24 March, 2016
The recent case of Siemens International Trading (Shanghai) Co., Ltd vs. Shanghai Golden Landmark Co., Ltd (2013) Hu Yi Zhong Min Ren (Wai Zhong) Zi No. 2 (27 November 2015) (“Golden Landmark Case”) is the first reported case where a PRC court has recognised and enforced a foreign award made in an arbitration between PRC domestic entities.
The Golden Landmark Case is a good reminder of the rule under PRC law that domestic disputes must be arbitrated in China, while parties are permitted to arbitrate their disputes outside China only if the dispute is “foreign-related” (the “Domestic Rule”). This alert discusses the current position under PRC law, enforcement in China of foreign awards rendered between two PRC parties, and implications for foreign investors in China.
Current PRC Landscape and Implications For Foreign Parties Doing Business in China
1. Foreign businesses in China and the Domestic Rule
Foreign businesses typically conduct business in China through Foreign Invested Enterprises (“FIEs”), such as Sino-foreign (equity or co- operative) joint ventures and wholly foreign-owned enterprises (“WFOEs”). For various reasons, foreign businesses usually prefer arbitrating disputes outside China. However, since FIEs are considered PRC domestic entities, their freedom to arbitrate disputes outside China is restricted by the Domestic Rule.
2. When is a dispute “foreign-related”?
In 2012, the Supreme People’s Court (“SPC”) released its Interpretation on Several Issues Concerning the Law on the Application of Laws to Foreign-Related Civil Relations (Fa Shi  No 24, 28 December 2012) (the “2012 Interpretation”).
The 2012 Interpretation assists PRC courts in determining whether a dispute is caught by the Domestic Rule and sets out in what circumstances a PRC court may determine a civil relation as foreign-related:
(i) At least one of the parties is a foreign citizen, foreign legal person or other organisation, or a stateless person; or
(ii) The habitual residence of at least one of the parties is outside the PRC; or
(iii) The subject matter is outside the PRC; or
(iv) The legal facts which give rise to, modify, or terminate the civil relation occur outside the PRC; or
(v) There exist any other circumstances that may be regarded as a foreign-related civil relation.
Whether a company is to be considered a “foreign legal person” is determined by its place of incorporation. Importantly, companies incorporated in Hong Kong, Macau and Taiwan are considered foreign legal persons because those territories are treated to be outside the PRC for this purpose.
3. Enforcement of foreign awards
A PRC court may only issue a decision refusing enforcement of a foreign award with the SPC’s prior approval. This procedure is known as the (internal) prior reporting system, which was introduced to ensure adherence by PRC courts to the spirit of the New York Convention (“NYC”) of which the PRC is a signatory.
By way of background, the NYC is a multi-party treaty that facilitates mutual recognition and enforcement of foreign arbitral awards. Pursuant to Article V(1)(a) of the NYC, recognition and enforcement of a foreign award may be refused if the arbitration agreement is not valid under the law to which the parties have subjected it or, failing any indication thereon, under the law of the country where the award was made. The SPC has confirmed that an arbitration agreement that violates the Domestic Rule is invalid under PRC law. Accordingly, PRC courts may rely on Article V(1) (a) of the NYC to refuse enforcement of foreign awards in violation of the Domestic Rule.
4. PRC courts’ refusal to enforce foreign awards in disputes regarded as purely domestic
The most recent example of PRC courts refusing to enforce foreign awards in disputes regarded as purely domestic is the case Beijing Chaolaixinsheng Sports and Leisure Co., Ltd v Beijing Suowangzhixin Investment Consulting Co., Ltd (2013) Er Zhong Min Te Zi No. 10670. In that case, the Beijing No. 2 Intermediate Court refused enforcement of a South Korean award. The court held that the arbitration clause in a contract entered into between a South Korean owned FIE registered in Beijing and another PRC incorporated company violated the Domestic Rule because both parties were domestic entities, the subject-matter of the contract was located in China, and the contract was concluded and performed in China. The court, however, did not consider whether there were any “other circumstances” that could be regarded as making the dispute foreign-related.
