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US Lawyers Launch New Arbitration Center in China (Corporate Legal Times)

May 2004

By Julius Melnitzer

China’s Court And Arbitration System Hampers U.S. Investment

A FORTUNE 500 company arrived in China in March 2001 armed with what it thought was an ironclad contract to do business in the region.Management looked forward to a long-term and profitable presence in the world’s fastest-growing economy.

Unfortunately, the Chinese government was a major shareholder in the company’s primary competitor. It turned out the competitor also was an industry regulator. Suddenly, the future didn’t look so bright.

“In its capacity as a regulator, the competitor sought to impose restrictions on the American company’s ability to do business” says Jay Tannon, the partner who heads up Frost Brown Todd’s international law department in Louisville, Ky. “And there wasn’t much point litigating the issues in the Chinese courts. It took more than two years of drawn-out negotiations before the U.S. company worked things out so it could get on with its business.”

This is a common story in China, which has no viable mediation or arbitration mechanisms, and whose court system often isn’t friendly to U.S. businesses. In addition, these problems only are going to get worse as U.S. companies flock to China to take advantage of its nascent markets. In fact, China–U.S. trade reached an all-time high of $126.3 billion in 2003. So the lack of a satisfactory dispute-resolution mechanism is a pressing issue.

“A new system must avoid the appearance of deck-stacking that has haunted the existing mechanisms for resolution of Sinoforeign commercial disputes,” says Robert Kapp, president of the Washington, D.C.-based U.S.–China Business Council, a nonprofit organization that serves American companies doing business in China.

Fortunately, that’s the aim of the newly created Center for Commercial Dispute Resolution, a project that blends U.S. and Chinese approaches to dispute resolution.

A New System

In early 2003, Tannon—who has been involved in developing commercial ties between China and Kentucky for the past 10 years—approached Tom Stipanowich, president of the CPR Institute, a New York-based non-profit dispute-resolution organization. Tannon broached the idea of creating a new commercial mediation service in cooperation with the China Council for the Promotion of International Trade (CCPIT), the largest trade-promotion entity in China (see “At A Glance: CCPIT”). Virtually all international arbitral disputes in China are adjudicated under the auspices of CCPIT, but the service hasn’t proven an
acceptable alternative to Chinese courts.

“The system is well-intentioned, but the arbitrators are Chinese trained and Chinese speaking, and lack sufficient familiarity with Western and international business conventions and notions of commercial rights and responsibilities,” Tannon says.

They also were trained in a civil law system that didn’t recognize private property rights, had limited exposure to international commercial disputes, and are usually sympathetic to Chinese defendants. What China does have, though, is a long history of conciliation as a dispute resolution mechanism.

“The U.S. business community only recently has embraced mediation, but the concept behind it is well-established in China,” Stipanowich says. “For thousands
of years, communities have resorted to village elders as intermediaries to solve all sorts of problems.”

The melding of old and new turned out to be fruitful.

Tannon introduced CPR to CCPIT in the spring of 2003. The two organizations quickly found common ground: Both appreciated mediation’s potential as a less
costly, more efficient way to help businesses in each country avoid the problems they perceived in each other’s systems. In June 2003, CPR and CCPIT signed a
“Protocol of Understanding” to proceed with the formation of a dispute-resolution center that featured Chinese and U.S. arbitrators who spoke both languages and understood both systems.

Less than seven months later, the parties signed a formal agreement at the CPR annual meeting in New York. Signed on Jan. 29, the agreement establishes a jointly administered Center for Commercial Dispute Resolution, with offices in Beijing and New York.
“CCPIT is the key to unlocking support from the Chinese business sector and ensuring cooperation on many different administrative and bureaucratic levels,” Stipanowich says.“But referrals will come from both CPR and CCPIT and eventually from outside sources as we get off the ground.”

The program will build slowly, beginning with the training of 48 mediators.

“We’re going to need people of exceptional experience and professional accomplishment who are bilingual and bicultural,” Stipanowich says. “The mediators from the West must understand the different business expectations that exist in China and those from China must understand the workings of the Western business world.”

And that can be a tall order because many of the differences can be traced to the parties’ varying perspective on the contract they have signed.

