China: International arbitration in China: A case study

Last Updated: 16 May 2019
Article by Maarten Roos

Clients often ask our advice on whether disputes involving Chinese parties are best resolved through litigation or arbitration; and if the latter, whether they should choose arbitration in China or option for international arbitration. There is no one-size-fits-all answer, as the most effective dispute resolution method depends on a number of factors including who are the parties and where are they located; where do they have assets; which of the parties is most likely to file a claim; and what are the likely amounts involved.

A recent case that we closed successfully, illustrates some of the difficulties that parties can face if they agree to resolve their China-related disputes through international arbitration. To be clear, this does not mean that it necessarily was the wrong choice – in the end our client got paid in full, and there is no guarantee that other methods would have yielded the same result. The fact is that disputes are rarely simple and straightforward to resolve; and this was certainly not an exception.

Background of the Case

Our client is a large European shipbuilder, and in 2011 it placed orders with a Chinese State-Owned Enterprise (SOE) to build 6 pontoons. Our client agreed to make advance payments worth some USD 2 million against a bank guarantee that could be called if the contracts were cancelled due to the Chinese SOE's failure to timely deliver the pontoons. After various delays, it became clear in late 2013 that the pontoons would never be delivered. As no settlement could be reached, our client the cancelled the contracts and demanded return of the advance payments. When the builder refused, our client called the bank guarantee.

International Arbitration with the ICC

To suspend pay-out of the bank guarantee, the Chinese SOE filed a request for arbitration in January 2014. Under the agreed arbitration clause, arbitration was subject to PRC laws but was to take place under ICC (International Chamber of Commerce) rules in Vienna, with three arbitrators. Considering that the case was fairly straightforward, and in the interest of efficiency and cost, we proposed to appoint only one arbitrator. The Chinese SOE disagreed and the ICC finally decided to stick to three arbitrators. By May 2014, each of the parties had appointed one arbitrator and the ICC had appointed the third, who became the President of the Arbitral Tribunal.

The next 18 months were occupied with procedural matters, submissions of arguments and evidence, and a limited discovery process. Hearings finally took place in November 2015. Post-hearing briefs were submitted three weeks later, followed by each party's Statements of Costs and the other's response thereto, and by the middle of December the Arbitral Tribunal had all the facts to decide and issue the award. Unfortunately, the Arbitral Tribunal needed till July 2017 to render the final award: the Chinese SOE's claims were rejected in full, while each party was to bare its own legal fees and arbitration costs.

The arbitration took 3.5 years to complete, which felt long for a small claim that in the final and unanimous opinion of the arbitrators was not in evidence. Pre-hearing procedures went on longer than necessary, but the biggest disappointment: after a hearing during which the claimant was unable to prove its claims, the Arbitral Tribunal needed another 18 months to come to the obvious conclusion. And finally, our client's costs for the arbitration were not awarded, despite the fact that the claims were rejected in full.

On the other hand, we won our case and it was now over. Or was it?

Enforcement in China

The arbitration award rejected the Chinese SOE's claims, and thereby confirmed that the Chinese SOE owed our client the return of the advance payments for the pontoons under the cancelled contracts. This means that technically, the suspension of the bank guarantee was automatically lifted and there was in principle no need to apply for recognition and enforcement of the international arbitration award – which would have required a separate procedure.

We decided to first send a demand letter to the Chinese SOE to negotiate a settlement of the outstanding debt, but when this did not yield a quick result, our client call the bank guarantee. To our surprise, the Chinese bank guaranteeing the refund of the advance payments refused to comply, citing a Chinese court order that prevented it from doing so.

We contacted the handling court and discovered that as soon as the arbitration award was issued, the Chinese SOE had filed an application to the court for an asset freezing ruling against pay-out of the bank guarantee, pending the outcome of a separate lawsuit that they were planning to file against our client. The ruling was duly granted and therewith the Chinese bank was ordered to refuse pay-out of the bank guarantee. The Chinese SOE then followed up with a lawsuit with claims that the arbitral tribunal had denied it.

Considering the nature of a bank guarantee and the contents thereof (that it can only be suspended when an arbitration is filed), it may come as a surprise that a Chinese court can order a bank not to pay out. Indeed, PRC law provides for the possibility for a court to grant an asset freezing ruling on funds to be paid out under a bank guarantee, but only when a number of very strict conditions are met, which include:

The guarantee is highly likely to be fraudulent; and

  • Failure to suspend the payment immediately would significantly harm the legitimate rights and interests of the claimant.

In this case, none of these conditions were even tested; the local court issued the ruling before it even saw any evidence in support of the claim.

We responded immediately: first, we filed an appeal against the asset freezing ruling, arguing that the legal standards were not met – there was no fraud, moreover our client had sufficient assets in China (in the form of subsidiaries) against which an eventual judgment could be enforced. Second, we challenged the jurisdiction of the Chinese court to handle the Chinese SOE's claims, on the basis that our client and the Chinese SOE has agreed to refer all disputes between them to arbitration. We felt strengthened in this argument by the fact that the Chinese SOE had raised similar claims during the arbitration, thereby acknowledging the arbitral jurisdiction.

It took a while for these cases to get started. Meanwhile we contacted to the Chinese SOE for a settlement, but since it was expecting a severe discount that our client had no intention to give after 4 years of battle, no settlement was reached. We turned our focus on the cases at hand; and after several hearings we got the following results:

  • On 7 February 2018, the Chinese court handling the jurisdiction objection refused our jurisdiction challenge; we filed an appeal with the higher court.
  • On 21 August 2018, the Chinese court that handled our objection against the freezing asset ruling found in our favor; the Chinese SOE filed an appeal with the higher court.
  • On 22 November 2018, the appeal court handling our objection to the freezing asset ruling confirmed the first ruling, i.e. it determined that there were insufficient legal or factual grounds for the injunction, and therefore it cancelled the freezing asset ruling. We immediately applied to the bank for release of our client's bank guarantee, and after several months of further procedures the funds were finally released to our client, with interest.
  • On 25 December 2018, the appeal court handling the jurisdiction challenge nullified the decision of first-instance to deny our challenge; and sent the case back to the court of first instance for re-consideration. We are still awaiting a new court hearing on the subject.

Lessons on Effectiveness of International Arbitration in Chinese Disputes

Resolving disputes, whether through the courts or arbitration, is rarely easy. A bank refund guarantee is one of the strongest tools available to parties to secure a refund, but even with this in place it took more than 5 years for our client to get its payments refunded.

One question that arises: was international arbitration the right choice? It is entirely possible that we were just unlucky with an Arbitral Tribunal that was not in a hurry; though the fact remains that especially in arbitration, there is nothing one can do to influence arbitrators to work more quickly. And still the most important aspect of the whole case: we won in full and our client did get its money back, plus interest.

On the other hand, domestic arbitration (e.g. with the SHIAC in Shanghai or CIETAC in Shanghai / Beijing, both reputable institutions that include many international experts on their panels) generally work faster and would certainly have been cheaper, while the results may well have been similar. Domestic litigation in China could have been faster as well and would have allowed us to avoid the second court case. The concern that foreign companies continue to have with domestic arbitration or litigation is on local protectionism – especially if the counterpart is an influential state-owned enterprise. On the other hand as this case has also shown, even if a first-instance court comes to the "wrong" conclusion, one has an opportunity to overturn this in appeal – something that arbitration does not offer.

One final issue to consider: should our client have settled earlier and avoided the dispute altogether? In our case, we do not think this would be a fair conclusion. Despite that it took so long, our client finally received much more than the Chinese SOE ever offered in settlement, even after deduction of arbitration costs and lawyer fees.

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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