By Paul Davies, Bridget Reineking, and Andrew Westgate

Since establishing the People’s Bank of China’s Green Finance Task Force in 2014, China has encouraged green financing mechanisms through a variety of pioneering initiatives. For example, the country has designated five green finance pilot zones, within which financial institutions are incentivised to provide credit and special funds for environmentally friendly industries.

However, investors have yet to take full advantage of these developments. The lack of uptake may in part relate to recommendations set out in the Green Task Force Final Report published in April 2015. In particular, recommendation 13 of the Report proposes imposing environmental lender liability on banks – the practical consequence of which is that banks and other financial institutions become liable for environmental pollution or damage caused by their borrowers. Although green projects are by nature less environmental risk-laden than other projects, they are not risk-free. As a result, investors have been hesitant to utilize the new financing mechanisms, and banks are equally hesitant to offer financing in the face of uncertain associated liabilities.

Moreover, Chinese banks typically limit loan periods to two years, requiring green project owners to raise funds as many as five times prior to project completion. Failure to obtain financing on one of those occasions could result in the shuttering of a major project. A further challenge is the lack of standardisation in funding rules across countries in the green finance space. For example, the fact that many European banks have their own market-based rules renders it difficult to compare green finance products between China and Europe.

Green bonds — so termed because they fund projects intended to offer environmental benefits — provide a possible solution. As the fastest-growing component of China’s green financial system, green bonds have emerged as an instrument capable of steering private capital and bond market capital to invest in green projects. The bonds are not restricted to the two-year funding terms of loan-based financing, and are issued subject to specific standards of regulatory authorities and stock exchanges. Consequently, investing in green bonds is a more transparent process than investing in other assets, such as green insurance or green funds. China’s willingness to embrace green bonds is therefore not surprising: while green bonds account for just 0.2% of the global bond market, in China this figure is 10 times higher.

The Chinese government has publicly endorsed the use of green bonds. Further, several major cities and regions — including Beijing, Shanghai, Qinghai Province, and Quzhou in Zhejiang Province — have implemented measures to support progressive green finance initiatives. As these initiatives gain traction and additional support from regional and central governments, investors will inevitably begin to capitalise on the tax advantages, green credit enhancements, and other opportunities available in China.

Read more on the development of China’s environmental policy:

China Encourages Green Finance to Meet Clean Development Goals

President Xi Jinping Pledges Sustainable Development to Build a “Beautiful China”

China’s War on Pollution: Measuring the Economic Impact

Proposed Draft Legislation Clamps Down on Soil Pollution in China

Will Tougher Environmental Laws Mean Measurable Change for Pollution in China?

U.S. Withdrawal from Paris Agreement Creates an Opening for China to Lead

This post was prepared with the assistance of Tegan Creedy in the London office of Latham & Watkins.

By Paul Davies, Bridget Reineking, and Andrew Westgate

The Chinese government has announced a US$4 trillion investment in developing infrastructure globally under the “Belt and Road Initiative” (BRI). Under the BRI the Chinese government will spend US$750 billion on overseas investments in the next five years alone. Although China often cites the BRI as the country’s way of fostering sustainable economic development, there are concerns regarding management of environmental risks, especially in countries lacking environmental governance. In response, the Chinese government has recently issued two publications encouraging sustainable investment practices overseas.

China’s National Development and Reform Commission, Ministry of Commerce, Ministry of Foreign Affairs, and the People’s Bank of China have jointly issued an Opinion on further Guiding and Regulating Outbound Investment (the Guiding Opinions). The four bodies intend that the Guiding Opinions will endorse foreign investment in strategically important areas, and discourage or ban investments that conflict with China’s national interests.

The Guiding Opinions classify overseas investments within one of three categories: “encouraged,” “restricted,” or “prohibited.” Transactions that fail to meet the host nation’s environmental, energy-efficiency, or safety standards fall within the restricted category. The four bodies will scrutinise these investments more closely, and may impose conditions on certain transactions. The level of a transaction’s non-compliance with environmental or energy-efficiency standards that will result in a restricted category classification remains unclear. However, China’s inclusion of host-country regulations in the Guiding Opinions indicates that China is pushing for stronger environmental standards beyond its own borders.

Following the International Green Finance Seminar in September 2017, the participating parties, including the Ministry of Environmental Protection’s Foreign Economic Cooperation Office, released the Environmental Risk Management Initiative for China’s Overseas Investment. This publication consists of 12 articles which set out the relevant principles, such as disclosure of environmental, social, and governance (ESG) information, and encourages investors to consider (ESG) factors in investment decision making.

The Chinese government is reportedly drafting legally binding regulations on overseas investment, including plans to implement the Environmental Risk Management Initiative’s 12 articles to form a detailed operational guide before the end of 2017.

