A Local Firm’s Baffling Trip Through China’s Arbitration System

The forlorn building on Nanjing Road, this city’s Rodeo Drive, was supposed to represent a pioneering effort to tap the pocketbooks of China’s nouveaux riches.

It did, for a while. But now the six-story building sits empty, its dusty windows boarded up and its once-elegant facade faded. When the weather’s warm, hawkers peddle cheap T-shirts and underwear in the main entryway of what was the Sino-American Shanghai Wan Xiang Empire Department Store.

Five years after the now-defunct store’s grand opening, Origon Group Corp., a small Los Angeles-area investment firm, is embroiled in a legal dispute in a country where the transition from “rule of man” to rule of law is far from complete.

Not long ago, Mark Hartzler, Origon’s L.A. attorney, might have advised his client to write off the $10 million it lost in the department store deal as an expensive lesson in global risk. But when China joined the World Trade Organization in 2001, Beijing vowed to rewrite its laws and clean up its court system. The next year, the Californians decided to test the promise of post-WTO China.

“We were hoping that now that it had entered the WTO, China would be more interested in showing how private disputes can be resolved,” Hartzler recalled recently.

Origon’s travails since serve as a reminder that though China’s judicial system has undergone significant modernization, it still is plagued by a lack of transparency, by influence peddling and by other problems that make it difficult for foreigners to get fair hearings, according to legal and commercial experts in China.

“Don’t think you’re going to fall back on the court system if things go bad,” Thomas Lee Boam, the former chief U.S. commercial consul in Beijing, warned a group of American executives attending a China seminar at USC. When Boam left China’s capital this year for a new posting, there were $9 billion in disputes sitting on his desk, the biggest pile of commercial legal trouble anywhere in the world.

Since China’s Communist leaders launched their economic reforms, inept judges have been removed and thousands of laws have been written or revised. Still, most judges are appointed by the party, and fewer than 7% have formal training, according to legal experts.

So foreigners often bypass the courts in favor of arbitration, which in China, as around the world, often is a less expensive and less time-consuming alternative.

Today, the China International Economic and Trade Arbitration Commission is the busiest arbitration agency in the world, said Jerome Cohen, a New York University professor and an expert on Chinese law. The commission is an arm of the China Council for the Promotion of International Trade, a government-affiliated association.

Established in 1959, the arbitration commission has aimed to keep up with the times. It has incorporated some of the international regulations followed in the U.S. -- though not all of them. For instance, there is no ethical code spelling out what a conflict of interest is or detailing the notion of confidentiality. Critics say that leaves arbitrators vulnerable to outside pressure from politicians or businesspeople.

“What goes on in court is only 10% of the action,” said Cohen, who has served as an arbitrator on the commission’s panels. “Everybody is contacting everybody right up to the prime minister’s office about an important case. That isn’t the way we expect the game to be played.”

The Californians didn’t know what to expect when they arrived in Shanghai in the spring of 2002. For Hartzler, who had never been to China, Shanghai was a dizzying blur of high-rise office towers, glitzy retail stores and crowded streets.

He felt relieved when he walked into the arbitration commission’s offices on the seventh floor of Jin Ling Mansion. This was no bleak, Communist-era interrogation chamber. The wood-paneled room would have fit into any big-city law firm back home.

In China, a dispute is heard by a three-person panel. Shanghai Shi Mao Co., the real estate firm with which San Dimas-based Origon had invested in the department store, tapped Zhou Han Ming, a powerful Shanghai lawyer who was deputy president of the Pudong New District, the city’s fast-growing financial district. Origon’s choice of arbitrator was Yao Zhuang, a prominent law professor. The chief arbitrator was Xia Fang, a top official at the commission’s Shanghai office.

The case outlined by Origon’s attorneys was one of alleged deception and fraud. In the summer of 1995, the investment group decided it wanted a foothold in China’s emerging consumer market. Through a friend of an Origon investor, the U.S. firm was introduced to executives from Shanghai Wan Xiang Co., a large real estate company.

They formed a partnership to develop an upscale retail center on Nanjing Road. Origon agreed to pay its Chinese partner a management fee to run it, with the partners splitting the profit. Wan Xiang Co. later was taken over by the Shi Mao Group, headed by Xu Rongmao, one of China’s richest men.

As Yuan Wei, one of Origon’s Chinese lawyers, told the arbitration panel, the U.S. investors sank $10 million into renovating the building. By 1999, the Sino-American Shanghai Wan Xiang Empire Department Store was 80% filled with tenants such as Christian Dior and Versace, and the cash registers were ringing.

Then, in the summer of 2000, the city government said the building wasn’t licensed to operate as a commercial business.

Origon’s attorneys claim that Shi Mao hadn’t obtained the necessary safety inspection permit; the city apparently had given Shi Mao a temporary, three-year permit that wasn’t extended because of a construction flaw that had caused the building’s foundation to sink precariously.

