International Trade

As the economic downturn lingers, more and more U.S. companies are seeking sales opportunities overseas. One such market is China — a top export destination with the world’s largest number of consumers.

When assessing benefits and challenges associated with the Chinese market, many companies have expressed concerns regarding their rights and legal protections against non-payment or delayed payment by Chinese buyers. This article discusses debt enforcement procedures in China and preventive measures companies can take to minimize payment risks.

If a Chinese company defaults, a U.S. party essentially has two options for collecting the delinquent account: it can sue in Chinese courts or take the matter to a Chinese or international arbitration tribunal. Using a debt collection agency is not a viable option in China. Such agencies are illegal under Chinese law, and as such, a creditor’s relationship with one is not protected by the law.1 This leaves a creditor with no recourse against an agency if a dispute arises in the debt collection process.

Litigation

China has four levels of courts: (i) basic courts at the county level, (ii) intermediate courts at the level of prefectures, (iii) higher courts in each province, and (iv) the national Supreme People’s Court.2  Most civil matters with international elements may be brought directly to an intermediate or a provincial higher court.

Judges in larger cities, such as Beijing and Shanghai, can be quite sophisticated and experienced in adjudicating international trade disputes, while their counterparts at lower levels may not have the same expertise and experience.3  Also, only Chinese attorneys are legally authorized to appear in court on behalf of foreign parties.4  Hence, a U.S. company should find a reputable Chinese law firm to act as its legal representative in litigation.

On average, the litigation process takes about six months from filing a lawsuit to receiving a court judgment and, depending on the amount of the debt collected, can be less expensive than litigating in the U.S.5  Filing fees are nominal — less than 1 percent of the total amount in dispute when a claim exceeds 1 million Renminbi (about $146,000 USD).6 Attorney fees usually range from 20 to 30 percent of the amount collected.7

The People’s Republic of China (PRC) Civil Procedure Law (CPL) establishes two types of asset preservation procedures (cai chan bao quan) in debt collection cases: pre-litigation asset preservation and during-litigation asset preservation.8  In both cases, the court is required to grant or decline a creditor’s petition within 48 hours. Moreover, the CPL provides that implementation of an asset preservation ruling commences immediately upon issuance of the order.

Common concerns among U.S. companies are that China’s judicial system is characterized by corruption and local protectionism. While there may be some basis for those concerns, central Chinese authorities have made tremendous efforts to improve their nation’s judicial system in recent years. 9  Indeed, foreign parties who have experience in Chinese court systems in recent years generally held the system in higher regard than those who had no experience with the country’s judiciary.10 

Arbitration

Arbitration is by far the most common forum for resolving commercial disputes in China. Under Article 128 of the PRC Contract Law,11 disputing parties may choose an arbitration tribunal in or outside of China if a contract at issue involves a “foreign element”12 and clearly states that arbitration is the agreed-upon dispute resolution method.

Many companies trading with China opt to conduct their arbitrations in a neutral territory where neither party has “home court” advantage. Popular international arbitration venues include Hong Kong, Singapore, Geneva, London, and Stockholm.13

Unlike court judgments, international arbitration awards are generally more readily enforceable across borders. China is a party to the New York Convention on enforcement of international arbitration awards, to which the U.S. and another 143 countries are also signatories.14 Under the New York Convention, Chinese courts generally cannot refuse to enforce awards of arbitrations conducted in a signatory country.

In recent years, more and more companies trading with China have chosen to resolve their disputes through Chinese arbitration commissions. China International Economic and Trade Arbitration Commission (CIETAC), the leading arbitration body in China for international disputes, has been used increasing by foreign companies because of its commitment in efficiency and impartiality.15

In a CIETAC arbitration proceeding, disputing parties may agree on the procedure to be followed, and each side can appoint its own arbitrator.16  Since evidence and pleadings are fully exchanged in writing, CIETAC hearings are generally very short, lasting only one to three days. As a result, most CIETAC cases are concluded within six months after the tribunal is duly constituted.17 Although generally higher than those for court filings, CIETAC arbitration fees are relatively lower than those of other major international arbitration centers.

A survey of U.S. companies in Beijing conducted by the American Chamber of Commerce in 2001 suggested that companies that had experience with Chinese arbitration rated the process in major Chinese arbitration centers highly when compared with that of other major international arbitration centers.18  In fact, some foreign investors who have years of experience in China prefer CIETAC’s shorter hearing periods — and consequently, lower legal costs — to longer processes in arbitration centers outside of China.

