What are China’s merger review priorities? [1]

China’s merger control regime has been a topic of discussion for some time now.

Some commentators interpret Chinese merger control as being influenced by political factors; namely, more than encourage competition, it is yielded by authorities to stop foreign competitors from flooding China’s market. [2]

But is that really the case?

What is the merger control regime like in China?

In China, like in the EU and the US, merger control regulates mergers, acquisitions and other transactions involving concentrations of undertakings. Since a concentration of undertakings may lead to concentration of market power, merger control is an important ex ante regulatory tool employed by antitrust authorities to keep markets healthy in many jurisdictions, and China is no exception.

If Chinese antitrust authorities decide that a concentration has the effect of eliminating or restricting competition in the relevant market, they may decide to prohibit the concentration, or more often approve it but with remedies imposed.

According to the 2008 Anti-Monopoly Law of the People’s Republic of China (“AML”), if a transaction involving a merger, acquisition (including equity or asset deals) or establishment of a joint venture meets the notification threshold prescribed by the State Council, the parties concerned must notify the State Administration for Market Regulation (“SAMR”). Otherwise, the transaction violates the AML, and SAMR may initiate an investigation and impose a penalty against the transacting entities.

To date, the notification thresholds for merger control in China are (generally) as follows[3]:

  • At least two of the concentration parties each has an annual turnover (within China and during the last fiscal year) which exceeds CNY 400 million (approx. USD 63 million); and
  • The aggregate turnover in the last fiscal year of all concentration parties exceeds
    1. (Globally) CNY 10 billion (approx. USD 1.58 billion); or
    2. (Domestically, within China) CNY 2 billion (approx. USD 315 million).

Because the determining factor is turnover, the above notification standards apply regardless of the nationality of the undertaking. In other words, a company’s status as a Chinese or foreign company is not a consideration that triggers Chinese merger control review. Merger review is also required for mergers between foreign entities operating in the PRC. For example, where an American company acquires 100% of a German company — both foreign entities in China — and either their global or Chinese turnover meets one of the standards above, the transaction must be notified to SAMR.

Failure to file a notification of concentration of undertaking renders it illegal, exposing the entities involved to regulatory penalties. Pursuant to the current AML, SAMR may decide to impose a fine of up to CNY 500,000 (approx. USD 72,000). This, limit however, may increase under the expected amendments to the AML (currently under review by the Chinese legislative branch). The penalties SAMR may impose against an illegal concentration of undertakings also include ordering the undertakings to cease the concentration, dispose of shares or assets, divest from the business, or adopt other necessary measures to restore the market situation before the concentration within a prescribed period of time. However, practically speaking, fines are the enforcement tool of choice and SAMR rarely imposes structural or behavioral remedies on illegal concentrations of undertakings. Since the introduction of AML in 2008, such remedies were imposed only in one case, namely the acquisition of China Music Corporation by Tencent Holdings Limited (who was ordered to give up its exclusive music rights to restore competition to the market).

These penalties apply without regard to the nationality of the undertaking. As in the example above, a foreign company operating in China which fails to notify a necessary transaction may be subject to such penalties even when the transaction involves only foreign-owned entities.

For concentrations falling below notification thresholds, Chinese antitrust authorities have the power to initiate an investigation if there is evidence indicating that the concentration has or is likely to have the effect of eliminating or restricting competition; additionally, undertakings may also voluntarily file notice of the concentration. Currently, under Chinese merger regulations, proactive investigation and voluntary filing are mainly used for “killer acquisitions” of startups by larger companies, especially in the Internet industry.

Chinese merger control is used to maintain domestic market competition.

Antitrust law and accompanying legislative intent vary across economic regions[4]. That said, generally speaking merger control rules are designed to prevent excessive concentration of market power within a given market. Since the implementation of the AML, Chinese antitrust authorities have published regulations, guidelines, and other documents to clarify China’s AML standards.

Accordingly, in China there usually are six main factors to be considered during the review of a concentration:

  • The market share (in the relevant market) of each undertaking involved in theconcentration and their existing control over the market;
  • Existingmarket concentration in the relevant market;
  • The effect of the concentration ofundertakings on market entry and technological progress;
  • The effect of the concentration ofundertakings on consumers and other relevant undertakings;
  • The effect of the concentration ofundertakings on the development of the national economy; and
  • Other factors affecting market competition, such as the effect of the concentration on the public interest, and whether the undertakings involved in the concentration are enterprises on the verge of bankruptcy.

In practice, Chinese antitrust authorities apply these factors to review merger filing cases regardless if a foreign entity is involved.

In fact, in recent years Chinese antitrust authorities have shown they typically approve merger filings involving foreign entities. According to the 2020 annual report published by SAMR[5], it approved 85 merger filings for transactions between domestic and foreign entities. These approvals included 37 foreign acquisitions of domestic entities; 15 domestic acquisitions of foreign entities; and 33 joint ventures between domestic and foreign entities. For filings between foreign entities, SAMR approved 179 concentrations of undertakings.

For concentrations involving only domestic entities and no foreign entities, the numbers speak for themselves. Failure to notify typically leads to an investigation and then penalties. In 2021, SAMR published 107 penalty decisions against concentrations which failed to notify under Chinese law. Among these penalties, 105 were applied only against domestic entities (98% of all cases). In other words, domestic (and not foreign) firms overwhelmingly bear the brunt of SAMR’s merger controls and accompanying penalties.

One interpretation of these numbers is that SAMR is significantly more lenient in its application of merger control rules towards foreign investors than it is towards domestic entities. Another interpretation is that foreign investors are typically more antitrust aware (even to the point of adopting China-specific market strategies), and as such are more likely to retain experienced antitrust counsel when considering large transactions. Both theories appear to have at least some traction in academia.[6]

Merger review across different jurisdictions is mainly based on whether the transaction will raise competition concerns within the jurisdiction. As a result, the same transaction may face different competition concerns and merger decisions across different countries and areas.

For example, in 2017, Chinese antitrust authorities unconditionally approved ChemChina’s acquisition of Syngenta, a global business operating in the agrochemical sector with its headquarters in Switzerland. However, this same concentration received only conditional approval from authorities in the EU, which had major reservations about the deal’s effect on competition in the European market.

A more nuanced understanding of Chinese merger control helps better predict merger approvals

It is common for analysis surrounding Chinese developments to be overly simplified, and merger control is no exception. This includes the facially appealing but flimsy argument that Chinese merger control is a political exercise, an argument that saw its apogee after the failed acquisition of Huiyuan by Coca-Cola in 2009.

In 2009, China’s Ministry of Commerce (“MOFCOM”, the predecessor to SAMR) blocked Coca-Cola’s acquisition of Huiyuan, a popular Chinese fruit juice producer. The decision was brief, and as a result The Economist ran an article titled “Coca-Cola in China — Squeezed Out” quoting Coca-Cola as describing MOFCOM’s decision as protectionist. The Economist bemoaned the outcome as “unfortunate […]  in an industry that has no economic or national-security significance.”

This decision ignited tremendous controversy that the AML was introduced to insulate Chinese companies from overseas competition. One theory, reported as the “Huiyuan test”, emerged to describe what foreigners could expect when acquiring targets in China’s market.[7]

However, the Huiyuan merger occurred while China’s anti-monopoly regime was still in its infancy. The test, while illustrative of the controversy, wariness, and disappointment among foreign investors in response to the decision, is not particularly helpful to predict or understand which mergers will ultimately receive approval.

One insight from the Huiyuan case is that in order to better understand and predict merger results in China, adopting a European competition policy lens may be more helpful than a US lens. MOFCOM had explained that Coca-Cola’s acquisition of Huiyuan failed merger review on three major grounds. [8] According to a case study on the Huiyuan deal, two of these reasons mirror the portfolio effects theory that the European Commission employs when intervening in conglomerate merger cases (namely the Tetra Laval/Sidel and Guiness/Grand Metropolitan cases). The third reason strongly resembles another approach, also used in EU cases, to maintain a competitive market structure. [9] It is thus more likely that the Huiyuan decision reflected a divergence between US and EU approaches (with MOFCOM preferring the latter, at least during the AML’s early years) rather than a divergence between Chinese and Western approaches. With the benefit of hindsight, commentators increasingly consider the concerns following Huiyuan unjustified.[10

Moreover, with China’s increasing antitrust enforcement experience since the introduction of the AML in 2008, published decisions present specialized economic and antitrust analysis that is much closer to western standards. For example, on December 22, 2021, SAMR published the decision conditionally clearing the acquisition by SK Hynix of the NAND memory and storage business of Intel. In the decision, SAMR used the Herfindahl-Hirschman Index (HHI) to analyse the concentration level in the relevant market and the market power of the merged entity post-deal. Another example of an Chinese antitrust authority using economic tools in its decision in 2021 was the penalty imposed against Sherpa (a popular food takeout app among foreigners in Shanghai) for abuse of dominance on April 12. In  that case, the Shanghai Administration for Market Regulation published detailed reasons applying the small but significant non-transitory increase in prices (SSNIP) test to define the relevant market, and explained how the SSNIP test was applied within its monopoly theory.

Chinese merger review authorities understand that Chinese corporate champions are forged in the crucible of healthy, fair, and transparent domestic competition. In fact, the “regulatory windstorm” of 2021 against Chinese tech companies was a powerful statement to this effect. That windstorm was almost entirely directed against home-grown tech champions, particularly in the platform economy, and not foreign investors.

Allegations of protectionism against the application of competition law are common when those on the receiving end of a regulatory decision are unhappy with the result. However, the differences between Chinese merger control regulation and the US approach (which is influenced more by the Chicago school) [11] do not amount to a protectionist agenda. Overseas investors in China who spend the time and resources necessary to become more familiar with China’s regulatory concerns typically reap rewards from their efforts.

Large foreign companies active in China need to understand and become familiar with Chinese merger control

Like the EU and the US, Chinese merger control regulation is used to ensure a well-functioning market and benefit consumers. To analyze and decide whether a concentration raises concerns of eliminating or limiting competition, numerous factors may be involved, such as market share and market concentration, market competition structure, potential unilateral and coordinated effects, foreclosure and conglomerate effects, the relevant industry’s maturity, and so forth. Like in other jurisdictions, when a foreign transaction or cross-border investment raises competition concerns within the relevant market, it may be blocked or approved with conditions.

For foreign companies running merger deals in China, it is necessary to retain counsel with an in-depth understanding of Chinese merger control and to consider the potential market impacts that may result from the transaction.

 

Authors: Hao ZHAN, Ying SONG, Libo ZHU, Yuhui YANG, Hannibal El-Mohtar


 [1] For the purpose of this article, China here refers to Mainland China which does not include Hong Kong, Macau, and Taiwan.
[2] Angela Huyue Zhang, “Problems in Following EU Competition Law: A Case Study of Coca-Cola/Huiyuan”, 3 Peking U J Leg Studies (2011) 96 at 97. Foreign multinationals were also concerned that they would be the primary targets under the AML, see ibid.
[3]  Note that turnover thresholds may change in the near future. In addition, there is a special threshold for financial sectors.
[4]  In the US, the stated objective of antitrust law is consumer welfare. See Reiter v. Sonotone Corp., 442 U.S. 330, 343 (1979) (floor debates “suggest that Congress designed the Sherman Act as a ‘consumer welfare prescription.’”) However, this stated objective has given rise to competing interpretations. See Barak Orbach, “Antitrust’s Pursuit of Purpose” Fordham L Rev vol 81 No. 5 (2013) 2151 at 2151.
In the EU, the stated objective of antitrust law is to ensure the proper functioning of the EU’s internal market. See European Parliament, “Fact Sheets: Competition Policy”, online: </www.europarl.europa.eu/factsheets/en/sheet/82/competition-policy>. See also Treaty on the Functioning of the European Union, Arts 3(3) and 101–109; Protocol No 27 on the internal market and competition; the Merger Regulation (Council Regulation (EC) No 139/2004) and its implementing rules (Commission Regulation (EC) No 802/2004);  Treaty on the Functioning of the European Union Arts 37, 106 and 345  (public undertakings), together with arts 14, 59, 93, 106–108 and 114 (public services, services of general interest and services of general economic interest).
[5] http://www.gov.cn/xinwen/2021-09/24/content_5639102.htm
[6] See Sandra Marco Colino, “The Internationalization of China’s Foreign Direct Investment Laws”, 45:2 Fordham Intl L J 275 at 288 (“the increased presence of overseas investors in China suggests that they are getting the hang of corporate negotiations in the country, and that perhaps enforcers afford them greater latitude”).
[7] Sandra Marco Colino, “The Internationalization of China’s Foreign Direct Investment Laws”, 45:2 Fordham Intl L J 275 at 284, n 40 citing David Wolf, The Huiyuan Test, Silicon Hutong (Sep. 8, 2008), http://siliconhutong.com/2008/09/08/the-huiyuan-test/ [https://perma.cc/2P4HGYJH] (quoting Steve Michael Dickinson’s China Law Blog originally published in 2008, which is no longer available). The Huiyuan test posited that:
(1) Foreigners are permitted to purchase small established Chinese companies where the government is too busy to be concerned with the management of the small company.
(2) Foreigners are permitted to purchase large established Chinese companies suffering from financial problems, provided that the foreign purchaser will restructure the company and assume the company’s obligations to workers and creditors.
(3) Foreigners are permitted to acquire a minority interest in large and successful Chinese companies, provided such investment will provide collateral benefits in the form of technology transfer or access to new markets.
(4) Foreigners are not permitted under any circumstances to purchase a majority interest in a large and successful established Chinese company.

