Growing Pains: A Road Map for
Chinese Companies Learning to Live
with Complex US Litigation
US plaintiffs have recently begun targeting Chinese companies in
highly complex litigations such as class actions seeking solvencythreatening damages for alleged securities fraud and antitrust
ROAD MAP
Service of Process
US litigation begins with the filing of a complaint in
a US Court. Next, the complaint must be “served
on” the defendants within a few months after it
has been filed. When a complaint is filed in US
court, the clerk of the court issues a summons
to the plaintiff. To effect service of process, the
plaintiff must either serve on each defendant this
summons together with a copy of the complaint
or the defendant must waive service of process.
violations. These suits, described here as “complex commercial
Generally, in cases involving foreign defendants,
service is effected in one of two ways. First,
through delivery of the summons and complaint
involved. The authors of this article provide a road map of the
to an officer, director, or an agent authorized to
receive service of process, and mailing a copy to
general process involved in complex commercial litigation in the
the defendant. Second, service may be effected
US, and address some of the aspects of complex commercial
pursuant to treaties in which the US and the
country where service is to be effected are both
litigation that may come as a shock to Chinese companies.
parties. For Chinese corporations and individuals,
the relevant treaty is the Hague Convention
By A. Robert Pietrzak, Joel M. Mitnick, and Henry Ding of Sidley Austin LLP*
on Service Abroad of Judicial and Extrajudicial
Documents in Civil or Commercial Matters
(the “Hague Convention”). Under the Hague
s stated by a report by the Congressional Research Service,
Convention, each signatory state must designate a “Central Authority,”
“since the initiation of economic reforms in 1979, China has
whose purpose is to accept requests for service from other signatory
become one of the world’s fastest growing economies. From
states. Service of process to Chinese individuals and corporations can
1979 to 2005, China’s real gross domestic product (GDP) grew at
not be effected through postal channels directly to the individual or
an average rate of 9.7%. Real GDP grew by 11.1% over the in 2006,
corporation because of a reservation to the Hague Convention by the
and during the first quarter of 2007, it rose by 11.1% . . . If projected
People’s Republic of China.
growth levels continue, China could become the world’s largest
economy within a decade or so.”1 Trade and foreign investment plays
As an alternative, a defendant may elect to waive formal service. In
a significant role in China’s booming economy and, to date, more than
order to initiate the waiver option, plaintiff must notify defendant that
200 Chinese companies are listed on US stock exchanges. China’s
an action has commenced and request defendant to waive service
economic growth has turned Chinese industries into attractive
of process. A defendant is not obliged to execute a waiver of service.
US litigation targets, both because these industries are finding
However, if a defendant chooses to exercise the right to be formally
themselves in a thicket of unfamiliar Western commercial rules and
served with process, the defendant may be required to bear the costs
because they have increasingly deep pockets.
of formal service. A foreign defendant who waives service of process
has additional time to respond to the complaint. By executing and
Being sued in the US is not, in and of itself, a new phenomenon
returning the waiver to plaintiff, defendant merely waives the right to be
for Chinese companies. Certainly, legal disputes between Chinese
formally served and does not waive the right to other objections related
manufacturers and their US buyers of goods sold and delivered
to the complaint.
have been resolved in US courts for many years. But in general,
Jurisdiction
Chinese companies face an additional challenge as compared to
In order for the litigation to proceed, it is necessary that the US court
their US counterparts in that they are relatively unfamiliar with the
process of large-scale US litigation. Indeed, such law suits can
possess “personal jurisdiction” over the defendants named in the
come as a shock to Chinese companies more familiar with discrete
complaint and “subject matter jurisdiction” over the issues raised in the
contract disputes. The complaints in such suits may contain personal
complaint.
allegations of fraud and misconduct. In addition, the extensive
Personal jurisdiction refers to a US court’s authority to adjudicate
and invasive process of pre-trial discovery in complex commercial
litigation will surprise many Chinese companies. Most of these
issues over a particular person, entity or piece of property. Accordingly,
matters will be resolved by a ruling from the judge that the
for an action to proceed against a Chinese company and its employees,
claims should be dismissed without the need for trial or through a
the US court must possess personal jurisdiction over the company and
settlement.
the individuals named in the complaint. A US court will only have personal
litigation,” present a tremendous burden for any company
A
This article was published in the December 2007/January 2008 issue of China Law & Practice magazine, and is reprinted with the permission of Euromoney Institutional Investor (Jersey) Limited.
