China Law Blog

Overtime Pay In China. What Ya Gonna Do?

Dan — Mon, 13 Feb 2012 22:48:04 +0800

The following is an email on which I was cc'ed from one of our lawyers to a client regarding paying overtime to employees in China. I am running it here because we are so often asked about China's overtime requirements and because they are so different from those in the United States. Speaking overly generally, overtime is not required to be paid to high level salaried management in the United States and that generally is not the case in China, unless prior approval from the Labor Bureau has been obtained. The ease of obtaining this approval varies wildly across China.

Here's China general system:

1. China does not recognize the concept of a salaried employee (without overtime) as is common in the U.S. for management personnel.

2. The only legal method of payment in China is by an hourly wage. If an employee works beyond the 40 hour week, then the employee must be paid overtime. If the employee works beyond the daily 8 hours, the employee must be paid overtime. That is the way the law works and there are no exceptions.

3. This inflexible approach is set up for the conditions of line workers in a large factory. It does not fit with the way that businesses like yours actually operate.

4. The employee manual we provided you accords with the strict requirements of China's overtime laws.

5. Companies deal with the overtime issue in various ways, depending on the actual conditions of the company. The most common is to have an informal policy for adjustment. That is, if an employee works too much in any day or week, the employee takes time off in subsequent days or weeks to compensate. This approach does not strictly comply with the law, but I am not aware of any company getting objections if the approach is actually followed. However, it is not something that should be memorialized in the employee manual and there are no guarantees that you will not be facing an overtime action at some point down the road for this.

6. For management personnel, the situation is more complex. It simply makes no sense to expect that management personnel will be paid on an hourly basis in the same way as production workers. Most Chinese companies therefore expect their management personnel to work on the same basis as U.S. style salaried workers. Even though this is common, it still exposes the company for a claim for overtime if there is a later dispute. Again, this is not something that should be included in the employee manual. It should instead be worked out with the manager on a case by case basis.

7. The really difficult issue is with sales staff who travel extensively and maintain irregular work hours. It is best to have a policy where their work hours are adjusted depending on how much time they have spent working in any given week. This is often difficult to do. A number of Chinese companies make no attempt to pay overtime or make any adjustment for this type of worker. As a result of this, these companies are exposing themselves to claims for back overtime in the event of a dispute. Here, the risk is quite real. I have seen a number of cases where this type of worker makes an overtime claim in situations where there is a dispute. Since the employment situation is getting more difficult in China, disputes are becoming more common. You therefore need to take particular care on these issues.

How do you handle overtime in China?

Do The Walls Have Ears, Part II: Traveling To China Naked. Electronically, That Is.

Dan — Mon, 13 Feb 2012 07:28:23 +0800

“Paranoia is just having the right information.”
― William S. Burroughs

Just when I think I cannot get any more paranoid.

The New York Times just came out with an article, entitled, "Traveling Light in a Time of Digital Thievery" (h/t Learn China Business), on how various U.S. government agencies and think tanks and companies are requiring their employees to travel "electronically naked" when they go to China. Electronic nakedness means bringing only data-free electronic devises. I hate to say it, but this probably makes sense for many people/companies.

I wrote on this same topic almost exactly two years ago, in a post entitled, "China: Do The Walls Have Ears." In that post, I said that when "I go to China and many other countries, I assume my hotel room is bugged and my internet is monitored. I assume the worst and I take every measure I can to be careful. I know people will (and have) laugh at my "paranoia" but I have plenty of stories to tell involving people who were not careful about their data.

I then listed out the following clear-cut privacy breaches/mistakes of which I had been made aware:

1. Many years ago, I was staying on the business floor of the Hotel Lotte in Pusan, Korea. This floor has a couple of computers for its guests. I got on one of those computers (to read the news) and the first thing that popped up was a letter written by a Seattle company revealing information I know they would not have wanted me to see. Someone from this company had written this letter on the computer (in Word format) and simply left it there. Not smart.

2. Many times I have gotten on the internet at an airport computer and been let right into someone's web-mail account. Not smart.

3. A couple of years ago, I found a memory stick in the desk drawer of my hotel in Shanghai that contained an incredible amount of information on a European plastics company. Not smart.

3. A stockbroker I know was sent an email by a rival stockbroker, urging my stockbroker friend to oppose some proposed law that would strike hard at those with massive net worth. The stockbroker who sent out this email cc'ed it to a half dozen or so of his clients and my friend figured these were people with the requisite massive net worth and he cold- called them for their business. He ended up getting a great client with this tactic. Not smart.

4. Many years ago, a client of ours discovered one of its employees was running a rival business within my client's business. My client then arranged for this employee to bring his two company laptops to the office and then when the employee went out to lunch, my client locked him out. You would not even believe the stuff we found on those laptops. I am talking both business and personal. Very, very personal. Naked photos with mistress personal. Not smart.

5. Many years ago, I was going to a particular city in a former Communist country and my client and I agreed that, above all else, I should completely avoid meeting with or even talking to "Oleg" [made up name here]. I had to go to this city, but I was going to be there for only two days. I fly in, walk into my hotel lobby and, before I can even check in, two people come up to me and say that Oleg will be coming by to take me to dinner at 7:00 pm. I felt I had to go at that point and when I asked Oleg how he knew of my arrival, he said that he gets emailed the list of all foreigners as soon as they arrive. Oleg runs a very successful private business.

