China: How Insurers Can Recover Domestic PL Losses For Products Manufactured In China

Last Updated: 11 December 2013
Article by Paolo Beconcini

A recurring problem facing insurers is understanding how best to recover losses suffered in the domestic market as a result of policyholders importing into the EU or the US, frequently through a dealer, a defective product manufactured in China which has caused injury or damage in the former countries.

Firstly, it is important that the contract between the policyholder and the Chinese manufacturer/dealer enables the insurer to promptly identify the latter (e.g. name in Chinese, office addresses, representatives, a copy of its business license), in order to initiate appropriate legal steps to recover its losses because of a product liability (PL) case. This will allow the insurer to get rid of a common problem: losing time and money identifying the manufacturer or the dealer.

Indemnity clauses in the retailer (policyholder)/manufacturer agreement may also be helpful, at least on paper. Nonetheless, such clauses do not solve the insurer's problem, once the indemnity is not paid and the retailer is not going to be able to enforce it. Others suggest as a solution that the Chinese supplier is also insured for product liability claims. In practice such types of insurances in China are uncommon and may at most be practicable only with larger and more renowned companies. Also, terms and conditions may be as such that these insurance policies will have no real impact in dispute resolution. Leaving these points aside, this article will focus only on the judicial recovery of damages by foreign insurance carriers from the Chinese manufacturer/seller.

Once the insurer has evidence to prove that the injury or property damage was caused by a defect in the product manufactured in China, there are essentially three options:

  1. The insurer can bring a lawsuit against the Chinese dealer/manufacturer in the State where the injury took place (e.g. the domestic market), or
  2. The insurer can take legal action against the Chinese dealer/manufacturer directly in China, or
  3. The insurer can use arbitration if this possibility is provided for in the contract between the policyholder and the Chinese manufacturer/dealer, together with a proper subrogation clause in favor of the insurer.

I. Bringing the action in the national Court

As regards the trial in the State where the injury took place, it should be underlined not only that the lawsuit will generally be very costly, but, above all, that China is not a signatory to any international Convention regarding the recognition and enforcement of foreign courts judgments, but simply established the principle of reciprocity. Because of the fact that this principle in practice rarely applies, it would be very unlikely for insurers to be able to persuade the Chinese court to recognize and enforce the foreign judgment in China. Initiating such a process would also add a further economic burden on the insurers.

II. Bringing the action in China

Insurance carriers are often reluctant to litigate a product liability case in China. This reluctance may be founded on cultural and language differences as well as on lack of proper information and practical experience of the Chinese legal system. It is indeed true that a foreign entity may start at a certain disadvantage in litigation due to the possible influence of local factors and nationalistic thinking of public officials.

However, this is not the case in every-day litigation in China. The role of local or non-legal factors in a judicial enforcement action in Cina should not be overestimated, but rather evaluated and considered on a case by case basis in light of the peculiarities of the Chinese tort law and judicial enforcement system. A distinction for instance, could be drawn between low courts of county level and those of metropolitan areas of first and second tier cities in China. The former is more likely to be influenced by local factors and surely less experienced in PL litigation especially involving foreign parties. Another risk factor is also constituted by the type of defendant. A state owned company will be a much harder counterpart to beat than a privately owned manufacturing company. The type of product and its technical complexity are also a factor to consider, especially in light of the possibility that court experts may later be appointed to verify the issue of "defect". Also, the ability to locate and secure assets from the counterpart(s) is a key factor which should be considered from the very inception of the enforcement action, if this has to bring the insurer effective monetary relief. All these factors must be carefully understood and evaluated when planning judicial enforcement in China.

On the other hand, China's legal system has developed significantly. The "rule of law" is now a prominent principle recognized and applied by Chinese civil courts to mitigate the influence played by other non-legal factors in the court decision making process. The laws and regulations have also much improved, as well as the consistency of the jurisprudence in their application. Nonetheless, problems may still arise when these laws are to be applied to a specific case. Knowledge of the laws and how they practically work is fundamental to handle such types of litigation in China.

2.1. Strict Liability and Burden of Proof

Since 2010 China has implemented a new product liability regime. Product liability law in China is now formally based on the strict liability principle. There will be no need for the claimant to prove the negligence of the defending Chinese manufacturer, seller or supplier. On the other hand, the claimant will have to prove defect, damages and causation, while the manufacturer/seller must prove that his product complied with mandatory quality standards in force at the time of production. Jurisprudence is generally consistent on the burden of proof issue.

