(By Zhu Weidong) 

The Evolution of the conflicts rules of arbitration agreements in China can be divided into three stages: Before the “Interpretation 2006” was issued by the Supreme People’s Court, when designating the applicable law of the arbitration agreement the Chinese courts followed the judicial practices developed for a long time; the “Interpretation 2006” provides clear guidelines for the courts to assign the law applicable to the arbitration agreement, but the rigidity of the conflicts rules in the “Interpretation 2006” often results in the arbitration agreements being held invalid because in most if not all the cases the Chinese law will be determined as the lex causae of the arbitration agreements, greatly frustrating the parties expectation to have their disputes settled through arbitration; the newly promulgated Law on the Application of Laws to the Foreign-Related Civil Matters (CPIL) contains a set of specific conflict rules of arbitration agreement, but such a provision is no but the old wine in the new bottle, causing more uncertainty and even contradictory results. The author analyzes the main approaches adopted in other jurisdictions in determining the validity of arbitration agreements and proposes the possible reform in Arbitration Law in China. 

I. Introduction

Arbitration agreements play a significant role throughout the arbitration process. The validity of an arbitration agreement can be directly determinative with regard to the arbitral tribunal’s jurisdiction, the circumstances in which the arbitral award can be challenged, as well as with regard to matters of recognition and enforcement. In most cases, the validity of an arbitration agreement is determined by reference to the applicable law designated by the conflict rules. This article first considers the historical development of the conflict rules of arbitration agreements, then analyses the current situation and particular problems that China faces in this area of private international law. Finally, we propose a possible reform to improve the choice of law of arbitration agreements in China, which is premised on an examination of the legislation and practice of other countries and regions.

II. Development of the Conflict Rules of Arbitration Agreements in China prior to the “Interpretation 2006”

According to the doctrine of separability, an arbitration agreement is independent and autonomous from the main contract, and thus has its own applicable law to determine its validity and effectiveness. The Arbitration Law of the People’s Republic of China (“CAL”), effective as of September 1, 1995, incorporated such a doctrine, however it did not make any explicit provision with regard to the applicable law. In early cases, the People’s Court simply applied Chinese law (lex fori) to determine the validity of a foreign-related arbitration agreement; in consequence, many arbitration agreements were held invalid under the strict requirements of the CAL. According to Art.16 of the CAL, an arbitration agreement shall include: the expression of the intention to arbitrate, the subject matter to be arbitrated, and the arbitral institution designated by the parties. Otherwise, the arbitration agreement will be held invalid by the People’s Court. In most arbitration laws in other jurisdictions, there is no requirement for the designation of an arbitral institution for the arbitration agreement to be valid. In the 1995 case of Novo Nordisk, for example, the contract between the parties included the following arbitration clause:

    “All disputes arising out of or connected with the contract shall be settled through arbitration according to the ICC rules in effect at the time of applying for arbitration. Arbitration shall proceed in London. The arbitral award is final and binding for both parties.”

The High People’s Court (“HPC”) of Hainan Province determined that the arbitration clause was invalid according to the CAL, and proceeded to report the case to the Supreme People’s Court (“SPC”), pursuant to the pre-reporting system. 3The SPC, in its 1996 Reply, confirmed the decision of the HPC of Hainan Province that the arbitration agreement was invalid due to its failure to designate an arbitral institution, notwithstanding that the agreement met the other CAL requirements since it stipulated an express intention to arbitrate, the subject matter, the seat of arbitration and the applicable arbitration rules. It is clear that the SPC based its Reply directly on the provisions of Art. 16 of the CAL, without considering any choice of law of the arbitration agreement in question.

Fortunately, the SPC shifted its attitude in 1999 in its Reply to the Report from the HPC of Hubei Province as to the validity of the arbitration agreement in Mitsubishi Commercial Ltd. ( Hong Kong) v Three Gorges Investment Ltd. In this case, the parties had stipulated in their contract that any disputes should be arbitrated in Hong Kong under the ICC rules; since this arbitral clause was valid pursuant to the Hong Kong law, the SPC held that it was valid and capable of being performed.4 However, the SPC failed to develop a conclusive set of choice of law rules of arbitration agreements in this case, and in subsequent Replies to the different HPC’s concerning the validity of arbitration agreements, it continued to make decisions in accordance with the CAL.