The New York Times article starts out focusing on the digital steps Kenneth Lieberthal takes before going to China:

He leaves his cellphone and laptop at home and instead brings “loaner” devices, which he erases before he leaves the United States and wipes clean the minute he returns. In China, he disables Bluetooth and Wi-Fi, never lets his phone out of his sight and, in meetings, not only turns off his phone but also removes the battery, for fear his microphone could be turned on remotely. He connects to the Internet only through an encrypted, password-protected channel, and copies and pastes his password from a USB thumb drive. He never types in a password directly, because, he said, “the Chinese are very good at installing key-logging software on your laptop.”

It seems other companies mandate similar procedures:

At AirPatrol, a company based in Columbia, Md., that specializes in wireless security systems, employees take only loaner devices to China and Russia, never enable Bluetooth and always switch off the microphone and camera. “We operate under the assumption that we will inevitably be compromised,” said Tom Kellermann, the company’s chief technology officer and a member of President Obama’s commission on cybersecurity.

Google said it would not comment on its internal travel policies, but employees who spoke on condition of anonymity said the company prohibited them from bringing sensitive data to China, required they bring only loaner laptops or have their devices inspected upon their return.

Does the above make sense? What do you do to protect your data in China and elsewhere?

Big City China Salaries

Dan — Sun, 12 Feb 2012 22:08:20 +0800

Danwei.com did a blog post on a recent J.M. Gemini salary survey of Beijing, Shanghai and Guangzhou. The salary survey is extensive in that it consists of about 25 pages of salary estimates for a whole slew of different jobs in these three cities. The survey itself points out that the salaries listed are just ranges and that they are "intended to give approximate salary ranges for the positions as described and
specific skills or experience requirements can mean that a premium may need to be paid." I would add that you can generally expect salaries in second tier cities to be lower than those listed in the survey. Despite all these provisos, I found this salary survey to be quite helpful and the next time someone asks me what I think salaries are for a particular position, I will immediately refer them to this.

Danwei pulled the following jobs/monthly wages in RMB from the survey as representative:

Junior secretary: 2,500 – 3,500
Executive secretary / PA: 13,000 – 21,000
Accountant: 10,000 – 15,000+
Finance director: 65,000+
Quality control manager: 14,000 – 24,000
HR manager: 20,000 – 35,000+
Translator: 8,000 – 18,000+
News editor: 5,000 – 8,500
Web editor: 6,000 – 19,000+
IT Programmer: 5,000 – 9,000
CEO advertising agency: 70,000 – 100,000
Regional sales manager: 26,000 – 36,000+
Mechanical engineer: 10,000 – 16,000
Senior architect: 25,000 – 45,000

What do you think? Are the survey numbers in line with what you are seeing? Are you aware of any other recent salary surveys available on the Internet?

Sourcing From China. The Captive Buyer Issue.

Dan — Sat, 11 Feb 2012 01:08:53 +0800

About a month ago, we did a post, entitled, "Buying A Chinese Company? Why China Deals DON'T Get Done," on why (in our experience) so few deals to buy Chinese companies actually close. Our explanation was that the cost structure of a Chinese domestic company is going to radically increase when and if it becomes a United States owned entity (WFOE). This will occur because the Chinese domestic company is (in most cases) not paying the taxes foreign entities simply cannot get away with not paying.

In that post, we talked quite a bit about a particular deal that had not gone through after the client determined that labor costs would pretty much double. That case involved an American company that felt almost compelled to buy its Chinese supplier because the owner of that supplier was retiring. In the end, the client chose not to buy the Chinese company because of the increased operating expenses it would need to take on. However, in a stroke of luck, the manager of the Chinese company stepped in and bought the company and the long-term successful buyer-seller relationship was maintained.

My thinking was "mission accomplished." But in a post entitled, "Beware Captive Buyer’s Syndrome- The Risks to your China Buying Program," The China Performance Group Blog (CPG) rightly disagrees. In that post, CPG points out how our client is still running "captive buyer" risks:

Now on the surface, this post about a foreign company buying a factory they had been working with reliably for many years may not seem to be related to China sourcing as it rather addresses issues related to market entry and M&A. However, what particularly caught our eyes here at CPG was this: “The potential deal was for a US manufacturer that had been receiving its product from the same China manufacturer for about fifteen years… the two companies had a “fantastic” relationship.”

Most experienced companies avoid setting up sourcing offices in China. This is typically because it is expensive and cumbersome from a management point of view, but they will have alternative approaches to create a reliable source of supply. One of these approaches is to set up a long-term relationship with one Chinese supplier, as with the US company in the post quoted above. It is only when that relationship is threatened that the vulnerabilities of this approach begin to become evident.

The post goes on to posit that "(1) the foreign customer (our client) is what we call a “captive buyer” and (2) they are paying too much for the product."

I buy both points.

The post goes on to define a “captive buyer” as "someone that does primarily most of their buying with one factory, and since their whole relationship is with one buyer, they have no Plan B with other vendors. This indicates that the vendor has acquired dominance in the relationship, and can afford to start taking advantage of the buyer (inflating pricing, etc.)."

The post then rightly notes that the buyer often views the higher price as a fair trade-off in return for getting a reliable supplier, but even reliable suppliers carry risks, made even bigger if there is no plan B. According to the post, plan B would be to closely monitor your existing factory and have contingencies in place, such as a back-up supplier or a sourcing company at the ready.

