The case of the day, Changzhou Amec Eastern Tools & Equipment Co. v. Eastern Tools & Equipment, Inc. (C.D. Cal. 2012), is a rare and disturbing case—the judge refused to confirm an international arbitral award after finding that the respondent had been forced to sign the arbitral agreement under duress.

Eastern Tools, a California corporation, was an importer and distributor of gasoline-powered generators. It purchased most of its generators from Changzhou Amec, a Chinese corporation. Eastern Tools claimed that the equipment it was purchasing did not conform to the contract specifications, and it stopped purchasing from Changzhou Amec. Eastern Tools then sought payment for storing, shipping, and repairing returned shipments of allegedly non-conforming generators. Changzhou Amec, in turn, demanded payment for those shipments.

The parties negotiated a settlement agreement under which Eastern Tools would keep the allegedly defective goods and pay Changzhou $2 million. But the parties did not sign the agreement. Changzhou Amec filed for bankruptcy in China in February 2007.

Shortly after the bankruptcy, the police in Changzhou arrested Eastern Tools’s president, Gouxiang Fan, held him in a detention facility, and told him that he was being held for criminal fraud. They confiscated his phone and asked him to give a statement about the dispute between the two companies. The fact of the arrest was not disputed, but Changzhou Amec characterized it as “residential surveillance.”

In April 2007, while Fan was under arrest, Xuchu Dai, the bankruptcy administrator of Changzhou Amec, visited Fan with the police present to negotiate a resolution. The police permitted an attorney to visit with Fan, but they monitored the visit, and the attorney testified that he was only allowed to advise Fan to sign the agreement that Dai had proposed. When the attorney began to ask Fan about the charges against him, he testified that the police told him to stop and pushed him out of the room.

Several days later, according to Fan, the police supervisor told him that Fan would not be released unless he signed the agreement. ¹Changzhou Amec argued that the policeman’s statement was inadmissible hearsay, but the judge rejected the argument, correctly, on the grounds that the issue was the voluntariness of Fan’s signature and the statement was offered to prove Fan’s state of mind, not the truth of what the policeman had asserted. The agreement required Eastern Tools to pay $2.5 million in installments and which made Fan a guarantor. The agreement also contained a penalty clause requiring a payment of $6.2 million if the $2.5 million wasn’t paid on time, and an arbitration clause requiring arbitration of disputes before CIETAC in Shanghai. The police released Fan after Changzhou received the first payment under the agreement (though apparently before Fan signed the agreement).

In June 2007, the creditors of Changzhou Amec rejected the April 2007 agreement. Fan had remained in China on business after his release from prison. In July 2007, the police called Fan back to Changzhou to sign the April agreement—it’s not clear why, since the creditors had already rejected the agreement. Fan ultimately signed an agreement more favorable to Changzhou Amec than the April 2007 agreement, and the creditors approved it.

In 2008, Changzhou Amec initiated an arbitration. Fan and Eastern Tools participated in the arbitration, but they contested the validity of the arbitration agreement. Fan also challenged the validity of the agreement in the Nantong Intermediate People’s Court, but he ultimately withdrew that challenge. The CIETAC tribunal issued an award in favor of Changzhou Amec, which sought confirmation in California.

The defendants raised several grounds for refusing confirmation under the New York Convention, but the ultimately decisive provision was Article V(2)(b), which provides:

Recognition and enforcement of an arbitral award may also be refused if the competent authority in the country where recognition and enforcement is sought finds that [ellipsis] [t]he recognition and enforcement of the award would be contrary to the public policy of that country.

While the court found many dicta supporting the proposition that enforcement of an arbitral agreement signed under duress would violate public policy, it did not find any cases that had actually held an award unenforceable on that basis. It did, however, note that it was well-established that a court would not compel arbitration where the arbitral agreement was signed under duress in light of Article II(3), which requires enforcement of agreements to arbitrate unless the court finds that the agreement “is null and void, inoperative or incapable of being performed.”

The court applied California law to the question of duress. The court found that on the facts, even though Fan had been released from prison before he signed the July 2007 agreement, his agreement was under duress. I am not going to outline the doctrine of duress here. Suffice it to say that the court found the following points sufficient:

• The police arrested and detained fain for twelve days without charge.
• The police barred Fan from speaking with a lawyer about his arrest and then told the lawyer that he could only advise Fan to sign the agreement
• The police told Fan that he would not be freed until the he signed the agreement
• The police freed Fan only after confirming that the first payment under the agreement had been received, even though the investigation had been closed more than a week earlier.
• Until Fan signed the second agreement, the police were frequently in contact with him, and a police officer directed Fan to sign the agreement, causing Fan to reasonably believe “that if he did not return and sign the agreement, the police would detain [him] again until he signed.”

Changzhou Amec argued that Fan could have left China between his release and the signing of the second agreement, but the judge took a dim view of that argument: “[T]he court declines to find a Chinese citizen, who has legitimate business to conduct in China, must flee the country in order to preserve a duress defense.”

This case is unusual but also troubling. The only basis for judicial enforcement of arbitral awards is the parties’ consent to arbitration. Since arbitrators can be given the power to decide on their own jurisdiction, it is especially important that the law take claims of duress seriously. Let’s hope this is an isolated incident.

Update (5/27/2014): The Ninth Circuit affirmed the decision in a per curiam opinion sub nom. Dai v. Eastern Tools & Equipment, Inc.

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  Changzhou Amec argued that the policeman’s statement was inadmissible hearsay, but the judge rejected the argument, correctly, on the grounds that the issue was the voluntariness of Fan’s signature and the statement was offered to prove Fan’s state of mind, not the truth of what the policeman had asserted.