According to Article 271 of Civil Procedure Law of the People’s Republic of China (“PRC”), parties may submit foreign-related disputes to “foreign arbitration institutions” outside Mainland China (“foreign” here encompasses Hong Kong, Macau, and Taiwan, in terms of jurisdiction only). However, the statutory law of the PRC is silent on whether parties may agree to submit non-foreign-related disputes to such foreign arbitration. In the past, the Supreme People’s Court of the PRC (“SPC”) holds that an arbitration agreement is invalid if parties agreed to submit dispute to foreign arbitration institutions or to foreign ad hoc arbitration (collectively, “foreign arbitration”, for referential purpose in this article) while the dispute is not foreign-related, which will in turn prevent the prevailing party from having the arbitral awards recognized and enforced by the PRC court. In practice, an often-seen scene is two PRC parties agree to have arbitration before a foreign arbitration institution. In such event, where the PRC court cannot find any party is foreign, the PRC court must examine specific facts in order to find out whether the underlying dispute by its nature may satisfy the requirement of “foreign-related” as to have the arbitration agreement exempted from the aforesaid prohibition. In a recent appellate proceeding for jurisdictional challenge heard by the SPC, with its ruling the SPC upheld this notion of prohibiting foreign arbitration for non-foreign-related disputes. However important questions remain unanswered. [1]

Facts

ArcSoft Corporation Limited (“ArcSoft”,the licensor) and Spreadtrum Communications (Shanghai) Co., Ltd. (“Spreadtrum”, the licensee) entered into a Software License Contract (“Contract”), effective on 1 September 2017. Article 17.2(b) of the Contract is the arbitration clause, which stipulates:

“if any dispute is not resolved within the time period specified aforementioned, upon written notice by either party, such dispute shall be finally resolved through arbitration handled by a single arbitrator both parties agree on and familiar with software industry, in accordance with the arbitration rules of the Singapore International Arbitration Centre (“SIAC”) in effect at that time.”

ArcSoft is a sino-foreign joint venture incorporated in Hangzhou City, Zhejiang Province, China. Spreadtrum is a foreign-invested PRC company incorporated in the Free Trade Zone of Shanghai.

ArcSoft alleged that Spreadtrum breached the Contract and ArcSoft initiated a litigation against Spectrum before Hangzhou Intermediate People’s Court (“Hangzhou Court”), rather than filing an arbitration before SIAC. In the litigation, ArcSoft sought the following reliefs,

  1. Spreadtrumshall continue to perform the Contract, by refraining from modifying the licensed software and developing the licensed software’s derivative works;
  2. Spreadtrum shall pay ArcSoft the license fees and relevant interest stipulated under the Contract as well as compensating ArcSoft’s other losses;
  3. Spreadtrum shall indemnify ArcSoft’s cost and bear the entire court fees.

Spreadtrum raised a jurisdictional objection, arguing that the Hangzhou Court did not have competent jurisdiction because, among others, the dispute shall be submitted to SIAC for arbitration. Spreadtrum further contended that, even if the dispute shall be heard by PRC courts, the proper venue shall be the court at Spreadtrum’s domicile. Among others, Spreadtrum argued that,

  1. The arbitration clause provides SIAC arbitration in Singapore, therefore the arbitration clause may be determined by Singaporean law, under which the arbitration clause is valid.
  2. The disputed Contract is foreign-related. Therefore, the requirement for foreign-related elements is satisfied and the arbitration clause is valid. Because, among others,
  • both parties are foreign-invested companies, especially because Spreadtrum incorporated in the Free Trade Zone of Shanghai;
  • the Contract provides that the territory of licensing for the licensed software is the entire globe;
  • the Contract stipulates that it is governed by U.S. laws;
  • the majority of the subject matter under the Contract is the underlying software’s intellectual property rights held by ArcSoft in and protected by the laws of different countries;
  • Spreadtrum’s products incorporated with the licensed software are mostly distributed in overseas.

On December 3, 2020, Hangzhou Court made a ruling (2020) Zhe 01 Zhi Min Chu No.406, dismissing the jurisdictional objection. Spreadtrum appealed to the SPC.

Question

Does the dispute have foreign-related element so that the arbitration clause is valid?

pinions of the Courts

Hangzhou Court held that,

  1. The Parties here are companies incorporated in and residing in Mainland China. The Parties failed to satisfy the SPC’s rule that parties may submit dispute to foreign arbitration institution if any party is a non-PRC party or such party resides outside the PRC.
  2. The main subject matter of the Contract is licensing of the software, in consideration of which Spreadtrum shall pay license fees. The licensed software was developed in Mainland China, and its copyright is owned by ArcSoft. Therefore, the subject matter does not involve foreign-related elements;
  3. The disputed Contract was also signed and performed in Mainland China. Even assuming Spreadtrum’s products incorporated with the software were mainly distributed in overseas, such distribution does not affect the basic relationship between the parties which is software licensing;
  4. Therefore, neither of the Parties, the subject matter of the Contract, nor the legal fact that creates, alters or terminates the legal relationship, involves foreign-related elements. Hence, the arbitration clause is invalid.