To obtain the original version, or copies of any other Asia Law & Practice publications, please email [email protected]. © Euromoney Institutional Investor (Jersey) Ltd 2008
China Law & Practice December 2007/January 2008 – 66
Chinese Companies and US Litigation
jurisdiction over defendants that have sufficient “minimum contacts”
with the US. Courts consider a number of factors to determine whether
it has personal jurisdiction over a defendant company, such as whether
the entity transacts business within the US, whether the conduct
complained of in the action took place within the US, or whether the
company purposefully availed itself of US commerce such that it was
foreseeable that certain actions could result in injury within the US. A
US court’s jurisdiction over a Chinese corporation does not necessarily
confer jurisdiction over the corporation’s officers and directors. Rather,
jurisdiction over each employee must be assessed individually. However,
if a court determines that it possesses personal jurisdiction over a
foreign entity, it may likely find personal jurisdiction over an individual
participating in the actions which formed the basis of jurisdiction over
the entity.
Subject matter jurisdiction is a requirement that the conduct at issue
in the complaint justifies the extraterritorial application of US laws to
a foreign company and its officers. The analysis of whether a court
possesses subject matter jurisdiction will vary based on the substantive
causes of action alleged in the complaint. For example, two tests have
generally been employed in the context of securities fraud suits to
determine when extraterritorial application of US laws is appropriate:
the “conduct test” and the “effects test.” Under the conduct test, a
court has subject matter jurisdiction over an action if the defendant’s
conduct in the US was more than merely preparatory to an alleged
fraud, even if the particular acts or culpable failures to act within the
US directly caused losses to foreign investors abroad. A court has
jurisdiction under the effects test where the illegal activity abroad
causes a “substantial effect” within the US. For example, US courts have
addressed whether subject matter jurisdiction is proper in the context
of a securities complaint on behalf of foreign purchasers of securities
of foreign companies on a foreign exchange. Several courts have found
that the mere filing of SEC reports, which were conceived, prepared
and published in a foreign country is not sufficient conduct to provide
US courts with subject matter jurisdiction over such complaints.
Likewise, US courts have found that the effects test cannot be satisfied
by a complaint alleging fraudulent acts that took place outside the US
without allegations that US investors or US markets were impacted by
the alleged fraud.
Motion Practice
A “motion” is a formal request by a party that the court take a specific
action. Typically, a motion is made in writing by the party requesting
the relief and the other side is given the opportunity submit a
written opposition. The court will take the parties’ arguments under
consideration and will issue an order stating whether the motion
is granted or denied. There are often a number of motions made
throughout complex commercial litigations matters. In particular, there
are three motions that may have significant impacts on the litigation: (i)
a motion to dismiss, (ii) a motion for class certification, and (iii) a motion
for summary judgment.
Motion to Dismiss – The initial response to a complaint often takes the
form of a motion to dismiss the complaint, which essentially argues
that the plaintiff’s claims are defective. Common arguments raised in
a motion to dismiss are that the complaint fails to state a claim or that
the court does not possess personal or subject matter jurisdiction. If
successful, the court will dismiss the complaint, in part or in its entirety,
“without prejudice”, i.e., the plaintiff is given an opportunity to amend
and refile the complaint, or “with prejudice”, i.e., the dismissed claims
are eliminated subject to appeal. If the motion is denied, the parties will
begin the process of pre-trial discovery, which is discussed below.
US courts impose a high standard that defendants must meet to obtain
dismissal of the complaint at this preliminary stage of the litigation. In
ruling on a motion to dismiss, a court will presume all factual allegations
contained in the complaint are true and draw all reasonable inferences
in favor of the plaintiff. There are two important caveats to this
standard. First, defendants may argue that a court should not credit
factual allegations that are contradicted either by statements in the
complaint itself or by documents upon which its pleadings rely, such
as a document filed with the SEC. Second, the court does not need to
accept the inferences plaintiffs propose to draw if they are unsupported
by, or do not logically flow from, the facts set out in the complaint. As
the United States Supreme Court has recently observed, a complaint
must state enough facts to state a claim for relief that is “plausible,” not
merely “conceivable.”2
By way of example, to state a claim under Rule 10b-5, a plaintiff must
plead that the defendants “in connection with the purchase or sale of
securities, made a materially false statement or omitted a material
fact, with scienter, and that the plaintiff’s reliance on the defendant’s
action caused injury to the plaintiff.”3 In response to frivolous law suits,
the United States Supreme Court has recently issued two opinions that
heighten the pleading standard for securities fraud complaints.