If the claimant has difficulty in proving the defect of the claimed product, he can ask the court to appoint an expert for verification. Expert opinions collected abroad will be of little use and will not be able to fulfill the burden of proof of the insurer as to defect. Court appointed expert verifications are one of the decisive factors in a product liability lawsuit in China. It is at this stage where the parties must persuade the court to appoint a certain expert rather than another. The selection of suitable and knowledgeable experts may be a rather difficult task, especially if the litigation is pending in third tier city or even county levels, due to the lack of proper local experts. Normally, a precondition to success in this most delicate phase of the litigation is for the claimant to be able to persuade the court to move away from local experts, who may be more likely influenced by local factors, and to appoint technical institutes at national level as court experts.

2.2. Manufacturer's Defences

Defendants can avail of the same defences provided by the European product Liability Directive 85/374/EEC of 1985. However, the new Chinese product liability law of 2010 provides that proof of compliance with administrative quality standards is no longer a viable defence if the claimant can provide evidence that the product was nonetheless unreasonably dangerous. This definitely favors the claimant and may be an incentive to litigate in China.

Whereby in the past the defendant could avoid liability by proving that a defects discovered at a later stage of technical development was not discoverable at the time of manufacture of the product, the new Tort law provides now that in case a defect is found after the product is put into circulation and the manufacturer or seller have failed to warn and recall the product in a timely manner, they will assume the tort liability for harms thus caused to people or property of third parties other than the product itself.

2.3. Damages

As to damages, the 2010 Tort law provides that the claimant can demand compensation for (material damages) pain and suffering (it was not clear before), medical expenses (or repair costs) and punitive damages. Calculation of damages for physical impairment, as well as pain and suffering will be evaluated by specially court appointed assessors. As to property damages, these will be recoverable from the manufacturer only if the damaged property is other than the defective product itself and the defective product itself was not used for exclusive commercial purpose.

Generally speaking, damage compensation in China is on average lower than in Europe and this may be a disadvantage for a foreign claimant. However, means of avoiding these shortcomings is offered by the 2010 statute on choice of substantive law. By this new law, Claimants in a product liability case before a Chinese People's Court can choose to have the Chinese People's Court apply to the case the law of the place where he has his habitual residence as long as the defendant maintains business operations at the habitual residence of the claimant. As a result, and in certain cases against larger Chinese corporation with presence also in Europe, the plaintiff may thus increase the liabilities of the manufacturer and sellers, and their exposure to higher damage compensation by choosing the substantive law most favorable to his case.

As to the payment of the court awarded damages, this can be transferred directly to the account of the foreign insurer as long as the defendant has a foreign currency account in China. This is indeed the case when the defendant is a large and established manufacturer dealing often with foreign clients. This is not the case if the defendant does not have a foreign currency account. In these cases, however, the payment can be made by the defendant to the international counsel of the plaintiff located in China, which, in turn, will transfer the money abroad to his client from his foreign currency account. Important is that the transfer is supported by solid legal titles such as obviously the judgment and a power of attorney between the insurer and the counsel in China.

2.4. Caveats

The first and more general risk factor for a foreign enterprise to litigate a product liability case in China is related to the language and the legal culture. However, it can be overcome by choosing to be represented by a suitable and experienced counsel.

More critical are the risks related to the identification of the liable Chinese entities, their legal status and the determination of their liquidity and assets. The contracts of policyholders with the Chinese suppliers are often lacking proper disclosure clauses and do not impose on the Chinese side obligations to inform about all the entities involved in the production and distribution chain. Training of the policyholders in this respect and assistance in contract drafting may help reducing the risks of the insurer of not being able to identify the proper defendant. If this is not done or the disclosure is incomplete and mendacious, insurers will have to take the burden of investigating in China.

Insurers must also be aware of peculiarities of the Chinese distribution system. Manufacturers may not possess any export license. They will therefore use generic traders or shipping companies for the export of their products abroad. The policyholder may therefore be dealing with middlemen and traders rather than directly with the manufacturers. The former often have no legal connection with the latter. According to the Chinese law, if the seller can prove that defect was not caused by him, he will then be free from liability as long as he names the manufacturer.