So what's a product buyer to do? Try the following:

Do whatever you can to solidify your relationship with your good supplier(s). For more on this, check out "Manufacturing Your Product In China.The Extreme Basics." This will help prevent your having to resort to plan B.
Have a plan B in place. This plan B is going to depend on your company and your situation. If you are buying massive quantities of product from one supplier in China, consider adding another supplier. Think of the extra cost of doing so as your risk insurance. If you are not willing to add another supplier, at least have duplicate tooling and/or molds made and be aware of who your next supplier might be.
Get product interruption insurance. I am not terribly familiar with these sorts of policies, but I know they exist. The potential shortcoming of insurance like this is that your getting a million dollars is not likely going to go very far in convincing your own customers that they can trust you to deliver your product on time the next time.

What are your thoughts? What else should product buyers do to protect themselves?

The End Of Cheap China, Part V. Even More On How YOU Must Prepare For It.

Dan — Tue, 07 Feb 2012 19:48:00 +0800

In part IV of our continuing series on the end of cheap China and the impacts arising from that, co-blogger Steve Dickinson wrote about the increased risks product buyers are facing from their China-based manufacturers. That post concluded with Steve talking about why paying your Chinese manufacturer in advance for product can be so risky. In this post, Steve addresses other, better, payment options.

To summarize my last post (The End Of Cheap China, Part IV. More On How YOU Must Prepare For It), the following are the basic rules you should employ to pay for product produced by Chinese manufacturers:

Avoid paying an advance deposit. If you must pay an advance deposit, understand the risk. Do not throw good money after bad in sticking with a manufacturer that shows it cannot do the job.

Inspect the product before you pay. Ideally, do the inspection after delivery. If you inspect the product in China, take into account the risk of deception.

Take your inspection seriously. If the inspection shows a problem, either cancel the contract or insist on a remedy. It is surprising how many buyers ignore the results of their own inspection. I have seen several cases recently where buyers contracted for OEM manufacturing of their product using the terrible 30/70 system discussed above. Having read about the problems of defects from China, they paid for a pre-shipment inspection. The inspection showed numerous surface defects, suggesting deeper problems with the product. However, as a result of feeling stuck by their deposit and being under time pressures, they paid the full amount and had the product shipped anyway. In each case, numerous defects appeared, rendering the entire shipment essentially worthless. They could have filed suit in China, but either the amount did not justify the cost of suit or they did not have the resources to sue. If your product inspection reveals a problem, take this seriously. Do not payuntil the problem is solved. Do not think that a theoretical right to sue will save you from disaster. International litigation is expensive and uncertain. Do not allow yourself to be put in a position where such litigation is even a possibility.

The above discussion shows how truly unusual the situation is in China concerning product sale. For most countries in the world, the standard product purchase and sale contract is something like this:

Payment is made after inspection. In most cases, the inspection is made in the country of delivery to prevent fraudulent substitution.

Inspection is made by a truly independent and expert inspector. The inspector usually works for an internationally recognized inspection agency with a long track record of expertise and independence.

Payment is made pursuant to an irrevocable letter of credit issued or confirmed by a major international bank.

The key to this system is the participation of truly independent, trusted intermediaries: the inspector and/or the bank. In drafting purchase agreements where such trusted intermediaries will be used, I focus far less on the litigation/ dispute resolution process because my client's protection comes from the payment system itself. I Instead focus on creating a set of clear rules so that the intermediaries will be able to do their job with no chance of mistake or misunderstanding. If my drafting is unclear, the inspector or bank will simply reject and I have to try again.

The situation in China is oftentimes completely different. In the China trade process, the usual trusted intermediaries are not permitted to operate. Inspections are done by state owned inspection companies. Letters of credit are issued by state owned banks. Since the 80s, these state owned entities have shown that they are not independent. They will virtually always side with the Chinese side in the case of a dispute.

The result is that they are seldom used. Without the services of trusted intermediaries, the Chinese trade system is set up so that one side of the transaction bears excessive risk. In smaller transactions, the foreign buyer usually bears the risk. In large transactions, the Chinese seller usually bears the risk. This would not be necessary if the Chinese companies and government simply made greater use of the existing system of well established inspection and trade finance.

However, I see no movement at all in this direction. The risk is considerable and must be taken into account in all purchases from China.

Buyer beware.

DAN'S ADDITION: Many years ago, I represented a US Company that was sued for having provided allegedly rotten food to a foreign fish buyer. The foreign company sued my client in a US Federal Court for the bad food. The foreign company's case hinged entirely on a Chinese government inspection of the fish, which said that the food was bad. Very soon after the case was filed, we told the foreign company plaintiff that there would be no way it could prevail because the Chinese government inspectors would never testify and without them, they had no evidence of bad product. Two years later, and right before trial, we settled the case for a pittance because the Chinese government inspectors had avoided being deposed and would not be showing up for trial. I mention this to point out that even in those cases where the Chinese government inspection reveals bad product, you may not be able to use that inspection in such a way to ensure a real recovery. This case was maybe five years ago and things may have changed since then, but I doubt it.

Another China WTO Loss. Another Nail In The Coffin Of World Trade.

Dan — Mon, 06 Feb 2012 19:48:21 +0800

By: Steve Dickinson

Preserving its track record of major defeats before the WTO, China recently lost its appeal of the WTO panel decision in the minerals export case. The appeal decision was issued on January 30 and can be found here. Briefly stated, the original panel report held that Chinese export duties and export quotas for certain industrial minerals violate WTO requirements. China was ordered to reduce its duties and dismantle its export quota system. China appealed and lost on all important issues.

