While foreign invested companies in China, either operating as a joint venture or wholly-owned entity, may have a strong desire to apply the rules and administration of an international arbitration commission due to their unfamiliarity with the Chinese arbitration system, there is a common misunderstanding that they can just draft an arbitration clause in their commercial contract to designate a foreign arbitration forum to arbitrate the case. The most recent decision rendered by the Supreme People’s Court illustrates that corporate users need to be very cautious in reviewing the “foreign-related” requirement before choosing a foreign arbitration forum.
On August 31, 2012, the Supreme People’s Court, in its certiorari, affirmed Jiangsu Higher People’s Court’s decision in Jiangsu Aerospace Wanyuan Wind Power Co., Ltd. vs. LM Wind Power (Tianjin) Co., Ltd. ("Wanyuan vs. LM”). The Supreme People’s Court held that the parties cannot choose ICC arbitration because there is no basis in Chinese law that permits parties to choose arbitration at a foreign arbitration institution or ad hoc arbitration outside the PRC’s territory if the dispute fails to present any “foreign-related” element.
Undisputed Facts and Evidence
This case involves Jiangsu Wanyuan Company (“Wanyuan”), a joint venture company engaged in the business of manufacturing, assembly, and installation of wind power equipment, which has entered into a purchase agreement with LM Tianjin Co. (“LM”), a wholly owned foreign enterprise (“WOFE”) held by LM Demark Co. to purchase wind turbines.
In the dispute resolution clause of the agreement, both parties stipulated that:
The agreement shall be governed by CISG.
If the dispute cannot be resolved through friendly negotiation, then the dispute shall be submitted to the International Chamber of Commerce (“ICC”) for arbitration in Beijing.
The agreed payment shall be made under the trade term “FCA” in U.S. dollars.
In the six attachments to the purchase agreement, the parties further stipulated that:
LM Denmark Co. guarantees to repay the down payment to Wanyuan if LM fails to make such payment. Demark law shall govern the guarantee obligation.
Pursuant to the warranty, LM Denmark Co. is obligated to replace or repair any defective parts free of charge to Wanyuan.
ACCIONA ENERGIA S. A., a Spanish company that was a shareholder of Wanyuan, guarantees Wanyuan’s performance of its contractual obligations to LM under Spanish law.
Additionally, at the hearing, Wanyuan submitted documents to show that Wanyuan had resold and installed the wind turbines bought from LM to buyers which are located in China.
Opinion of the Supreme People’s Courts and Jiangsu Higher People’s Court
The Supreme People’s Court noted that the validity of an arbitration clause that has nominated a foreign arbitration institution to arbitrate the parties’ dispute involves the intersection of the Civil Procedural Law of the People’s Republic of China (2007) (“Civil Procedural Law”) and the Contract Law of the People’s Republic of China(1999) (“Contract Law”). First, under Article 255 of the Civil Procedure Law, “in the case of disputes arising from foreign economic, trade, transport, or maritime activities, if the parties concerned include an arbitration clause in the contract or have subsequently reached a written arbitration agreement and choose to go to arbitration before a Chinese arbitration institution or another arbitration institution, the parties concerned shall not bring an action with a People’s Court.” Secondly, under Article 128 of the Contract Law, parties to a contract with a "foreign element" can opt for arbitration before a Chinese arbitration institution or a foreign arbitration institution. By combining these two statutes, the Supreme People’s Court concluded that the parties could submit their dispute to arbitration before a foreign arbitration institution only when a foreign-related civil legal relationship exists. Parties to a contract without a "foreign element" will have no choice other than to have their arbitration conducted at a Chinese arbitration institution.
Moreover, the Supreme People’s Court has provided three factors in determining whether a “foreign-related” civil legal relationship exists. In Article 178 of the Opinions of the Supreme People’s Court on Several Issues concerning the Implementation of the General Principles of the Civil Law of the People’s Republic of China (1988) (“Opinion”), a foreign-related legal relationship is where: 1) one party or both parties are foreign nationals, stateless persons, or foreign legal persons; or 2) the subject matter of dispute is located in a foreign country; or 3) the legal facts which create, modify, or terminate a right or obligation occurred in a foreign country.
The Jiangsu Higher People’s Court applied the Opinion and found that: Wanyuan and LM are both legal entities registered in China; the subject matter of the case, wind turbines in the purchase agreement, were manufactured, transported, and installed in China; and Wanyuan and LM have both signed and performed the contract in China. Therefore, the contract entered into by Wanyuan and LM is not a foreign-related civil legal relationship because the parties, the subject matter, and the creation, modification, and termination of the civil legal relationship were all in China.
In the motion to compel arbitration, LM made several arguments to show that the foreign-related elements existed in the purchase agreement. LM claimed that: the guarantee obligation of a foreign entity under the contract was governed by the foreign law; the payment of the contract is calculated in U.S. dollars; and the responsibilities under the warranty clause are enforceable against LM Demark Co.
However, Jiangsu Higher People’s Court rejected LM’s arguments and reasoned that: 1) despite the guarantee obligation of a foreign entity, the civil legal relationship of the purchase agreement and the nature of the dispute are domestic; 2) the agreement is only enforceable against Wanyuan and LM, the parties that entered into the purchase agreement, and not the foreign entities; 3) the dispute resolution clause between the parties failed to indicate that the dispute resolution method is also binding on foreign entities; and 4) the guarantee and warranty clauses are relatively independent and a separate contractual agreement and thus do not change the domestic nature of the purchase agreement.
Foreign investment enterprises ("FIEs"), contractual and equity joint venture companies, and wholly-owned foreign enterprises incorporated in China with foreign investment are deemed to be "domestic" entities under PRC law. The Supreme People’s Court’s affirmation of the Jiangsu Higher Court’s opinion reinforced the Supreme People’s Court’s long-standing view that in order for FIEs and other domestic Chinese enterprises to have the ability to opt for arbitration before a foreign arbitration institution, there must be a foreign party to the contract or another "foreign element" present.
On December 10, 2012, the Supreme People’s Court elaborated further on the issue of “foreign-related” civil legal relationship in its Interpretation of the Supreme People’s Court on Certain Issues Concerning the Application of the "Law of the People’s Republic of China on the Application of Laws to Foreign-Related Civil Relations" (“Interpretation”). The Supreme Court expanded the factors considered in determining the existence of a foreign-related civil relation, including a factor of whether the habitual residence of any party is outside the territory of China and a catch-all clause on situations where the court deems appropriate to recognize as a foreign-related civil relation. The Interpretation defines habitual residence as the place where a natural person has already resided continuously for at least one year. However, it is still unclear as to whether a legal person, like a WOFE or JV, would have a similar test applied to them.
In conclusion, the recent Supreme People’s Court ruling in Wanyuan vs. LM and the relevant laws in China have posted a high bar for foreign investors to be able to successfully choose foreign arbitration with an intention to skip the Chinese judicial and arbitration system. Therefore, in drafting an arbitration clause to submit a dispute to a foreign arbitration forum, it is strongly advised that the parties consult with a Chinese counsel specialized in arbitration practice to determine whether the parties’ legal relationship will satisfy the “foreign-related” requirement.