China: Foreign Parties Doing Business In China - Don't Dismiss Chinese Governing Law And Dispute Resolution Clauses

Last Updated: 7 September 2017
Article by John Chung and Jamie Rowlands

Foreign investors into China may naturally assume that it is advantageous to seek the law and court with which they are familiar to govern their contracts.

However, in certain cases this tendency may be wrong. Here, we illustrate that in the case of a foreign company signing a commercial contract with a Chinese party, it can be advantageous to seek Chinese choice of law and dispute resolution clauses. We briefly outline a number of reasons why this is so.

I. Choice of law clause

1. Foreign law clauses may be unenforceable. Under PRC law, parties to a civil commercial contract are free to choose laws governing their commercial contract if their contract is deemed "foreign related". Therefore, if your commercial contract is not foreign related, PRC laws will automatically apply despite the parties' selection of a foreign law to govern their contract.

Foreign related contracts are defined to contain any of the following characteristics:

  • at least one party is a foreign national/corporation;
  • at least one party has its habitual residence outside PRC;
  • the object of the contract is located outside PRC;
  • the contractual relationship was made, amended or ended outside PRC; or
  • other circumstances which may be construed as foreign related.

This means that wholly foreign owned companies in China ("WFOE") or joint ventures between foreign and PRC companies ("JV") may not have the right to choose laws governing their respective contractual relationships with domestic Chinese companies, as WFOEs and JVs are themselves deemed domestic Chinese entities unless the relevant contract qualifies as foreign related by other means.

2. PRC laws mandatorily apply to certain commercial contracts. Even if a commercial contract is deemed foreign related, PRC law calls for its mandatory application if the contract fits any one of the following categories:

  • Sino-foreign equity or co-operative joint venture contracts;
  • contracts for Sino-foreign joint exploration and development of natural resources within hina;
  • contracts transferring shares in Sino-foreign equity or co-operative JVs and FOEs;
  • management contracts engaging foreign nationals/corporations to manage Sino-foreign equity or co-operative joint ventures established in China;
  • purchase contracts involving foreign nationals/corporations acquiring shares in wholly Chinese owned companies established in China; or
  • purchase contracts involving foreign nationals/corporations acquiring assets of wholly Chinese owned companies established in China.

3. Enforcing foreign law clauses in Chinese courts may be expensive and arduous. For foreign companies entering into commercial contracts with Chinese counterparts located in China, we suggest weighing carefully the chances your business may sue the Chinese party or vice versa before deciding on the governing law.

If your Chinese counterparty is more likely to be the defendant in a lawsuit, choosing the laws of your home country may seem like a sensible idea. However, if you sue in a Chinese court to ensure a greater chance of enforcing any judgment against the Chinese party in China, it may prove challenging to choose non-Chinese law as it is likely to be expensive to hire legal experts to explain to Chinese judge(s) the relevant laws the parties have chosen.

The challenge is increased by the fact that, frequently, Chinese judges will only apply substantive PRC law because it is more reasonable and/or convenient to apply PRC law under the circumstances, and, in practice, PRC law is what Chinese judges know!

4. Choice of foreign law may be construed against "public interest" or rejected on other grounds. PRC law also states that where the application of foreign laws offends PRC's public interest, foreign laws shall not be applied and PRC law prevails. "Public interest" is a vague and under-defined concept in China that any governing law selection may be rejected based on this vague notion. Foreign laws may also be rejected if it is deemed to conflict with equally under defined concepts such as "basic morals" or "PRC sovereignty". This, of course, allows considerable wiggle room for a counterparty to argue that a foreign law clause should not be enforced or is invalid.

II. Dispute Resolution Clause

5. PRC courts may turn out to be vital in your litigation strategy. If the parties agree the court of another country will exclusively adjudicate any contractual dispute, then PRC courts will not be able to hear the case even if all of the Chinese party's assets are located in China, unless mandatory PRC law prompts the court to intervene.

Alternatively, you may consider a non-exclusive dispute resolution clause to possibly retain the flexibility to sue in a foreign country where the Chinese party has assets or is doing business.

If the foreign party believes it is more likely it will be the plaintiff suing the Chinese counterparty, it makes sense to sue in China to obtain a judgment enforceable in China.

6. Foreign court judgments are rarely recognised and enforced in China. Foreign parties tend to choose foreign courts to hear commercial disputes. This choice may be flawed on several grounds. First, unless the Chinese counterparty has assets overseas in the foreign party's home jurisdiction, or a jurisdiction which recognises and enforces such court decisions (e.g. the UK will generally recognise US, Canadian or Australian court decisions and vice versa), a court decision obtained overseas is virtually meaningless in China as China rarely recognises or enforces foreign civil commercial judgments.

In theory, China will recognise a foreign money or default judgment from a country with which China has signed a bilateral/multilateral civil or commercial judicial assistance treaty or practiced reciprocity. To date, China has only entered into a handful of bilateral judicial assistance treaties and recognised even fewer foreign court judgments based on the principles of reciprocity - the essence of which entails China recognising a foreign court judgment only if a court in that country has previously recognised a PRC court judgment.

Therefore, we recommend that if the PRC company has no assets overseas, either generally or in your home jurisdiction specifically, choosing PRC courts (or arbitration to be held within and outside China) may be a strategically sensible choice.

7. Foreign arbitral decisions are enforced in China but can be challenged and invalidated. To some, foreign arbitration for foreign-related transactions is a more preferable choice than foreign litigation. China is a signatory state to the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (known as the New York Convention). Thus, China tends to have a stronger track record of recognising and enforcing arbitral awards issued by reputable foreign institutional arbitration bodies seated outside China.

In our next instalment, we will look at how China deals with foreign arbitral awards in more details.

Conclusion

In the preceding discussion on how to formulate governing law and dispute resolution clauses in commercial contracts involving a Chinese party, we hope to raise the awareness in foreign parties doing business in China that their instinct to rely on law and courts outside of China to govern their Chinese contracts may not the best strategy to adopt in all circumstances.

In fact, an old Chinese adage that "water afar may be difficult to put out a nearby fire" appropriately captures the essence that if the foreign party foresees the best way to make the Chinese party assume its contractual obligations is here in China because it holds significant assets in China, then the foreign party should consider agreeing to a governing law and dispute resolution clause to most effectively achieve an enforceable judgment.

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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