Question: What are some best practices for foreign companies and funds looking to manage disputes and resolve conflicts in business relationships in China?

Robert Woll

Before signing any commercial agreements with PRC parties, a foreign company or fund should anticipate and plan for potential disputes. Risk assessment begins with a review of what has gone wrong in preceding deals and an analysis of what can go wrong in the deal under consideration. The foreign investor’s immediate task is to understand, through extensive due diligence, the investor’s prospective PRC counterparties and the commercial context in which they operate. The distinctive contours of capitalism in China require a broad investigation of the Chinese business and its ownership, whether it be an entrepreneurial start-up, a real estate developer, or a large non-state conglomerate. A thorough analysis will require an understanding of, among other things, the broader political economy in which the business operates, interactions between the business and political elites, and the history of the business and the founders or controlling shareholders. The investor should undertake the broadest possible due diligence exercise, covering commercial and financial issues, management background, corporate structure, assets, valuation, and policy and regulatory risks; this in turn should determine the key rights and liabilities to be covered by the applicable agreements.

In addition, the transaction documents should include the best available enforcement mechanisms, which the investor’s team may test using a “tabletop exercise”. Dispute resolution clauses and governing law clauses are important tools; one should never dismiss them as “boilerplate”. Arbitration seated in Hong Kong is usually best suited to resolving disputes between foreign investors and PRC counterparties. Mainland courts will enforce Hong Kong arbitral awards under the “2000 Arrangement” for mutual enforcement of arbitral awards. Moreover, foreign parties can now gain access to Mainland courts for interim relief in Hong Kong-seated arbitrations under the 2019 “PRC-HK Arrangement on Interim Measures”. This arrangement enables foreign parties to apply to Mainland courts to secure claims pending final determination (e.g., by freezing bank accounts). Practitioners see it as a critical mechanism in preventing the dissipation of assets and preserving evidence. Thus, in most transactions with PRC parties, a foreign investor should ensure that the suite of transaction documents incorporates consistent arbitration clauses specifying Hong Kong as the seat of arbitration. If a dispute arises, the investor must be prepared to move decisively to enforce its remedies: 当机立断.

Robert Woll is a partner in the Hong Kong office of Mayer Brown LLP with more than 25 years of experience advising corporate and private equity investors on China transactions and market access issues. He has worked on a wide range of financings, acquisitions and joint ventures involving Chinese parties, including forming and advising Asian private equity funds.

Daniel Philip Senger 盛斐德

Westerners too often dismiss nuance when doing deals in China or, even worse, are not sufficiently aware of what is happening, due to an overreliance on their value system. Failing to reconcile ethical issues or Lunlixue 伦理学 can easily lead to conflict in what should be a practical and commercially successful deal. Since a core tenet of Chinese thinking is to avoid conflict, it is best to start with some fundamentals and an understanding of a holistic approach or Zhengti Guannian 整体概念 whereby it is typical to discuss multiple issues simultaneously, emphasizing the whole deal over individual elements. No term is settled until everything is agreed and this can cause variability throughout the process and be the greatest source of conflict. Westerners need to appreciate that the Chinese language is composed of characters based on concepts and not an alphabetical sequence. It is also not productive to think of negotiations as a confrontational “us” and “them” stance but rather interpersonal harmony or Renji Hexie 人际和谐: so avoid being rude should a conflict arise.

So how does this relate to practical deal-making? For starters, the typical term sheet process where both parties agree on LOI/MOUs based on definitive terms does not always work well in China and can often cause delays and uncertainty. Other delays can be due to thrift or Jie Jian 节俭 by not committing to extraordinary legal expenses, greatly frustrating Westerners. Once terms are “agreed” it is best to anticipate changes, while not relenting on the core proposition. This seemingly Alice in Wonderland part of the process requires hard work, patience and endurance or Chiku Nailao 吃苦耐劳 while also avoiding loss of “face” or Mianzi 面子 where broken promises, verbal and written, displays of anger or other aggressions can be deal killers. Drafting terms into a definitive agreement, where Westerners will deepen through legal sophistication, the Chinese will sometimes broaden by adding new terms, creating conflict with the Westerners screaming “re-trade”, an unpleasant and emotional response that can also kill a deal. Bankers don’t need to become anthropologists, cognitive scientists or even linguistic specialists. But some appreciation and respect of Chinese thinking will go a long way in managing conflicts.

