China Contracts: To Arbitrate or Not to Arbitrate, That is the Question.

Arbitration clauses fascinate me. I can nearly always judge the legal thought that went into an agreement through its arbitration/litigation provision alone. I usually can instantly tell from just that one provision whether the contract was drafted by a lawyer or not, and if it was drafted by a lawyer, whether that lawyer knows international law. Mistakes in this critical provision are rampant. Huge mistakes.

I got a call a few weeks back from a company wanting to discuss some of the things it could do with its OEM (Original Equipment Manufacturing) contract to protect itself from bad China product. I mentioned that my law firm’s  international lawyers typically put a China litigation provision in those contracts because it makes the contracts less likely to be breached and it makes collecting damages easier. Arbitration sometimes makes sense for these contracts, but not usually. I also mentioned the importance of NNN provisions in such contracts.

A few days later I got an email telling me they are getting closer to needing the OEM Agreement, but in the meantime, they are talking with a potential new supplier and they had required this potential supplier to sign an NDA (Non Disclosure Agreement) in English, with a Hong Kong arbitration provision.

I quickly replied with the following email:

I hate to tell you this, but you made a huge mistake with your NDA agreement. You do NOT want to arbitrate this sort of thing in HK because arbitrators (even in China) have no real power to force parties to do anything. All they can do is issue a monetary award. I hate to be so harsh, but your agreement is very likely of almost no value at all. You need one in Chinese that provides for your ability to go to Court in China to enforce and maybe, (though we would have to know more to say) allows you to arbitrate in China for damages. The key in these situations is usually not damages; it is stopping the wrong-doing as soon as possible. The way you have set this up, even in a best case scenario, you will be arbitrating for about 8 months in Hong Kong and then spending another 4-5 months trying to get that award enforced in China before you can even think about asking the Chinese court to stop anyone from doing anything. In other words, you have put exactly what you want to accomplish in a deep freeze for about a year. You truly would be better off not having this agreement at all.

The BizCult blog is guilty of the same thing. In a post, entitled, Foreign Arbitration: No Little Whitey Lie, the good folks over at BizCult write about co-blogger Steve Dickinson’s talk on Chinese Joint Ventures (JVs) at JP Morgan’s recently completed (and excellent) China Conference in Beijing. BizCult attributes to Steve the view that arbitration outside China is NOT advised in what sounds like every case:

Anyway, you remember Mr. Dickinson saying at J.P. Morgan’s China Conference 2008 (which ended just last week) NOT to rely on arbitration of disputes outside of China.

BizCult then goes on to cite (correctly) Steve’s written materials from that conference on arbitration:

The next mistake foreign investors make when they lose the battle for control is to provide for arbitration of disputes outside of China. As with separate guarantees, many foreign investors will say that they are not worried about the fundamental problems with their joint venture structure because they have provided for arbitration of disputes in a neutral third country such as Sweden or France. This is also a mistake.

Arbitration or litigation outside of China is not likely to resolve any problems that result from fundamental issues related to management of the joint venture company. Arbitration outside of China is cumbersome and expensive, and is therefore not a really practical alternative. More important, when critical issues arise concerning the management of a Chinese joint venture, it is important that the foreign partner have a legal forum within China that will allow the foreign party to make its case in China. By taking action outside of China, the foreign partner actually makes it difficult or impossible directly to confront the issues in China with staff, media and the courts…. Many foreign investors insist on foreign arbitration because they are concerned about receiving fair treatment in the courts or arbitration panels in China. For the most part these concerns are misplaced. China now has reasonably capable and fair courts and arbitration panels.

I respond to BizCult by leaving the following comment:

Whoa, whoa, whoa. Choosing whether to have a foreign arbitration clause should definitely be made on a case by case basis. All Steve said at the JP Morgan conference was that foreign arbitration is not usually a good way to get control of your joint venture back. Generally, and I mean VERY GENERALLY, foreign arbitration is good for securing damages, but not so good for securing injunctive relief — getting someone to be ordered to do something. For example, foreign arbitration is not so good for getting a Chinese company to have to stop manufacturing your product, but it might be the best way to get that company to have to pay you damages for having engaged in that manufacturing. So in this example, the contract might call for foreign arbitration (where?) but have a “carve out” provision calling for litigation in China for injunctive relief. These things are hugely complicated and at least 9 out of 10 times it is done wrong by those putting in these provisions without help from experienced international lawyers. In fact, many years ago I spoke at an end of year Continuing Legal Education conference where about ten of us from different areas of law were given about 15 minutes to speak on one thing in our area of law we thought it most important for all lawyers to know and I spoke on the uses and abuses of arbitration provisions in international contracts. I chose this topic because non international lawyers nearly always get it wrong too.

I cannot stress enough that the decision on whether to arbitrate, what to arbitrate, and where to arbitrate absolutely must be made on a case by case basis and it must be done by skilled and experienced legal counsel. The article, Seven key points to consider when using arbitration provisions [link no longer exists], says it best:

To the untrained negotiator, an arbitration provision may be legal “boilerplate,” which means typical clauses that require little or no negotiation — a throw-in type provision. The reality is that parties should carefully weigh the benefits and disadvantages of arbitration in every transaction . . . .

The decision to use or write an arbitration provision in commercial transactions should not be made with a mechanical “one-size-fits-all” approach. It is critical that transaction parties consult with their litigation lawyers, not just their transactional counsel, and take the long view of the business relationship at hand and how the parties are going to resolve disputes. To neglect to tailor a dispute resolution provision to your needs at the outset of a transaction may lead to unnecessary disadvantage, expense and distraction down the road.

To which I say, Amen.