The SPC held that, among others,

  1. Article 271 of Civil Procedure Law allows parties to submit “disputes occurred in foreign-related economy and trade, shipment and maritime matters” to overseas arbitration. Article 128 paragraph 2 of the Contract Lawallows “parties to foreign-related contracts” to initiate arbitration overseas. The PRC law has not permitted parties to submit disputes to foreign arbitration institutions if the dispute does not have foreign-related element. Given the parties are both PRC parties, the Court shall identify whether the disputed contract has foreign-related elements.
  2. The parties here are all PRC entities, the disputed Contract was signed in Mainland China and the subject matter thereunder is located in Mainland China. The legal facts whichcreate, alter or terminate the legal relationship between the parties lack foreign-related element. Therefore, the arbitration clause in the disputed Contract is an arbitration clause concluded by PRC parties which provides foreign-seated arbitration for disputes which lack foreign-related elements. Hence the arbitration clause is invalid, and the PRC court has competent jurisdiction over this case.

The SPC then dismissed Spreadtrum’s appeal and sustained Hangzhou Court’s ruling.

According to PRC court’s rulings and the SPC’s public comments, parties are prohibited from submitting non-foreign-related disputes to foreign arbitration institutions or to ad hoc arbitrations seated in foreign jurisdictions (“foreign arbitration” for referential purpose in this article). However, several issues cry out for clearer answers.

  1. The basis of prohibiting foreign arbitration for non-foreign-related disputes is unclear.

Article 271 of the Civil Procedure Law (“CPL”) provides that parties may submit foreign-related disputes to foreign arbitration. However, under the PRC law, there is no explicit prohibition barring parties from resolving non-foreign-related disputes through foreign arbitration. This prohibition rooted in PRC courts’ rulings. According to the PRC court’s rationale in published rulings, this is an implied prohibition embedded in Article 271 of CPL. PRC courts’ rationale is, given the PRC law does not expressively permit PRC parties to submit non-foreign-related disputes to foreign arbitration, then submitting non-foreign-related disputes to foreign arbitration shall be deemed as prohibited.

There are quite a number of published cases, in which the PRC courts relied on such implied prohibition and deemed arbitration agreements invalid. These cases are of diverse types of proceedings, such as jurisdictional challenge, independent application seeking court’s declaration on the arbitration agreement’s validity, and application for recognition and enforcement of foreign arbitral award.

A well-known case is Chao Lai Xin Sheng v. Suo Wang Zhi Xin, 2013-Er-Zhong-Min-Te No. 10670, decided by Beijing 2nd Intermediate People’s Court in 2014 after obtaining the SPC’s approval.[2] In this case, two PRC companies submitted dispute to Korean Commercial Arbitration Board (KCAB). The disputed contract does not specify the governing law. When the winning party applied for recognition and enforcement of the award in China, the PRC court held that the governing law of the disputed contract and the arbitration agreement therein shall be PRC law, “regardless the parties had chosen or not,” and the PRC court dismissed the application for recognition and enforcement on the ground of Article V.1(a) of the New York Convention, by holding that the arbitration agreement is invalid. In particular, the court held that the underlying arbitration agreement is invalid “according to the law which the parties subjected to the arbitration agreement”.

Article V.1 (a) of the New York Convention reads,

“1. Recognition and enforcement of the award may be refused, at the request of the party against whom it is invoked, only if that party furnishes to the competent authority where the recognition and enforcement is sought, proof that:

  • The parties to the agreement referred to in article II were, under the law applicable to them, under some incapacity, or thesaid 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; or”

Therefore, in the context of Article V.1 (a) of the New York Convention three types of laws may be applied in determining the arbitration agreement’s validity,

  • The law applicable to the parties, under which they are under some incapacity;
  • The law which the parties subjected to the arbitration agreement;
  • The law at the seat of the arbitration.

The PRC court’s rationale in Chao Lai Xin Sheng v. Suo Wang Zhi Xin is intriguing, since it established a notion that, in the context of Article V.1(a) of the New York Convention, “the law to which the parties have subjected to the arbitration agreement” may refer to a law not chosen by the parties, and such unchosen law may override the arbitration agreement’s governing law chosen by the parties. To date, Chao Lai Xin Sheng v. Suo Wang Zhi Xin is the only publicized PRC court ruling where the PRC court refused to recognize and enforce foreign arbitral award by holding that the arbitration agreement is invalid since foreign arbitration for non-foreign-related disputes is prohibited under the PRC law. In Chao Lai Xin Sheng v. Suo Wang Zhi Xin, if the parties explicitly agreed on the governing law of the arbitration agreement, the outcome in the PRC court’s ruling might be different, and we expect to witness such a case in the future.