Dan is a Partner at CDI Global China – Wilton Partners, a boutique M&A firm, and 35-year investment banking veteran, based in Shanghai. He has been a “China Hand” for 16-years starting with restructuring of the equities business for the former Beijing Securities, now UBS Securities. Dan previously worked in New York, Chicago, London, Tokyo, and Hong Kong.

Phillip Georgiou

Around 10 years ago I was co-counselling with US lawyers to assist a client in negotiations of a supply contract with a Chinese manufacturer based in Shenzhen. The negotiations were unsurprisingly tedious and difficult. A particular area of tension involved issues of governing law and dispute resolution. My client wanted Texas law and the state courts (because that’s where they were from), and the Chinese side wanted Chinese law and local courts or CIETAC arbitration (because that’s where they were from). The stock standard—and not always well thought out—solution to this issue is to agree on the laws of a neutral jurisdiction—like Hong Kong or Singapore—using arbitration under the rules of an established institution (HKIAC, SIAC, ICC, etc.). Most of the time this is a sensible solution. But there are times when it’s not if the foreign party wants to obtain remedies that have actual bite against the Chinese counterparty. As such, the issues surrounding rights and risks (commercial, legal, regulatory, reputational, etc.) should be carefully analyzed and weighed before outright rejecting Chinese law and courts/arbitration for no other reason other than a party and its lawyers not understanding or trusting the system.

On this occasion I explained to the client and co-counsel that the only law and courts that could provide any meaningful protection and enforcement of key rights and risks would be the local Chinese courts (and the appellate courts) particularly in relation to the client’s trade secrets and intellectual property rights. To put it mildly, they thought I had lost my mind—or that my mind had been ‘manipulated’ after being in China for too long! Instead, something close to the usual compromise was reached with Texas as the governing law (the client saw this as a major victory in the negotiation) and disputes settled by arbitration in Hong Kong. The postscript to this affair was that within a few months of starting the supply arrangement the client discovered that the Chinese manufacturer ripped off its trade secrets. Arbitrating in Hong Kong under Texas law would not provide a solution anytime soon. And Chinese courts could not be accessed because the parties agreed to Texas law and Hong Kong arbitration. The client was not happy. But that’s another story.

Phillip is an international arbitration and litigation lawyer who has been based in Hong Kong since 2000. His clients are primarily in the energy, infrastructure, building and technology industries. He started his own law firm with two partners in November 2017 after being a partner at international law firms for a number of years. Georgiou Payne Stewien LLP is one of Hong Kong’s few boutique firms with a focus on international arbitration. 

Kalavinka View

The resolution of disputes in Imperial China has a long history and included legal elements familiar today. However, there were significant differences depending on the time period, nature of the dispute, and other practical and political concerns. Disputes were generally expected to be settled within communities and elevating them to the level of a district magistrate was not for trivial matters. Resources were limited and courts could easily be overwhelmed if every petty grievance required official adjudication. A party to a dispute using a legal advocate was not common as these sorts of intermediaries were held in particularly low esteem. Judges were the ultimate authority and made decisions based not simply on the merits of a case but also had to consider other factors, such as Confucian principles, which gave precedence to the “rule of man” over the “rule of law”. For example, a son reporting a crime involving his father could run afoul of filial traditions where a son’s duty to his father is paramount. Practically speaking judges also had to be mindful that decisions must be accepted back in the village from where the dispute originated. A decision too much in favor of one party could lead to a blood feud resulting in conflict over generations. A judge, therefore, might ensure both parties win a little and lose a little thus reducing the likelihood of escalation.

In modern times, a local judge in China could find himself in a situation where a foreign party is pressing him to find against a local company that has breached a contract or infringed intellectual property. To Western observers, it might be an open and shut case, but the foreign party is from outside and has no roots in the community while the local party may be a homegrown champion and could suffer if the judge finds against them. An angry local company could make the judge’s life more difficult if his decision leads to job losses, political complaints, or loan defaults. Fortunately, times are changing and China’s legal system continues to evolve. Judges are better educated and specialized courts have appeared to handle complicated matters like bankruptcy. Nevertheless, it is useful to keep in mind that the pursuit of justice in China often needs to balance competing factors and conflicting interests.