The situation changed in the SPC’s Reply of July 16, 2002, regarding the validity of the arbitration agreement in Hong Kong Yunwei Shipping Agency Ltd. v Shenzhen Tea Import and Export Company. The SPC made it clear in this Reply that the law applicable to the validity of an arbitration agreement shall be the law chosen by the parties. In the absence of such a choice by the parties, the law of the seat of arbitration (lex arbitrii ) shall apply; where there is neither choice of law nor an agreed seat of arbitration, or where the seat of arbitration is unclear, the lex fori (i.e. the Chinese law) shall apply. This practice was confirmed by the Second National Meeting on Foreign-Related Civil and Commercial Trials, held in China in November 2005, being recorded in the meeting minutes, which were subsequently sent to the Peoples Courts competent to hear foreign-related cases, for reference purposes. The SPC’s subsequent Interpretation on the Application of the CAL, which came into effect on September 8, 2006, (“Interpretation 2006”), completely adopted such a practice, although there are some slight differences in the wording of the Interpretation 2006 as compared to that recorded in the meeting minutes.

III. The Conflict Rules of Arbitration Agreements Contained in “Interpretation 2006” and the Problems therein

The choice of law rule contained in the Interpretation 2006 is essentially consistent with Art. V(1)(a) of the 1958 New York Convention,6 to which China became party in 1986. Article 16 of the Interpretation 2006 provided that the validity of a foreign-related arbitration agreement shall be governed by the law chosen by the parties; in case the parties made no such choice but stipulated the seat of arbitration, then the lex arbitrii shall apply; in case the parties chose neither the applicable law nor the seat of arbitration, or the seat of arbitration was difficulty to identify, then the lex fori shall apply. Generally, courts in China will follow such a rule in determining the validity of arbitration agreements, although some courts have deviated from this practice at times. The question arises, however, whether recourse to the lex fori (i.e. the Chinese law in general and the CAL in particular) is appropriate in cases where there is no choice of law or as to the seat of arbitration, or where the seat of arbitration is uncertain, given that most, if not all, defective arbitration agreements will be held invalid under the strict requirements of Art. 16 of the CAL.

A. Where the parties have chosen the law to govern their arbitration agreement

Notwithstanding the rarity of the occurrence in practice, where the parties have chosen the law to govern their arbitration agreement, the People’s Court will respect that choice and decide the validity of the agreement according to that law. The parties can make such a choice at the conclusion of the arbitration agreement, or alternatively at any time before the end of the first oral hearing in the People’s Court. Thus, for example, in Nantong Gangzha Shipbuilding Factory (China) v IHDA Shipbuilding Service B. V. (Netherlands), the parties stipulated in their arbitration agreement that “this contract and all other agreements relating hereto shall be construed and interpreted in accordance with Dutch law”. The People’s Court ruled the arbitration agreement valid according to Dutch law and dismissed the plaintiff’s action, notwithstanding that the arbitration agreement provided for ad hoc arbitration in the Netherlands, which is not allowed under the CAL.

In another case, the parties provided in their contract that any disputes occurring in performance of the contract should be settled through amicable consultation; where such consultation failed, the dispute was to be submitted to the relevant arbitral institution in the Macao Special Administrative Region (“Macao SAR”) for arbitration according to that institution’s arbitration rules. The parties did not provide the law applicable to the arbitration agreement. When a dispute arose regarding validity, one of the parties applied to the People’s Court for a declaration denying same, and both parties agreed that the law of Macao SAR should apply in determining the issue. In its Reply to the Report from the HPC of Sichuan Province about the case, the SPC confirmed the validity of the arbitration agreement according to the law of Macao SAR.

B. Where the parties have not chosen the law but have specified the seat of arbitration where the parties have made no choice about the law applicable to their arbitration agreement but have specified the seat of arbitration, the People’s Court will apply the law of the seat of arbitration to determine the validity of the arbitration agreement. In most cases that the author has reviewed, the People’s Court followed such a rule, however in a few exceptional cases the court showed some hesitance or even deviated from this tendency, particularly in cases decided before the conflict of law rule was adopted in the Interpretation 2006.

