China Litigation: Not the Same but Different

Many years ago a US company came to us wanting to sue a Chinese company in China. Legally, its case was very strong and we told the company that. But we also told the company that we had serious doubts about its ability to prevail in a Chinese court because we didn’t like the case’s optics. More specifically, we believed that a Chinese court would be reluctant to rule in the US company’s favor for equitable reasons.

The general counsel of this company HATED our analysis and the US company hired a different US law firm for the case. An “insider friend” at this company later revealed that the US company ended up spending hundreds of thousands on the case and lost it 100%. To make matters worse, it had rejected an opportunity along the way to settle the case in a way that would have (over time) allowed it to recover around 35% of its damages.

What the US in-house lawyer failed to realize is how different Chinese courts are from American courts. In an American court the US company would almost certainly have won nearly every dollar it sought because the law and the facts clearly favored it. But Chinese courts are different.

But how?

I often struggle to explain this to foreign companies. In my speeches, I used to do this in part with a slide that asked “Remember Equity? I then followed that with another slide that noted how in China “Harmony is more than just a baby name from the 1960’s.” I would then go on to explain how Chinese courts truly consider equity and social harmony in reaching a decision on pretty much every case, even those that where we as Western lawyers see no role for such things.

I read today a really good piece written by two Chinese lawyers, explaining the basis on which Chinese judges make their decisions. The article is entitled, How Chinese Judges Think, and if you are contemplating bringing a law suit in China, you should absolutely read it.

The article starts out by noting how in determining their rulings, Chinese judges will consider the “legal effect, social effect and political effect.” It then talks about how these basis for legal decision-making are ingrained in various documents of the Chinese courts via common expressions such as “judges should pursue the unification of legal effects, social effects and political effects in case trials.” They then write how this is “not only the official requirement of the Chinese courts; in fact, according to my years of experience in litigation, the judges have habitually thought in this way when hearing cases.”

The article then goes on to explain each of these three effects as follows:

1. Legal Effect. Judges “should accurately apply the law when hearing cases and making judgments.” Very strictly.

For example, pursuant to the Contract Law of China, if the parties concerned have no agreement on the terms of the transaction or the agreement is unclear, the judge should first determine the terms of the transaction according to the business practices; if the terms of the transaction cannot be determined, the judge should use the relevant provisions of the Contract Law as the terms of the transaction. Therefore, the judge should first try to explore the terms of the transaction agreed by the parties, and the terms of the transaction stipulated by the law shall only be adopted if it is indeed impossible to find out the agreement. However, in most cases, the judge is not willing (or does not dare) to explore the authentic agreement (real intention) of the parties, which is reflected as follows: if the parties’ written contract does not specify the terms of the transaction, or divergent interpretations of the contract exist, the judge will tend to directly adopt the terms of the transaction stipulated by the law.

The reason for the judge doing so is because, on the one hand, if he speculates on the authentic agreement of the parties according to his own judgment, and this judgment will benefit one of the parties, then he is likely to worry that others will think that he colludes with the party benefiting from such judgment. However, if he strictly applies the law and others accuse him, he would have a solid reason to defend himself. On the other hand, the majority of Chinese judges are directly admitted to the court after graduating from law schools, so they mostly only work in the profession of judges without other professional experiences, which makes them lack enough experience and background knowledge to speculate on the authentic trading conditions of the parties.

2. Social Effect. “Judges should obtain positive comments and recognition from the public on their judgments when trying cases and making judgments.” This is the “harmony” thing I talked about above and the Chinese government takes this extremely seriously:

Consideration of social effects has led judges to sometimes care more about the public’s perception of justice, rather than the parties’ perception of justice in a particular case. For instance, the Chinese public generally does not recognize huge liquidated damages, and the SPC also stipulates that liquidated damages cannot exceed 30% of the losses. Therefore, even if the parties agree that the defaulting party should pay huge liquidated damages, the judge is likely to lower the liquidated damages according to the public’s perception of fairness. For another example, China’s traditional concept adheres to “harmony”, which makes most Chinese people think that cooperation should avoid being terminated as much as possible, and transactions should be completed as much as possible, so the contract should avoid being terminated as much as possible. The judge will also follow this view. Unless the parties expressly agree on the conditions for the termination of the contract and such conditions are clearly fulfilled, the judge will not easily make a judgment in favor of the termination of the contract.

3. Political Effect. “The Chinese courts usually do not mention political effects. Because there is a view that if the judge achieves social effects, the public’s trust in the political authorities will be enhanced, that is, the political effects are achieved. However, sometimes political effects can be exhibited in a more concrete manner.” This effect is usually (but not always) relevant or only barely relevant to business disputes.

Failing to recognize these “effects” can lead to bad litigation results.

We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.