Clearly, Chinese investors will need to consider ESG standards in evaluating outbound investment opportunities, as China seeks to deliver on its promise of sustainable economic development both inside and outside the country.

Read more on the development of China’s environmental policy:

President Xi Jinping Pledges Sustainable Development to Build a “Beautiful China”

Proposed Draft Legislation Clamps Down on Soil Pollution in China

Will Tougher Environmental Laws Mean Measurable Change for Pollution in China?

U.S. Withdrawal from Paris Agreement Creates an Opening for China to Lead

China One of First Countries to Sign Paris Agreement

This post was prepared with the assistance of Tegan Creedy in the London office of Latham & Watkins.

By Paul Davies, Bridget Reineking, and Andrew Westgate

China, the world’s largest producer and consumer of pesticides, is strengthening its regulation of agrochemicals. The Ministry of Agriculture (MOA) recently issued revisions to the country’s pesticide registration requirements, which officially came into effect on November 1, 2017. Pesticide use in China accounts for over one-third of total world pesticide usage, so the new rules will affect a significant number of national and multinational entities and a large percentage of the country’s population.

The MOA issued the revisions pursuant to the new Regulation on Pesticide Administration (RPA) and Pesticide Registration Management Measures (MOA Order No. 3, 2017). The new rules, entitled “Data Requirements on Pesticide Registration” (MOA Proclamation No. 2569), require all pesticide chemistry and toxicology tests required under the RPA to be conducted by laboratories located in China, or overseas laboratories possessing a mutual recognition agreement with China. The new rules do not offer much granular detail with respect to how laboratories would obtain such recognition or the applicable requirements — for example, the rules do not indicate whether application data prepared in a foreign language must be translated into Chinese prior to submission. The revisions also follow the MOA’s recent elimination of temporary pesticide registrations, which effectively prolongs the timeline for the review and use of all pesticides in China.

The revisions are the latest rules that China has implemented pursuant to amendments made to the RPA, which became effective on June 1, 2017. The new rules exacerbate existing ambiguities regarding the requirements of new application submissions and amendments to existing pesticide registrations. However, the new rules clearly aim to ensure that pesticide manufacturers and distributors provide fulsome and verified information to the MOA, signaling that the bureau will be scrutinizing pesticide applications carefully. Notably, the MOA took steps to render the process of pesticide review and approval more efficient in October 2017 with the establishment of the Pesticide Management Office, which will regulate the review, approval, production, sale, advertisement, and use of pesticides throughout China. Previously, several independent bureaus shared responsibility for the regulation and oversight of pesticides; the new pesticide bureau replaces all of them to serve as a central authority.

As the new Pesticide Management Office develops policies and priorities, stakeholders in Chinese agrochemical businesses will likely see further guidance in key areas: pesticide registration and approvals; marketing; production; and licensing. Latham will continue to observe and assess new pesticide regulations and issued guidance in this developing area of regulation in China.

Read more on the development of China’s environmental policy:

China Encourages Green Finance to Meet Clean Development Goals

President Xi Jinping Pledges Sustainable Development to Build a “Beautiful China”

China’s War on Pollution: Measuring the Economic Impact

Proposed Draft Legislation Clamps Down on Soil Pollution in China

Will Tougher Environmental Laws Mean Measurable Change for Pollution in China?

U.S. Withdrawal from Paris Agreement Creates an Opening for China to Lead

This post was prepared with the assistance of Tegan Creedy in the London office of Latham & Watkins.

By Paul Davies and Catherine Campbell

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In recent years, China has taken significant steps in developing its environmental policy. In 2014 China’s Premier Li Keqiang declared a “war on pollution”, which began in earnest in 2017. Since then, regulators have been more proactive in enforcing environmental regulations. Factory closures have become a key part of this strategy, causing significant disruption to the global supply chain this year.

In our view, dealmakers should carefully consider environmental and supply chain due diligence in China, as companies work out how to navigate the factory shutdown process. PE firms should review whether portfolio investments and target companies are likely to be affected in the event that critical supply chains are broken. Engagement with environmental agencies in China is useful, but environmental policy and consistent regulatory enforcement are still maturing. The appropriate level of due diligence could prove to be critical to a portfolio company’s ongoing operations.

Factory Closures Impact Portfolio Company Supply Chains

Some of the largest environmental crackdowns in Chinese history have occurred in the past few years. Estimates suggest that about 40% of the country’s factories were forced to shut down at some point in 2017, and as many as 70,000 factories were reportedly shut down in the provinces of Hebei, Henan, and Shandong alone.

