PE arbitration takes off amongst Chinese firms

Chinese companies are increasingly proactive in dealing with arbitration cases involving their foreign private equity investors, say market players.

This new-found willingness to engage in legal disputes has been attributed to different types of lawyers hired by Chinese firms as well as modernised contracts with arbitration clauses.

However, Chinese companies’ motives have been questioned amid a belief that they are keen to delay proceedings.

Pinpointing the source for this trend is difficult, although Robert Pé, Hong Kong-based partner at law firm Orrick, Herrington & Sutcliffe, suggests that this could be boiled down to greater willingness amongst Chinese companies to hire in-house lawyers, many with international experience.

At the same time, with foreign investors having previously been burnt by mainland courts, which generally favour Chinese parties over foreign investors when faced with legal disputes, many PE groups have been inserting arbitration provisions into transactional documents.

But while Chinese investee companies are generally more engaging when faced with arbitration, this is not always with the best of intentions, says Pé, who specialises in commercial litigation.

“Sometimes they just want to delay matters. One thing we have seen happen quite often is that when a dispute is blowing up, a Chinese investee will actually commence arbitration on some spurious grounds because he or she wants to be in the position of the claimant,” said Pé.

While this may visually look better and give Chinese investees the opportunity to affect the timing of the case, the tables can quickly turn against the investees when the case is carefully investigated by the arbitrators.

But others with a genuine wish to resolve disputes through arbitration have found it a useful platform. Apart from being able to demonstrate the independence of the tribunal, rulings are also made in private, helping Chinese investees avoid “losing face” than were it to have happened publicly. This allows for greater flexibility in negotiation and even settlement between the two parties, noted Pé.

Common examples that Pé has worked on involved foreign PE groups investing in Chinese real estate companies, with the investments often structured as loans that can be converted into equity in advance of an IPO.

And with the sector under pressure on the mainland, many Chinese companies are now starting to find themselves in financial difficulties and unable to honour their loan agreements with foreign investors.

Adding to the problem is the fact that a large IPO backlog and a recent suspension in new share issuances has meant there have been fewer potential exits available for both parties.

“With the IPO backlog [in China], foreign investors seemed to have more appetite to take some kind of legal action against Chinese investee companies or selling shareholders, even if the problems [with the companies] had been around for some time, as at times it was the only way they could see to get their money out,” said Mustafa Hadi, head of international arbitration in the recently opened Hong Kong office of expert consulting firm Berkeley Research Group.

“PE funds tend to have a three- to five-year investment horizon, and the fund itself is set up for a limited duration of perhaps 10 years. They measure their performance quite carefully and there is sometimes pressure from investors to return funds particularly when the fund is nearing the end of its life, so investors seem more willing to enter into legal actions where there are no other prospects of them getting their money back," Hadi added.