[8] The three main reasons in the MOFCOM’s decision were:
(1) After the completion of the concentration, Coca-Cola will be able to transfer its dominant position in the carbonated soft drinks market to the juice drinks market, which would have the effect of excluding and restricting competition to the existing juice drinks enterprises and thus harm the legitimate rights and interests of beverage consumers.
(2) The brand is a key factor affecting the effective competition in the beverage market, after the completion of the concentration, Coca-Cola through the control of “Juice Source” and “Huiyuan” two well-known juice brands, the control of the juice market would be significantly enhanced, coupled with its dominant position in the carbonated beverage market and the corresponding transmission effect, the concentration would make potential competitors to enter the juice beverage market barriers significantly increased.
(3) Concentration squeezed the domestic small and medium-sized juice enterprises living space, inhibiting the ability of domestic enterprises to participate in the juice beverage market competition and independent innovation, to China’s juice beverage market effective competition pattern caused by adverse effects, is not conducive to the sustainable and healthy development of China’s juice industry.
[9] Angela Huyue Zhang, “Problems in Following EU Competition Law: A Case Study of Coca-Cola/Huiyuan”, 3 Peking U J Leg Studies (2011) 96 at 101.
[10] In addition to ibid, see Sandra Marco Colino, “The Internationalization of China’s Foreign Direct Investment Laws”, 45:2 Fordham Intl L J 275 at 285–6 (who noted that while the decision may not have “encapsulated the sophisticated theories of harm expected of well-established competition agencies”, many foreign concerns that emerged from Huiyuan were not justified).
 [11] See Richard A Posner, “The Chicago School of Antitrust Analysis” (1979) 127(4) U Penn Law Review 925; Peter M Gerhart, “The Supreme Court and Antitrust Analysis: the Near Triumph of the Chicago School” (1982) Supreme Court Rev 319; Sandra Marco Colino, “The Internationalization of China’s Foreign Direct Investment Laws”, 45:2 Fordham Intl L J 275 at 287.

For this 11th edition, the Editorial Committee received a record-breaking 1,200+ submissions during the nominations period, out of which it selected:

– 100+ Academic Articles

– 130+ Business Articles

– 42 Soft Laws

– 20 Student Papers

As a reader, you can vote online for your favorite writings in all 4 categories from today, January 19 until March 25, 2022.

The Jury voting will also take place during this period – first with the Academic Steering Committee, Business Steering Committee, and Student Committee, then with the Board. To learn more about the prominent antitrust enforcers, academics, in-house counsel, and students in the 2022 Jury, see here.

Winners will be announced by Bill Kovacic and the Board members at the Gala Dinner on April 5th, in Washington DC. Early Bird tickets for the Gala Dinner are available until February 5th.

Now in their 11th year, the Antitrust Writing Awards are the field’s largest awards for written thought. Participation in the Awards process, whether as an author, jury member, or reader, helps highlight the best antitrust ideas of the past year.

We would like to express our congratulations to all of the 2022 nominees, invite you to read their articles, and vote for your favorites, all of which you can do below.

On November 19, 2021, China State-owned Assets Supervision and Administration Commission (“SASAC”) of the State Council released the “Circular on Strengthening the Management of Financing Guarantees of Central State-owned Enterprises” (the ” Circular “) (Guo Zi Fa Cai Ping Gui [2021] No. 75)

On January 4, 2022, SASAC released an explanation to clarify the queries regarding the Circular (the “Explanation”).

Drafting Background of the Circular and the Explanation

In recent years, SASAC has attached great importance to the management of financing guarantees of central state-owned enterprises (“CSOEs”) and has successively put forward some relevant requirements in a series of documents such as the “Supplementary Notice on Strengthening the Fund Management of Central Enterprises” (Guo Zi Ting Fa Ping Jia [2012] No. 45). However, it is also found in daily supervision that some CSOEs still have problems such as excessive growth in the scale of guarantees, expansion of implicit guarantee risks, and increased risk of compensation losses.

To further strengthen the financing guarantee management of CSOEs, prevent the risk of major capital loss, and promote the high-quality development of enterprises, SASAC released the Circular, which clarified the requirements in the supervision system of financing guarantee business of CSOEs.

On January 4, 2022, to facilitate the understanding of the content and requirements of the Circular, SASAC released the Explanation.

Main Features and Contents of the Circular and the Explanation

(1) The scope of management and control is more comprehensive.

Firstly, it is highlighted that the Circular not only applies to CSOEs themselves, but also applies to CSOEs’ subsidiaries at all levels.

Secondly, in terms of management and control content, the Circular defines the scope of management to include all financing guarantees, including not only standard guarantees provided for corporate financing activities, but also implicit guarantees with guarantee effectiveness.

Specifically, the legal departments of the CSOEs needs to decide whether the joint loan contract, the margin compensation commitment, the comfort letter, the letter of support and other letters have the effect of guarantee according to the specific terms. If so, those are all implicit guarantees.

(2) The management requirements are more stringent.

Regarding the benefited parties in financing guarantees, based on the principle of “same shares, same rights” and the principle of risk-control, no guarantees of any form should be provided to companies outside the group that have no equity relations, and guarantees to high-risk subsidiaries should be strictly controlled. In principle, financing guarantees can be provided. Financing guarantees can only be provided to subsidiaries or shareholding companies that have the ability to continue operations and solvency.

Financing guarantees beyond the shareholding ratio will be strictly controlled.  CSOEs shall provide guarantees to their subsidiaries and enterprises held by them in strict accordance with their shareholding ratios therein. If it is necessary to provide a financing guarantee to a subsidiary beyond its shareholding ratio in such subsidiary, it must reported to the group’s board of directors for approval and a full and realizable counter-guarantee shall be provided by the minority shareholder or a third party through mortgage, pledge or otherwise.

Besides, the scale of financing guarantees is also strictly limited.  The total guarantee scale of a CSOEs shall not exceed 40% of the group’s consolidated net assets, and the guarantee amount of a single subsidiary (including the headquarters) shall not exceed 50% of its own net assets.

(3) The management and control methods are more detailed.

The Circular points out few important key elements in the review of illegal guarantees, including: the guarantor, the amount of guarantee, the benefited party and its operating status, the method of guarantee, the guarantee fee, and the cleanup plan for illegal guarantees and etc.

In addition, given that provision of guarantee is a major risk for CSOEs and PRC Company Law provides that guarantee shall be approved by board or shareholder meetings, the Circular stipulated that the guarantee budget need to be approved by the board or its authorized decision-making body.  However, to maximize the board’s risk control function, the enterprise guarantee system and special guarantee matters are still subject to the approval of the group’s board.

(4) The rectification and cleanup timeline is provided for illegal guarantee. 

The new illegal financing guarantee will be investigated and relevant personnel will be held liable.  The Circular requires CSOEs to rectify existing financing guarantees that are not in compliance with the Circular in three years.  The guarantees of no equity relationship arising from spin-off from the group or the disposal of equity, and the guarantees for enterprises held by it beyond its shareholding ratios therein shall be cleaned up within two years.

If you have questions about this client alert, please contact the authors listed below or the Anjie lawyer with whom you normally consult.

 

Jason Chan

jason.chan@anjielaw.com

D +86 21 231 3130

M & WeChat +86 136 8160 4177

According to Article 271 of Civil Procedure Law of the People’s Republic of China (“PRC”), parties may submit foreign-related disputes to “foreign arbitration institutions” outside Mainland China (“foreign” here encompasses Hong Kong, Macau, and Taiwan, in terms of jurisdiction only). However, the statutory law of the PRC is silent on whether parties may agree to submit non-foreign-related disputes to such foreign arbitration. In the past, the Supreme People’s Court of the PRC (“SPC”) holds that an arbitration agreement is invalid if parties agreed to submit dispute to foreign arbitration institutions or to foreign ad hoc arbitration (collectively, “foreign arbitration”, for referential purpose in this article) while the dispute is not foreign-related, which will in turn prevent the prevailing party from having the arbitral awards recognized and enforced by the PRC court. In practice, an often-seen scene is two PRC parties agree to have arbitration before a foreign arbitration institution. In such event, where the PRC court cannot find any party is foreign, the PRC court must examine specific facts in order to find out whether the underlying dispute by its nature may satisfy the requirement of “foreign-related” as to have the arbitration agreement exempted from the aforesaid prohibition. In a recent appellate proceeding for jurisdictional challenge heard by the SPC, with its ruling the SPC upheld this notion of prohibiting foreign arbitration for non-foreign-related disputes. However important questions remain unanswered. [1]

Facts

ArcSoft Corporation Limited (“ArcSoft”,the licensor) and Spreadtrum Communications (Shanghai) Co., Ltd. (“Spreadtrum”, the licensee) entered into a Software License Contract (“Contract”), effective on 1 September 2017. Article 17.2(b) of the Contract is the arbitration clause, which stipulates:

if any dispute is not resolved within the time period specified aforementioned, upon written notice by either party, such dispute shall be finally resolved through arbitration handled by a single arbitrator both parties agree on and familiar with software industry, in accordance with the arbitration rules of the Singapore International Arbitration Centre (“SIAC”) in effect at that time.”

ArcSoft is a sino-foreign joint venture incorporated in Hangzhou City, Zhejiang Province, China. Spreadtrum is a foreign-invested PRC company incorporated in the Free Trade Zone of Shanghai.

ArcSoft alleged that Spreadtrum breached the Contract and ArcSoft initiated a litigation against Spectrum before Hangzhou Intermediate People’s Court (“Hangzhou Court”), rather than filing an arbitration before SIAC. In the litigation, ArcSoft sought the following reliefs,

  1. Spreadtrumshall continue to perform the Contract, by refraining from modifying the licensed software and developing the licensed software’s derivative works;
  2. Spreadtrum shall pay ArcSoft the license fees and relevant interest stipulated under the Contract as well as compensating ArcSoft’s other losses;
  3. Spreadtrum shall indemnify ArcSoft’s cost and bear the entire court fees.

Spreadtrum raised a jurisdictional objection, arguing that the Hangzhou Court did not have competent jurisdiction because, among others, the dispute shall be submitted to SIAC for arbitration. Spreadtrum further contended that, even if the dispute shall be heard by PRC courts, the proper venue shall be the court at Spreadtrum’s domicile. Among others, Spreadtrum argued that,

  1. The arbitration clause provides SIAC arbitration in Singapore, therefore the arbitration clause may be determined by Singaporean law, under which the arbitration clause is valid.
  2. The disputed Contract is foreign-related. Therefore, the requirement for foreign-related elements is satisfied and the arbitration clause is valid. Because, among others,
  • both parties are foreign-invested companies, especially because Spreadtrum incorporated in the Free Trade Zone of Shanghai;
  • the Contract provides that the territory of licensing for the licensed software is the entire globe;
  • the Contract stipulates that it is governed by U.S. laws;
  • the majority of the subject matter under the Contract is the underlying software’s intellectual property rights held by ArcSoft in and protected by the laws of different countries;
  • Spreadtrum’s products incorporated with the licensed software are mostly distributed in overseas.

On December 3, 2020, Hangzhou Court made a ruling (2020) Zhe 01 Zhi Min Chu No.406, dismissing the jurisdictional objection. Spreadtrum appealed to the SPC.

Question

Does the dispute have foreign-related element so that the arbitration clause is valid?

pinions of the Courts

Hangzhou Court held that,

  1. The Parties here are companies incorporated in and residing in Mainland China. The Parties failed to satisfy the SPC’s rule that parties may submit dispute to foreign arbitration institution if any party is a non-PRC party or such party resides outside the PRC.
  2. The main subject matter of the Contract is licensing of the software, in consideration of which Spreadtrum shall pay license fees. The licensed software was developed in Mainland China, and its copyright is owned by ArcSoft. Therefore, the subject matter does not involve foreign-related elements;
  3. The disputed Contract was also signed and performed in Mainland China. Even assuming Spreadtrum’s products incorporated with the software were mainly distributed in overseas, such distribution does not affect the basic relationship between the parties which is software licensing;
  4. Therefore, neither of the Parties, the subject matter of the Contract, nor the legal fact that creates, alters or terminates the legal relationship, involves foreign-related elements. Hence, the arbitration clause is invalid.

