Arbitration: Only The First Step

The Wall Street Journal recently ran an article regarding arbitration in China that described the pros and cons of Western companies submitting to arbitration in China or insisting on arbitration in more neutral venues such as Sweden. 

It’s an excellent article as far as it goes, but what it doesn’t emphasize is that arbitration is only the first step towards resolving legal conflicts in China. Whether a complaint is arbitrated in China or outside the country, the enforcement of any arbitral award that involves China will require a trip to a Chinese court, and that leads to the issue of enforcement.

For better or for worse, I have had a fair amount of experience dealing with the legal system here. Because it such an important issue, I devoted a section to it in my book, Managing the Dragon. Here is what I wrote:

Contrary to what most people think, China does in fact have a body of law and a legal system, including courts and arbitration panels where grievances can be brought.  On December 29, 1993, the National People’s Congress adopted a Company Law, which has been refined over the years and was last modified in 2006. The point is that China already has laws on its books. The difficulty lies in enforcement. 

There’s an International Arbitration Tribunal in Beijing, made up of both Chinese and Western judges, where a contractual dispute with a Chinese partner (or something of that nature) can be taken.  When I was researching the idea of setting up a business in China, I was told that a foreign investor or company could get a fair hearing in arbitration, and that foreign companies had actually prevailed in a majority of the cases.  I have found this to be true.

During the course of our history in China, we’ve had three cases that have gone to arbitration, two that we brought and one that was brought by one of our Chinese partners.  What we didn’t realize at first, but soon learned, is that prevailing in arbitration and getting an arbitral award is actually only the first–and the easier–step in the process.  Having the arbitral award enforced is the second and harder part. Because the job of enforcement reverts to the Chinese court system, the party with better relationships in the area in which the grievance occurred has a substantial advantage.

In the first case, we were new at the game and thought winning in arbitration was everything.  With the Tribunal’s ruling in our hand, we marched off to court in Harbin, the site of the complaint–only to find that our Chinese partner already had the system wired.  Despite several years’ worth of efforts, we got nowhere.

The second case was the one you read about in Chapter 8, where the general manager and our Chinese partner in Anhui had set up a competing factory in violation of a non-compete agreement that he’d signed only months earlier. Right was clearly on our side, and we won in arbitration.  But this time, we lined up support from the local government ahead of time. Armed with a favorable ruling, we asked them to help and got what we wanted in one meeting, presided over by the Party Secretary.  We never even had to go to court.

In the final case, a Chinese partner that we had bought out–with the blessing and encouragement of the local government–made claims against us and took us to arbitration.  (The local government was as frustrated as we were with the actions of the Chinese partner over the years, and believed we could better develop the business if it were wholly-owned.)  The case wasn’t credible and we won rather easily.  At all times, the local government was on our side, so enforcement wasn’t an issue.

My best advice on legal actions is to avoid them at all costs and use them only as a last resort.  The outcome is uncertain, and it’s going to take time–no matter what.  In all three arbitration cases, even though they were open and shut according to any objective legal advisor, it took a year to go through the arbitration process.  If you then have to go to court to enforce the award, you can easily add on a couple of years.  And that whole time, the business that’s the subject of the dispute will be in turmoil, with a cloud of uncertainty hanging over it.  Under these circumstances, given the competitiveness of the Chinese market, final victory will probably be pyrrhic, if it ever comes at all.

Maybe the best reason to avoid legal action in China is that once you go down that path, all other avenues for resolving a dispute are foreclosed.  We had this experience in each case.  Once we had filed arbitration, the local and provincial governments took the position that the matter was being resolved through the legal system, and they didn’t want to interfere.  Once the legal gauntlet is thrown down, you have no choice but to see it through to the end.  In my experience, negotiation is a better way to go.

All that said, the legal system is evolving and improving every day.  With government support and help from international legal experts, the body of law governing commercial transactions and contracts in China is becoming increasingly sophisticated.  It’s no longer so different from the legal frameworks that exist in the most developed countries.  But the key link remains enforcement through the judiciary system, and in this area personal relationships will continue to play an important role for some time to come. 

The article cites a case involving PepsiCo and a Chinese bottler. As part of their joint venture agreement, the parties agreed to resolve any disputes through arbitration in Stockholm. Subsequently, Pepsi took its partner to arbitration in two separate arbitration complaints, alleging several breaches of various contracts and seeking an order terminating the joint venture. The lead judge in the arbitration proceedings was Swedish, and along with the judge selected by Pepsi, sided with Pepsi. Both arbitrations were decided in Pepsi’s favor and were wrapped up in 2005.

Here is where the article makes my point. The last paragraph begins with: “Meanwhile, PepsiCo has yet to recover on the judgment…” Those final words say it all. Arbitration is only the first, and the easiest, of the two steps. Enforcement is where the rubber meets the road in China.

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