Lawsuits of subrogation and arbitration agreements in China

By Craig Zhou, MHP Law Firm
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Article 73 of the Contract Law and articles 11 and 14 of the Interpretation of the Supreme People’s Court on the Application of the Contract Law I stipulate the circumstances and conditions under which the obligee may initiate a lawsuit of subrogation. Article 18 of interpretation I stipulates that the secondary obligor has the right to protest. However, in practice, there are still debates on whether the secondary obligor may protest against the subrogation right of the obligee in the lawsuit on the ground of the arbitration agreement entered into by the secondary obligor and the obligator.

周富胜 CRAIG ZHOU 君悦律师事务所律师 Associate MHP Law Firm
周富胜
CRAIG ZHOU
君悦律师事务所律师
Associate
MHP Law Firm

The Civil Trial Chamber II of the Supreme People’s Court set out in its Guidance to the Commercial Trial (4th edition, 2013) that “the exercise of the subrogation right must be by the way of litigation and under the jurisdiction of the court of the defendant’s domicile. The agreement on arbitration between the obligator and the secondary obligator is the dispute resolution determined by the negations of both parties, which has the effect of exclusion of the court jurisdiction.

“However, the obligee is not a party to the agreement on arbitration, and therefore must not be subject to that arbitral jurisdiction, and the secondary obligator may not raise, on the ground of arbitral jurisdiction, an objection to the jurisdiction of the suit of subrogation initiated by the obligee.”

Meanwhile, Shanghai High People’s Court upheld, in a civil ruling over a related case on 20 March 2017, the objection to court jurisdiction by the secondary obligator on the ground of arbitration agreement between the secondary obligator and the primary obligator, and rejected the suit brought by the obligee.

LEGAL GROUNDS

In the first place, article 14 of Interpretation I stipulates that, “where an obligee brings a suit of subrogation pursuant to article 73 of the Contract Law, jurisdiction must vest in the People’s Court in the place where the defendant is domiciled.” Literally, the right of subrogation must be exercised by the obligee by way of lawsuit, and under the jurisdiction of the court of the defendant, i.e., the secondary obligator’s domicile.

In the author’s opinion, there are two reasons for this article to only mention the way of “suit”: (1) under common circumstances, the obligee only has knowledge of the obligation owed by the secondary obligator to the obligator, and has no knowledge of other agreements (including the agreement on the dispute resolution) between the secondary obligator and the obligator; and (2) the obligee is not a party to the arbitration agreement, therefore, in light of the principle of voluntary arbitration by the parties provided in the Arbitration Law, must not be bound by the arbitration agreement. Therefore, the judicial applicable way to exercise the right of subrogation by the obligee is only by bringing a suit, rather than by arbitration.

Secondly, article 18 of Interpretation I provides that “in a suit of subrogation, the secondary obligator may raise challenges in respect of the obligor against the obligee.” This article does not specify whether the challenges by the secondary obligator can include those against the procedural methods of dispute resolution, hence causing the debate on whether the secondary obligator may challenge the suit of subrogation by the obligee on the ground of arbitration agreement between the secondary obligator and the obligator.

In the author’s opinion, this complicated issue can be made clear as follows: since article 14 of Interpretation I has stipulated the way of exercising subrogation right by the obligee, and indicated the competent court under which the suit of subrogation must be brought by the obligee, which has solved the problem of procedure of the suit of subrogation, the secondary obligator must exercise the subrogation right under the jurisdiction of a local court, which must not again involve the matter of procedure.

Therefore, the Contract Law and its Interpretation, the Arbitration Law, and the opinion of the Supreme People’s Court, actually all exclude the right of the secondary obligator to protest against the suit of subrogation by the obligee on the ground of arbitration agreement.

EXCEPTIONAL CIRCUMSTANCES

As China is not a case law country, and there are cases with different backgrounds in judicial practice, the court must, under the premise of adherence to the legal principle, be allowed to deal with the case respectively in light of its detailed circumstances.

With respect to the above-mentioned jurisdiction objection case handled by the Shanghai High People’s Court, despite the opinion held by the court in the civil ruling that “the secondary obligator may raise protests in respect of the obligor against the obligee. Such protests include not only those raised on the basis of substantive law but also procedure law” is debatable, the court found out at the same time the fact that the obligee had, at the time of entering the negotiation memo with the obligator, knowledge of the arbitration agreement between the obligator and the secondary obligator, and that the obligee and the obligator had an associated relationship.

The author assumes that there may be the agreement by the obligee and the obligator on avoidance, by the suit of subrogation by the obligee, of the arbitral jurisdiction agreement between the obligator and the secondary obligator, which therefore infringed the legal rights of the secondary obligator.

The purpose of the suit of subrogation by the obligee is with respect to the circumstance that the obligator neither performs the due obligation nor claims, by suit or by arbitration, its due monetary creditor’s right against its obligator, which results in the failure in payment of the debt. Under this circumstance, the obligator’s non-performance is sustained and the legal rights of the obligee are infringed.

Where, occasionally, the obligator maliciously colludes with the obligee and infringes with intention the secondary obligator’s legal right of protest (as to the substantive law as well as the procedure law) while performing its obligation, such legal right of protest of the secondary obligator must be upheld by the court.

The detailed consideration may include whether there is an associated relationship between the obligee and the obligator, and the closeness of such a relationship, whether there is false debt between the obligee and the obligator, whether the obligee has knowledge of the arbitration agreement between the obligator and the secondary obligator, and whether the obligator actively exercises its right to object over the debt.

Craig Zhou is an associate at MHP Law Firm

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