The SPC held that, among others,

  1. Article 271 of Civil Procedure Law allows parties to submit “disputes occurred in foreign-related economy and trade, shipment and maritime matters” to overseas arbitration. Article 128 paragraph 2 of the Contract Lawallows “parties to foreign-related contracts” to initiate arbitration overseas. The PRC law has not permitted parties to submit disputes to foreign arbitration institutions if the dispute does not have foreign-related element. Given the parties are both PRC parties, the Court shall identify whether the disputed contract has foreign-related elements.
  2. The parties here are all PRC entities, the disputed Contract was signed in Mainland China and the subject matter thereunder is located in Mainland China. The legal facts whichcreate, alter or terminate the legal relationship between the parties lack foreign-related element. Therefore, the arbitration clause in the disputed Contract is an arbitration clause concluded by PRC parties which provides foreign-seated arbitration for disputes which lack foreign-related elements. Hence the arbitration clause is invalid, and the PRC court has competent jurisdiction over this case.

The SPC then dismissed Spreadtrum’s appeal and sustained Hangzhou Court’s ruling.

According to PRC court’s rulings and the SPC’s public comments, parties are prohibited from submitting non-foreign-related disputes to foreign arbitration institutions or to ad hoc arbitrations seated in foreign jurisdictions (“foreign arbitration” for referential purpose in this article). However, several issues cry out for clearer answers.

  1. The basis of prohibiting foreign arbitration for non-foreign-related disputes is unclear.

Article 271 of the Civil Procedure Law (“CPL”) provides that parties may submit foreign-related disputes to foreign arbitration. However, under the PRC law, there is no explicit prohibition barring parties from resolving non-foreign-related disputes through foreign arbitration. This prohibition rooted in PRC courts’ rulings. According to the PRC court’s rationale in published rulings, this is an implied prohibition embedded in Article 271 of CPL. PRC courts’ rationale is, given the PRC law does not expressively permit PRC parties to submit non-foreign-related disputes to foreign arbitration, then submitting non-foreign-related disputes to foreign arbitration shall be deemed as prohibited.

There are quite a number of published cases, in which the PRC courts relied on such implied prohibition and deemed arbitration agreements invalid. These cases are of diverse types of proceedings, such as jurisdictional challenge, independent application seeking court’s declaration on the arbitration agreement’s validity, and application for recognition and enforcement of foreign arbitral award.

A well-known case is Chao Lai Xin Sheng v. Suo Wang Zhi Xin, 2013-Er-Zhong-Min-Te No. 10670, decided by Beijing 2nd Intermediate People’s Court in 2014 after obtaining the SPC’s approval.[2] In this case, two PRC companies submitted dispute to Korean Commercial Arbitration Board (KCAB). The disputed contract does not specify the governing law. When the winning party applied for recognition and enforcement of the award in China, the PRC court held that the governing law of the disputed contract and the arbitration agreement therein shall be PRC law, “regardless the parties had chosen or not,” and the PRC court dismissed the application for recognition and enforcement on the ground of Article V.1(a) of the New York Convention, by holding that the arbitration agreement is invalid. In particular, the court held that the underlying arbitration agreement is invalid “according to the law which the parties subjected to the arbitration agreement”.

Article V.1 (a) of the New York Convention reads,

“1. Recognition and enforcement of the award may be refused, at the request of the party against whom it is invoked, only if that party furnishes to the competent authority where the recognition and enforcement is sought, proof that:

  • The parties to the agreement referred to in article II were, under the law applicable to them, under some incapacity, or thesaid agreement is not valid under the law to which the parties have subjected it or, failing any indication thereon, under the law of the country where the award was made; or”

Therefore, in the context of Article V.1 (a) of the New York Convention three types of laws may be applied in determining the arbitration agreement’s validity,

  • The law applicable to the parties, under which they are under some incapacity;
  • The law which the parties subjected to the arbitration agreement;
  • The law at the seat of the arbitration.

The PRC court’s rationale in Chao Lai Xin Sheng v. Suo Wang Zhi Xin is intriguing, since it established a notion that, in the context of Article V.1(a) of the New York Convention, “the law to which the parties have subjected to the arbitration agreement” may refer to a law not chosen by the parties, and such unchosen law may override the arbitration agreement’s governing law chosen by the parties. To date, Chao Lai Xin Sheng v. Suo Wang Zhi Xin is the only publicized PRC court ruling where the PRC court refused to recognize and enforce foreign arbitral award by holding that the arbitration agreement is invalid since foreign arbitration for non-foreign-related disputes is prohibited under the PRC law. In Chao Lai Xin Sheng v. Suo Wang Zhi Xin, if the parties explicitly agreed on the governing law of the arbitration agreement, the outcome in the PRC court’s ruling might be different, and we expect to witness such a case in the future.

  1. The test for identifying “foreign-related elements” is to be further clarified and unified.

Beside the applicability of prohibition of foreign arbitration for non-foreign-related disputes, the key issue is how to determine a dispute is foreign-related or not.

As to the definition of “foreign-related elements”, both Article 522 of the SPC’s Interpretation on Civil Procedural Law and Article 1 of the SPC’s 1st Interpretation on the Law on the Application of Law in Foreign-Related Civil Legal Relationship provide that a case may be deemed foreign-related, if any of the following elements exists:

  • Any parties or both parties are foreign citizen, foreign legal person or other entities, or, individual without nationality;
  • Any party or both parties resides outside the territory of the PRC;
  • The subject matter is outside the territory of the PRC;
  • The legal facts which create, alter or terminate civil relations occurred within the territory of the PRC;
  • Other circumstance based on which it can be found that foreign-related civil relationship exists. (emphasis added)

The underlined three criteria above are abstract. Hence PRC courts may reach different conclusions depending on various fact matrix, and in practice they did so. To date, the SPC has not published a clear guidance or a representative case which may clarify on the interpretation and application of this test.

In a case decided by Beijing 4th Intermediate People’s Court (docket number: (2018) Jing 04 Min-Te No.145) [3], the court held that the requirement is satisfied as foreign-related element exists. The disputed contract is a product purchase contract concluded between two PRC companies, which provides ICC arbitration in Hong Kong. The court found that the origin of the products is Germany, and the transaction involves the buyer’s taking of delivery in Germany. The court consequently found that the requirement of foreign-related element is satisfied because the products as the subject matter of the contract are outside the territory of the PRC, hence the arbitration agreement is valid.

In a case decided by Shanghai Maritime Court in 2018 (docket number: (2017)-Hu-72-Min-Te No.181) [4], the court held that the arbitration agreement in a shipbuilding contract concluded by PRC parties is valid, which provides arbitration in London. The court found that the disputed ship has various connections with foreign jurisdictions, including that the parties agreed that the ship is to comply with the standard of and registered with the American Bureau of Shipping, and they further agreed that Marshall Islands shall be the ship’s flag country, and the buyer shall set up a foreign subsidiary to be assigned with the shipbuilding contract. The court ruled that the arbitration agreement is valid on the ground of “other circumstance based on which it can be found that foreign-related civil relationship exists.”

However, in ArcSoft v. Spreadtrum here the disputed contract is a software licensing agreement. Hangzhou Court found that the underlying software was developed by ArcSoft in Mainland China, and its intellectual property right is held by PRC parties. Hangzhou Court further held that, even assuming Spreadtrum’s products incorporated with the software were mainly distributed in overseas, such distribution does not affect the basic relationship between the parties which is software licensing. The SPC directly gave its conclusion that there is no foreign-related element, without giving any discussion on the specific case facts. Spreadtrum had argued in the proceedings that the disputed Contract involves ArcSoft’s intellectual property held by ArcSoft in overseas therefore the underlying contract is foreign-related. Speadtrum had further argued that the scope of licensing stipulated in the Contract is the entire globe. Neither Hangzhou Court nor the SPC responded to these two arguments. Perhaps, if the courts reached a finding that the Contract deals with ArcSoft’s copyright to the licensed software and such copyright is registered in overseas, the courts may conclude that the subject matter of the Contract is in foreign countries and consequently they would hold that the Contract is foreign-related. With respect to identifying what “the legal facts that create, alter or terminate civil relations” are in the case, and whether such legal facts occurred in foreign jurisdictions, Hangzhou Court and the SPC did not give any explanation either.

The notion under the PRC law on prohibiting foreign arbitration for non-foreign-related matters is still controversial. However, it remains the prevailing attitude in practice which may result in refusal of recognition and enforcement of foreign arbitral awards. We look forward to further development on this issue in legislation and judicial practice in the PRC.


[1] The SPC’s ruling of ArcSoft v. Spreadtrum can be found here: https://wenshu.court.gov.cn/website/wenshu/181107ANFZ0BXSK4/index.html?docId=b0a3613dc00a4583b219ad5f0124cf9c

[2] The ruling of Chao Lai Xin Sheng v. Suo Wang Zhi Xin can be found here:

https://www.bjcourt.gov.cn/cpws/paperView.htm?id=00000000000000000000100200434922&n=1

[3] The ruling of (2018) Jing 04 Min-Te No.145 (Jing-Jin Electric v. SEMIKRON Electronics (Zhu Hai)) can be found here:

https://wenshu.court.gov.cn/website/wenshu/181107ANFZ0BXSK4/index.html?docId=4b53ae25136a4869aa3dab98000cbcbc

[4] The ruling of (2017)-Hu-72-Min-Te No.181 (Mekers v. Shanghai BESTWAY, Jiangsu Dajin) can be found here: https://wenshu.court.gov.cn/website/wenshu/181107ANFZ0BXSK4/index.html?docId=3bf1a11336f7478b863eaa7800f7b380

 

In China, workplace accidents and deaths have steadily declined since the mid 2000s[1]. Although rarer than before, regretfully, workplace accidents causing death in China continue to occur on average 75 times per day[2].

Oftentimes, such fatal accidents immediately result in a shutdown order from the local municipal safety bureau (a “Stop-work Order”) to prevent further harm.

Stop-work Orders can cause a worksite to completely cease operations for weeks or even months while the safety bureau investigates the accident, leading to lost operating time.

The losses from this down-time can reach dollar amounts in the tens of millions. This is especially common in manufacturing and construction industries after a fatal equipment malfunction.

Whether such losses are covered by Business Interruption (“BI”) insurance, is the central question in many property insurance disputes.

Stop-Work Orders

Intended to uncover additional workplace hazards and prevent further harm, the site of an accident is cordoned off and access restricted upon issuance of a Stop-work Order. Stop-work Orders are typically issued by local safety bureaus pursuant to the Work Safety Law of the People’s Republic of China (“Work Safety Law”).

Under Chinese law, any accident resulting in a workplace fatality is grounds for a Stop-work Order. They are commonly issued in response to occurrences which meet the statutory definition for an “accident”. Per the Regulations on the Reporting, Investigation and Disposition of Work Safety Accidents, the death or injury of a worker, or losses amounting to RMB 10 million yuan, meet this definition.

BI Insurance

Because Stop-work Orders interrupt business for weeks or even months, they frequently lead to BI claims.

BI insurance is commonly purchased by the policyholder as additional coverage to property damage insurance.

However in the PRC insurance market, BI policies cannot be purchased independently. Instead, they can only be purchased together with property damage polices, such as property all-risks insurance or property comprehensive insurance.

Therefore, a given BI policy usually specifies that in order to be triggered, a threshold level of physical damage must first be met. Among such formulations are clauses stipulating “this policy only provides coverage directly resulting from physical loss or damage to the insured property as described in the property damage policy.” A serious workplace accident is usually a sufficient trigger, especially when it involves damaged equipment or facilities.

However, when an additional event such as a Stop-work Order is factored in, determining the period of liability becomes very difficult.

Is the insurer liable only for the time lost from restoring property due to physical loss or damage caused by the accident (EG: replacing broken equipment, a few days or weeks), or is the insurer instead liable for time lost due to the Stop-work Order (potentially months)?

In some cases, the difference between the two periods of liability can vary the insured’s insurance benefit by tens of millions of dollars.

The answer almost always lies in contractual interpretation.

In the US, in many cases, losses resulting from a Stop-work Order following an accident are not covered by BI property insurance. When the policy includes the following proviso, that losses be “directly resulting from physical loss or damage”, time lost due to a Stop-work Order is not factored into the benefit. Instead, such language limits the period of liability to the time needed to repair or replace broken equipment. That down-time time will be included, but any additional losses due a Stop-work Order will not.

The reasoning is simple: people are not property. Stop-work Orders result directly from hazards or harms to people, not property. They are issued to prevent harms to human life, upon the occurrence of a workplace accident or death, and only rarely due to damage to equipment or facilities. That is also why extensions to BI losses which clearly cover Stop-work Orders, such as “Denial of Access,” and “Civil Authority Order” extensions, are commonly offered by property insurers.

However, in some cases, a policy features subtle words or formulations which include losses resulting from a Stop-work Order within a BI clause’s scope of coverage, even absent an extension.

In some cases, just two words make the difference between a modest benefit and a potential windfall for the insured. Losses from the Stop-work Order are not included when the policy ends the period of liability upon the damaged property being restored to the “same or equivalent physical conditions that existed prior to the damage.”

However, adding two simple words to the policy, “physical and operating conditions,” can broaden the scope of coverage to include a Stop-work Order. This is because while restoring “physical conditions” refers strictly to repairing or replacing damaged property, restoring “operating conditions” extends to restoring the work site to the state it was in prior to the accident.

Proximate Cause in China

What about the role of causation in such clauses? In the absence of compelling contractual wording like that shown in the paragraph above, the scope of coverage for BI losses will depend on judicial findings of proximate cause.