This may be the beginning of a nightmare. It could indeed be possible, for instance, that the manufacturer is an illegally operating company, an occurrence which is actually very common in China. Even if the manufacturer is a registered and legally operating company, the fact alone that it was not timely identified and brought in immediately into the lawsuit, may result in delays and additional expense. In sum, proper preparation and disclosure are a requirement in these transactions, so that at the time of the lawsuit, the insurance carrier will have already identified all the proper defendants.

As mentioned above regarding the selection of court experts, another important risk to take into account in China is that represented by local political and economic factors. According to Article 29 of the Civil Procedure Law of the People's Republic of China (CPL), the action shall be brought in the defendant's domicile. This means that, depending on the location of the defendant, a Court may be influenced by local economic and political factors. This could be for instance the case of a big factory in a small city, or even in a major city in case the manufacturer is a State-owned company.

In these cases the chances to win the lawsuit will considerably decrease. There are also inconsistent approaches among different courts. Some are more claimant friendly, others not. On the other hand, with the claimant being a foreign entity, the lawsuit will land within the functional jurisdiction of "Intermediate Courts". These are normally appeal courts for the lower grassroot courts. Intermediate courts reside in larger cities and are composed by judges with legal education and are of better quality than grassroot courts.

All these factors must be carefully evaluated on a case by case basis before deciding whether a claim can be successfully litigated in China. For the same reason, early identification of the manufacturer and its distribution network, its location and history are very important to determine the chances of success of product liability litigation in China.

Also, suing the Chinese manufacturer directly in China will involve lower costs than in the EU and the US, as well as time, and will avoid the problem of gaining recognition for and enforcing the foreign court judgment. On the other hand, there is a general risk that damage awards may be lower than those obtainable in the UK. Furthermore, local factors may play an important role in the chances of succeeding in a civil lawsuit.

Generally, choosing to litigate in China may be a very suitable option in certain cases, but less in others. This will depend on the specific circumstances of each case. It will be for the insurer, together with his selected counsel, to evaluate which case may be more appropriate for successful civil enforcement in China.

III. Use of arbitration

The third solution is arbitration. China is party to the Convention on the Recognition and Enforcement of Foreign Arbitral Awards, signed at New York on 10 June 1958, and thus will in theory recognize and enforce not only domestic awards, but also those made in other contracting States (almost 150 States are parties to the Convention). It is therefore important to carefully draw up a contract of supply in order to avoid the refusal of the enforcement of an arbitral award by People's courts.

Indeed, according to Article 140 of the CPL, cancellation or refusal of enforcing an arbitral award cannot be appealed against. People's courts can refuse the enforcement, for instance, when the arbitration clause did not specify the arbitration institution. In order to reduce such risks it is suggested to carefully choose the arbitration institution itself.

More precisely, the chances of an award recognition and execution in China will increase if the arbitration is conducted at the China International Economic and Trade Arbitration Commission (CIETAC) or at the Hong Kong International Arbitration Centre (HKIAC). These are the preferred choice because they are located in China, and retain a certain degree of political independence, legal authority and experience in international disputes.

On the negative side, the insurer shall also take into account that, according to Article 215 of the CPL, the time limit for the submission of an application for enforcement is only two years. The expiration of this time limit would enable People's courts to refuse the recognition and enforcement of an arbitral award. Also, such clauses may be successfully disputed by the Chinese party and more in general may present issues of practical feasibility. It will be on the insurer to negotiate with the policyholder when such arbitration and clauses will be more appropriate and suitable in light of the best practice in the home country.

Conclusion

Based on the analysis above, the second and third options appear to be most suitable for successful product liability enforcement against Chinese manufacturers of defective products. Both options entail risks. It will be up to the insurance carrier with the advice of his counsel to determine in which case litigation or arbitration may be most suitable.

In general, there is room for optimism. Litigation in China is not a chimera. Laws are modern and reflect the latest international standards, as illustrated by the recent regulations on conflict of law allowing a Chinese judge to decide a case based on the substantive law of the country of the plaintiff. There are increasing numbers of courts which are tested and proven on the rule of law to provide the forum for a fair trial. Again, it will be up to the complainant to select the right case to pursue after carefully evaluating its circumstances in light of the legal and factual issues typical of Chinese product liability litigation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Authors
Paolo Beconcini
 
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