When the Deal Goes Sour: Contracting and Dispute Resolution in China

1
When the Deal Goes Sour Contracting and Dispute
Resolution in Chinas Transitional Political
Economy

• Susan Whiting
• University of Washington

2
Dramatic increase in economic court cases
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Hypothesis

• In the rapidly changing context of Chinas
  transition from socialism to the market,
• Both the informal networks in which firms are
  embedded
• and the bureaucratic structures by which firms
  are governed
• fail to provide adequate information and
  sanctions for the resolution of disputes,
• making the courts an increasingly important
  element in the process of dispute resolution

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Why surprising and counter-intuitive based on
existing literature?

• Social bases of contracting and dispute
  resolution
• Contractual relations are grounded in
  informal social ties and not in legal rules and
  sanctions
• Chinese communities
• role of guanxi (??)
• Comparative studies
• role of informal social ties

5
Why surprising and counter-intuitive based on
existing literature?

• Confucian tradition
• Emphasis on harmony and mediation
• CCP legacy
• Official emphasis on mediation
• Courts in China are problematic
• Courts suffer from a range of drawbacks
• subordinate to the Communist party
• incompetent judges
• weak enforcement powers

6
Appears to be consistent with claims of Weber,
North

• Weber, North
• Legal order offering stable and
• predictable rights of property and
  contract
• is prerequisite for sustained economic
  growth
• Here, focus on contracts
• Whiting (2001) focuses on property rights

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Study fills empirical gap

• paucity of empirically based scholarship on the
  actual operation of the emerging legal system
  (Pei, 2001)

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Original data

• Representative sample of 76 purchase and sales
  contract disputes (1999-2001) from one district
  court in Nanjing
• Convenience sample survey with face-to-face
  interviews of 76 enterprise managers (2002-04)
  regarding contracting practices and dispute
  resolution

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Additional data

• World Bank Study of Competitiveness, Technology,
  and Firm Linkages
• survey of 1500 enterprise managers
  (2000) with small battery of questions on
  contracting and dispute resolution

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Summary of empirical findings

• Steady evolution of legal basis for market
  economy, improving legal recourse for private
  firms
• Contracting less grounded in social networks than
  expected
• Greater use of courts associated with
• relative absence of alternatives and
• growing supply of legal services,
• themselves related to strategies of
  political
• legitimation for CCP rule of law and
  
• economic performance

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Implications for comparative political economy

• Law and economic growth
• Legal order not a prerequisite for
  economic
• growth, but conditions economic growth
• Relationship between institutions and culture
• Institutions shape culture as much or
  more
• than culture shapes institutions

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Evolution of contract law

• Problematic elements of early contract regime
• private enterprises excluded
• transactions controlled rather than
  fostered
• 1981 Economic Contract Law
• 1985 Foreign Economic Contract Law
• 1987 Technology Contract Law
• Evolving contract regime better suited to market
  economy
• 1993 Amended Economic Contract Law
• 1999 Contract Law (unified)

13
Changes reflected in court records (Nanjing
district court 1999-2001)

• Examples
• Private enterprise
• Plaintiffs in 34 of cases
• Defendants in 36 of cases
• Oral contracts
• Oral contracts in 46 of cases
• Findings for plaintiffs 55 of these cases

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MacCaulay (1963) What good is contract law?
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Bases of contracting

• What does the available data tells us about the
  social basis of contractual relations?
• Zhou et al. (2003) Social networks (47) and
  open information sources (47) predominate
• Shanghai/Nanjing data Professional ties
  predominate over social ones

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Bases of contracting

• Few alternatives to social sources of
  information/monitoring to underpin contracting
• Not government
• Not trade associations
• Not credit bureaux
• Result managers scramble to evaluate
  customers creditworthiness and
• trustworthiness

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Bases of contracting credit bureaux
Chinas credit system is underdeveloped. There
is no unified system for evaluating enterprise
credit theres no way to investigate an
individual managers creditworthiness
(??????????,?????????????,????????????)
(Interview with lawyer nj020925p).
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Bases of contracting credit bureaux