In Jiangmen Huaeren Glass Ltd. v Stanyin Huote Company , for example,10 the parties stipulated in their contract that:

   “Any dispute under or arising from the contract which can not be resolved by amicable consultation shall be settled through arbitration. The arbitration shall proceed in accordance with the ICC rules. The arbitrators shall take into account all the relevant facts and circumstances and make the arbitral award according to the terms of the contract. If the arbitrators can not settle the dispute according to the contract, they can apply the relevant Swiss laws. The arbitration shall take place in Geneva (Switzerland). The arbitral award shall be final and binding on both parties.”

The plaintiff subsequently brought an action base on product liability in the Intermediate People’s Court (“IPC”) of Jiangmen, and the defendant challenged the courts jurisdiction on the ground that there was a valid arbitration agreement between the parties.

The IPC of Jiangmen held the arbitration agreement invalid pursuant to the CAL, without analysing the choice of law problem. The IPC of Jiangmen then reported the case to the HPC of Guangdong Province for confirmation. In its report to the SPC, the HPC of Guangdong Province submitted that in its scholarly opinion, notwithstanding that in countries such as England and Switzerland the validity of an arbitration agreement for which the parties have made no choice as to the governing law is determined according to the lex arbitrii , the HPC was nevertheless inclined to apply the lex fori (i.e. the Chinese law) to determine validity, which it regarded as a procedural matter, notwithstanding that the seat of arbitration was in Switzerland. In addition, the HPC noted the practical difficulties of applying the Swiss laws and the necessary prejudice of Chinas judicial sovereignty if the arbitration was to occur in Switzerland.

In its Reply to the said Report, the SPC dismissed the views of the HPC, asserting that it is a long-established practice and principle in China that the lex arbitrii shall govern the validity of an arbitration agreement where the parties fail to choose the law to govern that agreement. The SPC asserted that this principle is more than a mere scholarly opinion, and that the lower People’s Courts must comply with same. The SPC reasoned that it would be inappropriate to deny the application of foreign law simply on the grounds of practical difficulties in proving the foreign law; and that a valid arbitration agreement will oust the court’s jurisdiction without prejudicing judicial sovereignty. Thus, the SPC found that in this case, the lex arbitrii (the Swiss laws) and not the Chinese law should determine the validity of the arbitration agreement.

In another similar case, the parties provided in their sales contract that all disputes in the performance of the contract should be settled through amicable consultation, failing which they should be submitted to a third country for arbitration. There was no choice of law or choice as to the seat of arbitration, therefore, the People’s Court applied the Chinese law, and in doing so found the arbitral clause invalid.13 Under such a practice, it is straightforward for the People’s Court to determine the law and applying the lex fori , nevertheless, parties must face the fact that their expectations with regard to arbitration will be frustrated by any negligence or carelessness they exhibited in drafting the arbitration agreement.

If the seat of arbitration is in China, it is straightforward for the People’s Court to apply the law, however if the seat of arbitration is in another country, there is the practical difficulty of proving the foreign law. If the foreign law cannot be proved conclusively, it is still possible for the People’s Court to make reference to the Chinese law.14 This allowance will, to some extent, increase the possibility of the application of the lex fori; considering that under the strict provisions concerning the validity of arbitration agreements in the CAL, most defective arbitration agreements will be held invalid, this may damage the parties’ legitimate expectation to settle their disputes through arbitration.

C. Where the parties have neither chosen the law nor specified the seat of arbitration

The question of which law applies to an arbitration agreement can be “even more complicated when the parties have not chosen a seat of arbitration or a governing law”. However, guidance can be found in the conflict rule in the Interpretation 2006, under which the People’s Court will directly apply the lex fori (the Chinese law, especially the notorious Art. 16 of the CAL) in such a circumstance.

In Davis-Standard Corporation v Ningbo Xiecheng Electric Wire Ltd., for example, the parties provided the following arbitration clause in their contract:

“All disputes relating to the contract or occurring during the performance of the contract shall be settled by amicable consultation. In failure of this, all disputes shall be submitted for arbitration. The arbitration shall proceed in a neutral state which should be a WTO member agreed upon by both parties. The losing party shall bear the arbitration costs.”

However, the parties did not stipulate the governing law of the arbitral clause, nor the seat of arbitration. The People’s Court ruled that the lex fori should apply, and accordingly it found the arbitral clause invalid under Art. 16 of the CAL.16 Under such a practice, the People’s Court will again have no difficulty in determining the law and applying the lex fori; nevertheless, the parties will again have to face the fact that their expectations with regard to arbitration may be frustrated as a result of their own negligence or carelessness in drafting the arbitration agreement.