As observed by an international law petitioner, there are several advantages of arbitration over litigation in China:19

  • Unlike court hearings, arbitration proceedings are usually private and confidential, and final decisions are not publicly accessible.
  • While litigants have no ability to choose judges, disputing parties in an arbitration case can appoint their own arbitrators.20  This is particularly useful in disputes for which technical expertise is needed or those involving specialized areas of law.
  • Courts often have long waiting lists for hearing dates. Arbitration proceedings, on the other hand, are usually held at the convenience of all parties concerned.
  • Arbitration is very useful in countries that have emerging economies, where judicial systems may not be on a par with those of nations with developed economies.

An Ounce of Prevention

The Chinese government has taken large steps toward strengthening protections for creditors in recent years,21 and litigation and arbitration processes can both be relatively effective venues for collecting debt in China. However, as a practical matter, the real difficulty often is not so much with the quality or fairness of the dispute resolution tribunal as with the enforcement process — a difficulty that parties may face in any event, whether the judgment or award is made in China or elsewhere.22

Other factors also may come into play. For example, even if a judgment or arbitration award is recognized by Chinese courts, a debtor may have insufficient assets to satisfy the judgment or award. Because an ounce of prevention is worth a pound of cure, U.S. companies should take appropriate preventive measures from the outset to avoid having to seek remedies through litigation or arbitration later.

Due Diligence. U.S. companies must conduct thorough due diligence on potential Chinese customers and partners. Generally, companies can seek help from private firms, such as U.S.-based or reputable Chinese law firms, as well as multinational accounting and consulting firms. They also can take advantage of U.S. government resources.

For example, the U.S. Commercial Service offers international company profiles (ICPs), background reports on foreign companies prepared by the service’s commercial officers at American embassies and consulates. Such a report provides financial background on a company and a discussion regarding its size, capitalization, years in business, and other pertinent information, such as the names of other U.S. companies that conduct business with the firm. China-specific information can be found on the Commercial Service’s Web site at www.buyusa.gov/china/en/icp.html.

Payment Methods. If a domestic buyer in the U.S. has good credit, sales are typically made on open account. For export sales, however, open account is not considered the most secure payment method. Accordingly, U.S. companies should always consider alternative payment methods that can provide them with more protection and security, such as letters of credit (LCs) and documentary collection (DC).

LCs are one of the most secure instruments available to international traders.23 An LC is a promise by a bank that payment will be made as long as the instrument’s terms and conditions have been met. A greater degree of protection is offered by an LC issued by a reputable Chinese bank, such as the Bank of China or China Construction Bank, and confirmed by a U.S. bank. The confirmation adds the U.S. bank’s commitment to that of the foreign bank to pay the exporter. 24

It is important to note that an LC can be either revocable or irrevocable. A revocable LC can be unilaterally changed by either party, and therefore presents higher risks for an exporter.

Another common payment method in international trade is documentary collection (DC). In such a transaction, an exporter entrusts collection of a payment to the remitting bank (U.S. exporter’s bank), which sends documents to a collecting bank (Chinese buyer’s bank) along with instructions for payment.25  Funds from the buyer are remitted to the exporter through the banks involved.

The exporter retains title to the goods until the buyer either pays the face amount or accepts the draft to incur a legal obligation to pay at a specified later date. DCs are generally less complicated and less expensive than LCs, but there is no bank promise to pay backstopping a buyer’s obligation (even though the banks act as facilitators and can often influence mutually satisfactory settlement of a DC transaction).

Because a secure payment method can greatly reduce the risk of non-payment, the issue should be addressed in the deal negotiation process. As a negotiation strategy, an exporter can delay quoting a final price until the parties have settled upon payment terms. Because any change in the payment method may increase an exporter’s risk of not getting paid, the exporter should retain the right to adjust the sales price if the method changes.

Export Credit Insurance (ECI). As mentioned earlier, greater risks are associated with open-account sales in the context of exporting. The absence of documents and banking channels might make it challenging to pursue the legal enforcement of claims in such cases.

Because of the greater risks involved, a U.S. company contemplating a sale on open-account terms — be it for convenience or upon request of the buyer — should consider purchasing export credit insurance (ECI) to help mitigate credit risk. ECI policies are offered by many private commercial risk insurance companies, as well as the Ex-Im Bank, a government agency that assists in financing exports of U.S. goods and services internationally.26

ECI significantly reduces risks associated with international trade transactions by giving exporters conditional assurance that payment will be made if a foreign buyer is unable to pay. However, ECI can be costly to maintain.

Meeting Challenges

An ancient Chinese adage asks, “How can one catch tiger cubs without entering the tiger’s lair?” Similarly, pursuing opportunities in an unfamiliar and sometimes intimidating market environment almost always entails challenges and risks, but the rewards can be substantial. With appropriate preventive measures in place and a good understanding of China’s legal system and arbitration procedures, companies and their advisors should be well-equipped and prepared to catch some “tiger cubs” in their export endeavors.

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