• 2001 State Council set up Group for Enterprise
  and Personal Credit Investigation to propose
  legislation governing credit evaluation agencies
• Only a few specially approved ones now exist
• 2004 Regulations for Managing Credit Evaluation
  (??????) still only in draft form
• Draft regulations set high barriers to entry
• Su Ning, Deputy Governor of PBoC
• government control will be quite strong

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Bases of contracting credit bureaux

• How do managers evaluate creditworthiness of
  potential customers
• 9 credit evaluation agencies
• 15 banks
• 26 other suppliers of a potential client
• 39 other
• (Shanghai/Nanjing data)

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Bases of contracting credit bureaux

• 39 Other (from open-ended responses)
• Managers personally visit potential clients
• 3-5 times on average
• Restrict size of deals initially

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Bases of contracting credit bureaux

• We mainly look at a series of deals and ability
  to pay. Clients reputations develop before we
  didnt pay much attention to this and got burned.
  Now weve begun to pay attention
• (????????????. ?????????, ???????????,???,????
  ???(Enterprise Interview 61).
• this firm previously relied on state
  purchasing meetings (???)

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Contract formality

• Formal written contract provisions for specifying
  volume, quality, price, deadlines, and
  contractual safeguards are the norm
• Shanghai/Nanjing data
• 90.5 of contracts with suppliers
• 98.6 of contracts with customers
• World Bank data
• 82.2 of contracts with suppliers
• 90.1 of contracts with customers

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Summary Bases of contracting

• Deals are less grounded in pre-existing social
  ties than expected
• Yet, there are few good institutional
  alternatives to social networks for gathering
  information about potential customers
• Use of formal, written contracts is the norm

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Disputes and dispute resolution

• In the year 2000,
• 31.1 of firms had one or more major dispute
  with clients
• 21.9 had one or more major dispute with
  suppliers
• (World Bank dataset)

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Dispute resolution self-enforcement

• Self-enforcing contracts
• (long-term cooperative solution based on
  anticipated value of future contracts)
• If a client is very late with payment, we
  stop
• (shipments of) goods (????????,??
• ???) (Enterprise interview 39)
• 90.6 of firms end long-term reciprocal
• relations in event of serious dispute
• (Shanghai/Nanjing data)

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Dispute resolution self-enforcement

• Self-enforcing contracts
• (long-term cooperative solution based on
  anticipated value of future contracts)
• Length of contractual relations
• average 7.5 years
• median 5.5 years
• Reputation
• 74.2 of firms said other businesses
  would
• know if a dispute arose with supplier or
  client
• (Shanghai/Nanjing data)

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Dispute resolution self-enforcement

• Self-enforcing contracts
• Partial pre-payment
• 28 of firms require pre-payment
• range of contractual terms for these firms
• 30 in advance
• 40-60 upon delivery
• 10-30 within thirty days
• (Shanghai/Nanjing data)

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Dispute resolution

• Direct negotiation
• Mediation
• Arbitration
• Litigation
• Gang enforcement

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Dispute resolution negotiation

• Direct negotiation
• No matter what firm or what dispute,
  enterprises first step is direct negotiation.
  On the one hand, this approach minimizes costs,
  and, on the other hand, it maintains good
  relations (???????,????,??????????.
  ?????????,?????????????) (Interview with lawyer
  nj020935p).