The question of the validity of an arbitration agreement typically arises in three situations: at the beginning of the proceeding, where one of the parties resists arbitration; at the stage of setting aside; and at the stage of enforcement. The conflict rule in the New York Convention will only come to play at the enforcement stage and in the enforcing jurisdiction, however some other national17 and international18 legislation adopt similar conflict rules to determine the validity of an arbitration agreement at the beginning of the proceeding or at the setting aside stage. If national courts adopt the same conflict rule as contained in the New York Convention, the arbitral award will not be denied recognition and enforcement at the enforcement stage.

We must note that under such a regime the seat of arbitration may be determined with absolute certainty at the enforcement stage; it will therefore be easy to ascertain the lex arbitrii, even in the absence of a choice made by the parties. However, at the beginning of the proceeding, where one of the parties resists arbitration, the seat of arbitration is often uncertain or the parties may have failed to specify it at all. In such a circumstance, we must question whether it is desirable for the People’s Court to resort to the lex fori (the Chinese law), under which we have demonstrated that many of the defective arbitration agreements will be found invalid.

In addition, recourse to the lex fori will unavoidably increase the risk of forum shopping by prospective defendants seeking to avoid arbitration by litigating before the national courts which will be most likely to hold invalidity of an arbitration agreement based on its lex fori. In fact, when a dispute arises, the Chinese party of an international transaction often brings action in the People’s Court, irrespective of the terms of the arbitration agreement, and indeed most ‘pathological’ arbitration agreements are ruled invalid under the current mechanism.

IV. The Current Conflict Rules of Arbitration Agreements in the New CPIL: the Old Wine in the New Bottle

On October 28, 2010, the 17th Session of the eleventh Standing Committee of the National People’s Congress adopted the The Law on the Application of Laws to Foreign Related Civil Matters (CPIL) which came into effect on April 1, 2011. Article 18 of the newly promulgated CPIL provides the choice of law rules of the arbitration agreements, which simply reads:“The parties may choose the law applicable to their arbitration agreement by agreement. Where there is no such choice, the law of the place where the arbitral institution locates or the law of the seat of arbitration shall apply”. This provision in the new act is nothing but the old wine in the new bottle. It adds some puzzlements instead of providing a clear guidance to the past practice in China. Pursuant to article 18 of the CPIL, the parties to a dispute can choose the law applicable to their arbitration agreement; absent such choice, the lex arbitrii or the law of the place where the arbitration institutions locate may apply. If the parties have chosen the applicable law of their arbitration agreements, the situation is just the same as that under the Interpretation 2006; the parties’ choice will be respected and the validity of the arbitration agreement will be determined according to the chosen law.

The reality is that in most cases the parties or even the lawyers often forget to or may not think of designating a law to their arbitration agreements and they can not be expected to have this in mind in concluding or drafting the clauses of their contracts soon in future. Different from the subsidiary connecting factors in the Interpretation 2006, article 18 of the CPIL adopted the alternative connecting factors. The legislators perhaps intend to bring flexibility to the choice of law of arbitration agreements, nevertheless, the alternative connecting factors in the new act will cause more uncertainty.

Where the parties do not choose the applicable law but stipulate the seat of the arbitration or the arbitration institution, then the validity of the arbitration agreement will be determined according to the lex arbitrii or the law of the place where the arbitration institution locates. Judging from the above analysis, to keep their arbitration agreements valid, the parties had better choose the lex causae other than the Chinese law or a seat of arbitration outside Mainland China. Another situation will arise under the new act, namely, the parties stipulate both the seat of arbitration and the arbitral institution in their agreements. For example, the parties provided in their contract that the disputes arising therefrom should be arbitrated by the CIETAC in France. If the arbitration laws in China and France contain contrary provisions on the validity of the arbitration agreement and the dispute concerning the validity of the arbitration agreement was put forward in a Chinese court, then what will the Chinese court do? If the legislators intend that the law which makes the arbitration agreement valid shall apply, they had better make it clear.

Perhaps the legislators realized that reference to the lex fori in the Interpretation 2006 often causes the arbitration agreements invalid, therefore, the lex fori as the last resort for determining the validity of the arbitration agreements was omitted in article 18 of the CPIL. But the question still arises: if the parties do not choose the applicable law, neither do they stipulate the seat of arbitration nor the arbitration institution, then which law will the court apply in such a situation? It may be argued that in such a case the law applicable to the arbitration agreements should be the law which has the closest relationship with the arbitration agreements in terms of article 2 of the CPIL. But the question follows: how is the most closest relationship determined in such a situation? So far, such questions have not appeared under the new act. Definitely, these above questions need the judicial interpretation in the future.