Factory closures have become an increasing source of frustration and concern for multinational companies this year. Many companies have a supply chain connection into China and are likely to be adversely impacted by the closure programme. Companies may not have full control over small but crucial elements of their supply chain, making closures a difficult problem to address.

Enforcement from China’s environmental agencies shows little sign of slowing. In many cases, companies receive little or no warning of factory shutdowns, while entire industrial parks have been closed based on the bad behaviour of one operator. Furthermore, environmental agencies are often unwilling or unable to give a clear time frame for how long a factory or industrial park will be closed. The immediate impact of closures can leave companies with no time to form a contingency plan, and the decisions taken by environmental agencies pose significant challenges for deal teams.

Deal Teams Must Identify and Mitigate Chinese Environmental and Supply Chain Risks

Firms operating in China or reliant on Chinese supply chains cannot eliminate the risk and unpredictability of regulatory shutdowns, but they can reduce and mitigate the effects by taking proactive measures.

Companies should be attuned to the regulatory environment and local regulators’ policy directives. Compliance with current regulations is not enough — firms need to “see where the ball is going” in order to anticipate the regulators’ next area of focus. Companies must identify and engage competent local counsel who are familiar with the regional personnel and the local regulator’s practices. This is because local priorities and the local regulators’ discretion drive so much of the uncertainty in enforcement activity in China. Relationships and local familiarity can prove critical in preparing for, and responding to, enforcement actions.

Further, detailed supply chain due diligence is increasingly important. While target environmental due diligence is commonly undertaken, in our view, conducting thorough due diligence on supply chains could help limit exposure to supply chain risk. PE firms should look beyond the company itself, tracing key third-party suppliers and partners to see if they are likely to be at risk from government enforcement. A shutdown anywhere in the supply chain can significantly impact production and profitability. PE firms must ensure any supply chain exposed to China is robust enough to withstand the possibility of a sudden factory shutdown.

By Paul Davies, Richard Butterwick, Terry Charalambous, and Catherine Campbell

In recent years, China has taken significant steps in developing its environmental policy. In 2014, China’s Premier Li Keqiang declared a “war on pollution”, which began in earnest in 2017. Since then, regulators have been more proactive in enforcing environmental regulations. Factory closures have become a key part of this strategy, causing significant disruption to the global supply chain this year.

In our view, M&A dealmakers and corporates should carefully consider environmental and supply chain due diligence in China, as companies work out how to navigate the factory shutdown process. Corporates should, as part of their environmental, social, and governance (ESG) strategy, review whether their group entities and target companies are likely to be affected in the event that critical supply chains are broken. Engagement with environmental agencies in China is useful, but environmental policy and consistent regulatory enforcement are still maturing. The appropriate level of due diligence could prove to be critical to a company’s ongoing operations.

Supply Chain Issues and ESG Strategies Are Changing

Supply chain issues are increasingly complex, spanning multiple jurisdictions. Unsurprisingly, companies are expected more than ever to understand and manage these risks. Until recently, ESG risk management has focused on corporates and their groups rather than on the broader supply chains. This focus is changing. There are good business reasons, including significant financial benefits, for companies to manage these risks more effectively.

Factory Closures Impact Portfolio Company Supply Chains

Some of the largest environmental crackdowns in Chinese history have occurred in the past few years. Estimates suggest that about 40% of the country’s factories were forced to shut down at some point in 2017, and as many as 70,000 factories were reportedly shut down in the provinces of Hebei, Henan, and Shandong alone.

Factory closures have become an increasing source of frustration and concern for multinational companies this year. Many companies have a supply chain connection into China and are likely to be adversely impacted by the closure programme. Companies may not have full control over small but crucial elements of their supply chain, making closures a difficult problem to address.

Enforcement from China’s environmental agencies shows little sign of slowing. In many cases, companies receive little or no warning of factory shutdowns, while entire industrial parks have been closed based on the bad behaviour of one operator. Furthermore, environmental agencies are often unwilling or unable to give a clear time frame for how long a factory or industrial park will be closed. The immediate impact of closures can leave companies with no time to form a contingency plan, and the decisions taken by environmental agencies pose significant challenges for deal teams.

M&A Deal Teams Should Identify and Mitigate Chinese Environmental and Supply Chain Risks

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Firms operating in China or reliant on Chinese supply chains cannot eliminate the risk and unpredictability of regulatory shutdowns, but they can reduce and mitigate the effects by taking proactive measures.

Dealmakers and companies should be attuned to the regulatory environment and local regulators’ policy directives. Compliance with current regulations is not enough — firms need to “see where the ball is going” in order to anticipate the regulators’ next area of focus. Companies must identify and engage competent local counsel who are familiar with the regional personnel and the local regulator’s practices. This is because local priorities and the local regulators’ discretion drive so much of the uncertainty in enforcement activity in China. Relationships and local familiarity can prove critical in preparing for, and responding to, enforcement actions.

