Avoiding uncertainty over validity of arbitration clauses

By Michael Wang, Martin Hu & Partners
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Although there are certain differences across the world concerning the determination of the severability of arbitration clauses, a doctrine is widely accepted: while an arbitration clause forms part of the contract, it is separable from other terms of the contract, and must not be regarded as invalid because the contract is invalid. This doctrine is also included in PRC legislation. According to article 19 of the Arbitration Law, an arbitration clause must exist independently, and the amendment, rescission, termination or invalidity of a contract must not affect the validity of the arbitration clause. In foreign-related contract cases, the validity of a contract is determined on the basis of the law applicable to the contract, as agreed upon between the parties concerned.

So can we judge the validity of arbitration clauses that are separable from the contract on the basis of the law applicable to the contract?

PRC LAW AND PRACTICE

According to article 16 of the Supreme People’s Court (SPC) Interpretation concerning Some Issues on Application of the Arbitration Law, the examination of the validity of an arbitration clause that involves foreign interests must be governed by the laws agreed upon between the parties concerned. If the parties did not agree upon the applicable laws but have agreed upon the place of arbitration, the laws at the place of arbitration must apply. If they neither agreed upon the applicable laws nor upon the place of arbitration, or the place of arbitration is not clearly agreed upon, the laws at the locality of the court must apply.

MICHAEL WANG, Associate, Martin Hu & Partners
MICHAEL WANG
Associate
Martin Hu & Partners

So there is a certain sequence to apply the laws of a country to determine the validity of arbitration clauses, and party autonomy must take top priority, followed by the laws at the place of arbitration, and finally the laws at the locality of the court must apply. But it seems that the above-mentioned provisions do not expressly specify whether the applicable law of the contract agreed upon between the parties is also the governing law chosen by the parties concerning the validity of arbitration clauses.

In Rising Investment Development Limited v China Hi-Tech Wealth Group, Beijing Beida Jade Bird and Hong Kong Jade Bird Science and Technology – a dispute over the validity of arbitration clauses and jurisdiction – article 10 of their agreement on insurance of convertible bonds entered into by related parties provides: “Any dispute arising from the performance of the agreement shall be resolved properly by amicable consultation, failing which either party may submit the dispute for arbitration. This agreement shall be governed by the applicable laws of the Hong Kong Special Administrative Region of the People’s Republic of China.”

In this regard the SPC held that, according to article 16 of its interpretation, the parties may agree upon the applicable laws to determine the validity of arbitration clauses in the agreement, but this kind of agreement should be expressly agreed upon. The governing law agreed upon to solve the dispute under the contract cannot be used to determine the validity of foreign-related arbitration clauses. In the above-mentioned case, the expression “the agreement shall be governed by Hong Kong laws” cannot be regarded as an agreement on the governing law of the validity of the arbitration clause. Since the parties neither agreed upon the applicable laws nor the place of arbitration in the agreement, the SPC found that the arbitration agreement was invalid under PRC law.

In the dispute on jurisdiction between Singapore Lianhe Resource and Rizhao Zhongrui Native Produce, it was specified in their contract: “Any dispute or claim arising from this contract shall be resolved by amicable consultation, failing which either party may submit the dispute for arbitration in Hong Kong. The dispute or the claim must be finally resolved in accordance with the then effective arbitration rules of Hong Kong International Arbitration Centre, and such rules are incorporated herein by reference as if fully set forth herein. The language of arbitration is English … The applicable law shall be the Laws of England.”

The court held that this arbitration clause did not expressly agree upon the governing law of the validity of the arbitration clause, and ultimately judged the validity of the arbitration clause in accordance with laws at the place of arbitration – Hong Kong.

So, the courts clearly hold that the governing law for validity of the arbitration clause and the applicable law to resolve the dispute is not necessarily the same, and needs to be distinguished. In the contract, such statements as “the applicable law of this contract shall be the laws of [a certain country]” cannot be deemed as the choice of the governing law of the validity of arbitration clause.

DRAFTING THE CLAUSES

The courts surely distinguish the applicable law to the contract and the governing law of the validity of the arbitration clause, but few parties in practice agree upon the governing law of the validity of the arbitration clause during the drafting process of foreign-related contracts – probably because both parties do not attach importance to the arbitration clause. As an important clause for resolving future disputes, not only the lawyers but also the parties should treat governing law of the validity of the arbitration clause carefully.

More and more parties in cross-border business activities will choose arbitration to resolve disputes. When the parties do not agree upon the applicable laws by which the validity of the arbitration clause must be governed, and select China as the place of arbitration, invalidity of the arbitration clause seldom occurs due to non-compliance with the Arbitration Law and its relevant provisions, as lawyers are relatively familiar with PRC law. However, since the parties may not choose China as the place of arbitration in many cases, the lawyers should examine and ensure the validity of an arbitration clause under the law of the place of arbitration, and make sure the parties are able to resolve disputes through arbitration. To this end, lawyers may seek help from local lawyers or experts at the place of arbitration.

To avoid the uncertainty of the validity of arbitration clauses, the author recommends that the parties should specify relevant governing laws when drafting the arbitration clause. Lawyers should also study the requirement of that governing law of the arbitration clause more carefully to ensure the validity of the arbitration clause.

Michael Wang is an associate at Martin Hu & Partners

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