V. Possible Reform of the Current Conflict Rules of Article 18 under CPIL in China

There are two main approaches to determining the validity of an arbitration agreement: (i) the conflict rule approach, whereby the governing law of the arbitration agreement is determined according the conflict of law rules of the lex fori; and (ii) the substantive rule approach, whereby the validity of the arbitration agreement depends exclusively upon the substantive rules, and not upon any applicable national laws.

Of the countries taking the conflict rule approach, only Switzerland and Sweden have explicit conflict rules in their statutes; other countries such as Germany, England, Belgium, and Italy have developed such rules through case law. With the exception of Switzerland, such countries have essentially adopted conflict rules similar to those in the New York Convention. Switzerland, however, in Art. 178 (2) of its Private International Law establishes a conflict law rule in favorem validitatis, providing that the arbitration agreement is materially valid if it is valid under either the law chosen by the parties, the law governing the main contract, or under Swiss law.

Contrary to the conflict rule approach, since the Dalico case in the early 1990s, the French courts have adopted a substantive rule approach. Under such an approach, the validity of the arbitration agreement is determined solely according to the intent of the parties, rather than by reference to provisions of any national laws. The newly revised French Arbitration Law of 13 January, 2011 consolidated such a position, it even stipulates that arbitration agreements in international arbitration are not subject to any mandatory formal requirements, which is contrary to the solution contained in the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards of 1958. This same method was explicitly enacted in the Uniform Arbitration Act of OHADA in 1999. This type of “intent of the parties” test, as one writer observed, “would probably be easier to apply, and no less likely to meet the parties ’ expectations”.

It is clear that the different approaches adopted in Switzerland, France and by OHADA all protect the parties’ legitimate expectation to submit their disputes to arbitration, however given that they depart from the conflict of law rule in the New York Convention, the danger exists of “contradictory judgments and difficulties at the enforcement stage”. On the other hand, each of these approaches confers a large degree of discretion on the judiciary; such discretion could conceivably be abused in China considering the respective level of knowledge and relative in experience of the Chinese judiciary in this regard.

On this premise, the author proposes that the conflict rules of the arbitration agreement in China should be kept consistent with that in the New York Convention. Due to the contradictions and loopholes that the conflict rules contained in article 18 of the CPIL may cause, the author suggest that the conflicts rules in Interpretation 2006 should be remained in the CPIL, however that the lex fori should be restricted in China. In other words, article 18 of the CPIL may be amended in future as the following: the law governing the arbitration agreement should be the law chosen by the parties, and in the absence of such a choice, the law of the seat of arbitration; in the event that the parties neither choose the law nor specify the seat of arbitration, the law applicable to the underlying contract or the lex fori may apply, whichever is favorable to the validity of the arbitration agreement. The proposed amendment aims at restricting the widely application of the lex fori to determine the validity of arbitration agreements in the Chinese judicial practice, which may result in contradictory judgments. According to the Interpretation 2006, the IPC at the place where the arbitral institution is located, or where the arbitration agreement is concluded, or where the plaintiff or the defendant has his domicile, is competent to hear a case involving the validity of an arbitration agreement. If one of the parties brings the merits of a dispute directly to the People’s Court irrespective of the arbitration agreement, and the other party challenges the court’s jurisdiction based on the arbitration agreement, there will be more People’s Courts competent to decide the validity of the arbitration agreement. Obviously, in most cases, the People’s Court deciding the matter will have no direct connection with the arbitration, unless it is the court of the seat of arbitration. If the parties choose neither the governing law nor the seat of arbitration, or where the seat of arbitration is uncertain, the court will apply the lex fori, and in such a circumstance contradictory judgments are likely to arise.

Of course, in the event that the CAL is revised in the future such that it is not longer necessary that parties designate an arbitral institution in the arbitration agreement in order for it to be valid, (i.e. such that an arbitration agreement will be valid provided that it includes only the parties intent to arbitrate and the subject matter to be arbitrated), then it will no longer be necessary to restrict the application of the lex fori in China.

(Edited by: China West Lawyer)