Breakthrough for identifying foreign-related elements in contracts

According to the Law on Choice of Law for Foreign-related Civil Relationships, the parties of a contract can choose the applicable law only when the contract contains foreign elements. At the samed im time, according to China’s current judicial practice, the parties may agree to resolve the dispute through a foreign arbitration centre when the contract contains foreign elements.

Otherwise, a people’s court is likely to consider the ruling of a foreign arbitration centre invalid, or refuse to recognize the terms made by foreign arbitration institutions because the contract concerned does not contain foreign elements.

Therefore, parties of the concerned contract when choosing the relevant law and arbitration institution should first consider whether the contract has foreign elements.

Identifying foreign elements

What qualify as foreign elements? According to the first clause in the Interpretations of the Supreme People’s Court on Several Issues Concerning Application of the Law of the People’s Republic of China on Choice of Law for Foreign-Related Civil Relationships (I), the foreign elements of a contract often hold when: (1) one or both parties of the contract are foreign citizens, foreign legal persons or organizations; (2) one or both of the related parties often reside outside the PRC; (3) the subject of matter is outside the PRC; (4) the establishment, execution or termination of the contract happen outside the PRC; and (5) the court identifies the case as foreign in other circumstances.

Although the law provides that the people’s court can determine foreign elements according to the situations of the case, the court usually takes into consideration the nationality and residence of the contract parties, location of the subject of matter and the place of establishing and executing the contract when it identifies foreign elements. However, based on the court’s judicial practice, it never uses its discretion to identify the foreign elements based on the characteristics of the subject matter or the type of enterprises in its consideration.

Ningbo Xinhui case

This unused right of discretion has reached a breakthrough in the case of the Beijing Fourth Intermediate People’s Court in Ningbo Xinhui International Trade v Maxpharm Trade Development and Shanghai First Intermediate People’s Court in Siemens international Trading (Shanghai) v Shanghai Golden Landmark for the recognition and enforcement of foreign arbitral awards.

In the case of Ningbo Xinhui, both of the disputed parties are domestic enterprises and the subject of matter is in Shanghai Free Trade Zone.

Both sides agreed to execute the contract by delivering the product in the Shanghai Free Trade Zone whereby one party claimed that the arbitral tribunal had falsely identified the case as a foreign arbitration case in the absence of foreign elements, and therefore asked to disregard the ruling of the arbitration by the court.

However, through investigation, the court claimed that the subject of matter should be considered goods pending clearance in the Shanghai Free Trade Zone.

According to the rules of the Customs, all goods pending clearance in the Free Trade Zone should be considered as foreign goods. Therefore, the Ningbo Xinhui case involved foreign elements, and should be considered as a foreign arbitration case.

Golden Landmark case

The Golden Landmark case reached further breakthrough in identifying foreign elements.

In this case, the court identified foreign elements based on the characteristics of the parties and the execution of contracts.

The court believed that although the related parties are both Chinese legal persons, the registered addresses of both parties are in the Shanghai Free Trade Zone, and the related parties are both foreign solely owned enterprises.

As in the usual cases, because the source of the capital, the final beneficiary and the operations of the foreign solely owned enterprises all have a close relationship with foreign investors, the parties involved in this contract compared to the usual domestic enterprises obviously contain foreign elements.

At the same time, although the subject of matter was finally delivered within the border, from the perspective in establishing and executing the contract the subject of matter first moved from outside China to the Shanghai Free Trade Zone for bonded supervision, and underwent customs and clearance procedures accordingly in compliance with the contract terms, and was transported from inside to outside the zone to finish the importation process of goods.

This contract involves the application of special supervisory of customs in the Free Trade Zone, and differs significantly from the domestic buy-sell contracts. This characteristic made the execution of the case involve foreign elements. Considering that both characteristics of the parties and the execution of contracts involved foreign elements, the court finally identified the Golden Landmark case as a foreign arbitration case.

Analysis of the breakthrough

The Ningbo Xinhui case and the Golden Landmark case finally broke the longstanding judicial practice in identifying foreign elements, which no longer equate foreign elements with foreign civil law, foreign subject of matter, or the establishment and execution of foreign contracts.

After the Golden Landmark case, in a scenario where both related parties of a contract are domestic enterprises, the related parties may choose the relevant laws and select domestic or foreign arbitration centres for resolving disputes according to these elements: the type of enterprises and their registered addresses; the source of the capital; the final beneficiary; the operations of the enterprises and their relationship with foreign investors; the workflow of the subject of matter; whether the execution of the contract involves export-import procedures; and whether the execution of the contract involves Customs in identifying foreign elements.