Even though the principle of proximate cause is not clearly defined in the Insurance Law of the People’s Republic of China, it has been broadly accepted as a fundamental principle of insurance law and applies when assessing causation for insurance claims.

Proximate cause refers to, within the chain of causation between risk and damage, the most direct, effective and decisive cause which plays a fundamental, traceable and dominant role in causing the damage to occur[3]. When the proximate cause falls within the insurance policy’s coverage, the insurer must bear liability and pay the benefit. However, when an intervening event “breaks” the chain of causation, the policy will not cover that secondary event’s resulting losses.

Under the circumstances described, a Stop-work Order will be seen as breaking the chain of causation and its resulting losses will not be covered by BI insurance. This is because while a physical accident is the most “fundamental, traceable, and dominant” cause for losses resulting from property damage, a Stop-work Order is, as a government directive, only a cause of non-property damage, which is generally outside the scope of coverage.

Conclusion

When a policy requires that losses be “directly resulting from physical loss or damage”, insurers are not liable for time lost due to a Stop-work Order. Under such a policy, the Stop-work Order — under the principle of proximate cause in China — is an intervening event which “breaks” the chain of causation. Accordingly, BI insurance will not cover that secondary event’s resulting losses. Without an applicable “Denial of Access” or “Civil Authority Order” extension, such policies will not cover Stop-work Order losses.

However, in some cases, a policy includes subtle words or formulations which incorporate losses resulting from a Stop-work Order within a BI clause’s scope of coverage, even absent an extension. In some cases, just two words (see “operating conditions” example, above) make the difference between a modest or fulsome insurance benefit.

Whether insurer or insured, retaining experienced counsel to review a new policy’s BI clause before concluding it can save valuable time, effort, and resources before an accident occurs.


 [1] China Labour Bulletin, “How China outsourced work-related accidents and deaths”, 16 January 2018, online: <clb.org.hk/content/how-china-outsourced-work-related-accidents-and-deaths>.

[2]  National Bureau of Statistics of China, “2020 Statistical Bulletin of the National Economic and Social Development of the People’s Republic of China” (Feb 28, 2021), online: <www.stats.gov.cn/tjsj/zxfb/202102/t20210227_1814154.html>.

[3]  Under Article 6.1.1.4 of the National Standard of the People’s Republic of China GB / T 36687-2018 Insurance Terminology, Proximate Cause means “the most fundamental, traceable and dominant cause of the loss. Note: Not necessarily the closest cause in time or space to the loss.”

Background

China has been continuously strengthening and developing data security rules over the last decade. One of the hallmarks of this trend is increasing regulation over outbound cross-border data flows.

Against this background, the Cyberspace Administration of China (CAC) issued the Draft Measures for Security Assessment for Cross-Border Data Transfers (the draft measures) on 29 October 2021, open for public comment until 28 November 2021. The draft measures seek to implement the outbound data transfer provisions within the Cybersecurity Law, the Data Security Law, the Personal Information Protection Law, and other laws and regulations by focusing on the compliance procedures that entities should follow for outbound data transfers.

The draft measures show a stricter regulatory approach towards cross-border transfers of data. They contain a security assessment trigger that is as low as 10,000 people’s sensitive information. Many companies expected higher thresholds, and multinational corporations (MNCs), which often use global systems to process customer and employee data, will likely be affected. As the draft measures require entities to conduct self-assessments before outbound data transfers, MNCs will also face uncertainty regarding current outbound data transfers and whether they can pass security assessments for future data transfers.

Purpose

The draft measures have the purpose of regulating outbound data flows, protecting personal information rights and interests, safeguarding national security and public interests, and promoting the safe and free flow of data across borders.

Application

The draft measures oblige entities that provide important data and personal information – collected and generated during their Chinese operations – to foreign recipients to conduct outbound data transfer security assessments. Entities must complete assessments before making transfers and continually monitor those arrangements.

Declaration thresholds

An entity must declare outbound data transfers to provincial cyberspace administration authorities and seek security assessments by the CAC in the following circumstances:

  • The personal information and important data are and were collected and generated by a critical information infrastructure operator.
  • The outbound data contains important data.(1)
  • The entity processes the personal information of at least one million people.
  • The outbound transfers cumulatively involve the personal information of over 100,000 people or the sensitive personal information of over 10,000 people.
  • Other situations where the CAC requires a security assessment exist.

It is understood that many companies would prefer to see a rise in the threshold transfer volumes that trigger declarations.

Assessment criteria

Two types of assessment are described in the draft measures: self-assessments and security assessments by the CAC. An entity must submit the following materials to apply for a security assessment by the CAC:

  • a written application form;
  • a cross-border data transfer self-assessment report;
  • the contract or other legally binding documents to be concluded between the entity and the overseas recipient; and
  • any other materials required for the security assessment.

The self-security assessment and the security assessment by the CAC involve the consideration of:

  • the legality, legitimacy and necessity of the transfer and the purpose, scope and manner of data processing by the overseas recipient;
  • the quantity, scope, type and sensitivity of the outbound data, and the risks the outbound data might pose to national security, public interests, and the legitimate rights and interests of individuals and organisations;
  • whether the management and technical measures and capabilities of the entity can prevent risks such as data leakage or destruction;
  • whether the responsibilities and obligations undertaken by the overseas recipient, as well as its management and technical measures and capacity to fulfil those responsibilities and obligations, can guarantee the security of data leaving China;
  • the risk of leakage, destruction, falsification and misuse of data after export and retransfer, and whether individuals have smooth channels to safeguard their rights and interests in their personal information and other data;
  • whether the contract related to outbound data flows adequately deals with data security protection responsibilities and obligations; and
  • the destination country’s laws and network security environment.

Assessment timescale

The CAC determines whether to accept security assessment applications within seven working days of receiving application materials. Once an application is accepted, the CAC must complete the security assessment within 45 working days. However, that term may be extended in complicated circumstances, or where supplementary materials are required, but it may not exceed 60 working days in total.

The security assessments by the CAC are valid for up to two years unless a triggering event occurs, in which case a new security assessment by the CAC is required. Triggers include changes to the factors upon which an outbound data transfer security assessment was made.

For further information on this topic please contact Samuel Yang at AnJie Law Firm by telephone (+86 10 8567 5988) or email (yanghongquan@anjielaw.com). The AnJie Law Firm website can be accessed at www.anjielaw.com.


Endnotes

[1] Important data is a type of regulated data, the criteria and scope of which is still to be defined by the authorities.

 

Standard-Essential Patents (“SEPs”) are patents which protect technology essential to compatibility with technical industry standards.

To avoid abuse by patent holders, SEPs are typically required to be licensed on Fair Reasonable and Non-Discriminatory (FRAND) licensing terms. However, what constitutes a FRAND rate is often unclear and can lead to protracted negotiations, hold-ups, and ultimately, litigation. FRAND disputes are notoriously complex and lie at the intersection of contract, patent, and antitrust law.

Chinese enterprises are increasingly familiar with FRAND disputes. The groundbreaking case was in 2013, when Huawei Technology Co., Ltd. (“Huawei”) litigated Huawei v Interdigital, the first FRAND dispute where a Chinese court publicly ruled on interpreting and enforcing FRAND commitments pledged by an SEP holder to a Standard Setting Organization (“SSO”). In the ensuing years, outbound Chinese tech champions like Huawei and ZTE Corporation (“ZTE”) also became important litigants in overseas disputes over FRAND-encumbered patents. Among the more prominent disputes, they were appellants in a landmark 2020 UK ruling, Unwired World/Conversant v Huawei/ZTE (“Conversant“).

Conversant is a noteworthy ruling where the UK Supreme Court (“UKSC“) interprets the policy of a foreign SSO. Namely, that of the European Technical Standards Institute (“ETSI“). In its decision, the UKSC allowed itself to rule on the language and drafting history of ETSI policy, and reached conclusions about the intent of that language. This ruling forced a hold-out licensee to accept a global patent portfolio, and was a blow to the use of protracted, jurisdiction-by-jurisdiction FRAND negotiations by SEP implementers.

August 2021 marked the start of a related new trend: not only Chinese companies, but now also Chinese courts are assuming a greater role in global SEP licensing disputes. Ruling over the dispute between Sharp Corporation, Saenbacher Hippo Co., Ltd. (“Appellants“), OPPO Guangdong Mobile Communications Company Ltd., and OPPO Guangdong Mobile Telecommunications Co., Ltd. Shenzhen Branch (“Respondents“, the “Oppo” case), the Intellectual Property Division of the Supreme People’s Court (“SPC IP“) affirmed Chinese jurisdiction over a global SEP patent licensing rate dispute.

In Oppo, the SPC IP not only affirmed jurisdiction but laid out a test for lower courts to follow when deciding whether to accept jurisdiction over such disputes. Specifically, it set out an “or” elements test for determining whether a global SEP licensing dispute has a sufficient enough connection with China for a Chinese court to accept jurisdiction. These include whether China was the jurisdiction which issued the patent, where the patent is exploited, where the patent license contract is executed or negotiated, where the patent license contract is performed, or whether the place where the property subject to seizure or enforcement is located in the territory of China. As long as one of the above places is within the territory of China, the case is deemed to have appropriate connections with China, and the PRC courts have jurisdiction over the case.

This jurisdictional test applies to global SEP patent license disputes generally. Ruling on whether it is appropriate for a PRC court to interpret the global licensing conditions of a disputed SEP, the decision determined the criteria outlined above based on the fact that “there is a willingness of the parties concerned to conclude a global license,” the principle of “closer connection”, and the convenience of the court. The SPC IP further ruled that even when the parties concerned did not express jurisdictional consensus on the global licensing conditions at issue, where the case has a closer overall relationship with PRC courts, it is still appropriate for PRC courts to rule on the global licensing conditions of the disputed SEPs.

Thus, the ratio from Oppo is that where the parties show a willingness to conclude a global (rather than localized) patent license, and there is a nexus with China, Chinese courts may claim jurisdiction. Moreover, absent a clear intent from the parties to conclude a global license, a sufficiently close connection to China will still allow a People’s Court to accept jurisdiction.

This is the first time that the SPC IP has clarified its jurisdictional rules on global patent licenses for SEPs. It marks a milestone on China’s road to more active participation in the formulation of global IP governance rules and precedents.

While the SPC IP only clarified the rules for jurisdiction, and did not go so far as to interpret the language of a foreign SSO and set rates itself in this case, it affirmed the Shenzhen court of first instance’s ruling doing just that, leaving the door open for other Chinese lower courts to follow suit.

Other observers have noted that because the SPC IP in Oppo rules on other markets’ rates, including the US, Germany, and Japan, it engages issues of sovereignty. This concern was also raised in the wake of Conversant. So far, comity towards foreign decisions like the UKSC’s in Conversant has avoided an international clash among judiciaries in rate-setting decisions. It remains to be seen whether the same deference will be extended to Oppo.

If the ruling in Oppo were to hold, China’s courts may very well begin to regularly serve as a forum for breaking through logjammed SEP licensing negotiations, so long as those cases have a sufficient connection to China. In fact, due to the patent exhaustion doctrine and to electronics being heavily produced in China, even years prior to this decision some authors wagered that China could become the most important jurisdiction when it comes to setting FRAND licensing terms and royalty rates. Should Chinese courts take the initiative and accept jurisdiction over such disputes, this prediction may become reality.

However, cases less intimately intertwined with China may be distinguished from Oppo by Chinese courts. Oppo stood out because most of the patents at issue were Chinese, Defendants’ principal place of business is China, negotiations were conducted in Shenzhen, China, and Defendants’ assets were located principally in China. While the SPC IP, by endorsing an “or” test in deciding jurisdiction, sent a strong signal that the patent’s place of issue, the parties’ place of business, place of negotiations, or the place where their assets are located may all engage a sufficient “nexus” with China, lower courts may avoid applying this dogmatically where parties satisfy the letter but not the spirit of this new guidance. In particular, they may be wary of parties abusing the courts’ newly enlarged jurisdiction in a bid to conduct strategic forum-shopping.

Conclusion

Chinese tech-champions like Huawei and ZTE have played an increasingly prominent role in the development of global SEP jurisprudence, as recently as last year litigating issues of jurisdiction over SEP disputes in Conversant. This year, Chinese courts have shown themselves ready and willing to decide cases involving foreign SEP rates litigated on Chinese soil. Going forward, FRAND rates set by Chinese courts will — to the extent tolerated by international comity — apply to foreign patents licensed beyond China’s borders.

These courts and tech-champions, located principally in Beijing, Shanghai, and Shenzhen, have picked up quill and ink and are now comfortable contributing and adding to the global FRAND precedents written in foreign jurisdictions. Left unchallenged, these decisions bind entities both inside and outside of China, engaging sovereignty concerns. While presently, comity has allowed such decisions to stand, the true test for global FRAND licensing rules will come when unsatisfied parties, having exhausted all avenues of appeal in one jurisdiction, try their luck in the next, potentially rekindling the very jurisdiction-by-jurisdiction FRAND disputes which decisions like Oppo and Conversant specifically sought to snuff.


