Demand Letters For China Disputes: They Just Work

Demand letters have become so common in the United States they rarely elicit either fear or action from their recipients. Some lawyers no longer bother with such letters, believing you should always sue first and discuss settlement later.

China is different.

Our international dispute resolution lawyers have a much higher rate of success in China demand letters than just about anywhere else. It is not clear exactly why we tend to have such a high success rate with these letters — nor on one level do we really care. But for whatever reason, in China, where demand letters (they are actually 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.

Two Columbia Law School professors, Benjamin Liebman and Curtis Milhaupt, did a study, Reputational Sanctions in China’s Securities Market , where they posit that avoidance of public humiliation is a big behavior inducer in China. Unlike in the United States where being sued is viewed pretty much strictly as legal matter, in China it is humiliating, as noted by the Economist Magazine in Shame fills a vacuum in China’s financial law enforcement:

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. 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 criticized 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 criticized, 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 stock market by an average of up to 6%. After the criticism, there was a further lag of up to 3% on average.

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. 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.

This study highlights the relevance of culture in how to handle a legal matter. 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 in China, one loses integrity in the public eye. For example, a few years ago, a Chinese friend of mine was sued by his boss in Houston and he was extremely distressed and felt “humiliated” by the lawsuit even though he understood such lawsuits in the United States are quite common. Public shaming goes deeper into the psyche for people in China because of the fear of failure and because of “face.”

It is shockingly common for Chinese companies to respond to our demand letters by admitting ifault (which American companies virtually never do) and even by 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 reputational problems that come from being sued.

Unfortunately, we are finding — particularly recently as a result of China’s economic downturn — that even threats of imminent humiliation do not work on Chinese companies that no longer exist or simply lack the funds to pay. It also is important to mention that we do not bother writing demand letters when the legal claim against the Chinese company has little to no merit. Just as in the United States, a demand letter in that sort of situation will almost invariably be a waste of time.

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