Further, detailed supply chain due diligence is increasingly important. While target environmental due diligence is commonly undertaken, in our view, conducting thorough due diligence on supply chains could help limit exposure to supply chain risk. Dealmakers should look beyond the company itself, tracing key third-party suppliers and partners to see if they are likely to be at risk from government enforcement. A shutdown anywhere in the supply chain can significantly impact production and profitability.

Parties must draft arbitration agreements with Chinese parties clearly and precisely to ensure validity and avoid unwanted litigation.

By Oliver E. Browne and Isuru Devendra

A Beijing court recently adopted a pro-arbitration approach in upholding the validity of an arbitration agreement designating a non-existent arbitral institution. While the decision reflects the increasingly pro-arbitration attitude of Chinese courts, the case also highlights the importance of drafting arbitration agreements involving Chinese parties clearly and precisely.

Background and decision

In Chinalight International Trade Co. Ltd v Tata International Metals (Asia) Ltd, the Beijing No. 4 Intermediate People’s Court was asked to determine the validity of an arbitration agreement designating a non-existent arbitral institution to administer disputes submitted to arbitration under the agreement.

The arbitration agreement between PRC-incorporated, Zhongqing Sanlian International Trade Co., Ltd and Hong Kong-incorporated, Tata International Metals (Asia) Limited provided that:

“All disputes arising out of the execution of this contract or in connection with this contract shall be settled by friendly negotiation between the parties. If it cannot be settled through negotiation, the dispute shall be submitted to the Singapore International Economic and Trade Arbitration Commission for arbitration in accordance with the US arbitration rules”.

As the Beijing court observed, there is no institution called the “Singapore International Economic and Trade Arbitration Commission”. Under PRC law, an arbitration agreement that fails to designate clearly an arbitral institution is invalid.[i] The PRC Supreme Court took this approach in 2008, in holding invalid an arbitration agreement designating the non-existent “English International Economic and Trade Arbitration Commission” as the administering institution.[ii]

However, on this occasion, the Beijing court held that the reference to the non-existent Singapore International Economic and Trade Arbitration Commission nonetheless evidenced the parties’ intention for the place of arbitration and the place of the arbitral institution to be Singapore. Under PRC law, in the absence of express choice by the parties, the law of the place of arbitration or the place of the designated arbitral institution governs the arbitration agreement.[iii] Accordingly, the Beijing court proceeded to determine the validity of the arbitration agreement in accordance with Singapore law, as opposed to PRC law, and upheld the validity of the agreement. The application of PRC law to the agreement would have reached the opposite conclusion.

Comment

The Beijing court’s decision in this case should be welcomed for its promotion of arbitration and party-autonomy. However, the decision also highlights the need for parties entering into arbitration agreements with Chinese parties to be especially mindful of the need for clarity and precision when drafting these agreements. Failure to do so — in particular, failure to designate clearly an arbitral institution — may expose parties to unwanted litigation before Chinese courts and may jeopardise the validity of the arbitration agreement. This risk is heightened in light of the PRC Supreme Court’s 2017 judicial interpretation confirming the jurisdiction of Chinese courts to determine the validity of arbitration agreements if one party to the agreement is domiciled in the PRC.[iv]

[i] Article 18 of the Arbitration Law of the People’s Republic of China.

[ii] Reply of the Supreme People’s Court to Request for Instructions Re Arbitration Clause Validity in the Agency Contract Dispute in the Case of Mashan Group Co., Ltd. v. Korea Chengdong Shipbuilding Ocean Co., Ltd. and Rongcheng Chengdong Shipbuilding Ocean Co., Ltd (30 October 2008).

[iii] Article 18 of the Law of The People’s Republic of China on the Laws Applicable to Foreign-related Civil Relations.

[iv] Article 2 of the Provisions of the Supreme People’s Court on Several Issues Concerning the Trial of Judicial Review of Arbitration Cases (2017), entered into force on 1 January 2018.

Drawing on Latham’s Sixth Private M&A Market Study, we explore trends and developments in consideration mechanics and deal conditionality.

Richard Butterwick, Martin Saywell, Simon J. Tysoe, Catherine Campbell, and Richard George

Uncertainty has been a significant market factor in 2019. The UK’s decision to leave the European Union, protectionist responses to China as a global investor, market volatility, and trade tensions have all given dealmakers pause for thought. With these growing pressures on international M&A, deal teams and in-house counsel are increasingly required to work with advisors to find strategies and solutions to get deals done — a task that requires an intimate knowledge of deal terms and current market trends. In our view, geopolitical factors can impact how parties approach deal architecture and key provisions of transaction documents.