The Golden Landmark Case
In the Golden Landmark Case, the Shanghai First Intermediate People’s Court enforced a Singaporean award even though both parties to the arbitration were WFOEs incorporated in the China (Shanghai) Pilot Free Trade Zone (“Shanghai FTZ”) and the contract was to be performed in China. Importantly, the court investigated what constitutes “other circumstances” under the 2012 Interpretation when determining whether a dispute is foreign-related. Prior to the Golden Landmark Case, there had been limited practical application of the 2012 Interpretation that provided guidance to foreign companies entering into contracts in China through FIE’s on the scope of what might be “foreign-related”.
The dispute arose from a sale of goods contract governed by PRC law and providing for arbitration in Singapore. A dispute arose between the parties and the Buyer commenced arbitration in Singapore. The Seller initially challenged the tribunal’s jurisdiction arguing that the arbitration clause was invalid under PRC law because it violated the Domestic Rule. The tribunal rejected the challenge. The Seller participated in the arbitration and raised counterclaims. The tribunal dismissed the Buyer’s claims and awarded damages to the Seller. Since the Buyer only satisfied part of the award, the Seller sought enforcement of the foreign award in Shanghai for the outstanding amount.
The Buyer resisted enforcement and revived the Seller’s jurisdictional defence in the arbitration that the arbitration clause violated the Domestic Rule. Accordingly, the court had to consider whether the dispute was foreign-related. The court noted that both parties were domestic entities and the contract provided for delivery of the goods in the PRC, but went on to consider whether there were “other circumstances” (as described in paragraph 2(v) above) that made the dispute “foreign related”.
In deciding to enforce the foreign award, the court identified the following facts that made the dispute foreign-related:
Both parties were incorporated as WFOEs in the Shanghai FTZ which aimed at facilitating foreign investment trade. The source of this type of companies’ capital, their ultimate interests ownership, and their business decision-making were all closely connected to foreign investors.
The contract had features of an international sale of goods contract because the goods had to be imported from abroad to the Shanghai FTZ, they were stored in bond and had to pass through Chinese custom procedures.
Actions to Consider
Foreign investors who prefer offshore arbitration should obtain specialist legal advice when contracting through FIEs with other PRC entities, to determine whether there are sufficient foreign elements to make their contractual relationship foreign-related.
Such an exercise has to be conducted on a case-by-case basis, as the legal assessment is highly fact sensitive.
A claimant who commences arbitration outside China without going through the above exercise at the contract drafting stage faces, in particular, the following risks:
i) Challenges to the validity of the arbitration clause;
ii) Parallel court proceedings commenced by the respondent in China; and
iii) Failure to enforce the foreign award in China.
If the position is unclear and enforcement of an award is likely to take place in China (for example, because the other party does not have any assets outside China), we recommend that parties adopt an arbitration clause providing for arbitration in China under the auspices of a Chinese arbitral institution with an established track record of administering international cases, such as the China International Economic and Trade Arbitration Commission (“CIETAC”). CIETAC’s new 2015 arbitration rules reflect many of the practices of international arbitration. We also suggest that parties spell out in the arbitration clause any specific preferences they may have which differ from the default position under the chosen arbitration rules. For example, if parties agree on CIETAC arbitration, the arbitration clause can provide, among other things, that:
- The presiding arbitrator shall be of neutral nationality;
- The parties are free to nominate arbitrators from outside CIETAC’s panel of arbitrators; and
- The arbitration be conducted in English.
The decision in the Golden Landmark Case is a welcome development.
The Shanghai court interpreted the “other circumstances” limb of the 2012 Interpretation broadly, and provided some indication of the type of circumstances a court might consider when deciding whether a dispute is foreign-related. However, it is uncertain to what extent the outcome was influenced by other factors, such as the principles of party autonomy, good faith in arbitration and estoppel. These factors were cited by the court in relation to the fact that the Buyer resisted enforcement although it had commenced arbitration in Singapore and paid part of the damages under the foreign award.
We will be monitoring developments in this area as the decision is not binding on other PRC courts and it remains uncertain what approach will be taken by other PRC courts when interpreting “other circumstances” to determine whether a dispute is foreign-related. Clarification by the SPC removing this uncertainty would therefore be welcome.
Meanwhile, our arbitration specialists in Hong Kong and China will be pleased to assist you in determining the most suitable seat for your arbitration and in the proper drafting of your arbitration clause.
For further information, please contact:
Cynthia Tang, Partner, Baker & McKenzie