Welcome everyone to Part 2 of a two-part post on China commercial litigation. Last edition of this newsletter, I talked about the importance of setting a clear choice in your contract (the dispute resolution clause) of what law will apply (Chinese or other), where a dispute will be settled (inside or outside China) and what type of forum (court vs arbitration) to argue the claims. And how there were some clear advantages to actually having that set as Chinese law and Chinese court.
Picking up on that thread for Part 2 here, note that you may actually have limited choices for where you can agree to settle a dispute. From time to time we see a contract between a foreign company’s China subsidiary and a Chinese counterparty, or we see even a contract between two Chinese subsidiaries of foreign companies where the dispute resolution is set to something other than Chinese law and a China-based forum.
A while back we had a client which had such a contract between two “WFOEs” (local subsidiaries of a foreign brand) where they chose to have dispute resolution as arbitration in Hong Kong. We were prepared to argue that this was in fact an invalid choice and instead to default to mainland China courts for dispute resolution. Sometimes people forget that WFOEs are, of course, considered Chinese companies. And just like purely domestic companies, when you have two local mainland Chinese parties with PRC law and all performance taking place locally, then arbitration in Hong Kong (which is considered a separate jurisdiction in these circumstances) is actually not proper and enforceable.
Why did we care? Why did we actually hope our client’s dispute resolution clause in the contract was invalid? Well the contract had a clear limitation of liability ((yes, commonly referred to LOLs) that no lost profits could be obtained in case of a breach. This is known as a limitation on consequential damages. And we actually wanted this question settled in a PRC court under PRC law to help us find a hole in that LOL.
Remember, for our client (and most companies), the larger amount of damages are usually consequential damages (lost profits). This was clearly true in our case, the early termination of a distribution agreement.
Under PRC law, a non-breaching party is entitled to “actual damages” (实际的损失) regardless of what kind of damages the parties try to explicitly limit in the contract. Of course, an interpretation of “actual damages” can vary a lot whether the forum is arbitration or court, or even vary from court to court.
In the case of a distribution agreement like our client's, where some portion of the contract had already been performed, we were fortunate to have a track record showing past profits which we could point to and help project future profits for the remaining term of the contract. On top of that, as loss of profits are likely to be the only major source of damages for this kind of breach, this was likely to work in our favor to be considered as “actual damages”, regardless that the contract clause specifically excludes damages for loss of profits.
We were of course still going to argue alternative types of damages – for example terminating staff that were directly assigned to handle the account our client was losing, especially if the termination of these people were foreseeable to the other side (for example, specific people were assigned to their account that they worked with regularly). But these damages would still pale in comparison to the potential loss of profits.
Practice Point: An important aside and one I may build out in a separate newsletter edition down the road. One of the things which you can try to do when you are worried about limitations of liability on recovering lost profits (and on top of that, the difficulty of trying to calculate those future profits) is to negotiate liquidated damages. Where the two parties pre-agree on damages for certain violations of the contract. Courts in China generally will respect those kinds of pre-agreed "liquidated damages" clauses and this is often much preferred to leaving damage award decisions to the discretion of the local courts.
Now we’ve talked about why you might prefer dispute resolution in China under Chinese law. As we mentioned in the last edition of the newsletter, this is especially true when the counterparty to your contract has no assets outside of China. We work with other counsel on these kinds of cases, and one of the best explanations I have heard that can give you some window into the Chinese party’s thinking is straight from one of their lawyers below.
Amiad Kushner, Chair of the Litigation Practice at Seiden Law Group, has a large part of his practice focused on defending Chinese companies which are sued around the world, including in the US. Amiad and I talked about how Chinese companies do not necessarily fear being sued in the US on an episode of the China Business Law Podcast. Remember as discussed last time, a Chinese court will not honor a U.S. judgment since there’s no treaty on this between the U.S. and China
On Chinese companies’ leverage when sued in the US:
Amiad explains:
“The fact that a U.S. court judgment is completely meaningless in China creates enormous leverage. And it really drives the entire case. It creates a very powerful dynamic where the American company that's suing the Chinese company knows that no matter how successful it is in the case, whatever judgment it obtains is probably going to be worthless. And so what you can do is extract very favorable settlements, and you know to be frank this is unfair, and I think it is an imbalance which should in all fairness be corrected. It really is not a level playing field in that sense. If I'm in the U.S. representing a Chinese company, you know, absolutely, I want to be in a U.S. court.”
Let me pull one other piece from that interview as well, while we’re on the topic of Chinese companies being sued in the US. Here's another great explanation from Amiad:
On describing how Chinese companies handle discovery
“In American litigation it is a fundamental principle that there should be very broad disclosure or “discovery”. And there's a presumption that each side should get access to the other side's information and data to the extent that it's material and relevant to a case. And in the United States, that has a very obvious meaning. What it means is that if a company in litigation has files such as emails with relevant information, that information must be disclosed and given to the other side.
And this is a very common sense notion in the United States. But to Chinese companies, this is quite shocking. The very idea that your secrets would be disclosed to the other side and that there would be no limit on this is quite shocking. In fact, I've been involved in disputes where our adversary produced emails and my client was shocked that they would actually give this up. How could they show us their emails?
The other aspect of this, I think is really more of a cultural aspect, is that in the US there is just a natural process by which events are documented. So if you have, for example an M&A transaction, you would have a series of emails going back and forth discussing the drafts of the M&A contract you have.
All kinds of deal points being talked about over email and you would be able to probably piece together the developments and the negotiation of a transaction just by looking at the email trail. In mainland China, you typically just wouldn't put things in writing.
Amiad goes on to say:
“It's just a culture where it doesn't accept that that is a necessary part of the process and the result is that Chinese clients often just don't have any emails. You know, they may have Wechat messages. But the Wechat messages are often going to be of a very vague and general nature. And because business is so often just based on trust, based on verbal discussions or even on unspoken understandings. It's just a lot less documentation.
In the cases that I've been involved in, there's often accusations by the American side that the Chinese must be hiding something and that the Chinese side is not playing by the rules. But more often than not what is happening is that the American side just doesn't understand the way business is done in China.”
OK let me end it with Amiad and that great excerpt from our earlier podcast discussion. Stay tuned for another post in 14 days, and remember if you haven’t already subscribed please do.
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