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Sarbanes Oxley : Law : China


By Megan Penick
Megan Penick
General Counsel
Global Holding and Investment Co., LLC

The Wall Street Journal recently described the difficulty one foreign investor faced in achieving success in its business venture in China.1 After investing in and bringing its China clothing store to fruition, Singapore Crocodile clothing company found itself at odds with its former Chinese manager, who, after being fired, pilfered Singapore Crocodile's files, stole its employees and opened a competing business right in the same shop Singapore Crocodile had originally been licensed to do business.2 The initial problem seemed to come about by inattentiveness by Singapore Crocodile's owners, but the real lesson is that foreign investors are often left with nothing to safeguard their interests when such disputes arise. While Singapore Crocodile did file numerous lawsuits in Chinese courts, it found that its former Chinese colleague seemed beyond the law as, even after criminal embezzlement charges had been brought against her, police refused to detain her and, four years later, none of Singapore Crocodile's lawsuits have been successful.3

Foreign lawyers in China frequently complain about the lack of predictability of China's legal system, both in terms of the transparency of China's laws and regulations and in terms of the enforcement of those laws within its court system. These factors are critical not only to the ability of China to attract and maintain foreign investment, but to the ability of foreign investors and their lawyers to plan and prepare for possible disputes that may arise in the course of doing business in China. In addition, even when a contract contains a valid arbitration clause and an arbitral tribunal finds in favor of the foreign party, if the Chinese party does not voluntarily comply with the arbitral award, the foreign investor is left to rely on a dysfunctional Chinese court system for enforcement of the award. As arbitration is the preferred method of dispute resolution for commercial transactions, this paper sets out to explore China's arbitration system, its laws and regulations, the enforcement of arbitration awards by China's courts,4 and how an ineffectual legal system ultimately influences business and capital investment.

Arbitration and Enforcement
"To enter a court is to enter a tiger's mouth."5 This traditional Chinese proverb holds true today, with China's broadly drafted civil code, largely unreported court cases and secretive court system with its protectionist leanings. But the saying may hold equally true for foreign parties who have agreed to arbitrate their disputes before a China International Economic and Trade Arbitration Commission (CIETAC) panel or even for those parties seeking to get foreign arbitral awards enforced in China's courts.6 Perhaps the biggest problem for foreign parties involved in commercial disputes is relying on the Chinese courts to protect their rights. After all, even if foreign parties rely on foreign courts and foreign arbitration systems to resolve disputes, where the Chinese party refuses to comply voluntarily with an arbitration award, the foreign party's only recourse is to go to the Chinese courts to seek enforcement.

Numerous law review articles have cited China's enforcement rate as improving in recent years, but enforcement rates of less than 50 percent are still reported for those cases where parties do not voluntarily comply with the arbitration panel's award. Yet what is recovered in many enforcement cases brought before Chinese courts is often far from rewarding.7 This stands in sharp contrast to Chinese parties seeking to enforce judgments abroad using the New York Convention, as it has been reported that Chinese parties have experienced at least a 90 percent success rate of getting their arbitral awards enforced overseas.8

Three documents are fundamental to understanding arbitration and the enforceability of arbitration awards involving foreign investors and Chinese individuals or companies in China: CIETAC Arbitration Rules, the Arbitration Rules of the People's Republic of China and Section 260 of the Civil Procedure Law of the People's Republic of China. To understand how China's rules compare with international standards, these rules must be read in light of Article V of the Convention on Recognition and Enforcement of Foreign Arbitral Awards9 ("the New York Convention") to which China became a party in 1987, when China's legal system was still at its infancy.10

The CIETAC Rules
Based on rules found in Anglo-U.S. legal systems, 11 CIETAC was formed in 1954 as a means of arbitrating domestic commercial disputes in China and has since developed into a center for foreign-related and domestic dispute settlement.12 CIETAC's rules have gone through several redrafts over the years in an effort to bring them into closer conformity with standards of international arbitral institutions and international expectations.13 All of this has been done with an eye toward encouraging foreign investment in China.