The Supreme Court has held that “the inference of scienter must be
more than merely ‘reasonable’ or ‘permissible’ – it must be cogent and
compelling, thus strong in light of other explanations.”4 Accordingly,
US courts have dismissed securities complaints where the inference
of scienter, which is the mental state embracing intent to deceive,
manipulate or defraud, is based solely on the defendants desire to
complete a successful securities offering. US courts have found that
such motives are possessed by virtually all corporations and corporate
executives, and, therefore are insufficient to plead scienter.
In another recent decision, the Supreme Court has held that a plaintiff
must allege a direct connection between the alleged misrepresentation
or omission and the loss actually suffered.5 This decision and others
provide defendants support for the argument that a securities fraud
complaint should be dismissed because it fails to plead “loss causation.”
Defendants may be able to argue that the price decline of the security at
issue was not due to any omission of material fact or misrepresentation
by the defendants, but was the result of factors unrelated to the alleged
fraud.
The arguments discussed above are merely illustrations of arguments
that may be included in a motion to dismiss a securities fraud complaint.
In each action, the arguments made at the motion to dismiss stage will
vary and depend on the claims and factual allegations contained in the
complaint filed against defendants.
Motion for Class Certification – This motion determines whether the
claims alleged in the complaint will be brought as a “class action.” A class
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Chinese Companies and US Litigation
action is a suit brought on behalf of a class of plaintiffs whose cases
involve common questions of law and/or fact. This motion is significant
because certification of a class will often result in defendants facing
solvency-threatening damage claims.
US law contains certain requirements that a plaintiff must meet to
maintain a class action. A plaintiff is required to make a motion that the
court certify the class identified in the complaint. A court may certify
a class only if: (1) the class is so numerous that joinder of all members
is impracticable; (2) there are questions of law and fact common to
the class; (3) the claims or defenses of the representative parties are
typical of the claims or defenses of the class; and (4) the representative
parties will fairly and adequately protect the interests of the class. The
court must also find that at least one of the following three conditions
are satisfied: (1) the prosecution of separate actions would create a risk
of: (a) inconsistent or varying adjudications or (b) individual adjudications
dispositive of the interests of other members not a party to those
adjudications; (2) the party opposing the class has acted or refused to
act on grounds generally applicable to the class; or (3) the questions
of law or fact common to the members of the class predominate over
any questions affecting only individual members, and a class action is
superior to other available methods for the fair and efficient adjudication
of the controversy.
Motions for class certification are highly technical and complex motions.
The parties will often retain an expert to submit testimony to the court
regarding issues such as market conditions or damage calculations.
A plaintiff seeking certification bears the burden of showing that the
above requirements are met by the complaint. Until recently, US courts
would review a plaintiff’s motion for class certification with a standard
similar to that used on a motion to dismiss, under which plaintiff’s
factual allegations are generally presumed to be true. US courts have
begun to place increased scrutiny on these motions, thus, providing
defendants with a greater opportunity to challenge a plaintiff’s factual
allegations that the suit is appropriate for class certification. If a
defendant successfully defeats the motion for class certification, the
case will often settle for an amount well below the range the plaintiff
anticipated prior to the motion being decided.
Motion for Summary Judgment – If the motion to dismiss the complaint
is denied, defendants will not be given the opportunity to again challenge
the merits of the lawsuit until a motion for summary judgment is filed.
Motions for summary judgment are typically filed after the close of the
discovery period. In complex commercial litigation, summary judgment
motions are lengthy and voluminous submissions that collect all material
evidence in support of defendants’ arguments that has been developed
in pre-trial discovery.
Summary judgment motions ask the court to issue a ruling on the claims
without the need for trial. In this motion, defendants will be able to
challenge the factual basis of the lawsuit, but again, the standard under
which US courts will decide the motion favors plaintiffs. To succeed at
summary judgment, defendants must establish that there is no genuine
issue of material fact in dispute and therefore defendants are entitled
to judgment as a matter of law. In determining whether a genuine issue
of material fact exists, the court must decide whether the evidence,
when viewed in the light most favorable to the plaintiffs, is sufficient to
permit a rational fact-finder to resolve the all relevant factual disputes
in favor of the defendants.
Discovery
Discovery is the process in which the parties gather evidence to support
the claims and defense at issue in the litigation. Chinese companies may
be surprised at the liberal standard that US courts apply to discovery.
Plaintiffs are given the right to access all documents and information
that may potentially lead to relevant evidence that can be used at trial.