Contractual Disputes

“The Chinese see a contract as a statement of good-faith intention,” Tannon explains. “They believe that if circumstances change, the contract must evolve. Western companies simply aren’t accustomed to that way of thinking.”

Peter Phillips,CPR’s senior vice president, cites the case of an American company that was party to what it perceived to be an enforceable contract to build turbines and other heavy equipment. Payment was to follow follow inspection of the products in the United States by the Chinese purchasers. But the Chinese never showed up to inspect the finished products, leaving the manufacturer holding the bag.

“The Chinese perceived the contract as a solicitation to negotiate where one side determined at the end whether it wanted to perform,” Phillips says. “The difficulty with this interpretation—which is well within the Chinese idea of fair dealing—is that it put the U.S. company at full risk for the cost of manufacturing.”
The problem can become more acute when the relationship is a continuing one.

“Difficulties relating to contract interpretation or industry standards can arise regularly where an American company is designing and supervising the  construction of a dam or a building,” Philips notes. “Everybody wants to get the problem solved, but there are fundamental communication problems that the Chinese legal and arbitration systems aren’t equipped to resolve.”

In other words, mediation works particularly well where the dispute occurs in the context of an ongoing relationship or project.

“The intention is not only to fix the problem, but to adjust the relationship in a way that will satisfy both parties in the future,” Phillips says. “Mediation is a process grounded in business rationale, and that helps everybody make more money.”

Indeed, initial reaction from in-house counsel to the CPR-CCPIT initiative has been favorable.

“Mediation is an attractive common sense process that is not new to China,” says Sherry Liu, a vice president and director at Motorola’s corporate law  department in the Greater China region. “Chinese business will view the Center positively because it fills the need for a sophisticated disputeresolution

Similarly, William Hawkins, general counsel and secretary at Cincinnati-based Convergys Corp.—which has been providing support services for Chinese telecom
companies for almost two years—welcomes the initiative.

“We’re constantly seeking to expand our operations, but the more business you do and the more contracts you sign, the more likely it is that high-stakes differences will arise,” he says. “If the Center can replicate the very positive experience American business has had with mediation elsewhere in the world, it will go a long way to creating structure and predictability in the dispute-resolution process.”

Still, American businesses going to China should remain alert.

“The Center isn’t going to protect you from choosing the wrong business partner,” Tannon says. “But it does mean that China will be a less risky place to do business.”

At A Glance: CCPIT

The China Council for the Promotion of International Trade (CCPIT) was established in 1952. Its 70,000 members form the largest Chinese institution for the
promotion of foreign trade.

Soon after it was founded, CCPIT formed two international arbitration institutions: China International Economic and Trade Arbitration Commission (CIETAC) and the China Maritime Arbitration Commission (CMAC). These institutions adopted the voluntary arbitration and final-award system that is the foundation of modern international arbitration. Indeed, before 1994, international arbitration in China was synonymous with proceedings conducted under the auspices of CCPIT.

The organization received a boost in 1994 when China introduced its first arbitration statute, the Arbitration Act of the People’s Republic of China (CAA), which came into effect Sept. 1, 1995. The legislation formally embraced voluntary arbitration and finality.

Today, the organization has more than 500 professional arbitrators who heard 731 international disputes in 2001 (the last year for which figures are  available), ranking it second in number of cases only to the International Arbitration Court run by the International Chamber of Commerce (ICC).

Although the CAA allowed for the establishment of other organizations to accept international cases, most parties still file cases with CIETAC. The primary reason is that arbitrations in China must comply with certain compulsory provisions that conflict with arbitral rules followed by other organizations. For example, Chinese rules governing the validity of arbitration agreements and the appointment of arbitrators differ fundamentally from the rules of arbitration formulated by the ICC.

If it’s successful, then the Center for Commercial Dispute Resolution will form the first viable alternative to CIETAC arbitration in China.
—Julius Melnitzer

Article Quotes

The Center isn’t going to protect you from choosing the wrong business partner. But it does mean that China will be a less risky place to do business.
—Jay Tannon
Frost Brown Todd

A new [mediation] system must avoid the appearance of deckstacking that has haunted the existing mechanisms for resolution of Sino-foreign commercial disputes.
—Robert Kapp
U.S. China Business Council

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