CIETAC's Arbitration Rules were most recently revised in 2000, the effect of which broadened the scope of disputes that may be brought before CIETAC. CIETAC's jurisdiction extends over any dispute that has arisen from contractual or noncontractual matters concerning economic and trade transactions.14 This allows for a broad scope so long as the parties have contracted broadly (rather than narrowly) to resolve any disputes arising from not only their immediate contract terms, but also any dispute arising from their business transactions and/or relationship. CIETAC Article 2 further extends the scope to cover international or foreign-related disputes, disputes arising from foreign investment enterprises (generally in the form of joint ventures), any dispute related to Hong Kong, Macao or Taiwan, and ?any other domestic dispute that the parties have agreed to arbitrate by the Arbitration Commission.? CIETAC's broad jurisdiction clause means that, in theory, the Chinese courts should have little cause to declare a CIETAC award unenforceable on jurisdictional grounds save for where the parties had not actually agreed to arbitrate their dispute in the first place.15

Articles 52-61 of the CIETAC rules cover when and how a CIETAC tribunal shall make an award. The award must be made within nine months from the date at which the arbitration tribunal is formed; requests for extensions may be made at the request of the arbitration tribunal and will be granted if the Secretary-General of CIETAC considers that it is really necessary and the reasons for extension are truly justified.16 What "really necessary" and "truly justified" means is uncertain as there is little if any case law published by Chinese courts to allow for interpretation; but theoretically where difficulties arise in arbitration and there is need for an extension to fully complete the arbitration, extra time will be permitted. Neither the New York Convention17 nor the UNCITRAL Model Rules18 impose time restrictions on arbitral proceedings. CIETAC's nine month time constraint might be viewed as too stingy and difficult to comply with and might even encourage arbitrators to proceed too quickly, even where parties are unable to be present.19

The award made by the arbitration panel must be based upon a majority decision, or if a majority cannot be reached, the presiding arbitrator must make the decision. The final determination of the arbitral tribunal, with oversight by the CIETAC Commission, shall be binding with no right of appeal.20 The finality of arbitration and the stated inability to appeal the award is congruent with international standards and expectations for arbitration.

CIETAC Article 63 governs enforcement of arbitral awards made pursuant to the CIETAC rules. Article 63 states that the parties must execute the award within the time limit specified in the arbitral award or immediately if no time limit is stated. When the losing party refuses to comply with the award, then the winning party may seek enforcement through the Chinese courts. Here, the problem of enforceability leaves the realm of CIETAC rules and enters the domain of Chinese courts and civil procedure law, as discussed below.

Enforcement - The Concern
If the losing party does not voluntarily comply with the arbitration award, the prevailing party may seek enforcement in the local District People's Court with jurisdiction over the location of the losing party or the assets in dispute, and, in principle, enforcement should be quite feasible.21 But, in reality, foreign parties have substantial reason to be skeptical about the Chinese courts' ability and/or desire to enforce awards against Chinese parties.22

Perhaps the most famous case for non-enforcement of arbitral awards in China is the Revpower case where a U.S. company entered into a joint venture with Shanghai Far East Aero-Technology Import & Export to develop a battery factory.23 When relations between the joint venturers went sour, Revpower brought the case to arbitration and an award was entered in favor of Revpower for $4.5 million. The Chinese court so delayed recognition and enforcement of the award that the losing party was able to dissipate its assets so that thereafter any enforcement of the award would be pointless.24 And this recognition by the Chinese courts came only after top-level diplomatic efforts were made by the U.S. to bring the dispute to resolution. By November 2001, it was reported that the Revpower case had yet to be resolved and the award had reached up to $10 million with interest.25

