China’s commercial litigation business is booming as companies are feeling confident of getting fairer judgements and happy with its faster judicial process. The recent economic slowdown and the growing importance of the Chinese consumer market have provided the immediate spur to the trend. However, serious pitfalls in the Chinese judicial system still advise caution.

Over the past year, the number of lawsuits involving non-mainland companies has risen by about 10 percent in China, according to the China Daily, and one of the main reasons is that foreign companies are realising it is possible to come out ahead in Chinese litigation. “There is a growing understanding of the working of Chinese courts, which has led to reduced reluctance among foreign companies to take the litigation route,” says May Tai, partner, dispute resolution, at Herbert Smith in Beijing.

With the economic downturn putting most expansion plans on hold, businessmen have more time to concentrate on recovering bad debts and enforcing their IP rights, says Tai. Additionally the economic downturn has led many companies to realise that it is cheaper to pay damages than carry out their commitments in  a contract, says Eugene Chen, Shanghai-based partner in Hogan Lovells’ international dispute resolution team.

Furthermore, Chen says that companies in China are also realising that litigation can be used as a strategic tool to gain leverage while negotiating a settlement. “They may (eventually) lose a case, but will manage to put extra pressure on the other side,” he says. According to him, this has led to a very distinct trend in China towards increased litigation.

There are other additional factors contributing to this trend. For example, the emergence of China as a nation of consumers in addition to a production hub has given rise to a totally separate source of litigation – foreign companies selling consumer goods.

“Five to 10 years ago, foreign companies would be mostly protecting their manufacturing in China, instead of being bothered about their China sales, which at the time were not substantial,” says Peter Wang, head of the litigation practice at Jones Day in Shanghai.

However, many multinationals earn substantial chunks of revenue from China today, and hope to grow even further, says Wang. To protect this market share, these western brands are moving forward to sue even international competitors in Chinese courts.

They have been encouraged by the swiftness of the Chinese judicial process, which provides the plaintiff with a distinct advantage. “The Chinese system is very front-loaded,” says Wang, “meaning that plaintiff can spend a lot of time to gather evidence on its own, while the defendant doesn’t have that much time.” 

Indeed, there are more ways for the plaintiff to make life difficult for other foreign companies, and they fully exploit the Chinese legal provisions to achieve that. Instead of suing each other directly, these multinationals use their Chinese subsidiaries to file suits against the opponents’ local companies.

Explaining the reason behind the practice, Wang says that for a Chinese company suing another Chinese company, the response period for the defendant is even shorter than the one given to a foreign company. “They may get just 30 days to respond,” he says.

There is no doubt that this provision puts a huge amount of pressure on the companies that get sued in China. “As soon as they receive notice of a lawsuit, they need to put a response plan in place,” says Wang.

Wang, who is a U.S.-qualified lawyer, says that the situation becomes more critical as multinational companies are less familiar with the Chinese judicial system. Buying more time is critical, and several factors need to be considered before making any response. Jurisdiction is one of them, he says. Often, companies successfully manage to object to the jurisdiction of a court on the basis that they do not have any substantial business in that area.

While adopting this approach, not only do the defendants manage to gain time, but also avoid fighting a case in a place where they perceive a local bias, says Wang.

The legal teams of the multinationals also need to get to grips with the Chinese civil law system, which, according to Herbert Smith’s Tai, does not seek disclosure, discovery of documents or witnesses’ testimonies. “Unlike in a common law system, where one has to get to the bottom of each case with lots of evidence and an argument for every point, the Chinese system heavily relies upon documentation,” she says.

The emphasis in Chinese courts is to get the dispute resolved as quickly as possible. “It's not so important that they leave no stone unturned,” says Tai. “[They want to] get justice and move on.”

There is a distinct advantage to this approach for China, where the courts do not have the kind of resources at their disposal that most Western countries do. “This allows a limited number of Chinese judges to deal with phenomenal number of cases,” says Tai, “I have heard that each of them handles up to 200 cases a year.”

However, it could be very risky for companies to have their sensitive cases adjudicated in a hurry and therefore, lawyers often prescribe preventive measures. “For a high-value contract, we always recommend the inclusion of an arbitration clause,” says Tai. To the advantage of the foreign companies, the Chinese arbitration system functions according to international norms, she says.

Also, Chinese courts in various parts of country vary greatly when it comes to efficiency. While admitting that there is a question mark on the capabilities of Chinese courts to deal with specialised cases, Wang says that “it is also clear that in some places, there are very capable judges and in others, there may be those which are less experienced in complex commercial litigation.”

According to Wang, most of the larger provinces and the major cities like Beijing and Shanghai are much more accomplished than others, and are, therefore, preferred by foreign companies. “They even have separate courts to handle intellectual property matters,” he says.

Even for those companies that are extremely reluctant to initiate any sort of litigation in Chinese courts, there is no other option left when it comes to enforcing intellectual property rights.

In one of the cases involving a famous Western brand, Herbert Smith filed an IP lawsuit against a large counterfeiting company in China. “It had premises, a website and a big sales network for goods that were counterfeits of our client’s,” says Tai.

Even though the litigation took place in a second-tier city, Tai says that it was handled very efficiently. “The hearing was completed, and the judgement came out in less than nine months of filing the case, which compares quite well with others jurisdictions,” she says.

Although Tai’s client won the case, it failed to enforce damages. Typical of the stories one hears about China, the respondent in this case managed to deregister his company and just disappeared. “The Chinese courts have still not been able to recover damages,” she says, “That was quite annoying for the client, although it was still a good result as the counterfeiting operations ceased.” 

It might not be very difficult to win a case against a counterfeiter, but taking influential parties to court in China is still a big challenge. Tai has a warning for foreign companies initiating litigation against big state-owned enterprises. “That might change the whole dynamics of the case,” she says. 

According to Chen, who has been based in Shanghai for the last five years, in cases involving influential parties, there is a risk of corruption or external interference to the judicial process. He says that the system is still not independent and prone to manipulation, even though there has been a gradual improvement.

One of the reasons, he says, is that the Chinese courts are relatively young, being created only in the 1960s. He adds that within these few decades, the developments have been quite substantial.

However, local regulations still do not allow foreign law firms to appear in court, and they have to employ local law firms for that purpose. This can lead to problems from time to time.

According to Chen, “there is a little bit of tension when it comes to dealing with local law firms over making sure that international clients receive the levels of service that they expect from us.”

Explaining the situation, he says that the local law firms often do not realise the influence China has over global business. “They are mainly focused on Chinese litigation, while they also need to think about the client’s entire global strategy,” he adds.

However Chen says that there are a lot of opportunities for both sides to collaborate further, and there are certainly gains to be made from the expanding legal industry in China. “The amount of litigation will keep rising as China’s judicial system becomes more and more reliable,” he says.

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