A potential blind spot on the validity of arbitration agreements

By Michael Wang, Martin Hu & Partners
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In international commercial agreements, parties to a contract will usually specify the scope of jurisdiction of the arbitration agreement as being disputes “arising from, or in connection with, this contract”. On the surface, it would seem that this clause expands the scope of application to the greatest extent, covering all disputes that could arise in connection with the contract in the arbitration agreement. Foreign parties to a contract often ignore the question of whether this clause is achievable per Chinese law. This column will consider the issue.

American Superconductor vs Sinovel

In the software copyright infringement case Suzhou American Superconductor vs Sinovel Wind Group and Dalian Guotong Electric, American Superconductor took legal action in the Hainan Provincial No. 1 Intermediate People’s Court, demanding that the two companies bear liability for infringement. American Superconductor claimed that Sinovel and Guotong had illegally obtained and modified software code in which it had exclusive right of use. Further, it claimed that Sinovel and Guotong had reproduced, installed and used the modified software on turbines, infringing American Superconductor’s software copyright.

Michael Wang Associate Martin Hu & Partners
Michael Wang
Associate
Martin Hu & Partners

The contract between Sinovel and American Superconductor provided that, “any dispute arising from, or in connection with, the performance of this contract shall be resolved by the parties through amicable consultations. If a consensus cannot be achieved through consultation, formal arbitration of the dispute shall be carried out, with the dispute referred to the Beijing Arbitration Commission for resolution by arbitration pursuant to its arbitration rules”. On this basis, Sinovel filed an objection to the court’s jurisdiction, arguing that the case should be referred to arbitration.

The court at first instance held that Sinovel’s objection was tenable. It also held that a lawsuit for joint infringement was non-separable and should be consolidated and referred to arbitration for resolution. If the tribunal did not handle the issue of infringement by Guotong, the court stated, a separate legal action could be instituted in the court. The original judgment was upheld on appeal.

Dissatisfied with the ruling, American Superconductor requested a retrial. The Supreme People’s Court (SPC) found that the court had jurisdiction in the case because Sinovel’s acts of reproducing and modifying the software, as asserted by American Superconductor, were not covered in the procurement contract between American Superconductor and Sinovel. SPC held that the infringement was not a dispute arising in connection with the performance of the contract. Therefore, it said, it was not subject to the arbitration agreement. The SPC further stated that Guotong, as one of the necessary codefendants in the joint legal action, was not a party to the procurement contract and therefore was not bound by the arbitration clause.

Focal points

In general, a dispute arising from a breach of contract should be subject to the arbitration agreement where one exists. Two issues must be considered in disputes arising from infringement.

Is the agreement binding in infringement disputes? Yes, in disputes relating to non-foreign-related contracts. However, the American Superconductor case suggests that the infringement itself must be connected with the performance of the contract. If not, then the dispute is not subject to the arbitration agreement.

Section 7 of the Minutes of the Second National Symposium on the Adjudication of Foreign-related Commercial and Maritime Matters provides that, “if the valid arbitration agreement executed by parties to a foreign-related commercial contract provides that any dispute arising from, or in connection with, the contract shall be resolved through arbitration and the plaintiff institutes a legal action in a people’s court, on the grounds of infringement, in a dispute arising between the parties in the course of the execution or performance of the contract, the people’s court does not have jurisdiction”.

It can be seen that the SPC takes a positive attitude toward this, but requires that the contract and the infringement be related. In certain circumstances, determining this relationship can give rise to debate. Based on SPC’s ruling in the American Superconductor case, the author would argue that the relationship should be determined by whether the act that gave rise to the infringement is provided for in the contract. If it is not, the dispute is not subject to the arbitration agreement.

Is the agreement binding in joint infringement disputes? SPC held in the American Superconductor case that the legal action was a necessary joint legal action, and that Guotong was not a party to the procurement contract, and therefore was not subject to the arbitration agreement. Similarly, in the infringement damages case WP
International Group vs Jilin Songmei Acetic Acid and Jilin Chemical
, the court found that it had jurisdiction in the case on these grounds.

It is evident that necessary joint legal action cases will not be subject to the arbitration agreement if one party is not a party to the arbitration agreement, and the court will have the right to exercise jurisdiction over the case.

Conclusion

Parties can specify that any dispute arising from, or in connection with, the contract be resolved through arbitration. However, legal action is often beyond parties’ expectations in practice, and the arbitration agreement may not necessarily be achievable. In infringement disputes, the infringement must be related to the contract, failing which it will not be subject to the arbitration agreement. Where a necessary joint legal action is involved and one of the parties is not a party to the arbitration agreement, the court has the right to exercise jurisdiction.

The author would recommend that when a dispute arises in relation to a contract and the parties wish to go beyond the constraints of the arbitration agreement, they should seek to do so from the perspective of infringement. When the court reviews the arbitration agreement’s validity, it should give full consideration to all manner of factors, but not overly strictly. After all, the parties have no way of knowing what could happen in future.

Michael Wang is an associate of Martin Hu & Partners

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Martin Hu

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Michael Wang

E-mail: michael.wang@mhplawyer.com