Why Demand Letters Work for China: Cultural Norms as Law Enforcement Mechanism.

I wrote the below in 2009 and I was asked today whether what we said here is still true. My response was that it is, but definitely less so than in 2009. The big change has been that Chinese companies that operate internationally have become more sophisticated and they now realize that few foreign companies will sue them unless they have a really good China-specific written contract backing them up. With such a contract, the below still holds true. Without such a contract, your odds have gone way down .

 

Demand letters are so common in the United States they rarely instill fear into or much action from their recipients. Many lawyers who no longer write such letters, believing US companies will not seriously discuss settlement until sued.

China is different.

My law firm’s dispute resolution lawyers have a greater success rate with demand letters sent to Chinese companies than just about anywhere else. We send these letters in Chinese and we usually conclude them by saying that if resolution is not reached within x number of days, we will commence a lawsuit.

In China, where demand letters (they are called lawyer’s letters there) are less common and companies are not as joined at the hip to their lawyers as in the United States, these letters are viewed as more important, unusual, and serious.

In Reputational Sanctions in China’s Securities Market two law professors posit that avoidance of public humiliation is a big behavior inducer in China. And, unlike in the United States where being sued is a legal matter, in China it is humiliating, as per an Economist magazine article:

Over the past 18 years, China has introduced rules against market manipulation, fraud and insider dealing, but enforcement remains patchy. The China Securities Regulatory Commission seems competent but overwhelmed. Sometimes it takes years to issue penalties after lengthy investigations—and along the way cases lose relevance.In the meantime, the exchanges have quietly begun to acquire authority. The power that they wield appears flimsy—the most serious penalty they can levy is a rebuke to firms and individuals through public notices.

But it is remarkably effective in a country with a long history of punishment by humiliation—think of the cangue, a rectangular slab around the neck, in pre-Communist times and dunce caps in the Cultural Revolution. As a result of the culturally relevant and effective method of financial enforcement mechanism, Messrs Liebman and Milhaupt write that between 2001 and 2006 the exchanges publicly criticised 205 companies and almost 1,700 people. They looked at the share prices of the targeted firms both when they disclosed the conduct for which they were being criticised and when the criticism was published. The admissions typically preceded the rebukes, and in the few weeks that followed the firms’ share prices underperformed the Shanghai stockmarket by an average of up to 6%. After the criticism, there was a further lag of up to 3% on average.

Furthermore, after an entity goes on the government “black list” through public criticism and shaming, raising money through equity markets and banks became more costly, and sometimes impossible, for companies that had been criticized. Suppliers and customers also took a tougher line. Some people lost the right to be a director or senior manager, and suffered from pariah status in a country where there is little pity for failure. The criticisms were sometimes even a prelude to formal investigations by the regulatory authorities.

From a comparative law point of view, this study points out not only the vast differences between legal regimes that actually work for different markets but also highlights the relevance of culture in establishing them. In the United States, being sued, investigated and/or prosecuted is pretty much a legal matter; while in China, it is more than that. When someone gets sued, it is as if she has lost part of her integrity in the public eye. For example, a few years ago a Chinese friend of mine was sued by his boss down in Houston, he was extremely distressed and felt humiliated by the lawsuit even though he understood that lawsuits in the United States are as common as cheese burgers. Public shaming goes deeper into the psyche of the Chinese (in general terms) because of the fear of failure and the love and care of one’s “face.”

It is shockingly common for Chinese companies to respond to our demand letters by admitting their fault and even explaining in some detail why the problem occurred. Most importantly, these letters work to generate payments fairly frequently as Chinese companies very much want to avoid the reputation problems that come from being sued in China.13

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