Do not lightly try the fifth “foreign element”

By Michael Wang, MHP Law Firm

To provide assurance for the development of the free trade zones, the Supreme People’s Court issued the Opinions on Providing Judicial Assurance for the Development of Free Trade Zones at the end of last year. The Opinions mention that, “if wholly foreign-owned enterprises (WFOEs) registered in free trade zones provide among themselves that commercial disputes are to be submitted for arbitration abroad, the relevant arbitration agreement shall not be found invalid solely on the grounds that the dispute has no foreign elements”.

Whether a contract has foreign elements is of major importance to whether the arbitration agreement is valid, to whether a foreign arbitration institution may be selected and to whether an arbitration award can be recognized and enforced by a Chinese court. What is of the greatest relevance to the Opinions is probably the case in which Siemens International Trading Limited, Shanghai applied for the recognition and enforcement of a foreign arbitration award.

In the case, Siemens and Golden Landmark entered into a contract and provided that contractual disputes be referred to the Singapore International Arbitration Centre for resolution by arbitration. After a dispute arose in the course of performance of the contract, the parties did go into arbitration in accordance with the contract. Pursuant to the final arbitration award, Golden Landmark bore a payment obligation towards Siemens, but it only partially performed the award.

王逸骏 MICHAEL WANG 君悦律师事务所律师 Associate MHP Law Firm
MHP Law Firm

Accordingly, Siemens submitted an application to the First Intermediate People’s Court of Shanghai Municipality for recognition and enforcement of the Singaporean award. In the course of the trial, Golden Landmark argued that there were no foreign elements in the case, and accordingly the relevant arbitration agreement was invalid. However, in its ruling the Shanghai court found that the case did have a foreign element, its main reasons being:

First, although both Siemens and Golden Landmark were Chinese legal persons, their place of registration was the Shanghai free trade zone, and they were both WFOEs. As the source of funds of such companies, the ultimate vesting of their interests and their business decision-making is generally intimately intertwined with their foreign investors, they, as compared with the typical wholly owned Chinese company, have a relatively clear foreign element.

Second, when performing the contract, the subject equipment was first transported from outside China to the free trade zone, where it was subject to bonded supervision. Further, pursuant to the contract, performance required the carrying out of customs clearance and duty payment procedures as appropriate and transfer from inside the zone to outside the zone, only at which point were the import procedures completed. Accordingly, the movement of the subject matter of the contract also had certain features of an international sale and purchase of goods. Accordingly, as the performance of the contract involved the application of special customs supervision measures of the zone, there was a relatively marked difference from disputes over the typical domestic sale and purchase contract.

The Shanghai court therefore found that the case had a foreign element pursuant to “another circumstance that can be found to be a foreign-related civil relationship” as specified in item (5) of Article 1 of the Judicial Interpretations for the Law on the Application of Foreign-Related Laws. However, the reply of the Supreme People’s Court reveals that the initial opinion of the Shanghai court was that neither the contracting entities, the place where the subject matter was located nor the place of performance of the contract in the case had a foreign element. The majority of the opinions of the Shanghai High Court likewise held that this case did not have a foreign element. However, the Supreme Court held that the case (1) was a free trade zone case; (2) the parties were WFOEs; and (3) the case had already been arbitrated by a foreign arbitration institution. Accordingly, it could be found that the fifth foreign element (other circumstances) in the Judicial Interpretations for the Law on the Application of Foreign-Related Laws applied.

The author argues that, in this case, the WFOEs are still Chinese legal persons, and, although the free trade zone is indeed a relatively particular area, it legally still falls within the territory of China. The author more strongly supports the opinion that there is no foreign element in this case. The Supreme Court’s opinion in its reply is more indicative of its inclination in terms of the weighing of values, i.e. supporting the try-first spirit in building the rule of law in the free trade zones.

Taking the foregoing case as the basis, and taking a second look at the Opinions, one can arrive at one of two understandings. First, the Supreme Court deems that there is in fact no foreign element in this case, but nevertheless resolutely supports the try first spirit in the development of the free trade zones.

Second, the Supreme Court does deem that there is a foreign element in the above mentioned case and, on this basis, it, with an even more liberal attitude, deems that even if it were a case without a foreign element, the relevant arbitration agreement should not be found invalid solely on this basis. More specifically, the Opinions specify, “if one or both parties is/are (a) foreign-invested enterprise(s), provide that commercial disputes are to be referred abroad for arbitration, after a dispute arises, the parties refer it for arbitration abroad, and after the relevant award is rendered, a party argues that recognition or enforcement be denied on the grounds that the arbitration agreement is invalid, the people’s court shall reject such argument; if the other party does not challenge the validity of the arbitration agreement during the arbitration procedure but, after the relevant award is rendered, claims that the arbitration agreement is invalid on the grounds that the relevant dispute does not have a foreign element and, on this basis, argues that recognition or enforcement be denied, the People’s Court shall reject such argument”.

Regardless of which of the above mentioned understandings one opts for, the Supreme Court holds an attitude of encouraging the fifth foreign element (other circumstances) in the above mentioned case. However, the author would argue that the above mentioned case and the Opinions are more a manifestation of the court making a choice in a weighing of values, and if looked at from strict legal perspective, it is not persuasive. On the other hand, China is not a case law country, and add to that the fact that there may be changes in the way values are weighed, accordingly, the author would still recommend that parties not lightly rely on the above mentioned case and Opinions in determining whether a foreign element exists.

Michael Wang is an associate at MHP Law Firm

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