Drawing on data from Latham & Watkins’ sixth Private M&A Market Study, we will examine how consideration mechanics and conditionality deal terms are responding to the current M&A market.

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Seller-Friendly Market and Seller Demographics Impact Choice of Consideration Mechanics

Our analysis of 240 European deals signed between July 2017 and June 2019 shows that as many as 50% of European deals include a locked box mechanism, demonstrating that Europe continues to offer a seller-friendly M&A market. 28% of deals include a completion accounts mechanism and 23% of deals do not provide for price adjustment (such deals tend to have simultaneous signing and closing).

Locked box mechanisms fix the deal price at an agreed date based on a set of accounts, with sellers giving undertakings that value will not be extracted, or leak, from the target before completion. In contrast, completion accounts mechanisms calculate the final deal price after completion, by reference to accounts drawn up to the date of completion. Buyers are therefore able to test and adjust valuation by reference to a target’s actual financials.

Breaking the figures down by jurisdiction, an interesting picture emerges. The proportion of French and German deals that feature a locked box are now as high as 52% and 64%, respectively. In the UK, the prevalence of locked boxes has returned to just under half of deals, having fallen to as low as 36% of deals in last year’s survey.

Private equity firms, which are seeking to deploy record amounts of unspent capital and traditionally favour locked box accounts, may be playing a role in increasing the frequency of locked box mechanisms in European M&A. The presence of US buyers in the UK market likely played a role in the decreased popularity of locked boxes in 2018. As a result of the weakening of the pound, we saw an influx of US buyers after the Brexit vote period. Locked box mechanisms are significantly less common in the US, where the majority of deals use completion accounts. The number of carve-outs (for which completion accounts are usually preferable due to a lack of robust financial information) and divestments in the market likely also influenced the figures in 2018. In our view, 2020 may see buyout firms compete against US acquirers with a keen interest in sterling transactions and a preference for completion accounts.

Deal Teams Bring Risk Experience to Deal Conditions, but Scope for Change Is Limited

There is a growing trend towards heightened national scrutiny of transactions and new legal tools to intervene in deals in sectors that were formerly not considered “sensitive”. These factors have led to a renewed focus on supply chains, trade, as well as acquirer and investor jurisdictions. Further, antitrust regulators have been responding to the presence of new technologies in global economies, leading to calls for greater policing of deals in affected market sectors. Antitrust and increasingly, national security clearances are common conditions on many deals. Notably, however, the uncertainty that these common conditions can bring to a deal, in addition to heightened global uncertainty, is not having an impact on the prevalence of other forms of deal conditionality.

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Material adverse change (MAC) clauses can refer to events that have a negative impact on the market generally or, more specifically, on the target company’s business. Our market study captures both types of MAC. These clauses remain relatively uncommon on European deals. Having gained ground with an increase from 15% to 18% of deals between 2016 to 2017, the frequency of material adverse change clauses in European deals has fallen back to 10%, and only 3% of deals with PE sellers. MACs are slightly more common in the UK (10%) than in Continental Europe (8%).

The position on MAC clauses in the US is different to that in Europe — the vast majority of US acquisitions include MACs. In Asia, a mix of US- and UK-style acquisition documentation is used, and the approach to MACs tends to follow the style of the SPA. Sectoral differences are also noticeable — MAC clauses feature fairly regularly in oil and gas transactions (circa 45%), especially those involving upstream deals in which myriad challenges such as regulatory, physical, environmental, and operational issues can deplete the value of a target to a buyer (such as termination of licences, damage to facilities, oil spills, and oil production shut-ins in the target company). Such MACs, once negotiated, are typically drafted quite tightly so as to address one or more identified potential events, rather than broadly seeking to capture any value impacting event.

Given the economic and political environment in which deals are done, stakeholders may be tempted to think that MAC clauses will become more prevalent in Europe. However, as long as competitive pressures remain on buyers, expending commercial goodwill in MAC negotiations will be challenging.

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Shijiazhuang Intermediate People’s Court declares arbitration agreement providing for ICC Rules arbitration seated in China invalid.

By Ing Loong Yang, Oliver Browne, and Isuru Devendra

In a dispute between Hebei Zhongxing Automobile Manufacturing Co., Ltd. (HZAM), a Chinese company, and Automotive Gate FZCO (FZCO), a UAE company, the Shijiazhuang Intermediate People’s Court declared invalid two related arbitration agreements that provided for arbitration in accordance with the Arbitration Rules of the International Chamber of Commerce (ICC) and to be held “in China”.