In the fall of 2000, the two companies filed dueling lawsuits in Shanghai People’s No. 2 Intermediate Court, each accusing the other of violating the contract.

The next February, the court upheld the city’s decision to rescind the permit, and the Wan Xiang Empire Department Store was shuttered. In the summer of 2001, Origon filed its arbitration request.

Chinese judicial proceedings, including arbitration hearings, generally are not open to the public. Critics say that is dangerous, easing the way for backroom deals or for other abuses to be covered up.

At Origon’s request, the Shanghai arbitrators took the unusual step of allowing a Times reporter and translator to observe the hearing as long as nothing was published until after the panel had made its decision.

In many ways, the hearing wasn’t that different from a similar event in the United States, Hartzler said. Each side outlined its case and submitted evidence, and the arbitrators asked questions. Sometimes such proceedings are dry as dust. In this one, the testimony sometimes was dramatic.

“Origon didn’t know the truth and was cheated,” Yuan at one point declared, banging his fist on the table.

Not so fast, interrupted Zhang Chen, the attorney for Shi Mao. “I think the [American] client has some very ugly and evil purpose to do such things, and their figures are not very accurate.”

He was in turn interrupted by Xia, the chief arbitrator. “Please pay attention to your words and don’t be so aggressive,” she warned him.

Zhang returned to his notes sheepishly. “All the things they have said were nonsense,” he said, dismissing Origon’s complaints. He said the joint-venture terms were agreed on by both parties and Origon was lucky to get a building in “such a good place.”

Pressed by the arbitrators, Zhang admitted that Shi Mao did not have the correct permit. But, he said, “that’s just a time problem. Sooner or later, we will get the examination paper.”

Zhang insisted that the U.S. investors were fully informed of the permit problem but willing to overlook it. And he claimed that the business failed because of Origon’s poor handling of the project. “Would the two sides consider a settlement?” chief arbitrator Xia asked. “No,” Shi Mao’s attorneys replied.

After consulting with her fellow arbitrators, Xia asked both sides to provide additional paperwork and then concluded the hearing. Before hurrying off, Zhang, Shi Mao’s attorney, declined to comment on the case. He cited the chief arbitrator’s request that the participants not speak to the press until the panel had made its decision.

As they exited the elevator, Hartzler and his Chinese colleagues were jubilant, recalling moments when the arbitrators appeared to favor Origon’s case. Later, over a lunch of tangy deep-fried pork and poached fish, Yuan conceded that Shi Mao’s corporate weight and “close relations with the government” might play a role.

“The court might have some consideration for that,” he said. “But I still believe they will make the right judgment for the law rather than other reasons.”

Months passed, and Hartzler grew worried. The longer the delay, the easier it was to imagine skulduggery on the part of Origon’s powerful opponent. Under Chinese arbitration rules, the panel is supposed to make its decision within nine months of the hearing. In the fall, as that deadline neared, the arbitration panel requested several extensions.

Then, Kevin Long, Origon’s chief representative in China, reported that he had heard from a source that the panel had made a preliminary ruling in Origon’s favor -- but that a Shanghai court official had intervened.

In April, more than a year after the arbitrators heard the case, Origon’s attorneys in China sent a letter to the arbitration commission alleging that officials from the Shanghai People’s Court had “improperly interfered.” The attorneys urged commission officials to “eradicate interference ... to ensure an early impartial arbitration to this case.”

Two months later, Origon got an answer: Go elsewhere to resolve this dispute.

Yuan, Origon’s Beijing attorney, was furious. Not only had the arbitration panel refused to rule, but it also asked Origon to pay 95% of the arbitration fees, which could be tens of thousands of dollars.

“This is ridiculous,” Yuan said. “The reason we applied for arbitration is we want a resolution.... The ruling means nothing.”

Zhang Yue, an official at the arbitration center in Shanghai, said he couldn’t comment on the specifics of the case or the accusation of judicial interference. But he insisted that the panel was impartial and that the “rule of arbitration will protect the rights of both parties.”

“I should say,” he added, “sometimes one party will think the verdict is unfair when they lose the lawsuit. That’s from their own point of view. But the angle of the law is different.”

Origon hasn’t given up. Shortly after the arbitration panel’s rejection, the firm filed a lawsuit with the People’s Court in Shanghai. Origon lost there and appealed to the high court in Shanghai, which hasn’t yet ruled.

For all the frustration and disappointment, Long said he wouldn’t dream of retreating from China, where his company produces low-priced consumer electronics for companies such as Wal-Mart Stores Inc.

“There are still many, many good people in China and there are still many, many people making money,” Long said.

Hartzler agreed: “My clients have to be in China. China is too big for them to ignore.”

Zhang Xiuying of The Times’ Shanghai bureau contributed to this report.