We are always writing on the importance of China contracts having a well-crafted dispute resolution provision. My favorite line about this is the following, from the post, “Arbitration In Your China Contract. Adult Supervision Required“:

With sushi restaurants, it’s the yellow-fin.
With new houses, it’s the windows.
With international contracts, it’s the dispute resolution provision.

The “it” I am talking about is the one easiest, fastest, most accurate, way to judge whether something is good or not. And the way I judge international contracts is by heading straight to the dispute resolution provision. The well crafted provision is, above all else, unambiguous. If it calls for litigation, it says where it will be and what law will apply. And it says who will pay for it and under what circumstances. If it calls for arbitration, it says where it will be, how many arbitrators will be required, how the arbitrators will be chosen, the language of the proceedings, the rules that will be used for the proceeding, and the law that will apply. And it says who will pay for what.

The above are minimums.

Because arbitration is of such mainline importance to contracts with China, I asked China arbitration expert, Dr. Clarisse von Wunschheim to write a series of guest posts on China arbitration and she has agreed to do so. I asked Dr. von Wunschheim because she literally wrote the book on China arbitration: Enforcement of Commercial Arbitral Awards in China. Dr. von Wunschheim presently heads up WunschARB, “a boutique advisory firm created in Zurich in 2010, with the Beijing branch opening in April 2011. It provides advice and practical assistance preventing, managing and resolving cross-cultural commercial disputes, with a particular focus on international arbitration and China related disputes.”

So without any further ado, Part I of Dr. von Wunschheim on China arbitration.

Introduction

One of the biggest bones of contention among lawyers and business people when it comes to negotiating and drafting arbitration clauses in China-related cross-border commercial contracts is whether it is better to arbitrate inside or outside China, and there are two main schools of thought:

  1. Avoid China as place of arbitration and try to agree on a place of arbitration outside China. Focus first on winning the arbitration, and worry then about enforcement.
  2. Avoid complications due to arbitrating abroad and keep your place of arbitration in China. Overall, you will be better off, especially when it comes to enforcement.

I believe that both of these approaches miss the point, and that the question of where to arbitrate is intimately linked to the parties’ expectations and needs and should therefore depend on a series of case-specific factors.

Before dealing with the pros and cons of each option (post no. 2), and determining which should – in view of the pros and cons and of the parties’ expectations – be the relevant criteria for selection (post no. 3), let me briefly set out the (legal) context of the issue.

Premise – Legal Restrictions on Choice of Forum

Under Chinese law (see in particular Art. 242 PRC Civil Procedure Law and Art. 128 Contract Law), only parties to a ‘foreign-related contract’ may choose a foreign dispute resolution forum.  The corollary of this is that parties to a purely domestic contract must keep their dispute and its resolution in China.

Based on this, the debate about a foreign or a Chinese place of arbitration would seem to be limited to ‘foreign-related’ contracts.

However, this statement does not fully reflect reality and raises two main questions:

1.         When is a contract deemed foreign-related?

The term ‘foreign-related’ can be misleading and the perception of foreign companies as to what counts as ‘foreign-related’ is therefore often wrong.

In 1992, the Supreme People’s Court defined a ‘foreign-related’ case as a case showing one of the following features:

(i)            one or both parties are of foreign nationality or stateless, or a company or organization is located in a foreign country;

(ii)          the legal facts that establish, alter or terminate the civil legal relationship between the parties occur in a foreign country; or

(iii)         where the subject matter of the dispute is situated in a foreign country.

Unless one of these three circumstances is present, the case will be qualified as domestic.

While the official definition of what counts as ‘foreign-related’ seems to be quite broad, the practice of the Chinese courts is very restrictive: When determining whether a case is ‘foreign-related’ they rely exclusively on the first criteria, i.e. the nationality of the parties involved.

In summary, for a case to be considered foreign-related, at least one of the parties involved must be of foreign nationality. In this regard, foreign companies too often overlook the fact that their Chinese subsidiaries, including joint ventures or wholly owned entities, are considered to be Chinese entities established under Chinese law. Therefore, disputes involving such subsidiaries will mostly be considered domestic, which means that the contracts entered into by such subsidiaries may not provide for a foreign place of arbitration.

2.         What happens if notwithstanding the domestic nature of your contract, you select a foreign place of arbitration?

If, notwithstanding the domestic nature of the contract, the parties opt for a foreign place of arbitration, they breach Chinese law and in particular Art. 242 PRC Civil Procedure Law and Art. 128 PRC Contract Law.

It is however not totally clear what the consequences of such breach are.

One argument could be to say that the arbitration clause is invalid because it breaches Chinese law.

However, this argument is not necessarily convincing, mainly for the following reason:

The law applicable to the validity of the arbitration agreement may not necessarily be Chinese law. Under most modern arbitration laws, the law applicable to the arbitration clause is the law chosen by the parties, and in the absence of an explicit choice, it is the law of the place of arbitration.

In other words, where the parties choose a place of arbitration abroad, let’s say in Switzerland, Swiss arbitration law will apply to the question of the validity of the arbitration agreement. Since there are no restrictions under Swiss arbitration law with regard to the place of arbitration, an arbitral tribunal constituted under Swiss arbitration law will have no reason to consider the arbitration agreement invalid.

The restriction imposed by Chinese law on the place of arbitration may therefore in principle not prevent the arbitration from taking place in another country.

However, the party seeking to enforce the arbitral award in China may encounter serious problems.

From the outset, I should say that I am not aware of any decision of Chinese courts refusing enforcement of a foreign award in relation to the breach of the legal restriction concerning foreign forum selection. In addition, the breach of legal provisions is – as such – not a ground for non-enforcement of foreign awards under the New York Convention.

However, I believe that Chinese courts would very likely consider such a breach to trigger the ground for breach of public policy under Article V(2)(b) New York Convention: Though it is true that the Supreme People’s Court has made it clear that a breach of – even mandatory – legal provisions does not necessarily amount to a breach of public policy (see e.g. ED&F Case 2003 [link no longer exists]; Mitsui Case 2005; GRD Minproc Case 2009), it has also made it clear that a breach of China’s jurisdictional sovereignty will in principle amount to such breach thereby justifying to refuse enforcement (see the Yongning case 2008).

Since Art. 242 PRC Civil Procedure Law and Art. 128 PRC Contract Law are meant to allow China to keep control over certain contracts and disputes, I anticipate that a breach of these provisions would be regarded as a breach of China’s jurisdictional sovereignty.

Consequently, I believe that enforcement of a foreign award rendered based on an arbitration agreement which disregards the forum selection restrictions set by Art. 242 PRC Civil Procedure Law and Art. 128 PRC Contract Law run a serious risk of being refused enforcement based on Article V(2)(b) New York Convention.

Does this mean that parties should refrain from entering into such arbitration agreements? Not necessarily. This ultimately depends on the importance given to the issue of enforcement, within the entire context of reasons why parties would want to choose arbitration abroad.

In this respect, it is my contention that the role of enforcement is often overemphasized and this will be the topic of the next two posts.

  • MHB

    Thanks for a really meaty legal post. Looking forward to Parts 2 and 3!

  • Kim

    This is so good. What a great job deciphering and articlulating the multiple layers of cross-border laws concerning arbitration. Also looking forward…

  • jsa87

    Will there be a TV series about this? Perhaps, Dr Clarisse Explains It All…?