Whether overseas arbitration institutions could govern the contract disputes between two domestic foreign-funded companies?

Company A, a US funded enterprise in Jiangsu, and Company B, a Japanese funded enterprise in Shanghai, have signed a sales contract, in which stipulates that in the event of a dispute, either party may submit it to an arbitration institution in Hong Kong for arbitration. Is this agreement valid?

A typical viewpoint is that one of the basic principles of civil laws is the “autonomy of will”, and such agreements should be valid. In fact, such viewpoint is incorrect. The attitude of the Supreme People’s Court is very clear. In Article 83 of the “Answers to Practical Issues in Foreign Commercial Maritime Trials”, it is stated that “the law does not allow domestic parties to submit disputes that do not have foreign-related factors to foreign arbitration institutions. Therefore, if domestic parties submit contracts or property rights disputes that do not have foreign-related factors to foreign arbitration institutions for arbitration or conduct temporary arbitration in foreign countries, the people’s court should determine that the relevant arbitration agreement is invalid.”. At the same time, the Supreme People’s Court also expressed this view in the “Response to the application of Beijing Chao Lai Xin Sheng Sports and Leisure Co., Ltd. for recognition of the arbitration award cases No. 12113-0011 and No. 12112-0012 made by the Korean Commercial Arbitration Court”. Therefore, if the relevant dispute does not belong to a foreign-related civil relationship, the agreement under the jurisdiction of the overseas arbitration institution is invalid.

The determination on foreign-related civil relationship is mainly based on Article 1 of the “Interpretation of the Supreme People’s Court on Several Issues Concerning the Application of the Law of the People’s Republic of China on the Application of Foreign Related Civil Relations”. This Article prescribes that, “If a civil relationship falls under any of the following circumstances, the people’s court may determine it as a foreign-related civil relationship: (1) one or both parties concerned are foreign citizens, foreign legal persons or other organizations, or stateless persons; (2) the habitual residence of one or both parties concerned is outside the territory of the People’s Republic of China; (3) the subject matter is outside the territory of the People’s Republic of China; (4) the legal facts that create, change, or eliminate the civil relationship occur outside the territory of the People’s Republic of China; (5) other circumstances that can be determined as foreign-related civil relationships.”

The determination regarding (1), (2), and (4) above are clear. For example, the two companies concerned in the case at the beginning of the article do not meet the requirements of (1) and (2). However, disputes over the determination regarding (3) “subject matter” and (5) “other circumstances” are common in individual cases.

Firstly, regarding the “subject matter”, the key issue is how to confirm it is outside of the territory of PRC? In the “美克斯Ship Case”, both parties were domestic legal persons, the Shanghai Maritime Court determined the “subject matter” is outside of the territory of PRC based on the following factors: 1) the vessel concerned was an international navigation vessel intended to be registered with the American Bureau of Shipping; 2) the Marshall Islands is agreed as the flag state; 3) the buyer will establish a wholly-owned subsidiary overseas to inherit the rights under the contract. In conclusion, the vessel concerned should either never enter the territory of China, or the ownership certificate should be registered in a country other than China. In the “Ningbo 新汇Case” ( (2015) Si Zhong Min (Shang) Te Zi No. 00152), the parties concerned were domestic legal persons, and the Beijing Fourth Intermediate People’s Court held that, “The delivery method stipulated in the contracts was spot delivery in the Shanghai Bonded Zone, and according to the customs management system, uncleared goods in the bonded zone were classified as goods that had not yet entered the country. Therefore, this case has foreign-related factors.” However, some other courts hold different opinions in similar cases.

Secondly, regarding the “other circumstances”, which is commonly referred to as “atypical foreign-related factors” in judicial practice. Cases related to this factor is rare. We have searched two cases which are all related to the entities established in the free trade zone. For example, in the “Siemens case” ((2013) Hu Yi Zhong Min Ren (Wai Zhong) Zi No. 2), the Shanghai First Intermediate People’s Court held that, “Both the applicant and the respondent are Chinese legal persons, and the delivery place and the location of the subject matter agreed upon in the contract are both within China’s territory. It seems that it does not have any foreign-related factors. However, both parties are foreign-funded enterprises registered in the Shanghai Pilot Free Trade Zone, and their sources of funds, ultimate interests, and company management decisions are closely related to foreign investors. In the context of promoting investment and trade facilitation in the pilot free trade zone, these foreign-related factors should be given more attention. In addition, from the perspective of contract performance characteristics, the subject matter should be delivered from overseas to the pilot free trade zone for bonded supervision, and then after the accomplishment of the customs clearance and tax procedures, it would be transferred from within the zone to outside the zone, which also has certain characteristics of international goods trading.” In the reply to this case ([2015] Min Si Ta Zi No. 5), the Supreme Court pointed out that, “Both parties concerned are Chinese legal persons, although the Goods Supply Contract concluded by both parties does not have typical foreign-related factors, this case is a case involving free trade zones, and both parties are wholly foreign-funded subsidiaries… In order to implement the ‘Several Opinions of the Supreme People’s Court on the People’s Court’s Judicial Guarantee for the Construction of the” the Belt and Road ” … In the spirit of supporting the construction of the rule of law in free trade zones, which can be tried first, … this case shall be deemed as ‘other circumstances.” In fact, the “Opinions of the Supreme People’s Court on Providing Judicial Protection for the Construction of Free Trade Pilot Zones” (Fa Fa [2016] No. 34) also clearly stipulates: “9. Correctly determining the validity of arbitration agreements to standardize the judicial review of arbitration cases. If wholly foreign-funded enterprises registered in FTZs agree with each other to submit commercial disputes for overseas arbitration, the relevant arbitration agreements should not be determined invalid for no overseas factors involved in their disputes.” However, in judicial practice, we still can find different judgments for similar cases.

In summary, when the contract does not meet the requirements of (1), (2), and (4) stipulated in the “Interpretation”, and there is uncertainty about whether the subject matter meets the requirements of (3), it is recommended to avoid agree on the jurisdiction of overseas arbitration institutions.