This decision has important implications. As most observers have noted, the real issue is export quotas and the real target is China’s export quota system for rare earths. Under the terms of this decision, China’s rare earths quota system is in clear violation of the WTO. The U.S. and others expect China to now act on its own and terminate the rare earths quota system. If this is not done voluntarily, the U.S. and the European Union have threatened to bring a follow-up action in the WTO, targeting rare earths. After this victory in the metals case, such an action against China would almost certainly succeed.

More important, China has an extensive export quota system covering over 600 products. These are all basic materials considered by China to be vital to its internal security: energy, raw materials and food. Under the terms of the panel decision and appeal, it is now clear that China's entire export quota system is in violation of the WTO. This recent decision on minerals therefore goes far beyond rare earths. It is a challenge to a vast and complicated system that the Chinese see as essential to national survival.

Ron Kirk, the U.S. Trade Representative, described the success of the appeal as as a “tremendous victory” for the United States. In reality, the decision is bad for both the United States and China and for the members of the WTO as a whole.

This case is a very hot issue in China. After the decision, assessments have appeared from the Chinese government, the Xinhua News Service (the Chinese government's propaganda arm) and from general business commentators. The universal conclusion of the Chinese is that China has no intent whatsoever to comply with the terms of this decision or any other decision relating to its export quota program or to any other regulatory regime China deems in its national interest (such as China's restrictions on importing print and audio-visual materials).

The basic position set forth in the Chinese press has been as follows:

Control of domestically produced raw materials, energy and food are vital to China’s national interest. China will not allow a trade law like the WTO to impact its pursuit of policies such as export quotas that are vital to its national interests. The attempt by the developed countries to use the WTO as a way to attack China’s national interest is unfair and shows bad intent. Such attempts will be rejected.

China still intends to remain within the WTO so as to be able to obtain certain trade benefits. Rather than openly disregard the minerals decision, China will resort to “procedural games” (游戏规则) to render any response against China ineffective as a practical matter. China is proud of how it has used “procedural games” to avoid its responsibilities to respond to adverse WTO decisions and it openly states that it will continue to use this approach in these "national interest" cases. In fact, the term “procedural game” has become a standard feature of the China's trade policy vocabulary.

This result is bad for supporters of the WTO trade system and it is bad for China. It is bad for the supporters because it exposes the weakness of the WTO dispute resolution process for resolving serious trade conflicts. China’s recent series of losses in the WTO justifies the US and other countries imposing major tariff and related trade sanctions against China, but no such sanctions have been imposed and China has concluded that no such sanctions will ever be imposed. China correctly believes that it can afford to ignore adverse WTO decisions because the complaining countries have no interest in actually imposing sanctions. We can thus expect China to continue ignoring most (all?) adverse WTO decisions against it. This will serve to progressively weaken the WTO trade system.

The odd thing about the export quota case, however, is that China itself is likely to be the biggest loser. China is the major importer in the world of raw materials, energy and food products. China therefore absolutely requires an open and fair export system for such products. By acting to support mercantilist export quotas and other restrictions on the export of critical raw materials, China is acting directly against its own economic and national security interest. China's control of the rare earths export market has convinced it that it can become a rare earths version of OPEC, giving them power to finally dictate terms to the developed world. This dream has blinded China to the real risks of its plan.

Both China and the U.S. are acting recklessly in a way that serves to undermine the WTO trade system. The damage has been done. The WTO minerals ruling is just another nail in the coffin. The WTO has been murdered. China pulled the trigger and the U.S. and Europe supplied the gun.

What do you think?

For more on China and the WTO, check out the following:

For more on China's rare earths, check out the following:

Dr. Clarisse von Wunschheim On Arbitrating Your China Disputes, Part III. Is Enforcement Overemphasized?

Dan — Sun, 05 Feb 2012 23:08:17 +0800

This is part III (the last) of Dr. Clarisse von Wunschheim's three part series of guest posts on China arbitration. I asked Dr. von Wunschheim to write this series because arbitration is so important to so many China transactions and she literally wrote the book on China arbitration: Enforcement of Commercial Arbitral Awards in China.

Dr. Clarisse von Wunschheim On Arbitrating Your China Disputes, Part II. Inside Or Outside China?

Dan — Sun, 05 Feb 2012 00:08:08 +0800

This is part II of Dr. Clarisse von Wunschheim's series of guest posts on China arbitration. I asked Dr. von Wunschheim to write this series because arbitration is of such crucial importance to so many China transactions and she literally wrote the book on China arbitration: Enforcement of Commercial Arbitral Awards in China.

More from Dr. Von Wunschheim:

PART 2: Pros & Cons of Arbitration Inside and Outside China

In my previous post, I tried to establish that though the question of whether to arbitrate in or outside China may seem to be primarily relevant for so-called ‘foreign-related’ contracts, it actually concerns all kinds of China-related contracts. Today’s post aims to determine the main pros and cons of each option, as well as the current trends which they give rise to.