[1] Wi-Fi is enabled by the 802.11 standard established by the Institute of Electrical and Electronics Engineers (IEEE). For more information, see IEEE 802.11 Wi-Fi Standards, RADIO-ELECTRONICS.COM, online: <http://perma.cc/69AN-D92X>. The IEEE publishes a list of patents associated with 802.11, online: <https://standards.ieee.org/about/sasb/patcom/patents.html>.

[2] A Douglas Melamed & Carl Shapiro, “How Antitrust Law Can Make FRAND Commitments More

Effective” (2018) 127:7 Yale L J 2110 at 2121.

[3] Ibid at 2022

[4] Jiaohu Shuzi Tongxin Youxian Gongsi (InterDigital Communications, Inc.) Su HuaweiJishu Youxian Gongsi, [Huawei Techs. Co. v. InterDigital Commc’ns, Inc.], pkulaw.cn (Guangdong High People’s Ct. Oct. 16, 2013) (China).

[5] Jie Gao, “Development of the FRAND Jurisprudence in China” (2020) 21:2 Colum Sci &

Tech L Rev 446 at 457.

[6] [2020] UKSC 37

[7] (2020) Zui Gao Fa Zhi Min Xia Zhong No. 517, decided Aug 19, 2021.

[8] Ibid.

[9] Ibid.

[10] Ibid.

[11] Ibid.

[12] Garry A Gabison, “Worldwide FRAND Licensing Standard” (2019) 8:2 Am U Bus L Rev 139, at n 222, citing D. Daniel Sokol & Wentong Zheng, FRAND in China, 22 Tex. Intell. Prop.

L.J.71, 73 (“The operation of market forces will result in globalization of the lowest rate set by a court or agency for a particular patent or patent portfolio in a major jurisdiction. China is such a jurisdiction. Consequently, if China is more influential, it will be because China will be inclined to set rates lower than other jurisdictions. In essence, what happens in China on FRAND now impacts decision-making in the boardrooms of Silicon Valley.”).

In Homer’s Odyssey, the wayward hero Odysseus is travelling by ship when beset by two threats within an arrow’s distance from one another: on one side is Scylla, a beast with many heads, and on the other side is Charybdis, a deadly whirlpool.[1]

This is an apt metaphor for what faces litigants trying to navigate the choppy waters of transnational discovery; nowhere is this more true than with managing jurisdictional discovery under both US and Chinese legal systems.

 

Foreign Defendants and Personal Jurisdiction

Since the US Supreme Court’s decision in International Shoe Co. v. Washington,[2] Courts have come to recognize two types of personal jurisdiction: “general” jurisdiction and “specific” jurisdiction.[3] This distinction can be attributed to Professors Arthur T. von Mehren and Donald T. Trautman, who authored a paper on the subject in 1966.[4]

With general jurisdiction, Courts rely on the “essentially at home” test. In other words the defendant’s contacts with the forum must be “so continuous and systematic as to render them essentially at home in the forum state.”[5] As it relates to foreign defendants, general jurisdiction was limited by the US Supreme Court ruling in Daimler and today plays a reduced role.[6]

Chinese defendants without a domicile in the US will typically be haled into US Courts through the use of “specific” jurisdiction. Unfortunately, this most often involves the infamous minimum contacts test. A minimum contacts enquiry involves two prongs. First, the “purposeful availment” prong, which asks whether the litigant intentionally directed their activities in the forum state.[7] Second, the “relatedness” prong, which asks whether the lawsuit results from injuries that are related to (or arise out of) activities in the forum state.[8] Nevertheless, defendants may defeat a finding of specific jurisdiction, even after meeting the minimum contacts test, if doing so is considered unreasonable in that it contradicts notions of “fair play” and “substantial justice”.[9]

The minimum contacts test is notorious because its elements (especially relatedness) have been described, by some, as nebulous at best:[10]

There is little in the way of clear standards for what makes a contact with the forum ‘related to’ the litigation or qualifies a dispute as ‘arising out of the defendant’s contacts with the forum.’

Indeed, there is more agreement among the Courts about what specific jurisdiction is not rather than what it is. While guidance from the US Supreme Court does suggest that specific jurisdiction is distinctive, in that it is “case-linked”, it stops short of clarifying thornier issues involved with the concept.[11]

The Role of Personal Jurisdiction — Taishan Drywall

In some cases, disagreements over personal jurisdiction can lead to a decade of litigation.

In the past, Chinese defendants in the US market could “have the best of both worlds.” It was common practice to access the US market while avoiding liability for breaching local laws. In the words of Peking University Professor Ray Campbell:[12]

Historically, with U.S. judgments not recognized in China, many Chinese defendants had the best of both worlds—they were free to sell into the U.S. market, but protected from after-the-fact regulation [in the form of litigation] should the products prove defective.

This changed drastically with a seminal class action involving a Chinese defendant. (“Taishan Drywall“).[13] A Chinese company, Taishan Gypsum Co., was not only held in default for failing to appear in a Louisiana Court to defend a claim (liability for defective drywall), but was further barred from the US market by presiding Judge Fallon. This was especially significant considering that the next most significant case fought over personal jurisdiction against a Chinese defendant at the time, Gucci Am., Inc v Weixing Li (“Gucci I” from Gucci “I“, “II“, and “III“, the “Gucci Trio“), resulted in contempt for failure to comply with an asset freeze,[14] not denial of market access.

Challenging this default judgment, Taishan argued that it must be void on the grounds that this and other US Courts lacked personal jurisdiction.

And so began, in October 2010, a jurisdictional discovery battle between Taishan and the plaintiffs. The former were required to prove that Taishan had sufficient “minimum contacts” with forum states to allow US Courts to exercise personal jurisdiction.

As a result of this battle, Taishan had to submit to the US plaintiffs’ discovery requests. These included three depositions in Hong Kong which degenerated into “chaos and old night” (as described by Judge Fallon), and which were ultimately in vain after being found ineffectual (due to disagreements among interpreters, counsel, and witnesses, among other issues). It also included production of both written and electronic documents, and a second, more “hands-on” deposition in Hong Kong where the Court appointed a Federal Rule of Evidence 706 expert to operate as the sole interpreter at the depositions. The Court also decided to travel to Hong Kong itself to preside over the depositions, allowing it to rule immediately on objections and avoiding many problems present during the first deposition.

Upon conclusion of this lengthy transnational process, the Louisiana Court found in favour of the plaintiffs. The Court held that Taishan, indeed, had the minimum contacts necessary to exercise personal jurisdiction. In 2014, the 5th Circuit upheld this ruling in two judgments.[15] Adding another wrinkle to the case, following the U.S. Supreme Court case of Bristol–Myers Squibb v. Superior Court of California,[16] Taishan again challenged the Court’s personal jurisdiction and filed a motion to dismiss in 2017.[17] This challenge, too, was in vain.

Finally, after a decade of litigation, the parties reached a settlement agreement. Under this agreement, finally approved on January 10, 2020, Taishan agreed to pay $248 million to settle the claims of most plaintiffs.[18] In US Courts, as evidenced by this hard-fought and lengthy litigation process, personal jurisdiction is a critical factor in determining whether or not a plaintiff will succeed in claiming against a foreign entity.

 

Jurisdictional Discovery: Hague Convention or FRCP

In conducting jurisdictional discovery to establish personal jurisdiction against a foreign defendant, an important consideration is whether the plaintiff should follow the procedures set out in the Convention on Taking Evidence Abroad in Civil or Commercial Matters (“Hague Evidence Convention“) or the Federal Rules of Civil Procedure (“FRCP“).

Despite being signatories, many countries imposed reservations at the time of their accession to the Hague Evidence Convention. China’s reservations are extensive,[19] making the Hague Evidence Convention a method that is tardy and inapplicable to most discoveries.[20] It is not a popular option. According to correspondence between Professor Campbell and the Chinese Ministry of Justice (“MOJ“), only about 40 requests are received — cumulatively from countries around the world — by the MOJ each year.[21] Nevertheless, the Hague Evidence Convention was designed not as a ceiling, but as a floor (Art. 27), and many Courts prefer to forego its processes in favour of other methods.

Much more popular is the FRCP, granting US plaintiffs speedier timelines and more familiar processes. Generally US Courts are willing to allow discovery under the FRCP, though further to the decision in Aerospatiale these must be case-by-case determinations.[22] Accordingly, Courts must balance the importance of the information sought, sovereign interests, and the likelihood that the Hague Evidence Convention will be effective in determining whether to grant discovery under the FRCP. While not automatic, the chances are that the FRCP will apply for obtaining foreign evidence against Chinese litigants. The District Court in Gucci v Weixing ruled that the “Hague Convention is of limited utility in China in large part because its implementation remains uncertain and unpredictable.”[23] Of course, one condition of relying on the FRCP is that the Court have personal jurisdiction over the defendant, or reason to conduct discovery into personal jurisdiction. When personal jurisdiction has yet to be established, as is the case with jurisdictional discovery attempts, failure to satisfy the latter condition (reason to conduct discovery into personal jurisdiction) can lead to a catch-22.[24]

It is noteworthy that Chinese defendants are increasingly choosing to avail themselves of their rights before US Courts. Large default cases like Taishan Drywall are now rare, and Chinese companies today are much savvier than before in navigating the US legal system.

 

A Rock and a Hard Place: Narrowing US Jurisdictional Discovery Requests

Invoking conflict with Chinese laws is a common way for Chinese defendants to seek to narrow the scope of US jurisdictional discovery requests. These include, most commonly, Articles 2 and 32 of the Law of the People’s Republic of China on Guarding State Secrets, under which state secrets are broadly defined to include trade secrets.[25] Divulging state secrets to a foreign entity in violation of this law can result in criminal consequences under Article 111 of the Criminal Code of China, and as such can sometimes narrow an overbroad discovery request when invoked before a US Court. An emerging trend is to also invoke conflict with Chinese data privacy laws, engaging numerous data control and privacy concerns. The latest such blocking statute, the Data Security Law which came into effect September 1st, 2021, imposes fines for unauthorized compliance with overseas judicial orders.[26]  This is significant because in a digital word, discovery increasingly means ediscovery.

In seeking to limit US discovery requests though, it is important to set realistic expectations, because overreaching risks reducing the defendant’s chances of success. US Courts have repeatedly ordered foreign banks to produce documents in violation of their home country laws. They are generally unwilling to consider fear of punishment under foreign laws when deciding whether to subject offshore documents to US discovery. The reason? To do so would encourage parties to hold such documents offshore and risk undermining US discovery. In a canonical US Supreme Court ruling on the subject, Société Internationale Pour Participations Industrielles et Commerciales v. Rogers,  the Court stated:[27]

[T]o hold broadly that petitioner’s failure to produce […] records because of fear of punishment under the laws of its sovereign precludes a court from finding that petitioner had “control” over them, and thereby from ordering their production, would undermine congressional policies […] and invite efforts to place ownership of American assets in persons or firms whose sovereign assures secrecy of records.

In light of this ruling it is no surprise then that US Courts are often unwilling to surrender sovereignty over the judicial process, even to the point of imposing “directly conflicting obligations” on a foreign party.[28] This was notably the case with the Bank of China (“BOC“) in the Gucci Trio of cases.[29] In this matter involving an action under the Lanham Act, a US Court ordered the BOC to freeze the assets of Chinese defendants suspected of counterfeiting (Gucci I). On remand from the Court of Appeal’s decision (“Gucci II“), District Judge Sullivan asserted personal jurisdiction over the BOC and granted Gucci’s motion even though this would force BOC to violate Chinese law (“Gucci III“):[30]

Although BOC asks the Court to consider the fact that granting Gucci’s motion would force BOC to violate Chinese law, BOC cites to no other courts that have considered such arguments in the context of assessing the reasonableness of an exercise of personal jurisdiction, as opposed to a separate and subsequent comity analysis, and the Court declines to be the first.

In another ruling, Wultz v Bank of China, the US Court compelled production of foreign electronically stored data despite the knowledge that doing so was illegal under Chinese state secret laws.[31] Rather than have the best of both worlds, the BOC was caught in a battle for judicial sovereignty between two of the world’s superpower legal systems.

Nevertheless, when performed as an analysis that is separate from a personal jurisdiction enquiry, the doctrine of international comity may in some cases successfully limit jurisdictional discovery and asset freeze orders from US judges. This was certainly a signal from the Second Circuit in Gucci II:[32]

[E]ven where personal jurisdiction over a foreign non-domiciliary is established, a court should not uphold an international subpoena in possible contravention of foreign law, without first performing a comity analysis pursuant to Section 442 of the Restatement (Third) of Foreign Relations Law.

This ruling in Gucci II was more conciliatory than that of the Court in Gucci I & III. The former considered an order issued against BOC from the Beijing Second Intermediate People’s Court that conflicted with Gucci I,[33] evidence from a Chinese law expert attesting to the direct conflict of law, Chinese official concerns on the order’s effects on China-US relations, and an amicus brief from the US government (then under the Obama administration) arguing for vacatur.[34] In at least one case similar to Gucci, Tiffany (NJ) LLC v. Qi Andrew,[35] the Court was also persuaded by the BOC and the Industrial Bank of China, and accommodated their request not to disclose customer records for fear of exposing them to Chinese civil and criminal liability.

