Can disputes without a foreign element be arbitrated outside china?

The phrase “dispute without a foreign element” means a dispute in which the subject, object and legal relationship all lack a foreign connection. In the past, when faced with the question of whether such disputes could be arbitrated outside of China, the typical reaction was not “whether it is possible”, but rather “whether it is necessary”. However, with the increasing complexity of civil and commercial law relationships, a new type of dispute has gradually evolved that, although not satisfying the three statutory conditions, nonetheless has an immediate connection with offshore interests.

For example, under a typical variable interest entity (VIE) framework, a dispute may arise between the foreign-invested enterprise established in China by a foreign investor and the wholly Chinese-owned licensed operator. Because the foreign-invested enterprise does not have the status of a foreign legal person, its dispute with the wholly Chinese-owned licensed operator is very likely to be deemed a domestic case. However, we understand that a significant number of VIE agreements have opted for foreign arbitration as the method of dispute resolution.

With the appearance of such new types of disputes, the arbitration abroad of disputes without a foreign element has become a very real need. In 2009, the Shanghai Pudong New Area People’s Court announced that among the cases that it had recently accepted, there were four involving the selection of foreign arbitration for disputes without a foreign element, and called upon the relevant authorities to clarify the adjudication yardstick in such cases.

Confusion and clarification

We find that in the current explorations of the issue of whether disputes without a foreign element can be arbitrated abroad lie a confusion of concepts. That question should in fact be further divided into two different levels, namely: (1) if a dispute without a foreign element were referred to a foreign arbitration institution, would it be accepted? and (2) in future, when applying for recognition and enforcement of the relevant foreign arbitration award, will the Chinese court accede?

The first question falls into the category of an analysis of the possibility of arbitration, and strictly speaking the second has little bearing on possibility – rather it actually explores the issue of the utility of such arbitration. However, possibly due to the fact that in the great majority of such arbitration cases enforcement needs to be sought in China, people are in the habit of additionally inserting “can it be enforced” into the discussion of “can it be arbitrated”. We find that the clarification of the issue of whether disputes without a foreign element can be arbitrated abroad should be analysed by looking separately at both of the levels mentioned above.

Some analysis

First, would a dispute without a foreign element referred to a foreign arbitration institution be accepted? The Shanghai Pudong New Area People’s Court mentioned above proves it, otherwise it would be unlikely for a basic level people’s court to encounter four such cases in a short period of time. Analysed from the perspective of law, the sole criterion for the acceptance of a case by an arbitration institution is the validity of the arbitration agreement, and the law of the great majority of countries will not deny the arbitration provisions of parties because a dispute does not have a foreign element. Even pursuant to China’s Arbitration Law, lack of a foreign element does not constitute grounds for invalidation of an arbitration agreement. Under such a circumstance, once a party submits an application for arbitration, the foreign arbitration institution does not have any reason to refuse to accept it and open a case.

Second, once the foreign arbitration institution has rendered its award, can it be recognised and enforced in China? In this question lies the true heart of the issue of whether disputes without a foreign element can be arbitrated abroad. Looked at in terms of the laws and regulations of China, there are no provisions that expressly prohibit the recognition and enforcement of such awards. One view has it that, pursuant to the provision of article 128 of the Contract Law stating that “parties to a contract with a foreign element may apply to a Chinese arbitration institution or another arbitration institution for arbitration on the basis of their arbitration agreement”, parties to a “contract without a foreign element” then cannot apply to an arbitration institution outside of China for arbitration.

However, the author is of the opinion that the “may” in the clause indicates that it is an authorising provision, and the conclusion that foreign arbitration is forbidden cannot logically be derived. Furthermore, when recognising and enforcing foreign arbitration awards, Chinese courts are required to abide by the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention), not the Contract Law. Of the grounds given in article V of the New York Convention for refusing recognition and enforcement of a foreign arbitration award, not one is directly related to “without a foreign element”.

One view has it that a Chinese court could, in respect of such an arbitration award, cite the public policy provision of the New York Convention to refuse recognition and enforcement. However, in fact, there has been no such precedent in practice to date. The Supreme People’s Court has in only two cases issued an official reply ruling to deny recognition and enforcement on the grounds of public policy, one involving the issue of cultural guidance and the other judicial sovereignty.

Furthermore, the FAQs on the websites of the Shanghai International Economic and Trade Arbitration Commission and the South China International Economic and Trade Arbitration Commission, in response to the questions: “if both parties are companies registered in China and their contract does not have a foreign element, must arbitration be in China?” and “can they agree to have arbitration conducted by a foreign arbitration institution?” state that: “at present, Chinese laws (e.g. the Contract Law) provide that arbitration by a foreign arbitration institution may be selected for a dispute involving a contract with a foreign element, but they are silent on whether arbitration by an arbitration institution outside China may be selected for a dispute involving a purely domestic contract. With a view to avoiding the risk that the arbitration award rendered by a foreign arbitration institution not be recognised and enforced by a mainland Chinese court, we would recommend that, to the extent possible, a domestic arbitration institution be selected to handle a dispute involving a domestic contract.”

In the next issue we will explore the means of dealing with such disputes.