Referring to the arguments most often invoked by the supporters of each option, the main pros and cons can be summarized as follows:

ARBITRATION OUTSIDE CHINA

PROs

CONs

- Neutrality of the forum, and thereby better assurance of independence of the arbitrators and the arbitration institutions

- Higher level of professionalism, ethical standards and competence of international arbitrators

- Increased flexibility and party autonomy, especially with regard to (i) choice of the arbitrators and (ii) conduct of the proceedings

- Expensive

- Slow

- Complicated

- Lack of availability of interim measures for protection

- Difficult enforcement of foreign awards in China

- Western Bias against Chinese companies

ARBITRATION IN CHINA

PROs

CONs

- Faster

- Cheaper

- Some availability of interim measures for protection

- Easier enforcement

- Lack of independence of the arbitrators and/or the arbitration institution

- Limited party autonomy regarding selection of arbitrators and design of the arbitration proceedings

- Lack of professionalism among arbitrators

- Restrictions regarding representation by foreign lawyers

- Lower ethical standards of lawyers and arbitrators

- Complicated

Though the above lists give a good overview of the most common ‘selling points’ of each option, they do not distinguish:

(i) the weight of each individual pro or con compared to the others;

(ii) what makes the difference at the end of the day, the pros of the chosen option or the cons of the opposite option.

With regard to the individual weight of each pro or con, this can be quite different if looking at the problem from the perspective of a Chinese company/lawyer or from the perspective of the foreign company/lawyer.

With regard to the position of Chinese lawyers/companies, most of them seem to favor arbitration in China for the following main reasons:
- They believe arbitration outside China is too expensive, takes too much time and is too complicated;
- They believe Western arbitrators and arbitration institutions are biased against Chinese companies;
- The Chinese arbitration system works just fine.

While there is merit in some of these arguments, I also think that they are partly misplaced:

- Regarding the costs: There is no doubt that arbitration according to international standards and with the involvement of international specialists is generally more expensive than arbitration in China under a local arbitration commission and with local experts. However, there is a reason why, and the list of pros and cons listed above already gives a hint of these reasons. In addition, many companies and especially Chinese companies, misperceive the real cost items and ignore that there are ways to control and limit these costs. They often believe that the main cost item are the fees of the arbitrators and arbitration institution, while it is actually the lawyers’ fees (which are estimated to represent over 80% of the total costs related to an arbitration). They will also often tell you that prices in Geneva, London or Stockholm are far too expensive and they can’t afford to travel there. This argument ignores that the place of hearings does not need to be at the place of arbitration (actually a lot of lawyers ignore that too…). The place of arbitration is a virtual place determining the applicable legal framework to the arbitration, and while they may need to hire lawyers from that region, parties do not need to go there. Hearings can be held in Hong Kong, or even somewhere in China, while the place of arbitration can be anywhere outside China.

- Regarding the time: It is also true that the deadlines provided in Chinese arbitration rules are usually shorter than in international arbitration rules, and that arbitration proceedings in China usually take less time than in international arbitration proceedings. However, firstly, while speed is good, it is rarely a virtue per se. If it is at the expense of quality it is useless, and even detrimental given the final and binding character of the award. Secondly, let’s not forget that in international arbitrations the parties are the masters of the proceedings, and therefore also of the timeline. In many cases, the problem does not lie with the arbitrators or the rules, but with the parties and their counsel. As busy as famous arbitrators may be, the same is true for high profile arbitration counsel… Here again, there are ways to control this issue, by choosing appropriate arbitrators and counsel. Many arbitration institutions now also provide for fast-track arbitration proceedings.

- Regarding the argument of ‘complicated’ proceedings, I believe this argument confuses ‘complication’ and flexibility. Chinese arbitration does not provide lawyers and parties with a lot of autonomy, and most things are decided by the arbitrators in a fairly expedited manner. Thus, when Chinese companies and lawyers are involved in international arbitrations, they do not know how to deal with the autonomy given to them and they see that as being ‘complicated’. Due to their lack of exposure to arbitration abroad, many Chinese companies and lawyers do not feel confident in their ability to efficiently conduct such proceedings. And, let’s be honest, no one likes to have to get external help…

- Regarding the argument of bias against Chinese companies, I believe it is closely linked to the previous argument. It is normal that Chinese parties feel safer at home, the same is true for any party from anywhere. However, this concern has recently been alimented by a survey from CIETAC according to which Chinese companies involved in arbitrations abroad lost in 9 out of 10 cases. Unfortunately, only the result of this survey was published without any information on the reasons for the loss or the methodology or scope of the survey. Thus, while some believe that this survey confirms Western arbitration is tainted by a general bias against China, others (myself included) prefer to explain the figure of 9/10 losses (if at all representative - I am still skeptical about this figure) with the lack of experience and familiarity of Chinese lawyers and companies with international arbitration, which leads them to make the wrong choices. Also, let’s remember that splitting the world into the West vs. China does not really reflect the current world map, be it in terms of geography, economic interests, culture or political power…

In summary, I believe most concerns of Chinese companies and lawyers arise from misperceptions concerning the real functioning of international arbitration. This is understandable to the extent that, except for a handful of mostly big Chinese law firms and their clients, most Chinese lawyers and companies have not yet been exposed to international arbitration.

However, I should also stress that I have noticed in recent years an increased willingness of Chinese companies and lawyers to arbitrate their dispute outside of China, though they often insist on places such as Singapore or Hong Kong. Chinese parties choose these venues because they feel culturally close to them and believe that the risk of a bias against them is limited. From an outsider’s perspective, since these regions having both adopted the UNCITRAL Model Law on International Commercial Arbitration, they are attractive options compared to arbitration in China. However, what the parties often do not realize is that these jurisdictions have common law legal systems, which means that the way that lawyers work and the manner in which the case will be pleaded may be very unfamiliar to them and different from the spirit in which their contracts were drafted. I am thus not sure that this is necessarily the best way to go for Chinese parties, and in particular I am not sure it will help them feel more confident with international arbitration.

