Enforcing Contracts with Chinese SOEs Still Challenging

Wall Street Journal On Line    By Andrew Galbraith   September 6, 2011

A spat over contracts between China’s biggest shipping company and foreign ship owners is calling attention to broader tension over the rise of a Chinese corporate sector that doesn’t always play by established global rules.

The move by China Cosco Holdings Ltd., the listed flagship of state-owned China Ocean Shipping (Group) Co., to halt or delay payments for vessels it leased at the height of the shipping boom in 2008 reflects in part the cyclical stresses in the global shipping industry. But some analysts, lawyers and executives in China say it also reflects a willingness among increasingly bold Chinese companies—often, like China Cosco, owned by the government—to snub existing norms of global commerce.

In recent years, foreign banks and other creditors have faced repeated difficulties getting payment on bonds or derivatives contracts with Chinese companies. In 2009, for example, China’s government encouraged state-owned airlines and shipping companies, including Cosco, to challenge losses from derivatives deals with foreign banks used to protect against sudden surges in the price of fuel. That same year, China-based Asia Aluminum Holdings Ltd. offered to buy back its debt for pennies on the dollar, eventually leading to losses for international investors.

Foreign companies that do business in China are routinely warned that contracts aren’t viewed in China with the same sort of legal sanctity that they receive in most developed economies. Jingzhou Tao, a Beijing-based lawyer with Dechert LLP, says that withholding payments is a frequent tactic used in China to force price negotiations. “A contract is not an unchangeable bible for Chinese companies,” Mr. Tao said.

Prices for leasing the cargo ships that carry commodities like coal and iron ore have plunged since 2008, when China Cosco signed the deals at issue. Industry executives say it is common for shipping companies to want to renegotiate long-term contracts as a result of economic swings. But it is unusual for financially solvent companies to unilaterally renege on contracts the way that China Cosco has done on some.

Representatives of Cosco Group and China Cosco didn’t respond to requests for comment Friday. During a conference call a week earlier after it posted a first-half loss, China Cosco Executive Director Zhang Liang called such disputes “normal” and blamed ship owners for “trying to use the media to make a bigger impact.” The company said it had renegotiated deals on 18 ships. A China Cosco official said Thursday that it plans to restructure its unprofitable dry-bulk shipping operations.

China Cosco, which has about 200 dry-bulk ships under charter and owns 234, appears to be trying to correct course. Some ship owners that had complained about the Chinese company’s failure to pay have said in recent days that they started receiving payments again.

On an earnings call Wednesday, DryShips Inc. Chief Financial Officer Ziad Nakhleh said the Greece-based company had been owed about $2.5 million by a China Cosco unit for three vessels, but that “Cosco has since resumed hire payments on all of the three vessels and we have no further issues with our counterparties.”

Angeliki Frangou, chairman and chief executive of Navios Maritime Holdings Inc., said Cosco stopped payments in July but has since met original agreements with no renegotiations. “We have been paid,” she said. “Cosco is a counterparty that we like to do business with and will continue to do business with. This was an incident that was very quickly resolved.”

But some in the industry remain frustrated and say the move could have lasting damage for Cosco’s reputation.

“They’ve paid up to date [and] I don’t want to be nasty,” said Raymond Ching, vice president at Hong Kong-based Jinhui Shipping & Transportation Ltd. “But obviously, withholding payments and giving us either no response or very, very absurd reasons—it’s just something that we won’t tolerate.”

Analysts and lawyers say big Chinese state-owned companies can be especially aggressive in dealing with foreign companies because of their government backing and the enormous clout they wield within China in industries that are often oligopolies.

“State-owned enterprises that are dominant in their own sector and in some cases more powerful than government departments are used to having things their way,” said Lester Ross, a Beijing-based partner at law firm WilmerHale. Mr. Ross said that Chinese companies in the minerals and cotton industries have a history of walking away from deals when prices move against them, and that foreign companies sometimes charge a premium for services to Chinese government companies because of the contract risks.

“These companies are only partly companies. They are also political entities,” said Carl Walter, a former Beijing-based banker for J.P. Morgan Chase & Co. who has co-authored two books about China’s state-owned enterprises. That means political imperatives, such as concerns over the value of national assets, can sometimes drive decisions by company chief executives, who at Chinese state-owned enterprises are appointed by the Communist Party. “When you do business with these major SOEs, you better make sure you make enough money to cover,” Mr. Walter said.

Arthur Bowring, managing director of the Hong Kong Shipowners Association, argues that while Cosco’s moves are worrisome for the industry, they won’t likely be that damaging to the company long term. He adds that in late 2008, Australian iron-ore producer Fortescue Metals Group Ltd. backed out of its obligations under some shipping contracts. After a period of arbitration, the company said in October that it had settled all disputes with shipping companies.

“People are now doing business with [Fortescue Chairman] Andrew Forrest again…and it’s almost like it never happened,” Mr. Bowring said.

Mr. Bowring said Cosco, which has been operating internationally for decades, is too experienced to think that it can apply Chinese rules to overseas deals. Still, he said that company relationships are viewed differently in China than in many other places. “Chinese culture will build a relationship before the contract,” he said. “The relationship is always something that can be talked about. The contract is just a set of papers that you keep in your bottom drawer.”

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2 Responses to “Enforcing Contracts with Chinese SOEs Still Challenging”

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