Managing commercial disputes in China: planning for success

The disputes landscape in China is evolving and complex. Companies should act early to gather information on counterparties and their assets, and then continue monitoring across the dispute lifecycle to ensure the best chance of success in a lawsuit and subsequent enforcement. Being prepared for adverse outcomes and extreme reactions by counterparties can also help companies avoid operational and reputational damage.

Evolving landscape

Cross-border commercial disputes involving mainland China-based counterparties are often complex and the current landscape presents a unique set of drivers and challenges. Globally, geopolitical tensions, inflation in Western economies, economic sluggishness and a slower than expected recovery from the COVID-19 pandemic have led to pressures for many companies. The zero-covid restrictions in past years have exacerbated issues for mainland China-based businesses – many companies entered agreements with bad actors or based on incomplete information when restrictions made it difficult to meet face-to-face. Other disputes have been driven by financial factors: the pandemic caused operational and cashflow issues for companies both in China and globally, and inevitably some failed to fulfil contractual obligations or became insolvent. Now, nearly a year after the end of restrictions in mainland China, many of these disputes are reaching court.

The dispute resolution landscape in Greater China is also evolving. Hong Kong remains an important centre for dispute resolution in the Asia Pacific region. In recent years there have been several developments in arrangements for mutual recognition of judgments between Hong Kong and mainland China, making it easier to enforce Hong Kong judgments across the two jurisdictions. Since the start of 2020, over USD 2bn of assets have been frozen by mainland China-based courts in relation to disputes heard in Hong Kong. Alternative dispute resolution, especially arbitration, is also playing an increasingly important role in cross-border disputes involving mainland China-based companies. The number of international and domestic cases heard by arbitration centres in the jurisdiction, such as the China International Economic and Trade Arbitration Commission (CIETAC) and the Shanghai International Economic and Trade Arbitration Commission (SHIAC), has been growing steadily. In 2022, CIETAC, China’s largest arbitration centre, heard more than 4,000 cases with a total value of almost RMB 130bn (approximately USD 18bn), both record numbers, putting it among the top arbitration centres worldwide. In this context, understanding dispute resolution with Chinese characteristics is crucial for companies.

Common pitfalls

Amid this evolving backdrop, companies engaged in disputes in Greater China should ensure that they prepare themselves as best possible. We frequently see a number of pitfalls.

First, companies often fail to sufficiently understand their counterparty and its unique characteristics beyond the information directly relevant to the dispute itself. For example, they might not have any knowledge of the counterparty’s modus operandi and history of disputes and are then caught off-guard when the counterparty acts in an overly aggressive or otherwise unusual manner. Companies might also underestimate the ability of their counterparty to control the market or to cause damage to business operations or reputation. In China, we have seen examples of multinational companies having their sales dry up overnight after initiating legal action against a distributor with massive market influence.

Companies also often focus on winning the dispute and fail to plan adequately for enforcement. In many cases, after a dispute is won, companies find that they are unable to enforce the judgment because the counterparty has no assets. In other cases, counterparties have assets but they have been pledged to creditors or frozen in relation to other disputes. Some counterparties might also put assets beyond the reach of enforcement, such as by moving ownership to family members, associates or related entities. In several recent cases, we have seen counterparties who established special purpose vehicles in Hong Kong to sign contracts. After the contracts were signed, assets were transferred to mainland China entities that, on paper, had no shareholding relationship with the Hong Kong signatories, making the enforcement of judgments much more difficult.

Preparation and planning is key

While managing commercial disputes in China can be challenging, there are a number of steps that companies can and should take to ensure the best outcome.

• Prepare early: Should things go wrong in a relationship and the prospect of legal action be raised, the process of asset identification should commence as early as possible to inform legal and negotiating strategy. Carrying out a fit to sue assessment to understand the counterparty’s asset profile and the likelihood of successful enforcement will also help companies to weigh up the costs and benefits of different legal strategies. Understanding the counterparty’s situation before it becomes aware of potential litigation and can take action to frustrate enforcement is key. As well as assets, investigative work should identify potential roadblocks for enforcement, such as creditors with prior claims, equity pledges, existing debt-related litigation and other encumbrances.
• Continue monitoring: Once the counterparty becomes aware of legal action, it may try to dispose of enforceable assets, transferring them to less enforcement-friendly jurisdictions or to other entities or individuals. Companies should conduct ongoing monitoring to identify and, if necessary, put in place legal measures, such as freezing injunctions, to prevent asset dissipation.
• Look beyond assets: Other factors might have an unexpected adverse impact when trying to enforce a claim. Before embarking on litigation, companies should understand their counterparty’s track record in disputes, industry and political connections, influence over the market, and ability to cause reputational or operational damage. Companies may also want to carry out research on themselves and any witnesses to the dispute to understand what information could be used against them and to identify any points of weakness.
• Scenario planning: Companies should plan for an extensive range of eventualities and risks, including most likely and worst outcome scenarios. Companies should assess what crisis plans they have in place should the dispute escalate, taking into consideration the leverage the counterparty might have against its IP, data and the methods it might employ to cause harm and any security threats to future business.

For many years, Control Risks has been supporting our clients throughout the dispute resolution cycle. In a recent case, our client was considering action seeking damages for a breach of contract in a complex dispute related to ship ownership and usage. We were engaged early in the process to identify assets before any formal action was taken, thus reducing the risk that the subject would try to move assets. We identified around USD 180m in property, shares and other assets in Hong Kong and other enforcement-friendly jurisdictions, much of which was unencumbered. We also carried out a detailed assessment of the owner’s background, identifying convictions for smuggling and connections to organised crime groups. Armed with this information, our client and its legal counsel were able to plan for potential adverse reactions and protect the business. We continued to monitor assets throughout the planning and litigation process, informing the client of asset dissipation once the counterparty became aware of the potential legal action.

There is an oft-quoted Chinese saying: “When you know both yourself and your opponent, you can fight a hundred battles without defeat.” Commercial disputes are no different; when companies plan early and have a good understanding of their counterparty, they stand a much greater chance of obtaining a favourable and enforceable outcome.