With regard to the position of foreign lawyers/companies, there is no unanimity and the two schools of thought find supporters. With regard to each of these options, the most common arguments I hear are the following:
- From supporters of ‘Arbitration outside China’: Arbitration in China is unpredictable. Arbitrators have too much power and the risk of lack of independence and impartiality reduces the chances of fair proceedings;
- From supporters of ‘Arbitration in China’: Arbitration outside China is not always efficient. After all, winning the arbitration is only half the battle, and enforcing foreign awards in China is more difficult than enforcing Chinese awards.

Again, I remain partly unconvinced by most of these arguments for the following reasons:

- Regarding the argument of unpredictability of arbitration in China: I agree that arbitration in China is often unpredictable. However I am not sure whether this is really due to the alleged lack of independence and impartiality of the arbitrators or the arbitration institution, as opposed to the general unpredictability of the Chinese legal system. In addition, one cannot deny that international arbitration always shows a certain degree of unpredictability, in particular when the case involves arbitrators from different backgrounds, lawyers and parties from different backgrounds and legal cultures, various laws applicable to various aspects of the dispute, etc. Who can honestly pretend to be able to predict the outcome? What must be predictable is the process; arbitration must provide the guarantee of a fair process according to pre-determined rules, and this brings me to the argument of lack of independence or impartiality of the stakeholders.

- Regarding the argument of lack of independence and impartiality of arbitrators: I have no doubt that this argument is justified in some cases. But this is also true on the international arbitration scene. Let’s not forget that the maxim: ‘the arbitration is only as good as the arbitrator’. In other words, your arbitrator can kill your arbitration, and this is true everywhere, not just in China. While it is true that the choice of arbitrators is more limited in China due to the system of panels of arbitrators, this limitation has been widely relaxed in recent years: Firstly, the current panels of some arbitration commissions, such as BAC or CIETAC, now list many foreign candidates, and secondly, these arbitration commissions now allow the parties to choose arbitrators outside the official panels (with regard to party-appointed arbitrators). In other words, when drafting their arbitration clause, parties have sufficient room to limit risks relating to the background and personality of potential arbitrators.

- Regarding the argument of enforcement: This is the argument that convinces me the least.

Firstly, why should enforcement of a Chinese arbitration award be easier than enforcement of a foreign award? While it is true that a Chinese award does not need to be first recognized before being enforced, this recognition phase consists in the review of the existence of grounds for non-recognition/enforcement. Such a review is also applicable to Chinese awards and they are subject to a similar system, though it is not called ‘recognition’. In addition, I am not sure that the end result of enforcement is more optimistic for Chinese awards than it is for foreign awards. Most of the difficulties encountered in enforcement proceedings are of a practical nature (finding the defendant, locating the assets, etc.) and apply generally to both types of awards. As to local protectionism or lack of independence of the courts, it can just as easily affect a Chinese award (rendered in favor of a foreign company) as a foreign award. In addition, numbers do not seem to support the theory that Chinese awards are easier to enforce (see a survey conducted by WunschARB).

Secondly, even if one was to assume that it is easier to enforce Chinese awards (which I do not believe), this can only be deemed an advantage if the award is the result of a fair process, which meets and corresponds to the parties’ expectations. And in this regard, in view of the cons listed above, many would say that the chances of getting a fair process is more difficult in a Chinese arbitration...

I draw two main conclusions from the above:

It seems to me that what makes the difference at the end of the day is often not the pros of the option eventually selected, but rather the cons of the other option.

This, together with the lack of persuasiveness of many of the cons, in turn indicates that the way parties choose between arbitration inside or outside China is still largely directed by their fear and ignorance of the other system and is not made in due regard of the specific needs and possibilities of the case at hand. And this will be the topic of my next post.

Dr. Clarisse von Wunschheim On Arbitrating Your China Disputes, Part I. The Legal Context.

Dan — Fri, 03 Feb 2012 12:08:25 +0800

We are always writing on the importance of China contracts having a well-crafted dispute resolution provision. My favorite line about this is the following, from the post, "Arbitration In Your China Contract. Adult Supervision Required":

With sushi restaurants, it's the yellow-fin.
With new houses, it's the windows.
With international contracts, it's the dispute resolution provision.

The "it" I am talking about is the one easiest, fastest, most accurate, way to judge whether something is good or not. And the way I judge international contracts is by heading straight to the dispute resolution provision. The well crafted provision is, above all else, unambiguous. If it calls for litigation, it says where it will be and what law will apply. And it says who will pay for it and under what circumstances. If it calls for arbitration, it says where it will be, how many arbitrators will be required, how the arbitrators will be chosen, the language of the proceedings, the rules that will be used for the proceeding, and the law that will apply. And it says who will pay for what.

The above are minimums.

Because arbitration is of such mainline importance to contracts with China, I asked China arbitration expert, Dr. Clarisse von Wunschheim to write a series of guest posts on China arbitration and she has agreed to do so. I asked Dr. von Wunschheim because she literally wrote the book on China arbitration: Enforcement of Commercial Arbitral Awards in China. Dr. von Wunschheim presently heads up WunschARB, "a boutique advisory firm created in Zurich in 2010, with the Beijing branch opening in April 2011. It provides advice and practical assistance preventing, managing and resolving cross-cultural commercial disputes, with a particular focus on international arbitration and China related disputes."