Background

HZAM and FZCO entered into an agency agreement and a technical cooperation agreement in 2007. The agency agreement expressly provided for Chinese law as the governing law of the contract, while the technical cooperation agreement was silent on the matter. Each agreement contained a clause providing that disputes shall be submitted to arbitration in accordance with the ICC Arbitration Rules “in China”.

A dispute arose between the parties and FZCO commenced arbitration against HZAM by submitting the dispute to the Hong Kong Secretariat of the ICC. FZCO contended that the parties’ selection of “China” as the place of arbitration included Hong Kong, and that Hong Kong should be designated as the seat of the arbitration. HZAM argued that the parties’ selection of “China” referred to Mainland China and did not include Hong Kong in the context of the selection of an arbitral seat. Pursuant to Article 14(1) of the ICC Arbitration Rules (1998), as applicable at the time, the Secretariat of the ICC notified the parties that the ICC Court had fixed Hong Kong as the place of arbitration.

Following this designation, the ICC Court appointed a sole arbitrator upon the recommendation of the Australian National Committee of the ICC. The terms of reference included whether the tribunal had jurisdiction to deal with the issues in dispute in the arbitration. In a partial award, the sole arbitrator determined that the matter of jurisdiction was to be determined as a matter of Hong Kong law and upheld the tribunal’s jurisdiction to determine the dispute.

HZAM applied to the Hong Kong courts pursuant to Section 34 of the Hong Kong Arbitration Ordinance and Article 16 of the Model Law to set aside the partial award issued by the sole arbitrator and challenged the designation of Hong Kong as the seat of the arbitration. That application was dismissed, with Mimmie Chan, J. holding that the tribunal had been properly constituted and that the sole arbitrator had jurisdiction over the dispute submitted to arbitration.[i]

In parallel to the arbitration and Hong Kong set-aside proceedings, HZAM applied to the Shijiazhuang Intermediate People’s Court, a court of the domestic jurisdiction in Mainland China in which HZAM is domiciled, for a declaration that the arbitration agreements in the agency agreement and technical cooperation agreement between HZAM and FZCO were invalid under Chinese law.

Decision of Shijiazhuang Intermediate People’s Court

In its decision, the Shijiazhuang Intermediate People’s Court found that HZAM and FZCO’s agreement to arbitration “in China” was insufficient expressly to designate a seat of arbitration.[ii] As such, in the absence of a designated seat ― and hence the absence of an applicable governing law ― the Court held that the validity of the arbitration agreements should be determined as a matter of Chinese law. Applying Chinese law, the Court held that:

• The parties’ agreement to apply the ICC Arbitration Rules did not constitute a reference to submit the dispute to arbitration administered by the ICC.
• The applicable version of the ICC Arbitration Rules did not provide that agreement to conduct the arbitration in accordance with those rules was sufficient to designate the ICC as the administering institution.

Accordingly, the Shijiazhuang Intermediate People’s Court held that the arbitration agreements were void for uncertainty. While that decision does not affect the validity of an award rendered by the sole arbitrator seated in Hong Kong, it does make enforcement of that award in Mainland China very difficult.

Comment

The decision of the Shijiazhuang Intermediate People’s Court highlights the need for parties to draft clear and precise arbitration agreements that concern Chinese parties, a seat in China, Chinese law, or that may require enforcement in Mainland China. Contracting parties should state expressly and unambiguously basic elements of an arbitration agreement, including the seat of arbitration, the governing law of the arbitration agreement, the arbitral rules, and the administering institution.. This is especially important because Chinese arbitration law does not follow the UNCITRAL Model Law and has certain differences that may lead to an arbitration agreement valid elsewhere to be declared invalid by a Chinese court.

For instance, whether an arbitration seated in Mainland China can lawfully be administered by a non-Chinese arbitral institution remains uncertain. As the HZAM and FZCO case demonstrates, whether a Chinese court would read a reference to the rules of an arbitral institution alone to reflect the contracting parties’ agreement to have disputes administered by that arbitral institution is also unclear.

The HZAM and FZCO case also demonstrates the need for parties to expressly distinguish between different Chinese jurisdictions. If the parties wish to have Hong Kong as the seat of arbitration, they should say so explicitly, rather than designating “China” as the place of arbitration. If an arbitration agreement contains discrepancies such as this, a Chinese court may find the agreement to be invalid and expose parties to litigation in domestic courts or the inability to enforce an arbitral award in China.

[i]           Z v A & Ors [2015] HKCFI 228.

[ii]              Hebei Zhongxing Automobile Manufacturing Co., Ltd v Automotive Gate FZCO (2011) 年石民立裁字第00002 号.

Sponsors should consider leveraging technologies and diligence practices to tackle today’s increasingly complex supply chains.

