furthermore, the arbitration clause should include the language to be used during the arbitration, the number of arbitrators, the nationality of the presiding arbitrator and the venue for the arbitration. Parties can provide for the language that will be used during the arbitration, but in the absence of a written agreement, the default language is Chinese. Similarly, if the parties don’t agree on the nationality of the presiding arbitrator, he or she will be selected by CIETAC and will most likely be Chinese. And although Article 31 of the CIETAC Arbitration Rules provides that the parties can agree on the place of arbitration, it is unclear whether that extends outside of mainland China. To date, there have been a limited number of CIETAC arbitrations held in Hong Kong, but there are different standards of judicial review for arbitral awards obtained under CIETAC auspices and for Hong Kong awards. As a result, and due to the potential for confusion arising therefrom, parties may wish to avoid Hong Kong as a venue for CIETAC arbitrations.

Despite many positive changes that have increased CIETAC’s flexibility, it still has a reputation for being slow and offering fees that are so low that many foreign arbitrators, even those who are on the CIETAC list of arbitrators, are unwilling to serve. Furthermore, even when foreign companies have used CIETAC to arbitrate its disputes, there have still been problems with enforcement. As stated above, Article 260 of the Chinese Civil Procedure Law allows the courts to refuse to enforce a judgment or award if it would be detrimental to the social or public interests of the community.15

While there are uncertainties when dealing with a Chinese manufacturer, one thing is clear: the process has become more expensive. As ostensible manufacturers, U.S. companies cannot shift liability to the Chinese manufacturer despite a low level of involvement, lack of control over the Chinese company or a total lack of negligence on their part. Accordingly, companies dealing with China should seriously consider incorporating a carefully drafted arbitration clause into their contracts. 

1 Mina Kimes, Is Sourcing in China Worth It? Businesses Weigh the Costs and Benefits, in the Wake of Product Recalls and Bans. CNNMONEY.COM, Aug. 3, 2007, http://money.cnn.com/2007/07/26/magazines/fsb/china_sourcing.fsb/index.htm.

2 “Liability attaches even when such non-manufacturing sellers or distributors do not themselves render the products defective and regardless whether they are in a position to prevent defects from occurring.” Restatement Third, Torts: Products Liability & 1 Liability of Commercial Seller or Distributor for Harm Caused by Defective Products. Comment e – Non-manufacturing sellers or distributors of products.

3 Convention on the Recognition and Enforcement of Foreign Arbitral Awards Art. 3, June 10, 1958, 21 U.S.T. 2517, 330 U.N.T.S. 3.

4 See Xiaowen Qui, Enforcing Arbitral Awards Involving Foreign Parties: A Comparison of the United States and China, 11 Am. Rev. Int’l Arb. 607, 626 (2000). It is important that all applications be submitted within the limitation period prescribed by the 1991 Civil Procedure Law.

5 Article 267 of the Civil Procedure Law provides that Chinese courts shall enforce foreign arbitral awards in accordance with any international treaty to which China is a party or on the basic of reciprocity. The People’s Supreme Court has published provisions that address specific procedures to be followed when seeking the enforcement of foreign arbitral awards.

6 Convention on the Recognition and Enforcement of Foreign Arbitral Awards Art. V(1)(b), June 10, 1958, 21 U.S.T. 2517, 330 U.N.T.S. 3. Despite its broad language, this refusal provision has been interpreted similarly to a denial of procedural due process and has been construed narrowly by the courts. See Parsons & Whittemore Overseas Co. v. Societe Generale de L’Industrie du Papier, 508 F.2d 969 (2d Cir. 1974); Biotronik Mess-und Therapiegeratete GmbH & Co. v. Medford Medical Instrument Co., 415 F.Supp, 133, 140 (D.N.J. 1976); Laminoirs-Trefileries-Cableries de Lens, S.A. v. Southwire Co., 484 F.Supp. 1063 (N.D.Ga. 1980).

7 Guanghope v. Mirant, Civil Ruling of the Supreme People’s Court, (2002) Min Si Zhong Zi No. 29 [not published]. For facts and comments, see Paul Donovan Reynolds & Song Yue, The PRC Supreme People’s Court on the Validity of an Arbitration Clause, 142 J. of the Chartered Institute of Arbitrators 70 (2004). The case is also referenced in: Joseph T. McLaughlin, Kathleen M. Scanlon, & Catherine X. Pan, Planning for Commercial Dispute Resolution in Mainland China, 16 Am. Rev. Int’l Arb. 133, 144 (2005). 

8 Convention on the Recognition and Enforcement of Foreign Arbitral Awards Art. V(2)(b), June 10, 1958, 21 U.S.T. 2517, 330 U.N.T.S. 3.

9 “Arrangement Concerning Mutual Enforcement of Arbitral Awards between the Mainland and the Hong Kong Special Administrative Region,” effective on February 1, 2000. Note that Hong Kong maintains a legal system separate from that of the People’s Republic of China until 2047.
10 See Melanie Ries & Bryant Woo, International Arbitration in Japan & China, 61-JAN Disp. Resol. J. 63 (2007).

11 See generally, Wang Sheng Chang, Resolving Disputes Through Conciliation and Arbitration in the Mainland China, 2 Ann.2000 ATLA CLE 1643 (2000).

12 See Rules of Arbitration of the International Chamber of Commerce, Appendix III, Art. IV (January 1998). These rules can be found online at http://www.jus.uio.no/lm/icc.arbitration.rules.1998/app3_04.html.

13 See Jerome A. Cohen, “Time to Fix China’s Arbitration,” Far Eastern Economic Review Jan/Feb 2005.

14 See Joseph T. McLaughlin, Kathleen M. Scanlon, & Catherine X. Pan, Planning for Commercial Dispute Resolution in Mainland China, 16 Am. Rev. Int’l Arb. 133, 141 (2005).

15 See Rebecca Fett, Forum Selection for Resolution of Foreign Investment Disputes in China, 62-APR Disp. Resol. J. 73, 78 (2007).

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