This dissipation of assets appears tailor-made for CIETAC's Article 23, allowing for property preservation during the arbitration process so that parties will not be able to dispose of assets.26 One problem with Article 23, however, is that a property preservation action may not be brought until after the arbitration panel has already been seated. The application for property preservation must be brought by the party to the Arbitration Commission and then the Commission must bring the action to the Intermediate People's Court in the jurisdiction where the property is located for a ruling on the requested measure. This is problematic in that it may be time consuming and the party against whom the action is brought may have enough advance notice to be able to remove its property or assets from the jurisdiction. The Revpower case may be cited here as that was a case in which the courts delayed action to preserve property ? or, more clearly stated, to enforce the award ? so that the Chinese party had time to get rid of its assets and property prior to the award being enforced. While Revpower ended in diplomatic embarrassment for China, China scholars have not reported a dramatic increase in the Chinese courts' reliability since then. If there are no assets, the Chinese court could avoid enforcement due to impossibility. Therefore, having a workable property preservation provision seems essential to achieving full compliance with or enforcement of an arbitral award.

The remainder of this article details the legal and extra-legal bases on which Chinese courts may deny enforcement of arbitral awards, including those awards that appear on their face to have been obtained properly. As will be seen, assuming that the parties had a properly formed arbitration agreement and arbitral panel, Chinese courts appear more likely to use extra-legal means, rather than strict application of the relevant law, when vacating or avoiding enforcement of awards granted by arbitration panels.

The Chinese Courts in Action
As a matter of Chinese statute, Article 206 of the China Civil Procedure Law (CCPL) governs the enforcement of arbitration awards. Article 206 provides that arbitration awards shall be enforced, unless:
  1. the parties have not stipulated clauses on arbitration in the contract or have not subsequently reached a written agreement on arbitration;
  2. the person against whom the application is made is not duly notified to appoint the arbitrator or to proceed with the arbitration, or the said person fails to state its opinions due to reasons for which he is not held responsible;
  3. the composition of the arbitration panel or the procedure for arbitration is not in conformity with the rules of arbitration; or
  4. matters decided exceed the scope of the arbitration agreement.27
Article 260 further provides that the award may be overturned if it is found to violate social or public interest.28 Chinese statutory law regarding enforcement of arbitration awards is therefore largely consistent with that of countries with more established traditions of arbitration.

Substantial difficulties arise, however, because many times the awards are refused enforcement due to reasons outside of China's laws, rules and regulations. The principal reasons cited for such nonenforcement include local protectionism and lack of judicial independence, ?guanxi,? and secrecy.29 Any number of these factors could come into play when a party brings an arbitral award before a Chinese court for enforcement and all of them have little to do with the law. Thus, lawyers working in China face an uphill battle in trying to properly advise clients on outcomes, risks and probabilities once a dispute reaches this stage. That may be why the majority of disputes are settled prior to or during arbitration so that parties may avoid the court system's lack of predictability.30

Local protectionism and lack of judicial independence frequently comes into play in the local courts where arbitral awards are sought to be enforced. Lawyers have complained of a lack of impartiality on the part of Chinese arbitrators and on the part of local courts where the arbitration is sought to be enforced.31 As for courts, this problem arises because of institutional flaws that bring about a lack of judicial independence; the close link between the political leadership and the judiciary has frequently been cited as the culprit.32 Judges are appointed by local government officials and are reliant on the government not only for their jobs and their paychecks but for their housing and basic living as well.33 This interconnectedness of politics and the judiciary goes even farther, though, as Beijing takes authority in directing judges and courts on how they should decide their cases.34

In 2000, Beijing's leadership sent a directive to all courts that said, in essence, ?When preparing your judgments, it is true that you should pay attention to the law; but you must also pay even greater attention to the political and social consequences of your judgments.? 35 Since that time, both foreign and Chinese lawyers representing foreign interests have not won a single case before a Chinese court.36 If this directive is being followed where arbitral awards are concerned, seeking enforcement of arbitral awards in China is not only an uphill battle but a losing one that is not worth the time, energy or money of a foreign party to pursue. That is a sad indictment of the Chinese legal system. For whatever reason, it seems courts, judges and ?judicial committees? are more bound to follow the political directives of the Chinese leadership than to follow the rule of law.