The holdings from these two conflicting strings of New York cases left the law on jurisdictional discovery unclear and unpredictable. In fact, the parties to a similar string of cases involving the Lanham Act, the Nike cases (Nikes “I“, “II“, “III“, “IV“, and “V“, together the “Nike Quintet“), expressly agreed to hold off on further litigation until resolution of the Tiffany case and the Gucci Trio.[36] In the Nike Quintet, Next (successor-in-interest for Nike) had succeeded in obtaining jurisdictional discovery, production, and asset freeze orders against the BOC and other Chinese banks in 2013.[37]

However, eight years later in Nike V, Next failed to convince the Second Circuit Court that the defendants should be sanctioned for failing to extend these orders to their banks located in China.[38] The reason? Ironically, because even after Tiffany and the Gucci Trio, the law remains somewhat unclear on the subject. The legal circumstances of this case set the burden on Next to show why these orders apply abroad, and the Court in Nike V was persuaded that Next had failed to do so because (without ruling, like the Nike IV district Court that it affirms did, on the correctness of BOC’s arguments) BOC raised reasonable arguments (specifically, a “fair ground of doubt”) that, due to both comity concerns and New York’s separate entity rule, the orders do not clearly apply to banks in China.[39] Next’s delay in bringing the action also frustrated the Court,[40] making it unclear whether acting earlier against BOC to enforce the orders in Nike I would have made a difference. Nike V also affirms important parts of Nike III (itself affirming Nike II),[41] most notably how they allow the Nike I discovery order to accommodate Chinese banking laws (allowing China’s MOJ to select and forward permitted documents to the US). Despite this, it is made clear in Nike II that the US’ interest in enforcing Lanham Act judgments against counterfeiters outweighs China’s interest in enforcing bank secrecy laws.[42]

The easiest conclusion to draw from these cases involving the BOC is that while the Second Circuit encourages a fulsome comity analysis when considering discovery requests, results from Second Circuit cases like Gucci II, Tiffany and Nike V remain difficult to replicate because narrowing such requests remains a case-by-case determination. On this point, Gucci II and the Nike Quintet support reliance on a comity analysis based on Section 442 of the Restatement (Third) of Foreign Relations Law. Under this approach, the Court must select and weigh five factors (like in Gucci II), or seven if the Court is considering a contempt motion (as in Nikes II and III),[43] in a balancing test to determine whether to limit foreign discovery against a foreign litigant: (1) the documents or information’s importance to the litigation, (2) the degree of specificity of the request, (3) whether the information originated in the United States, (4) the availability of alternative means of securing the information, and (5) the extent to which noncompliance with the request would undermine important interests of the United States or compliance with the request would undermine important interests of the state where the information is located.[44] These factors vary even among similar cases and leave considerable room for discretionary analysis.

From a policy perspective, serious contempt orders from Chinese courts might help dissuade US Courts from placing Chinese litigants between Scylla and Charybdis. One practitioner’s insight on why US Courts force Chinese defendants to violate Chinese laws in order to comply with US laws is revealing: “U.S. courts are no longer convinced that there is a credible threat of punishment for violating the PRC bank secrecy laws […] While foreign laws purport to prohibit disclosure, governments generally do not impose penalties on their banks for complying with U.S. court orders.”[45] This analysis is consistent with the results in Nike I, Wultz, and Gucci III, where in the latter case the Court imposed a USD $50,000 contempt order for every day the BOC failed to comply with the Court’s production order. While it is harder to square with the more recent Nikes II through V, that line also affirmed that China’s bank secrecy laws are not a “get out of jail free” card,[46] and that banks cannot “hide behind Chinese bank secrecy laws as a shield,”[47] suggesting that the Nike Quintet is not intended to afford significantly more leniency towards litigants trying to use foreign legal restrictions to check US discovery requests.

Of course, different facts or circumstances may lead to narrower jurisdictional discovery orders. A US Court may be more amenable to narrowing jurisdictional discovery against a Chinese litigant if the underlying claim is not grounded in the Lanham Act. Moreover, requiring a Chinese bank to disclose information on a state-owned enterprise or government official, rather than a counterfeiter, could involve a more persuasive sovereign-immunity defense.[48] Under the Foreign Sovereign Immunities Act, jurisdictional discovery is generally allowed only to confirm specific facts that are crucial to the immunity determination.[49]

Finally, to further narrow discovery, retaining US-licensed counsel allows Chinese litigants to benefit from the same rules of legal privilege enjoyed by US litigants. There are risks to having no US counsel at all, because US Courts do not recognize any Chinese analogy to legal privilege. This was at issue in the aforementioned case Wultz v Bank of China, where the Court compelled the production of documents governed by Chinese law, on the grounds that a Chinese lawyer’s duty of confidentiality falls short of US-style attorney-client privilege:[50]

Because attorney-client and work-product communications and documents could be subject to discovery under Chinese law, applying Chinese privilege law does not “violate principles of comity” or “offend the public policy of this forum.”

[…]

Because Chinese law does not recognize the attorney-client privilege or the work-product doctrine, Bank of China must produce those items listed on its privilege log which are governed by Chinese privilege law.

Does this mean US-licensed attorneys can, merely by laying eyes on the communications records of foreign counsel, earn the right to affix upon said documents “attorney-client privileged” in bold letters? While having US-licensed counsel certainly helps establish privilege abroad, US law on this point is far more nuanced. US Courts adopt the “touch-base” approach to applying privilege to foreign documents. In the words of the Court in another case (also involving Gucci), Gucci America, Inc. v Guess?, Inc.:[51]

“[C]ommunications relating to legal proceedings in the United States, or that reflect the provision of advice regarding American law, ‘touch base’ with the United States and, therefore, are governed by American law, even though the communication may involve foreign attorneys or a foreign proceeding.

[…]

[such communications should] have a ‘more than incidental’ connection to the United States.”

Therefore to benefit from US-style privilege against US proceedings involving Chinese evidence, it is not enough to simply have an American lawyer in the room. The document must be relating to or in anticipation of legal proceedings in the US, or otherwise provide advice involving the US, and that advice’s connection to the US must be more than incidental. It is certainly not enough to simply stamp “attorney-client privileged” on every page if the “touch-base” requirement is not satisfied.

 

Conclusion

Discovery into personal jurisdiction is intended to be narrower than ordinary discovery.  That said, it is stubbornly difficult to narrow any further. US Courts tend to favour domestic interests even at the expense of international comity, whether by applying the FRCP over the Hague Evidence Convention or by requiring foreign banks to violate home country laws to comply with discovery orders. This is especially the case with Lanham Act claims.

Invoking a violation with home country laws did, in some cases (Tiffany, Gucci II, Nikes II & III)  successfully narrow discovery. However this is not the rule and is instead a case-by-case determination following the five-factor comity analysis endorsed by Gucci II. US Courts are generally not persuaded that complying with their discovery orders will lead to at-home sanctions, and until such sanctions begin to appear, it is unlikely that the policy fundamentals on this point will change. Courts are aware that litigants in such cases caught between Scylla and Charybdis will, like Odysseus, steer their compliance efforts down the path that harms them the least.

 

[1] Homer, Iliad, The Odyssey, 12.235 (“For on one side lay Scylla and on the other divine Charybdis terribly sucked down the salt water of the sea”).

[2] (1945) 326 U.S. 310.

[3] See comment in Bristol-Myers Squibb Co. v. Superior Court of California (2017) 137 S. Ct 1773 at 1780; 198 L. Ed. 2d 395 (“Since our seminal decision in International Shoe, our decisions have recognized two types of personal jurisdiction: ‘general’ (sometimes called ‘all-purpose’) jurisdiction and ‘specific’ (sometimes called ‘case-linked’) jurisdiction.”); see also Xin Xu, “Show Me the Money: Evaluating Personal Jurisdiction over Foreign Nonparty Banks in Light of the Gucci Case” Cornell Intl L J, Vol 49, Issue 3 (Fall 2016) at 749, which posits another line of thinking that this distinction only emerged after International Shoe in Helicopteros Nacionales de Colombia, S. A. v. Hall, 466 U.S. 408, 414 (1984).

[4] Arthur T. von Mehren & Donald T. Trautman, “Jurisdiction to Adjudicate: A Suggested Analysis” (1966) 79 Harv L. Rev. 1121, 1136.

[5] Goodyear Dunlop Tires Operations, S.A. v. Brown, 131 S. Ct. 2846 (2011).

[6] Daimler AG v. Bauman, 134 S. Ct. 746 (2014), which found that Courts may exercise general jurisdiction only when the corporation is “essentially at home” in the forum state, replacing the previous “continuous and systematic general business contacts” test, which was “unacceptably grasping.”

[7] Hanson v. Denckla, 357 U.S. 235, 253 (1958) (discussing purposeful availment);

[8] Burger King Corp. v. Rudzewicz, 471 U.S. 462, 472 (1985) (Burger King), applying the concept of relatedness created in International Shoe v. Washington, 326 U.S. 310, 316– 18 (1945).

[9] Burger King, 471 U.S. at 477–78.

[10] Lea Brilmayer, A General Look at Specific Jurisdiction, 42 Yale J. Int’l L. Online 1, 5 (2017).

[11] Howard M. Erichson, John C. P. Goldberg & Benjamin C. Zipursky, Case-Linked Jurisdiction and Busybody States, 105 Minn. L. Rev. Headnotes 54 (2020) at 55 (n 6: “For example, [Courts] do not like specific jurisdiction premised solely on the plaintiffs contact with the forum state. See Walden v. Fiore, 571 U.S. 277, 284 (2014). Nor do they like a sliding scale approach that merges general jurisdiction with specific jurisdiction. See Bristol-Myers Squibb, 137 S. Ct. at 1781.”).

[12] Ray Worthy Campbell & Ellen Claar Campbell, Clash of Systems: Discovery in U.S. Litigation Involving Chinese Defendants, 4 PEKING U. Transnat’l L. REV. 129 (2016) at 156.

[13] Ibid at 157, describing Germano v. Taishan Gypsum Co. (In re Chinese Manufactured Drywall Prods. Liab. Litig., No. 2047, 2014 U.S. Dist. LEXIS 183686 (E.D. La. July 17, 2014). See also ibid, n 88 citing Gucci Am., Inc. v. Huoqing, No. C-o9-o5969 JCS, 2011 U.S. Dist. LEXIS 783, at 63 (N.D. Cal. Jan. 3, 2011), where Huoqing was forbidden from doing further business in the USA following a series of counterfeiting and trademark violations against the plaintiff.

[14] Gucci Am., Inc. v. Weixing Li, No. 10 Civ. 4974 (RJS), 135 F. Supp. 3d 87 (S.D.N.Y. Sept. 29, 2015) (Gucci III), reaffirming on remand from Gucci Am., Inc. v. Bank of China, No. 11-3934-cv (2d Cir. Sep. 17, 2014) (Gucci II) the asset freeze and document production request in Gucci Am., Inc. v. Weixing Li, No. 10 Civ. 4974 (RJS), 2011 U.S. Dist. LEXIS 97814 (S.D.N.Y. Aug. 23, 2011) (Gucci I, vacated on other grounds, together the “Gucci Trio“). For a detailed discussion of this trio of rulings, see Xin Xu, “Show Me the Money: Evaluating Personal Jurisdiction over Foreign Nonparty Banks in Light of the Gucci Case” Cornell Intl L J, Vol 49, Issue 3 (Fall 2016).

[15] In re Chinese-Manufactured Drywall Prods. Liab. Litig., 753 F.3d 521 (5th Cir. 2014); In re Chinese-Manufactured Drywall Prods. Liab. Litig., 742 F.3d 576 (5th Cir. 2014).

[16] 137 S. Ct.

[17] In re Chinese-Manufactured Drywall Prods. Liab. Litig., Doc. 22460, MDL NO. 2047 [Jan 10, 2020], online: <www.laed.uscourts.gov/sites/default/files/drywall/09-2047%20%28Drywall%29%20-%20Final%20Approval.pdf>

[18] Ibid at 12.

[19] Hague Evidence Convention PRC, Hong Kong & Macau Reservations, HCCH, online: <www.hcch.net/en/instruments/conventions/statustable/notifications/?csid=493&disp=resdn> (last visited Aug. 16, 2021).

[20] Ray Worthy Campbell & Ellen Claar Campbell, Clash of Systems: Discovery in U.S. Litigation Involving Chinese Defendants, 4 Peking U. Transnat’l L. Rev. 129 (2016) at 153.

[21] Ibid.

[22] Societe Nationale Industrielle Aerospatiale v. U.S. Dist. Court for S. Dist. of Iowa, 482 U.S. 522 (1987).

[23] Gucci I at *27 (upheld in part, vacated on other grounds).

[24] Ray Worthy Campbell & Ellen Claar Campbell, Clash of Systems: Discovery in U.S. Litigation Involving Chinese Defendants, 4 Peking U. Transnat’l L. Rev. 129 (2016) at 154.