This standard will often require a company to turn over millions of pages
of documents that may have little relevance to the lawsuit. Current and
former employees of the company will also be deposed by the plaintiffs’
attorneys. Chinese companies face the additional burden that either
documents or deposition testimony will need to be translated.
Each defendant, and each entity that has reason to believe it may be
named as a defendant, is under an obligation to preserve all documents
that may be relevant to the lawsuit. Therefore, companies will often
have an obligation to preserve documents even before a complaint is
filed. Failure to preserve relevant documents could result in the court
imposing sanctions at a later date. Sanctions may take various forms,
including an instruction from the court to the jury to presume that the
destroyed documents would have supported plaintiffs’ case or it might
include monetary penalties, among other possibilities.
Settlement
Settlement negotiations in complex commercial litigation will not only
focus on the actual merits, or lack thereof, of a litigation. Instead,
plaintiffs’ attorneys will be able to use the cost and burden of pre-trial
discovery as leverage in settlement negotiations and the threat, no
matter how remote, that defendants will ultimately be found liable and
be subject to huge class action damage awards.
Even if the parties do agree in principle on a settlement, it should be
mentioned that settlement only begins at the negotiating table and the
process will take at least several more months to complete. First, the
parties must draft a settlement agreement. The settlement agreement
will be committed to writing by counsel for the parties and will outline the
obligations of each party required to effect settlement. The specifics of
the settlement agreement will be the product of extensive negotiations
during which drafts will be exchanged between the parties. It typically
takes several weeks to prepare an initial draft and it may take several
months to produce a final settlement agreement.
Next, if the settlement involves a class action, it must be approved by
the court to ensure that the settlement is fair, adequate and reasonable
in order to protect the interests of the class members. Approval of the
settlement of a class action will generally require a process including, (i)
preliminary approval of the proposed settlement at an informal hearing;
(ii) dissemination of notice of the settlement to all affected class
members informing them of the proposed settlement and their right
to participate in, object to or opt-out of the settlement class; and (iii) a
final fairness hearing at which class members may be heard regarding
the settlement and at which evidence and argument concerning
the fairness, adequacy and reasonableness of the settlement is
presented. If final approval is granted, the settlement becomes binding
on all settlement class members and the claims of the class members
China Law & Practice December 2007/January 2008 – 68
Chinese Companies and US Litigation
against the defendants are released and dismissed. While this process
appears cumbersome, settlement agreements are typically approved
by US courts. The decision to grant or deny approval of a settlement lies
within the broad discretion of the court, which is to be exercised in light
of the general judicial policy in the US favoring settlements.
Culture Clash
Chinese companies may experience a clash of cultures when they are
thrust into complex litigation matters in US courts. Situations that many
first-time Chinese litigants find surprising, if not off-putting, include:
•
At the beginning of the litigation, a company will only have a limited
ability to challenge the accusations made in the lawsuit
•
Complex commercial litigation often entails wide-ranging and
costly discovery during which the company will be required to turn
over millions of pages of documents, which may contain sensitive
business information
the merits of the lawsuit, such as the costs and burden required to
successfully defend against the action
•
A complex matter can take years to litigate
Anticipating such obstacles will assist Chinese companies as they
navigate through the process of large complex lawsuits in US courts.
* A. Robert Pietrzak and Joel M. Mitnick are Partners in the New York
office of Sidley Austin LLP. Henry Ding is a Partner in the Beijing office of
Sidley Austin LLP. Eli Glasser is an associate with the Firm and assisted
in drafting the article. This article has been prepared by Sidley Austin
LLP for informational purposes only and does not constitute legal
advice. This information is not intended to create, and receipt of it does
not constitute, a lawyer-client relationship. Readers should not act upon
this without seeking advice from professional advisers.
Endnotes
1
China’s Economic Conditions, CRS Report for Congress, updated on July 13 2007.
Bell Atl. Corp. v. Twombly, 127 S. Ct. 1955, 1974 (US 2007).
3
Lawrence v. Cohn, 325 F.3d 141, 147 (2d Cir. 2003) (quotation omitted).
•
The adversarial nature of US litigation can lead to a lack of civility
2
4
Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S.Ct. 2499, 2504-2505 (2007).
•
Settlement negotiations will often be based on factors unrelated to
5
See Dura Pharms. Inc. v. Broudo, 125 S. Ct. 1627, 1632 (2005).
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China Law & Practice December 2007/January 2008 – 69