Guanxi has always been a means of gaining favors for all things from goods and services to winning friends and influencing people in China. As involves the courts, this means that where a party or a party's counsel has a connection in the judiciary or within the country's or region's political elite, that party may be more likely to get his way in the courts. Citing the case of the Chinese manager of the Singaporean clothing company, the Chinese manager's connections enabled her to function as though she was above the law.37 In any society connections can be helpful. But so long as connections and guanxi allow parties to win such great favors in the legal system and allow Chinese entities to escape liability based on those connections, it will be difficult for foreign business interests to function as the civil code remains misleading and unpredictable.

Secrecy is perhaps the greatest flaw overarching the entire Chinese legal system. Secrecy comes in many forms such as back-room ?judicial committees? deciding cases, secret ex parte meetings between the Chinese party and the judge, and guanxi used to influence local political elites and decision makers. Both foreign and Chinese lawyers representing foreign clients have complained of judges meeting privately with the Chinese party. This distorts the court proceeding as the foreign party is not cognizant of all that is going on ?before the court;? the Chinese judges do not seek out the foreign party for such covert meetings.38 Such meetings could easily give the Chinese party the upper hand. Secrecy is a factor not only when judges hold private meetings with the Chinese party, but where decisions are made by ?judicial committees? or backroom ?judges? who have neither seen nor heard the case, yet freely overrule the opinion of the judge or judges who heard the case.39

The unavailability of published opinions by Chinese courts makes it difficult to trace the outcomes of arbitral enforcement.40 It also makes it difficult for lawyers to adequately advise their clients on the variety of outcomes possible when deciding to invest in China or for lawyers to adequately assess risk once a dispute breaks out. There are generally two options: pursue negotiations which may end less favorably than an arbitral award or face the possibility that if an arbitral award is won the losing party may not comply with the award and the Chinese courts will likely refuse enforcement.

While the Chinese legal system seems to have all of the theoretical underpinnings for proper enforcement of both foreign and domestic arbitral awards, adherence to the rule of law remains lax and unpredictable. It is this weakness of the court system that pushes judges and arbitrators to coerce parties to settle rather than relying on compulsory enforcement. 41 Changing this system and moving China from a nation governed by men to a nation governed by law is critical for China's post-WTO entry success. WTO member states are required to have transparent legal systems that allow for predictability in international trade relations. So long as the mechanism for dispute resolution remains ineffective, disputes will continue to spill over into government-to-government relations.42 For now, however, where a Chinese party loses the arbitration and fails to voluntarily adhere to the arbitration panel's decision and award, the foreign party's best bet is to seek a settlement. Relying on the Chinese courts as they currently exist seems far too risky a means of achieving a satisfactory resolution where the Chinese party refuses to comply with an arbitral award. To overcome what otherwise would likely be a lose-lose situation, the foreign party may be best off negotiating a settlement for partial recovery with the Chinese party rather than expending its valuable time and resources for the slim chance that its enforcement action will be successful.