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Dispute resolution mediation

• Most striking finding apparent lack of
  appropriate third parties

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Dispute resolution arbitration

• Only 17.6 of firms use arbitration
• Arbitration Law1995
• Nanjing Arbitration Commission not even
  established until 1998
• Comments like Where is there an arbitration
  commission? (????????)? (Enterprise interview
  16) are common.
• First 5 years nationwide 3,400 cases per year on
  average arbitrated compared to 1.3 million
  litigated
• Concerns about lack of appeal, enforcement

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Dispute resolution litigation

• 36.8 of firms used the courts in their most
  recent dispute
• (Shanghai/Nanjing data)

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Supply of legal services

• 91.6 of firms had legal representation
• (Shanghai/Nanjing data)

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Dispute resolution litigation

• Credible threat to use court leads parties to
  bargain in the shadow of the law (Cases
  withdrawn increased from 8 to 21)
• Litigants seek authoritative (?????) resolution
  of dispute (Enterprise interview nj021127p judge
  interview sh040817p) (Cases decided increased
  from 5 to 44)

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Dispute resolution litigation

• Court-sponsored mediation has been locus of
  government interference (Potter 1992)
• (Cases mediated by courts declined from 80 to
  31)
• Respondents feel that interference in judgments
  in contract disputes is low
• (Shanghai/Nanjing data)

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Dispute resolution litigation

• About 60 of judgments enforced (details from
  Nanjing court data)
• Government interference in contract disputes,
  when it occurs, occurs more often during
  enforcement
• Interference most common when enforcement of
  judgment would lead to financial difficulties
  resulting in lay-offs of employees

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Attitudes toward business and legal systems

• Attitude toward legal business
• system people
• High/very high 18.3 4.1
• Average 56.3 42.9
• Low/very low 25.3 53.0
• (Shanghai/Nanjing data)

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Attitudes toward business and legal systems

• Attitude toward legal system
• Its better than it was before, and in the
  future it will definitely be good weve entered
  the WTO. The effectiveness of the courts is
  okay in Nanjing, were fairly satisfied with the
  fairness. When companies do business they
  consider legal factors relatively often
  (????,??????, ????. ????????, ????,???????????.???
  ???????????????). (Enterprise interview 39)

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Attitudes toward business and legal systems

• Attitude toward business people
• Theres no trust to speak of. The Cultural
  Revolution destroyed the normal relations between
  people theres no more mutual trust. Under the
  planned economy, one wouldnt even call it trust
  just irresponsibility. The situation of trust is
  pretty bad. (??????. ???????????????, ??????.
  ???????????, ?????. ??????). (Enterprise
  interview 39)

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Conclusion 1 law and economic growth

• Contra Weber and North
• well functioning legal institutions
• not a prerequisite for growth
• but absence of well functioning legal
  institutions
• does limit growth
• (Recall examples from legal regime for
  contracts during 1980s)

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Conclusion 2 bases of contracting

• Contracts are often not grounded in pre-existing
  social networks
• But, rather, occur at arms length

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Conclusion 3 role of courts

• With respect to contract disputes,
• Institutional alternatives to the courts are
  unavailable or underdeveloped
• Courts are neither as completely flawed as
  they have been portrayed,
• nor are disputants as non-litigious as they
  have been portrayed

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Conclusion 4 comparative institutions

• Comparative context
• Myth of the reluctant litigant
• Japan (Haley 1978)
• Taiwan (Winn 1994)
• Korea (Park 1997)
• Why myth?
• Reject non-litigious culture
• Highlight institutional incapacity

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Conclusion 4 comparative institutions

• Contrast China rapid development of
  institutional capacity at earlier stage of
  economic development
• Korea (2002) per cap income US 11,280
• China (2002) per cap income US 960
• Korea (2002) per cap lawyers 9,383
• China (2002) per cap lawyers 9,510

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Conclusion 5 rule of law and legitimation

• Why rapidly develop institutional capacity?
• Rule of law new element in CCPs legitimation
  strategy
• 1999 Constitutional amendment The Peoples
  Republic of China exercises the rule of law,
  building a socialist country governed according
  to law.
• Complements early reliance on economic
  performance in legitimation strategy
• Rule of law to gain benefits of market
  economy and deepen links to international economy

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Conclusion 5 limits to rule of law and
legitimation

• Instrumental approach to rule of law
• Contract disputes among most common and least
  politically sensitive
• no direct spillover to other legal arenas
• When contract disputes do become politically
  sensitive (e.g. may lead to lay-offs,
  unemployment)
• rule of law does not always hold sway