So without any further ado, Part I of Dr. von Wunschheim on China arbitration.

Introduction

One of the biggest bones of contention among lawyers and business people when it comes to negotiating and drafting arbitration clauses in China-related cross-border commercial contracts is whether it is better to arbitrate inside or outside China, and there are two main schools of thought:

Avoid China as place of arbitration and try to agree on a place of arbitration outside China. Focus first on winning the arbitration, and worry then about enforcement.
Avoid complications due to arbitrating abroad and keep your place of arbitration in China. Overall, you will be better off, especially when it comes to enforcement.

I believe that both of these approaches miss the point, and that the question of where to arbitrate is intimately linked to the parties’ expectations and needs and should therefore depend on a series of case-specific factors.

Before dealing with the pros and cons of each option (post no. 2), and determining which should – in view of the pros and cons and of the parties’ expectations - be the relevant criteria for selection (post no. 3), let me briefly set out the (legal) context of the issue.

Premise – Legal Restrictions on Choice of Forum

Under Chinese law (see in particular Art. 242 PRC Civil Procedure Law and Art. 128 Contract Law), only parties to a ‘foreign-related contract’ may choose a foreign dispute resolution forum. The corollary of this is that parties to a purely domestic contract must keep their dispute and its resolution in China.

Based on this, the debate about a foreign or a Chinese place of arbitration would seem to be limited to ‘foreign-related’ contracts.

However, this statement does not fully reflect reality and raises two main questions:

1. When is a contract deemed foreign-related?

The term ‘foreign-related’ can be misleading and the perception of foreign companies as to what counts as ‘foreign-related’ is therefore often wrong.

In 1992, the Supreme People’s Court defined a ‘foreign-related’ case as a case showing one of the following features:

(i) one or both parties are of foreign nationality or stateless, or a company or organization is located in a foreign country;

(ii) the legal facts that establish, alter or terminate the civil legal relationship between the parties occur in a foreign country; or

(iii) where the subject matter of the dispute is situated in a foreign country.

Unless one of these three circumstances is present, the case will be qualified as domestic.

While the official definition of what counts as ‘foreign-related’ seems to be quite broad, the practice of the Chinese courts is very restrictive: When determining whether a case is ‘foreign-related’ they rely exclusively on the first criteria, i.e. the nationality of the parties involved.

In summary, for a case to be considered foreign-related, at least one of the parties involved must be of foreign nationality. In this regard, foreign companies too often overlook the fact that their Chinese subsidiaries, including joint ventures or wholly owned entities, are considered to be Chinese entities established under Chinese law. Therefore, disputes involving such subsidiaries will mostly be considered domestic, which means that the contracts entered into by such subsidiaries may not provide for a foreign place of arbitration.

2. What happens if notwithstanding the domestic nature of your contract, you select a foreign place of arbitration?

If, notwithstanding the domestic nature of the contract, the parties opt for a foreign place of arbitration, they breach Chinese law and in particular Art. 242 PRC Civil Procedure Law and Art. 128 PRC Contract Law.

It is however not totally clear what the consequences of such breach are.

One argument could be to say that the arbitration clause is invalid because it breaches Chinese law.

However, this argument is not necessarily convincing, mainly for the following reason:

The law applicable to the validity of the arbitration agreement may not necessarily be Chinese law. Under most modern arbitration laws, the law applicable to the arbitration clause is the law chosen by the parties, and in the absence of an explicit choice, it is the law of the place of arbitration.

In other words, where the parties choose a place of arbitration abroad, let’s say in Switzerland, Swiss arbitration law will apply to the question of the validity of the arbitration agreement. Since there are no restrictions under Swiss arbitration law with regard to the place of arbitration, an arbitral tribunal constituted under Swiss arbitration law will have no reason to consider the arbitration agreement invalid.

The restriction imposed by Chinese law on the place of arbitration may therefore in principle not prevent the arbitration from taking place in another country.

However, the party seeking to enforce the arbitral award in China may encounter serious problems.

From the outset, I should say that I am not aware of any decision of Chinese courts refusing enforcement of a foreign award in relation to the breach of the legal restriction concerning foreign forum selection. In addition, the breach of legal provisions is – as such – not a ground for non-enforcement of foreign awards under the New York Convention.

However, I believe that Chinese courts would very likely consider such a breach to trigger the ground for breach of public policy under Article V(2)(b) New York Convention: Though it is true that the Supreme People’s Court has made it clear that a breach of – even mandatory – legal provisions does not necessarily amount to a breach of public policy (see e.g. ED&F Case 2003; Mitsui Case 2005; GRD Minproc Case 2009), it has also made it clear that a breach of China’s jurisdictional sovereignty will in principle amount to such breach thereby justifying to refuse enforcement (see the Yongning case 2008).

Since Art. 242 PRC Civil Procedure Law and Art. 128 PRC Contract Law are meant to allow China to keep control over certain contracts and disputes, I anticipate that a breach of these provisions would be regarded as a breach of China’s jurisdictional sovereignty.

Consequently, I believe that enforcement of a foreign award rendered based on an arbitration agreement which disregards the forum selection restrictions set by Art. 242 PRC Civil Procedure Law and Art. 128 PRC Contract Law run a serious risk of being refused enforcement based on Article V(2)(b) New York Convention.

Does this mean that parties should refrain from entering into such arbitration agreements? Not necessarily. This ultimately depends on the importance given to the issue of enforcement, within the entire context of reasons why parties would want to choose arbitration abroad.