1 Ben Dovlen, ?Foreign Investors Find That China's Legal System Resolves Few Disputes,? 4/7/03 Wall St. J. A14 (April 7, 2003).
2 Id.
3 Id. One Chinese lawyer quoted in this story said of resolving disputes, ?Rule One is to try to resolve the dispute before it gets to the courts. [Rule Two is to] try your best to follow Rule One.? This indicates that China's courts and its legal system may be of little help to foreigner businesses when disputes arise. While the Chinese manager in this case did seem to be one with very special connections ? she was described as being a frequent ?special guest? to China's political elite ? it nonetheless demonstrates the unpredictability and lack of transparency of China's legal system.
4 This paper will limit analysis to disputes arising between foreign investors and Chinese individuals or Chinese companies. This paper will not discuss dispute resolution between foreign companies and the Chinese government as there are additional considerations to be taken into account where sovereigns are involved.
5 Traditional Chinese proverb, as reported in Bee Chen Goh, Law Without Lawyers, Justice Without Courts: On Traditional Chinese Mediation (Ashgate Publishing Co. 2002).
6 The CIETAC Arbitration Rules were adopted in 1988 to meet the growing needs of a market economy and to develop both international and domestic trade. Since then, CIETAC's Arbitration Rules have gone through several changes, each time bringing the rules in closer alignment with international treaties (the New York Convention) and bilateral commitments to dispute resolution. See Presentation of Prof. Mochtar Kusuma-Atmadja Arbitration in the 1990s: Developments in East Asia: Arbitration in the Southeast Asia Region: People's Republic of China (presented April 29, 1996).
7 Randall Peerenboom, Enforcement of arbitral awards in China, 28 China, Bus.Rev. 812 (Jan. 1, 2001). Mr. Peerenboom published a study on enforcement of 89 foreign and CIETAC arbitration awards brought before the Chinese courts for enforcement, of which only 49 percent actually recovered. Of those 49 percent, only 17 percent received full recovery, 10 percent received less than half of the award, and one-third of all applicants were likely to receive between 75 to 100 percent of the award.
8 Bumpy ride for reform, S. China Morning Post 2 (available in 2001 WL 29884334).
9 U.S.C.A.§ 201 (June 10, 1958). Article V(1) of the New York Convention allows enforcement of an arbitral award to be refused by a competent court where (a) the party or parties entering into the contract were under some kind of incapacity or the agreement was not valid under the law governing the agreement, (b) the party against whom the award was invoked was not given proper notice of the arbitration proceedings or the appointment of an arbitrator, (c) the award deals with issues beyond the scope of issues contemplated by the parties to be dealt with in arbitration, (d) the composition of the arbitral tribunal was beyond the scope of the parties' agreement, or (e) the award has been set aside by the competent authorities of the country in which the award was made. The award may also be set aside under Article V (2) where (a) the subject matter of the dispute is not capable of settlement by arbitration under the law of that country, or (b) recognition and enforcement of the award would be contrary to the public policy of that country.
10 It could be said that even today, China's legal system is still in its infancy as prior to the development of its civil code in 1982, China's court system served primarily as a penal system; civil disputes were resolved by mediation within the community. See Bee Chen Goh, Law Without Lawyers, Justice Without Courts: On Traditional Chinese Mediation (Ashgate Publishing Ltd. 2002). The new civil code was written primarily with the goal of encouraging foreign investment. Chinese themselves still remain leery of the court system and tend to prefer mediation as their primary means of dispute resolution.
11 See Arbitration Rules of the China International Economic and Trade Arbitration Commission.
12 Of course, foreigners contracting with Chinese companies need not limit themselves to CIETAC and may agree to bring disputes before arbitral bodies located outside of China. Under the New York Convention, theoretically, China should be bound to enforce such awards within its borders. Chinese parties may be more inclined to resolve disputes before CIETAC (for example, arbitrations conducted under the CIETAC rules must be conducted in Chinese) and therefore the arbitration body the parties choose contractually ? whether that be the International Chamber of Commerce, ad hoc arbitration, or otherwise ? may depend on which party has the greater bargaining power.
13 See at FN 7.
14 CIETAC Article 2, .