[25] Ray Worthy Campbell & Ellen Claar Campbell, Clash of Systems: Discovery in U.S. Litigation Involving Chinese Defendants, 4 Peking U. Transnat’l L. Rev. 129 (2016) at 163 (Article 2 requires Chinese Citizens to guard against revealing “state secrets”, and Article 30 requires State pre-approval before furnishing some of them to others).

[26] Data Security Law of the People’s Republic of China, National People’s Congress, 13th sess., Standing Committee, 29th sess., enacted June 10, 2021, arts 36, 48, online (unofficial English translation): <www.cov.com/-/media/files/corporate/publications/file_repository/data-security-law-bilingual.pdf> (art 48 reads: “Where entities violate requirements under Article 36 of this Law and provide data to overseas judicial or law enforcement organs without obtaining approval from competent authorities, departments performing data security duties shall issue warnings [sic] impose a fine …”).

[27] 357 U.S. 197, 205 (1958) at 204.

[28] Gucci II, Dkt. 346, 09/17/2015.

[29] 15 U.S.C. § 1051.

[30] Gucci III, at 99; see also ibid quoting Licci, 732 F.3d at 171 (the banks’ “in-forum conduct is deliberate and recurring, not ‘random, isolated, or fortuitous. … the selection and repeated use of New York’s banking system … constitutes ‘purposeful availment of the privilege of doing business in New York.”).

[31] Wultz v. Bank of China Ltd., 942 F. Supp. 2d 452, 466, 473 (S.D.N.Y. 2013); see also Societe Nationale Industrielle Aerospatiale v. U.S. Dist. Court for S. Dist. of Iowa, 482 U.S. 522, 546 (1987).

[32] Gucci II, at 141; per Linde v. Arab Bank, PLC, 706 F.3d 92, 111 (2d Cir. 2013) (quoting Societe Nationale Industrielle Aerospatiale, 482 U.S. at 543-44, 107 S.Ct. 2542) this analysis must weigh “all of the relevant interests of all of the nations affected by the court’s decision.” See also Nike II, infra, which quotes this reasoning.

[33] Gucci II, Dkt. 346, 09/17/2015.

[34] Ray Worthy Campbell & Ellen Claar Campbell, Clash of Systems: Discovery in U.S. Litigation Involving Chinese Defendants, 4 Peking U. Transnat’l L. Rev. 129 (2016) at 170.

[35] 276 F.R.D. 143 (S.D.N.Y. 2011). Interestingly, this and another Tiffany case, Tiffany (NJ) LLC v. Forbse, No. 11cv4976 (NRB), 2012 WL 1918866 (S.D.N.Y. May 23, 2012), are among the few Chinese precedents where evidence was produced through the Hague Evidence Convention. The result was deemed unsatisfactory by the Court (in both cases, the Chinese Ministry of Justice only “partly executed” the Hague Convention requests that the Ministry “deem[ed to] conform to the provisions of the [Hague] Convention,” QI Andrew, 2015 WL 3701602, at *1 n.1). This was raised again in Nike II, infra.

[36] Nike, Inc. v Wu (S.D.N.Y. 2020) WL 257475 at 3 (“Nike IV“) (“the two sides agreed to put their dispute on hold until the Second Circuit ruled on two pending appeals in the Tiffany and Gucci cases, two other trademark infringement suits in which certain of the Chinese Banks were challenging the enforceability of discovery orders and prejudgment asset freezes overseas”).

[37] Ibid.

[38] Next Investments, LLC v. Bank of China, No. 11-3934-cv (2d Cir. Aug. 30, 2021) (“Nike V”).

[39] Nike V at lines 11–2 (“there is a fair ground of doubt as to whether, in light of New York’s separate entity rule and principles of international comity, the orders could reach assets held at foreign bank branches”).

[40] See ibid at 22 (Next’s delay in bringing an action was not well regarded by the Second Circuit Court, noting that the district Court “refused to reward Next’s “‘gotcha’ tactics” and other 16 efforts “to delay resolution” of key legal issues”).

[41] 349 F. Supp. 3d 310, 318 (S.D.N.Y. 2018) (“Nike II”), interestingly, Nike II like Gucci II allowed evidence from a Chinese law professor, Banks Mem., at 14–5, citing Guo Decl. ¶ 15-21.

[42] Nike II at *339.

[43] Per Linde v Arab Bank, PLC, 706 F.3d 9284 Fed.R.Serv.3d 961 at 110, a Second Circuit decision, when deciding whether to impose sanctions, a district court should also examine the [6] hardship of the party facing conflicting legal obligations and [7] whether that party has demonstrated good faith in addressing its discovery obligations. Note that for an asset freeze, the comity enquiry is different and relies instead on s. 403 of the Restatement (Limitations on Jurisdiction to Proscribe), Nike V, at 25 (“we eschew any categorical rule and instead draw on the eight-factor framework found in Section 403 of the 15 Restatement (Third) of Foreign Relations Law.”)

[44] Societe Nationale Industrielle Aerospatiale v. U.S. Dist. Court for S. Dist. of Iowa, 482 U.S. 522, 546 (1987).

[45] Meg Utterback, “Lessons from the GUCCI case: Chinese banks increasingly subject to U.S. jurisdiction”, Lexology (Aug 29 2016), online: <www.lexology.com/library/detail.aspx?g=88f05267-e346-4e0d-8f6c-3a393e579ad3>.

[46] Nike III at *364.

[47] Nike II, citing Gucci I at *10.

[48] Ibid.

[49] Laura G. Ferguson & Charles F. B. Mcaleer Jr, “Playing the Sovereign Card: Defending Foreign Sovereigns in US Courts”, Litigation, Vol 43, No., 2, Winter 2017.

[50] Wultz v. Bank of China Ltd., 979 F. Supp. 2d 479 (S.D.N.Y. 2013).

[51] U.S. Dist. Court 271 F.R.D. 58  (S.D.N.Y 2010).

Nearly six years and a half since four Ningbo magnetic material manufacturers (“Plaintiffs”) brought lawsuits against Hitachi Metals, Ltd. (“HML”), China’s Ningbo Intermediate People’s Court (“Court”) finally entered its first instance rulings on 23 April 2021, in which the Court found in favour of the Plaintiffs and ruled that the refusal to license patents by HML constitutes an abuse of dominance, as the non-SEP patents owned by HML were held as ‘essential facility’ under the antitrust law scheme by the Court. In essence, the ruling required HML to license its patents to the Plaintiffs on FRAND terms while HML itself has never made any FRAND commitments in the past as its patents have never been considered as standard essential patents (“SEPs”). Currently, HML already has eight licensees in China.

  1. Relevant Facts
  • The Beginning of the Story

In August 2013, an Alliance established by seven Chinese companies including the four Plaintiffs-i.e., Ningbo Tongchuangqiang. Magnetic Materials Co., Ltd., Ningbo Permanent Magnetic Industry Co., Ltd., Ningbo Ketian Magnetic Industry Co., Ltd. and Ningbo Huahui Magnetic Industry Co., Ltd., filed a complaint to the U.S. Patent Office against HML for invalidation of its core patents of sintered neodymium-iron-boron (“sintered NdFeB”), a type of rare earth magnets.

In May 2014, the Alliance and HML negotiated in San Francisco yet failed to reach an agreement; the seven companies have not obtained the relevant licenses. Therefore, the four Ningbo members sued HML at their base, Ningbo; the case was officially accepted on 11 December 2014.

  • The Long Trial

The first hearing was held on 17 December 2015, and the second one on 10 March 2017. And then, the dormant case was back to life in early 2021, after four years of silence. The regional court handed down all four decisions on 23 April 2021, in favour of the Plaintiffs. The Court ordered partial damages for the Plaintiffs, for a total of RMB 142.6 million, and required HML to stop its refusal to license.

  1. Key Issues of the Rulings

In those lengthy 69-page rulings, upon citing the factual claims and legal arguments as well as evidence from both sides, the Court went on laying down its own findings and reasoning; key issues of the rulings are set below:

  • Overstepping the Boundary between Antitrust and IPRs Protection

Intellectual property rights (“IPRs”) protection and antitrust regulations alike, is set to stimulate innovation, promote competition and consumer welfare. The existence of patents, serves the basic needs of IPRs protection by establishing a legal monopoly. Such monopoly is granted to an inventor to enable the inventor to exploit the benefits of his or her creativity. Therefore, antitrust law, in general, must respect the exercise of such monopoly power; interference is allowed, only under exceptional circumstances. As Article 55 of the Anti-Monopoly Law of China (“AML”) stipulates that, the AML is not applicable to undertakings who exercise their IPRs in accordance with the laws and administrative regulations on IPRs unless such undertakings eliminate or restrict market competition by abusing their IPRs. However, the Court seemed to believe that all IPRs related conducts are subject to the AML, that the “abuse of IPRs” is simply the summarisation of the anti-competitive effects of a given exercise of IPRs. Such an interpretation by the Court could render the clause of AML an empty shell, so as to jeopardise its protection of IPRs.

  • The SEP Treatment for a Non-SEP and The Fabrication of ‘Essential Patents’

In the Guide of the Anti-Monopoly Committee of the State Council for Countering Monopolisation in the Field of Intellectual Property Right, it is clear that the definition of the relevant market in terms of IPRs related cases shall follow the ordinary approach thereof. And according to Guidance of the Anti-Monopoly Committee of the State Council for the Definition of the Relevant Market, the substitution analysis shall centre from the perspective of the demand side, and only where supply substitution constitutes similar competitive restraints on undertakings’ behaviours as demand substitution, supply substitution may also be taken into consideration. Therefore, in both Chinese and foreign practices[1], it is the SEPs relates to widely used standards that would usually be considered as constituting a separate relevant market; for non-SEPs, substitutability should be analysed.

In the current case, having defined the downstream product market as the market for sintered NdFeB products, for lack of substitutability between NdFeB and other magnetic products, the Court decided that the relevant upstream market as the market for the licensing of the essential patents related to sintered NdFeB owned by HML, which means that HML is the sole market player in such a defined market. In reaching such conclusion, the Court mainly and solely relied on the opinions of the Plaintiffs’ witness that claimed a series of patents owned by HML are necessary for sintered NdFeB production, the marketing strategies of HML using words such as ‘critical’ and ‘essential’ to describe its patents, and the compliments and recognition of HML’s patents by customers and industry. Customers and industry analysis speak highly of HML’s patents because HML has a reputation for producing high-end sintered NdFeB products, which constitutes only a part of all sintered NdFeB products. For the same reason that HML prides on its quality and exaggerates in its marketing-a common commercial practice that most companies take; the indispensability test of a patent cannot be a subjective one as the duty to deal only arises from the commercial indispensability of the facility it controls. In addition, what the Court has chosen to ignore is the fact that Plaintiffs have, on many occasions, publicly declared that they had the independent production process and technology of sintered NdFeB, which did not infringe on HML’ patented technology. Although the Court recognised that the technology concerned is not the subject of any industry standard, it, nevertheless, acknowledged the so-called ‘essential patents’(‘必需专利’ in Chinese), made up by the Plaintiffs. As the name ‘standard essential patents’ speak for itself, a SEP refers to a patent that claims an invention that must be used to comply with a technical standard. Absent a standard, there would be no SEP. Even in practice, a de facto SEP is found, there must be a de facto standard at present. In the current case, the mere preference and recognition of the customers for a small part of the products is nothing close to what could be considered as a standard. But even so, the Court still managed to define some of HML’s patents to constitute an independent relevant market where they are replaceable with many other technologies owned by competitors. If such a decision and the reasoning behind were to prevail, valuable patent holders would tremble with fear for the uncertain fate of their own, even when the patents they hold are not SEPs.

  • The Framed Monopoly

Given that the upstream market is defined by the Court as the licensing market for part of HML’s NdFeB patents, it readily concluded that HML has a dominant position in the market as it has 100% market share therein. In doing so, the Court pontificated that HML possesses the ability to set prices above competitive level and prevent others from launching effective competition. While in fact, China, the country that accounts for approximately 36.67% of global rare earth resources, provides the largest rare earth production worldwide. The eight Chinese licensees are all leading enterprises in the relevant industry; they have more advantages in the acquisition of raw materials as well as strong competitiveness and bargaining power. The reasonable licensing fees set by HML for the eight companies could well be an illustration of this. Yet the Court’s findings suggest that the assessment of whether the licensing fees set by HML are beyond competitive level has never been part of its six years’ headwork.

In addition, the Court also found market power of HML from its ‘control force’ over non-licensees since the latter are allowed to sell only outside HML’s licensing scope. It is exactly the ‘control force’ that lays down the foundation for patents, a type of intellectual property that gives its owner the legal right to exclude non-licensees from making, using, or selling an invention for a limited of time at the very land that the patent is granted.

  • The Application of ‘Essential Facilities Doctrine’ to a Non-SEP

The essential facilities doctrine, an antitrust and competition law doctrine, refers to a duty imposed on a monopoly that controls access to an important resource “essential” or “bottleneck” facility to deal with its competitors by providing access to such a ‘facility’ that it controls and is deemed necessary for effective competition, at a reasonable price. Such doctrine applies in rare cases, with strict standards. An undertaking shall “freely to exercise his own independent discretion as to parties with whom he will deal”[2]; antitrust and competition law ‘does not restrict the long-recognised right of trader or manufacturer engaged in an entirely private business’[3]. Compulsive trading runs contrary to fundamental principle of freedom of contract.