By Paul Davies, Tom Evans, David Walker, Michael Green, Hannah Berdal, and Catherine Campbell

Global supply chains have come under significant pressure in recent years, compounded by the effects of this year’s pandemic and shifting global policy agendas. In our view, supply chain analysis and management will remain critical for sponsors in the coming year as they seek to avoid risks including reputational damage, loss of revenue, and loss of goodwill. Performing diligence on a target is no longer enough — rather, the target’s value chain and broader supply chain require careful analysis to determine resilience and uncover risk areas, but such review can also identify opportunities.

Recent Challenges

In the UK and other jurisdictions, supply chains have been under increased media and regulatory scrutiny. The recent government review of the UK’s Modern Slavery Act found many companies were not compliant with the legislation, and suppliers were brought into media focus this year following the exposure of illegal labour activities in the UK.

Heightened investor and consumer focus on environmental, social and governance (ESG) issues has also increased public scrutiny of portfolio company supply chains and their oversight by PE firms.

A New Approach

Supply chain diligence is becoming an integral part of the deal process, and deal teams are embracing new technology to help identify supply chain risks on a broadening spectrum of transactions. Tools such as RiskHorizon (which Latham has helped develop) are being used to benchmark a target’s operations against wide-ranging ESG data, identify supply chain risks, and obtain tailored due diligence recommendations. Further, a growing number of companies are using other new technologies, such as smart devices and blockchain, to enable transparent and end-to-end tracking in many sectors, including minerals and cosmetics.

Aside from these innovations, portfolio companies should consider what legal protections are in place across their supply chain. Having focused on force majeure and termination-related clauses earlier in the year (to determine provision for lockdown-related scenarios or sudden changes in contractual performance), as the economic crisis develops the spotlight is now shifting to include the risk of customer distress. Where a target is a supplier, the implications of recently enacted legislation restricting termination and other contractual rights if a customer enters one of several UK restructuring or insolvency processes, require review.

Obtaining a Strategic Advantage

We expect supply chain issues to be a continuing area of regulatory, investor and consumer focus. Multiple jurisdictions, and the European Commission are seeking greater corporate accountability on a growing range of supply chain topics, including labour infringements, human rights and deforestation.

While many will focus on risk management, in our view, effective supply chain analysis of a target can be viewed as an opportunity to gain a strategic advantage. A strong understanding of value drivers, vulnerabilities, and areas of improvement at the center of a business’ operations (and that of its competitors) can enhance value and performance in times of disruption.

The UFLPA aims to clamp down on the import of items produced by alleged forced labor in and relating to the XUAR.

By Erin Brown Jones, Les P. Carnegie, Paul A. Davies, Nathan H. Seltzer, James Bee, and Allison Hugi

On 16 December 2021, the US Senate unanimously passed the Uyghur Forced Labor Prevention Act (UFLPA), following its approval in the US House of Representatives earlier the same week. The UFLPA is one of several measures that the US hopes to use to prevent what it views as forced labor and human rights abuses in the Xinjiang Uyghur Autonomous Region (the XUAR) of China. The UFLPA is the culmination of bipartisan attempts over a number of months to introduce a bill that would restrict imports from the XUAR.

The UFLPA will, by creating a rebuttable presumption against such imports, effectively prohibit imports into the US of items “mined, produced, or manufactured wholly or in part” in the XUAR, or produced by specific entities to be identified by the Forced Labor Enforcement Task Force.

This new law represents a significant expansion of historic US restrictions on XUAR-origin imports into the United States, which have to date been limited to bans on specific categories of items and items produced by specific suppliers (including one of the world’s major silica manufacturers). This new law will effectively ban imports of all items produced in whole or in part in the XUAR, which produces a large amount of cotton, agriculture items, and key supplies used in solar panel production, among other goods.

To enter into legislation, the UFLPA must now be signed into law by President Biden, and his press secretary has already stated he will sign the Act.

The Strategy

Under the UFLPA, the Forced Labor Enforcement Task Force (an existing body established in 2020), in consultation with the US Secretary of Commerce and Director of National Intelligence, will develop a strategy (the Strategy) for supporting the enforcement of the Tariff Act 1930 to prevent the import into the US of goods mined, produced, or manufactured wholly or in part with forced labor in China.

The Strategy is required to provide guidance (the Guidance) for importers with respect to:

1. Due diligence and supply chain management measures that importers may adopt in relation to items produced using Chinese labor
2. The type, nature, and extent of evidence that demonstrates that items produced in China were not, in fact, produced in the XUAR
3. The type, nature, and extent of evidence that demonstrates that items originating in China, including goods detained at the US border, were not produced using forced labor

This type of guidance was not contemplated in the House version of the bill passed earlier this month, and will provide importers with critical insights into US government expectations regarding appropriate compliance measures and documentation sufficient to overcome the rebuttable presumption against imports (discussed in further detail below).

