Recent Developments of Commercial Arbitration in China — Interpretation of Opinions of the Supreme People’s Court on Providing Judicial Protection for the Construction of Pilot Free Trade Zones

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China, Global September 27 2017

I. Recent Developments of Arbitration Law in China

In recent years, the number of arbitration cases in China has continued growing, from 37,304 in 2004 to 208,545 in 2016, with an average annual growth rate of about 16%; the dispute amount involved has also risen from RMB 51.5 billion in 2004 to RMB 269 billion in 2016, the average annual growth rate of which is about 22%.

It is easy to see from the above statistics that arbitration in China has gradually obtained more and more attentions from commercial entities, and has been one of the main approaches of dispute resolution. In addition to its Arbitration Law, China has issued several relevant official judicial interpretations or opinions on arbitration issues. Among them, the latest one, which reflected substantial reform, is Opinions of the Supreme People’s Court on Providing Judicial Protection for the Construction of Pilot Free Trade Zones (promulgated on 9th Jan 2017, hereinafter referred to as the “Opinions”). Before its promulgation, strict limitation has been seen when a Chinese party wants to submit disputes to arbitration in foreign forums. Besides, only institutional arbitration is permitted in the Mainland of China while ad hoc arbitration is not recognized under the framework of the Chinese Law. However, the situation seems to be changed with the promulgation and entering into force of the Opinions.

II. Submitting Dispute to Arbitration in a Foreign Forum

Under Chinese law, although parties may agree to submit foreign-related civil disputes to arbitration in a foreign forum, in principle, disputes without foreign-related factors are not allowed to arbitrate outside China.[1]

Article 1 of the Interpretation of the Supreme People’s Court on Several Issues Relating to Application of the Law of China on Application of Laws to Foreign-related Civil Relations (I) defined foreign-related factors:

“Under any of the following circumstances, the People’s Court may determine a civil relation as a foreign-related civil relation:   

1. Where a party concerned or both parties concerned is/are (a) foreign citizen(s), (a) foreign legal person(s) or any other organization, or (a) stateless person(s);
2. Where the habitual residence of a party concerned or both parties concerned is located outside the territory of China;
3. Where the subject matter is located outside the territory of China;
4. Where the legal facts that trigger, change or terminate the civil relation take place outside the territory of China; or
5. Any other circumstances that can be determined as foreign-related civil relations.”

In this regard, Article 9 (1) of the Opinions provides for a limited exception – if both parties are wholly foreign owned enterprises registered in the FTZs, their agreement to submit the dispute to arbitration in a foreign forum shall not be ruled as invalid only because there is no foreign-related factor.

Article 9 (2) further stipulates that if one party or both parties are foreign-invested enterprise/s registered in the FTZs and agree to submit disputes for arbitration outside China, after receiving the reward, if the parties apply for refusing to recognize or enforce the award on the ground that the arbitration clause/agreement is invalid, courts shall not support; or in the events that the opponent party hasn’t objected to the validity of the arbitration clause/agreement in the arbitration proceedings, then after the award is rendered, claims that the arbitration clause/agreement is invalid on the ground that the relevant case has no foreign-related factors, thus further applies for refusing to recognize or enforce  the award, courts shall not support.

The above provisions have established the legal framework for FTZs enterprises to submit arbitration in foreign forums. Special attentions shall be paid to:

Distinguish wholly foreign owned enterprises and foreign-invested enterprises:

If both parties are wholly foreign owned enterprises registered in the FTZs, they may agree to submit disputes among themselves to arbitration outside China, no matter if there is a foreign-related factor or not.

If one party or both parties is foreign-invested enterprises registered in the FTZs, their agreement of submitting disputes to arbitration in a foreign forum is not necessarily invalid even though the dispute is lack of foreign-related factor. However, although courts will not directly determine that the agreement is invalid, if one party raises objections towards the validity of the arbitration clause/agreement to the arbitral tribunal or the court prior to the first hearing, the arbitral tribunal or the court will review the validity of the arbitration clause/agreement in accordance with the general rules and, if no foreign-related factor is involved, the arbitration clause/agreement will be deemed as invalid.

III. Limited Approval of ad hoc Arbitration in FTZs

Before the Opinions came into force, ad hoc arbitration was not recognized under Chinese law. Now, Article 9 (3) of the Opinions seems to provide an exception.