In this respect, it is my contention that the role of enforcement is often overemphasized and this will be the topic of the next two posts.

The End Of Cheap China, Part IV. More On How YOU Must Prepare For It.

Dan — Wed, 01 Feb 2012 23:38:17 +0800

By: Steve Dickinson

In my previous post in this series on the end of cheap China, I noted that the risks relating to purchases from Chinese manufacturers are rising in the export sector in China's Eastern provinces. Given the risks, it surprises me that I still see many buyers who continue to use the worst payment system possible in their dealings with Chinese manufacturers. The standard (terrible) system for payment in most of the export sector is: 30% down payment on signing of contract with the remaining 70% payable prior to shipment.

Why is this a terrible system for the Buyer? Let's consider the deposit system first. It is common for a Buyer to learn that the manufacturer is not able to make the product, makes the product with excessive defects or substantially delays in delivering the product. If the Buyer has paid a 30% deposit, the Buyer is basically "stuck" with the manufacturer and is not able to go elsewhere even after these problems are discovered. I have seen many Buyers who find themselves trapped in this way.

More important, the need for deposits reveals weakness of the manufacturing sector. Many foreign buyers naively believe the deposit is retained in a special account or is at least reserved for their own project. This is not the case. The 30% deposit is not used as any sort of security. Rather, the deposit is used as a financing tool for the manufacturer. Most raw materials for production are purchased with these deposits without regard to the specific project or buyer. Other costs are paid from the same general deposit fund.

As a result, when there is a problem, the deposit is almost never returned. There are two reasons for this. First, the manufacturer has already spent the money on costs and simply does not have the funds available to pay a refund. Second, the manufacturer knows that the amount of the deposit is so small that there is little risk of the foreign buyer filing suit for a refund. Indeed, normally there is not contract so the basis for requiring a refund is not clear. Thus the Buyer is forced to negotiate a price reduction or an extension or some other make-do remedy with a manufacturer that has already revealed ts clear weaknesses.

Now consider payment of the 70% upon shipment and prior to delivery. Under this approach, if the Buyer does not inspect in China, the Buyer only discovers what has actually been shipped after the payment and after the product has been delivered to the buyer. To consider the risks, consider these stories that have come into my law firm over the years:

Buyer purchases carrying cases for its notebook computer. Computer is 8 inches wide. The cases arrive. They are beautiful, except for one "minor" problem: they are all seven inches wide.

Buyer purchases jewelry bracelets with clasps that are to be mounted on the left side. The bracelets arrive. They are beautiful, except for one minor problem: the clasps are all mounted on the right side.

Buyer purchases hand blown glass Christmas tree ornaments. The ornaments arrive just in time for holiday sales. The are beautiful except for one minor problem: the ornaments do not include a ring on top for mounting on the tree.

Buyer purchases candle lamps. Lamp must be made from inflammable safety materials. Buyer pays extra for use of this material. The lamps arrive. They are beautiful except for one minor problem: they are made from normal, flammable paper and plastic and explode into flames at the touch of a match.

In each case, the Buyer received a full container of 100% defective product. The defect was so obvious that it would have been discovered by even the most rudimentary inspection prior to shipment. By failing to inspect, the buyer suffered a total loss. So much for the China price.

Of course, the more common thing is finding a smaller number of defects that result in damages ranging from 10% to 30% of the delivered product. Since the money has been paid, if these defects are discovered only after delivery to the buyer, then the buyer is entirely at the mercy of the manufacturer and is virtually without an effective remedy. The manufacturer knows that the amount at issue is too low to justify a lawsuit on the part of the buyer. If the manufacturer is looking for repeat business, the most common result is that the manufacturer will admit there are defects, refuse to pay a refund or damages and will instead offer a "credit" (typically 5% to 10%) against future purchases.

As with advance deposits, the "credit for defects" system is also a terrible system for the buyer that virtually always ends in failure. Let's take a look at how this works. In order to obtain the credit, the buyer must purchase from a manufacturer who has already shown that it will make a defective product and not give a refund for having done so. Buyers then get locked in a downward spiral. Each shipment has defects, and the amount of the credit grows. The manufacturer knows that the price for the subsequent shipments will be discounted, so the manufacturer gets even sloppier. So defects increase and delays become common. Finally, the buyer just gives up and writes the whole thing off or simply goes out of business due to the lack of adequate product.

Some buyers have finally understood that making payment prior to inspection is an invitation to disaster. Many buyers now perform inspections in China prior to shipment. This is an excellent trend and is basically required for protection of the buyer. However, this approach is still not as safe as inspection after delivery in the home country of the buyer. The basic reason is that we are aware of many times where Chinese manufacturers deceived inspectors and shipped non-conforming product.

As I mentioned in my previous post, some really bold manufacturers will substitute an entire container of non-conforming product by replacing a sealed container with an alternative. More often, manufacturers will rig the container so that conforming product is easy to find, with non-conforming product hidden deep in the container or in alternative locations on the loading dock. The only way to avoid these deceptive practices is to inspect at the place of delivery in the home country of the buyer and to make payment after that inspection is complete. Most Chinese manufacturers will strenuously resist payment only after inspection upon delivery. Buyers should therefore at a minimum inspect in China prior to shipment and then take into account the inherent risk in this practice. The price the buyer pays is actually substantially higher than its face value since this inherent risk is built into the price.

In part V of this series, I will discuss payment options that can reduce your risks.