In addition to the above Guidance, the Strategy also requires the Forced Labor Enforcement Task Force to develop a list of:

1. Entities in the XUAR that mine, produce, or manufacture wholly or in part any goods, wares, articles, and merchandise with forced labor (List 1);
2. Entities working with the government of the XUAR to recruit, transport, transfer, harbor, or receive forced labor or certain minority groups out of the XUAR (List 2);
3. Products mined, produced, or manufactured wholly or in part by entities on the lists required by 1 or 2 (List 3);
4. Entities that export products described in 3 from China into the US (List 4); and
5. Facilities and entities that source material from the XUAR for the poverty-alleviation or pairing assistance programs or other government labor programs involving forced labor (List 5).

Notably, List 5, by extending the scope of the UFLPA to cover entities involved in government programs such as the poverty-alleviation program and pairing assistance program (programs which have been accused of transporting Uyghur and other ethnic minority workers out of the XUAR to work in factories elsewhere in China), broadens the impact of the UFLPA so that it may affect companies with supply chains that do not actually involve the XUAR. Therefore, all companies with supply chains extending into China should note the possible impacts of the UFLPA on their operations.

Rebuttable Presumption

The UFLPA requires US Customs and Border Protection (CBP) to apply a presumption that the following categories of goods, wares, articles, and merchandise are in contravention of the Tariff Act 1930 and not entitled to entry at any US port:

1. Items mined, produced, or manufactured wholly or in part from the XUAR; or
2. Items produced by an entity on one of Lists 1, 2, 4, or 5. The products in List 3 would not be presumed banned, which appears to be form over substance, as those products will, by definition, be produced by an entity on List 1 or 2.

Importantly for importers, the presumption can be rebutted, if the CBP determines that:

1. The importer of record has fully complied with the Guidance and any regulations issued to implement it;
2. The importer of record has completely and substantively responded to all inquiries for information submitted by the CBP to ascertain whether the items were produced using forced labor; and
3. By clear and convincing evidence, the item was not produced wholly or in part by forced labor.

The standard of “clear and convincing” is not detailed in the UFLPA, but usually is interpreted as “highly probable.” See, e.g.,  Colorado v. New Mexico, 467 U.S. 310 (1984).

If the presumption is rebutted, and the item is permitted to enter the US, the UFLPA requires the CBP to submit to Congress and make available to the public a report identifying the item and evidence considered in rebutting the presumption within 30 days of any determination. As a practical matter, this may mean that CBP will be more reluctant to agree to such rebuttals, as those decisions could be publicly scrutinized.

No XUAR-specific Disclosure Requirements

As noted above, the UFLPA marks the culmination of a lengthy process that involved separate bills, each known as the Uyghur Forced Labor Prevention Act, passing through the House (in 2020 and earlier in December 2021) and the Senate (in July 2021).

Notably, unlike the House bill from earlier this month, the final version of the UFLPA does not include any affirmative disclosure obligations on issuers that deal with the XUAR. This element could have had a significant impact on public companies with dealings in the XUAR, but ultimately was not included in the reconciled version of the law that will be sent to President Biden.

Navigating China Supply Chain Challenges in Light of UFLPA

Companies with supply chains that extend into China should monitor developments with respect to the implementation of UFLPA as well as other current or proposed legislation in the US and globally, and should think strategically about how to deal with the potential impact of UFLPA on their direct and indirect reliance on suppliers in China.

Under the new law, companies attempting to import goods from and relating to the XUAR will need to ensure they have full insight into their supply chain and the ability to clearly and convincingly compile documentation sufficient to meet the standards to rebut the presumption. This may require enhanced internal documentation, representations and warranties from partners, training for employees based in China and around the world, and a system of internal controls to ensure documentation is truthful and accurate. Beyond potential supply chain disruption, the law presents a host of reputational and other legal risks – all of which will undoubtedly increase compliance costs and therefore overall costs for companies wishing to import from the region.

The Latham & Watkins team, including attorneys across our White Collar Defense & Investigations, ESG, and Export Controls and Sanctions, and Public Company Representation practices, are carefully monitoring these legal and commercial developments. Please contact one of the authors of this post or your usual Latham & Watkins contact for:

• A detailed breakdown of the different US and international regimes targeting alleged human rights abuses in the XUAR that could impact China-based supply chains
• Practical guidance to deal with the potential impact of UFLPA and other laws on supply chains in China, including due diligence, contractual terms, monitoring, and remediation