Article 9 (3) of the Opinions stipulates that “in the events that enterprises which registered in the FTZs agree to submit dispute for arbitration at a designated place in the Mainland of China, in accordance with designated arbitration rules and by designated person(s), such arbitration clause/agreement may be affirmed as valid. If the court of first instance considers the arbitration clause/agreement is invalid, that court shall report the case to the court which in the next superior level. If the superior court agrees with the court of first instance, it shall submit the review opinion to the Supreme People’s Court[2] and render the verdict only after receiving the reply from the Supreme People’s Court.”

The above provision is now being considered as an introduction of ad hoc arbitration into Chinese legal systems, nevertheless, special attentions should be paid to:

1. Both parties shall be enterprises registered in the FTZs;
2. There must be three “designated”:

The designated place in the Mainland of China, the designated arbitration rule and the designated person(s). Only with all these three elements, the arbitration clause/agreement then may be affirmed by Chinese courts as a valid arbitration clause/agreement. However, it’s a “may” situation rather than “shall” one, which means that courts still have discretion;

1. The judicial review mechanism for scrutiny of validity of arbitration clause/agreement falls into Article 9(3) of the Opinions:

For arbitration clause/agreement which falls into this category, if the court of first instance considers the agreement is invalid, that court shall report the case to the court which in the next superior level. If the superior court agrees with the court of first instance, it shall submit the review opinion to the Supreme People’s Court, and the verdict could be rendered only after receiving the reply from the Supreme People’s Court.

Nevertheless, the provisions under the Opinions are still quite vague with ambiguity. It is noteworthy that the Opinions itself has not used the phrase “ad hoc arbitration”. Thus, as for to what extent the Opinions supports ad hoc arbitration may still need to wait for further implementation regulations or official guidelines.

IV. Suggestions on Drafting Arbitration Clause/Agreement in FTZs

For submitting arbitration in a foreign forum:

If both parties are wholly foreign owned enterprises registered in the FTZs, they may agree to submit disputes among themselves to arbitration in a foreign forum, with or without foreign-related factors.

However, if one party or both parties is foreign invested enterprise/s registered in the FTZs, unless the transaction has obvious foreign-related factors, agreement on submitting dispute for arbitration outside China is still not recommended. Although Chinese court will not directly determine that the agreement is invalid, if one party raises objections towards the validity of the arbitration clause/agreement prior to the first hearing, tribunal/court will review the validity of the arbitration clause/agreement in accordance with general rules and, if no foreign-related factor is involved, the arbitration clause/agreement will be deemed as invalid.

For ad hoc arbitration:

Both parties shall be enterprises registered in the FTZs.

The arbitration clause/agreement shall meet the requirement of “three designated”, that is, the designated place in the Mainland of China, the designated arbitration rule and the designated person(s).

For designated place, it is unclear whether it refers to the seat of the arbitration or the venue of hearings, therefore it is advisable to either make the same agreement on the seat of the arbitration and the venue of hearings – designate one specific place in the Mainland of China, or make different yet clear agreements regarding the seat and the venue. As for designated arbitration rule, it is also unclear whether it is enough for the parties to agree in advance on their own rules regarding procedure issues or they should clearly agree to use a certain set of existing arbitration rules (e.g. ICC rules, CIETAC rules, LMAA rules, etc.); therefore, it is advisable to use a certain set of existing arbitration rules (it may be noteworthy to exclude the arbitration rules which stipulate that by choosing the arbitration rules, it is deemed to automatically refer the dispute to the relevant arbitration institution, for example, ICC Arbitration Rules[3]).

Furthermore, it is also advisable to specify the number and name(s) of the arbitrator(s).

Currently, the provisions in the Opinions in relation to the above “three designated” are still vague, in the absence of further official clarification, it is advisable that the parties shall interpret them with a narrow perspective, and make a clear and specific agreement.

Besides, such arbitration clause/agreement is only “shall” be deemed as valid— courts still have discretion here. Therefore, there are still some risks in practice. Therefore, one should be very cautious when drafting such arbitration clause/agreement— preferably making a clear and specific agreement based on narrow interpretation of the Opinions in order to avoid the possibility of being deemed as invalid.