Despite the usual strictness and prudence in applying the doctrine by the courts all over the world and the fact that by far, not a single Chinese court has used this doctrine in the refusal to license cases, the Court in this case, simply listed the test of essential facilities and concluded the following without providing any solid analysis. In his speech of ‘intellectual property and competition policy’, Joaquín Almunia, the vice president of the European Commission responsible for Competition Policy, specified that “the Courts have also made it clear that refusing to licence can be an infringement of competition law only in ‘exceptional circumstances’; that is, when a company needs access to the IPR to enter the market and effective competition would be eliminated if the license were not granted”[4]. Article 7 of the  Provisions on Prohibiting the Abuse of Intellectual Property Rights to Preclude or Restrict Competition (“IP Provisions”) lists the similar preconditions for the application of essential facilities: (1) the IPRs cannot be reasonably substituted, and it is necessary for other operators to participate in the competition in the relevant market; (2) refusal to license the IPRs will adversely affect competition or innovation in the relevant market and harm the interests of consumers or the public interest; (3) licensing the IPRs will not cause unreasonable damages to the right holders. The existence of many other independent patents, the rapid growth of the leading competitors with innovative products and technology, and the competitiveness in the market, all exclude the application of the essential facilities doctrine in the current case.

Behind the circumspect practices of courts from different jurisdictions is respect to transaction freedom and the foundation of the intellectual property system. Should mandatory licensing become commonplace, innovation would come to an end.

  • The Accused of Violating FRAND Principles and Imposing ‘Non-Challenge’ Clause

While the absence of evidence proving the anti-competitive effects of HML’s conducts by the Plaintiffs seems to suggest that they failed to fulfil their burden of proof, the Court, nevertheless, voluntarily pointed out that HML did not act in accordance with FRAND principles and restricted the Plaintiffs’ assess to the downstream market without comprehensive competition analysis. However, as a non-SEP holder, HML has never made any FRAND principles in any form nor should it need to. Similarly, the Court viewed HML’s termination of negotiation when the Plaintiffs brought litigation against HML as a demand of a, de facto, “non-challenge” clause and further accused HML of attaching an unreasonable trade condition of such a ‘non-challenge clause’, another abusive behaviour under the AML. However, these clauses refer to clauses that set ‘direct or indirect obligations not to challenge the validity of the licensor’s intellectual property, without prejudice to the possibility, in the case of an exclusive licence, for the licensor to terminate the technology transfer agreement in the event that the licensee challenges the validity of any of the licensed technology rights’[5]. It is, essentially, preventing a licensee from ‘biting the hand that feeds it’. In the current case, such a licensing agreement is absent.

As mentioned above, according to the IP Provisions, adverse competition effects to competition or innovation in the relevant market and harm to consumers or the public could not be circumvented in finding an abuse of dominance under Article 17 of the AML

In fact, in the concerned sintered NdFeB product market, there are more than 200 companies competing in China alone. HML’s refusal to license does not hinder the emergence of new products; by seeking licensing from HML, the Plaintiffs were only trying to produce and sell the same sintered NdFeB products. The licensing practices of HML have not changed the market structure in the past years and the product market remains extremely competitive; undertakings including the Plaintiffs, have seen an increasing turnover every year.

  • The Unbearable Heaviness on A Non-SEP Holder     

In its decisions, the Court compelled HML to license its non-SEP to the four Plaintiffs, so these four Ningbo manufacturers could sell in some part of the relevant geographic market. If such decisions become the common practice of the Chinese courts, every single non-SEP holder will face the possibility of being forced to hand over their fruits of painstaking labour to all of their non-licensees.

Furthermore, such a ruling may lead to significant inefficiency as a result. For one, if HML is imposed on the obligation to license to any market player in the downstream market, the transaction cost and monitoring cost would be a huge burden to HML and will disturb its operation of normal business. For another, as the rulings did not specify the licensing terms between HML and the plaintiffs, which means, if HML and the Plaintiffs cannot agree on the licensing terms, the ruling is hard to be enforced in practice. Further disputes on this issue will lead to inefficiency as well.

In addition, the Court allowed partial damages for the Plaintiffs in the case. By its nature, HML was held liable for its unauthorisation. If such decisions become the common practice of the Chinese courts, every single valuable non-SEP holder will face the possibility of having to compensate all of its non-licensees. The floodgate of litigations will inevitably be open, attracting slackers or rent-seekers who are not enthusiastic about innovation, but to seek ‘compensation’ and plunder the fruits of others.

And then there is none, under the patent system in China.

 

Admittedly, the HML rulings by the Ningbo Court is a case of many firsts. Unlike in Huawei v InterDigital, it is the licensing practices of a non-SEP holder in the current case that are found as abuse of dominance; it is the first case of its kind. The unprecedented application of essential facilities raises many questions, questions now left with the Supreme People’s Court of China (“SPC”). Clarifications are needed to assure millions of non-SEP holders, who now have to worry whether they will be compelled to give away their critical intellectual property assets if they ever say no to a Chinese competitor seeking licensing.

[1] For example, Unwired Planet International v Huawei, [2017] EWHC 711; Huawei v IDC (2013) Yue Gao Fa Min San Final Instance No. 306.

[2] United States v Colgate, 250 US 300, 39 S. Ct. 465 (1919).

[3] Ditto.

[4] https://ec.europa.eu/commission/presscorner/detail/en/SPEECH_13_1042.

[5] Guidelines on the application of Article 101 of the Treaty on the Functioning of the European Union to technology transfer agreements, https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:52014XC0328(01)&from=EN.

Due to the COVID-19 epidemic, many observers are predicting an increase in claims relating to insolvency proceedings. Against the backdrop of the increasing prevalence of arbitration clauses and agreements governing commercial disputes, in 2021 courts are likely to face a growing number of claims at the intersection of both arbitration and insolvency law.

In the PRC, the applicable laws for arbitration claims against an insolvent debtor are the 2006 Enterprise Bankruptcy Law of the People’s Republic of China (“EBL“) and the Arbitration Law of the People’s Republic of China (“PRC Arbitration Law”).

There are two paths to bankruptcy under the EBL, both requiring approval from the competent people’s court. First, the debtor may voluntarily petition the court for bankruptcy, and second, a creditor may pursue an involuntary petition against the debtor.

Bankruptcy Results in a Stay of Arbitration Proceedings

Whether initiated by the debtor or creditor, a successful petition for bankruptcy results in a temporary stay of legal proceedings — including both litigation and arbitration claims — against the debtor.  This stay suspends arbitration proceedings relating to the debtor until the court appoints a third-party administrator (the “Administrator“) to handle the debtor’s assets. Until such appointment, ongoing arbitration is suspended and the court is not permitted to direct any of the parties to submit further disputes to arbitration (EBL Art. 20). Note that while the EBL does provide for debtor-in-possession proceedings, in practice, in almost all cases an Administrator is appointed.

The Administrator May Disclaim Some of the Bankrupt’s Contracts, While Arbitration Agreements are Subject to the Strict Doctrine of Severability

Pursuant to EBL 18, once the stay is lifted, the Administrator has a special right to rescind the debtor’s unperformed contracts, but not an arbitration agreement within such a contract. This limited power of rescission is the result of how EBL Art 18 interacts with the strict doctrine of severability articulated in Art 19 of the PRC Arbitration Law. Under Article 19 of the PRC Arbitration Law, an arbitration agreement exists independently from the contract that contains it, such that a contract’s rescission (解除) does not affect the arbitration agreement within. Instead, the validity of the arbitration agreement is decided by PRC Arbitration Law Article 17(3), whereby arbitration agreements can be invalidated only when entered into “by coercive means”. In practice, showing coercion is only possible in exceptional cases.

In a similar vein, pursuant to EBL 31 and 32, the Administrator also has a special right to apply with the court or arbitration commission having jurisdiction over the matter to revoke a contract that is obviously unfair.

The Administrator Steps into the Debtor’s Shoes

Upon the Administrator assuming control of the debtor’s assets, the Administrator registers creditor claims against the debtor and steps into the debtor’s shoes during civil proceedings. First, creditors are required to submit their proof(s) of claims to the Administrator, who then tallies them to create a register of debts (EBL 57). This includes would-be litigants. Unregistered claimants may not bring claims against an insolvent debtor, and claimants seeking to stand on an arbitration agreement to circumvent this requirement are unlikely to succeed.

The Administrator reports to creditors once they are registered, who then supervise the Administrator’s efforts (Ibid Arts 23, 68–69). The Administrator must therefore participate in any applicable arbitration against creditors on the debtor’s behalf, while attempting to maximize the realizable returns of the other creditors. This is an ongoing duty. Where said arbitration continues even after the insolvency proceedings have concluded, the Administrator must nevertheless continue to perform the duties involved and carry such litigation or arbitration through to completion (Ibid Art. 122).

Once the Administrator takes charge of the debtor’s assets, is it business as usual for arbitration claimants against the debtor? The unfortunate fact for most arbitration claimants is that once the debtor enters insolvency, winning an award is still no guarantee that the claimant will recover the amount owed.

There are special procedural hurdles unique to insolvency law which require special consideration from arbitration claimants. Most creditors must follow the priority of claim order detailed in EBL Arts 43 and 113, which describe which creditors are paid first. These clauses call for priority payments to go to bankruptcy expenses, collective debts, medical and disability benefits, pension payments, old-age insurance premiums, employee wages, social insurance premiums, taxes, and finally “common bankruptcy claims”. Art 119 protects claimants whose civil or arbitration proceedings against the debtor extend beyond the conclusion of bankruptcy proceedings. It does so by apportioning a share of the debtor’s assets (proportionate to the claim sought) before an award or judgment is issued:

Article 119

With respect to a claim that involved […]  a […] pending arbitral decision […] [A]dministrator shall preserve the share involved in distribution in advance.

Facing an Administrator, an Arbitration Claimant Must Carefully Craft an Arbitration Strategy

The Administrator is an unusual adversary for an arbitration claimant.

During arbitration proceedings, the arbitration claimant faces an Administrator acting on the debtor’s behalf. The Administrator is also responsible for investigating the amount and validity of claims. However, when the arbitration claimant’s creditor rights have yet to be determined, that claimant may not always have a chance to exercise voting rights along with the other creditors (EBL Art 59, an exception to this is when the People’s Court is able to determine creditor rights provisionally). In addition, and perhaps to the arbitration claimant’s dismay, the Administrator also proposes how to apportion the debtor’s assets for the benefit of creditors (Ibid para Art 115(4)).

This would affect an arbitration claimant in two ways. First, this leaves the door open to the Administrator adjusting the arbitration claimant’s notional claim downwards as new evidence comes to light.  Second, the Administrator can use their role as the drafter of the plan of distribution as leverage against the arbitration claimant. Depending on the size of the arbitration claimant’s claim relative to those of other creditors, it may be easily out-voted during creditor meetings. Once the Administrator’s distribution plan is approved by the Creditors’ Meeting, it is submitted to the People’s Court for approval (Ibid Art 116), and once approved, the debtor’s assets are liquidated and distributed to the creditors. If those creditors wrongfully enlarged their shares at the expense of the arbitration claimant, the claimant’s only recourse after dissolution may be a pyrrhic victory on appeal, since the debtor by that point no longer exists as an entity.

An additional consideration for arbitration claimants is the importance of carefully setting the notional value of an arbitration claim before the responsible people’s court. Once the people’s court grants the arbitration claimant a notional value, this may set a ceiling on their realizable award. Strategically speaking, the amount to be “reserved” for the arbitration claimant’s benefit under EBL Art 119 is difficult to increase after the debtor’s assets have been liquidated. This means that obtaining an unfavourably low “reserve” award could be costly for an arbitral claimant. By way of example, if only $1 million was reserved for the claimant, it does little good for a claimant to win a $5 million award, since any amounts that were not earmarked may be distributed to other creditors by the time the award is issued. Therefore to maximize the amount of a realizable award, an arbitration claimant’s attorneys must be ready to front-load their case and present the full merits of their claim before they may, in fact, have fully developed their arbitration strategy.

Overall, an arbitration claimant should carefully weigh the options available in devising a suitable arbitration strategy against an insolvent debtor.

 

[1]Steele et al, “Trends and Developments in Chinese Insolvency Law: the First Decade of the PRC Enterprise Bankruptcy Law” 66 Am. J. Comp. L. 669 (2018) at 682

[2]William Lu, “Arbitration and Insolvency Proceedings: The Chinese Law Perspective” Asian Dispute Review, Vol. 23, Issue 1 (January 2021) 18 at 20. See also Supreme People’s Court, “Application of the Enterprise Bankruptcy Law of the People’s Republic of China, Provisions on Several Issues (3)” People’s Court News Media Network, March 28, 2019, online: <www.chinacourt.org/law/detail/2019/03/id/149865.shtml>.