  1. The test for identifying “foreign-related elements” is to be further clarified and unified.

Beside the applicability of prohibition of foreign arbitration for non-foreign-related disputes, the key issue is how to determine a dispute is foreign-related or not.

As to the definition of “foreign-related elements”, both Article 522 of the SPC’s Interpretation on Civil Procedural Law and Article 1 of the SPC’s 1st Interpretation on the Law on the Application of Law in Foreign-Related Civil Legal Relationship provide that a case may be deemed foreign-related, if any of the following elements exists:

  • Any parties or both parties are foreign citizen, foreign legal person or other entities, or, individual without nationality;
  • Any party or both parties resides outside the territory of the PRC;
  • The subject matter is outside the territory of the PRC;
  • The legal facts which create, alter or terminate civil relations occurred within the territory of the PRC;
  • Other circumstance based on which it can be found that foreign-related civil relationship exists. (emphasis added)

The underlined three criteria above are abstract. Hence PRC courts may reach different conclusions depending on various fact matrix, and in practice they did so. To date, the SPC has not published a clear guidance or a representative case which may clarify on the interpretation and application of this test.

In a case decided by Beijing 4th Intermediate People’s Court (docket number: (2018) Jing 04 Min-Te No.145) [3], the court held that the requirement is satisfied as foreign-related element exists. The disputed contract is a product purchase contract concluded between two PRC companies, which provides ICC arbitration in Hong Kong. The court found that the origin of the products is Germany, and the transaction involves the buyer’s taking of delivery in Germany. The court consequently found that the requirement of foreign-related element is satisfied because the products as the subject matter of the contract are outside the territory of the PRC, hence the arbitration agreement is valid.

In a case decided by Shanghai Maritime Court in 2018 (docket number: (2017)-Hu-72-Min-Te No.181) [4], the court held that the arbitration agreement in a shipbuilding contract concluded by PRC parties is valid, which provides arbitration in London. The court found that the disputed ship has various connections with foreign jurisdictions, including that the parties agreed that the ship is to comply with the standard of and registered with the American Bureau of Shipping, and they further agreed that Marshall Islands shall be the ship’s flag country, and the buyer shall set up a foreign subsidiary to be assigned with the shipbuilding contract. The court ruled that the arbitration agreement is valid on the ground of “other circumstance based on which it can be found that foreign-related civil relationship exists.”

However, in ArcSoft v. Spreadtrum here the disputed contract is a software licensing agreement. Hangzhou Court found that the underlying software was developed by ArcSoft in Mainland China, and its intellectual property right is held by PRC parties. Hangzhou Court further held that, even assuming Spreadtrum’s products incorporated with the software were mainly distributed in overseas, such distribution does not affect the basic relationship between the parties which is software licensing. The SPC directly gave its conclusion that there is no foreign-related element, without giving any discussion on the specific case facts. Spreadtrum had argued in the proceedings that the disputed Contract involves ArcSoft’s intellectual property held by ArcSoft in overseas therefore the underlying contract is foreign-related. Speadtrum had further argued that the scope of licensing stipulated in the Contract is the entire globe. Neither Hangzhou Court nor the SPC responded to these two arguments. Perhaps, if the courts reached a finding that the Contract deals with ArcSoft’s copyright to the licensed software and such copyright is registered in overseas, the courts may conclude that the subject matter of the Contract is in foreign countries and consequently they would hold that the Contract is foreign-related. With respect to identifying what “the legal facts that create, alter or terminate civil relations” are in the case, and whether such legal facts occurred in foreign jurisdictions, Hangzhou Court and the SPC did not give any explanation either.

The notion under the PRC law on prohibiting foreign arbitration for non-foreign-related matters is still controversial. However, it remains the prevailing attitude in practice which may result in refusal of recognition and enforcement of foreign arbitral awards. We look forward to further development on this issue in legislation and judicial practice in the PRC.

[1] The SPC’s ruling of ArcSoft v. Spreadtrum can be found here: https://wenshu.court.gov.cn/website/wenshu/181107ANFZ0BXSK4/index.html?docId=b0a3613dc00a4583b219ad5f0124cf9c

[2] The ruling of Chao Lai Xin Sheng v. Suo Wang Zhi Xin can be found here:

https://www.bjcourt.gov.cn/cpws/paperView.htm?id=00000000000000000000100200434922&n=1

[3] The ruling of (2018) Jing 04 Min-Te No.145 (Jing-Jin Electric v. SEMIKRON Electronics (Zhu Hai)) can be found here:

https://wenshu.court.gov.cn/website/wenshu/181107ANFZ0BXSK4/index.html?docId=4b53ae25136a4869aa3dab98000cbcbc

[4] The ruling of (2017)-Hu-72-Min-Te No.181 (Mekers v. Shanghai BESTWAY, Jiangsu Dajin) can be found here: https://wenshu.court.gov.cn/website/wenshu/181107ANFZ0BXSK4/index.html?docId=3bf1a11336f7478b863eaa7800f7b380