15 In such a case, it seems unlikely that a dispute would have ever made it through arbitration to a final award as the arbitration panel itself would have either found that the parties had not agreed to arbitrate or the party claiming no agreement to arbitrate would have brought the case directly to the courts.
16 CIETAC Arbitration Rules, Article 52.
17 9 U.S.C.A. ? 201 (June 10, 1958).
18 United Nations Commission on International Trade Law: Model Law on International Commercial Arbitration (June 21, 1985).
19 See CIETAC Arbitration Rules Article 42. This rule states that arbitrators may proceed and enter a default judgment where one of the parties is not present. Read in conjunction with the automatic nine-month time limit, this rule could work to a party's disadvantage as it unduly speeds up the arbitration process and could cause a party to default merely due to conflicting schedules. It should be noted that under the UNCITRAL Model Rules there is no time limit placed on when an arbitration hearing should be complete.
20 CIETAC Arbitration Rules, Articles 52-61.
21 Enforcement of An Award. If the losing party's assets are located outside of China, the winning party can apply to a foreign court so long as that court is in a country that is signatory to the New York Convention.
22 E-mail from Clive Ansley, Attorney, Arvay Finlay, Canada and China law expert, to Megan Penick, Letter to the angry young man! (Sept. 11, 2002) (copy on file with author). Mr. Ansley's letter was a response in explanation to a Chinese law student who had objected to Mr. Ansley's criticism of the Chinese legal system. In the letter, Mr. Ansley describes how even Chinese lawyers and judges, themselves, decry the ineffectiveness of the legal system. Sometime in 2000, Mr. Ansley reported that a directive came down to the maritime courts from Beijing with the words, ?Whenever you have a dispute involving a foreign party and a Chinese party, you must ensure that your judgment reflects the national interest.? Since that time, no foreigner in the maritime court has won a case. It seems likely that such a directive would not be limited to the maritime courts alone.
23 Supra n. 10.
24 Id.
25 Id.
26 CIETAC Arbitration Rules, Article 23, .
27 Arbitration Law of the People's Republic of China (adopted Aug. 31, 1994).
28 Id. Although the New York Convention and the UNCITRAL rules also allow non-enforcement on that basis, it has been noted by China scholars that Chinese courts rarely invoke the public policy exception for denying enforcement for fear of weakening China's credibility on the world stage.
29 ?Guanxi? refers to relations or special connections that can allow one to get special favors. In this case, guanxi would refer to the Chinese party's or Chinese counsel's connections with judges, officials, or politicians that might help to shape the outcome of the case.
30 Some China lawyers might argue there is predictability as it can almost always be predicted that the non-Chinese party will lose in the end.
31 Denton Wilde Sapte, Arbitration newsflash (Jan. 2002).
32 E-mail, supra n. 26.
33 Supra n. 42.
34 E-mail, supra n. 26; supra n. 9.
35 E-mail, supra n. 26.
36 Id. Here, Mr. Ansley was addressing the Chinese Maritime Courts specifically, as that is where 95 percent of the cases involving foreigners take place; this is largely because in the case of maritime cases foreign parties have little choice but to go before the Chinese courts once their ships have been seized in Chinese waters. But as of the date of this paper, foreigners remain limited in their ability to litigate successfully in the civil courts. By implication this means that foreign parties would have great difficulty in successfully taking arbitral awards before the Chinese courts for enforcement against their Chinese adversaries. But, by signing onto the New York Convention, China has bound itself to allow foreigners to bring arbitral enforcement actions before its courts.
37 Supra n. 1.
38 Where such meetings take place, the foreign party usually is unaware of its occurrence and has no way to protect itself against such extra-legal actions.
39 Supra n. 9; E-mail, supra n. 26.
40 Bonnie Hobbs, O'Melveny & Myers, CIETAC Arbitration Rules and Procedures: Recent Developments and Practical Guidelines, (April 1999).
41 Supra n. 9.
42 Supra n. 38. The Revpower case is a prefect example of this as when an arbitral award was entered in Revpower's favor, the Chinese government so delayed action to enforce the judgment that the judgment ended up unenforceable by way of insolvency. Whether such outcomes will become common, or whether China will work to protect and improve its status as a favorable place to conduct business, is yet to be seen.

Note: This article was previously published in the Fall 2004 edition of The International Law Quarterly, a publication of the International Litigation Committee of the Section of Litigation, American Bar Association. Volume 20, Issue 2.

Megan Penick
General Counsel
Global Holding and Investment Co., LLC

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