Chinese Court Nullifies HK Arbitral Award by Declaratory Relief

This newsletter discusses the Chinese court’s approach to declaratory relief on the validity of disputed foreign arbitration agreements and the binding effect of the declaration and the impact on the enforcement of the related foreign arbitral award. This is particularly important for the business community, because in the case discussed below, the Shijiazhuang Intermediate People's Court (“Shijiazhuang Court”) (confirmed by the Supreme People’s Court) applied this declaratory jurisdiction independently to an enforcement proceeding under the New York Convention.
By way of introduction, in circumstances where proceedings are already pending before the arbitral tribunal, or where the commencement of such is imminent, the parties may obtain a declaration as to the arbitration agreement’s validity from the court at the seat of arbitration or by a foreign court.[1]
For example, English law[2] provides where the seat of arbitration is England, parties to arbitration can file an action seeking a positive or negative declaration as to the arbitral tribunal’s jurisdiction. Parties who do not take part in the arbitration proceedings could also file an action for declaratory relief to this effect.[3]
A further example is German law[4] which provides that prior to the constitution of the arbitral tribunal, an application may be made by either party to a court seeking declaratory relief on whether the arbitration agreement is null, void, inoperative or incapable of being performed.
Chinese law[5] also provides that parties may file a declaratory action to one of four separate courts[6] to seek negative declaration as to the validity of the arbitration agreement.
This raises an interesting question that if the arbitration agreement in question designated a seat outside China[7] and the arbitration proceedings were conducted in accordance with that arbitration agreement, what implications the Chinese court’s negative ruling on the validity of the arbitration agreement will carry in respect of the validity of the arbitration agreement and enforceability of the arbitral award in China.
The case below provides helpful guidance in answering the above question.
Background
This case concerns a long-debated issue on whether parties can choose a foreign arbitral institution while designating China as the seat of arbitration. From another perspective, the question is whether Chinese law gives effect to such an arbitration agreement, e.g. “ICC arbitration in China”. This should not be an issue for UNCITRAL Model Law regimes or many non-UNCITRAL Model Law jurisdictions, since the seat of arbitration is no more than a juridical concept which allows the courts to exercise a supervisory jurisdiction and provide assistance over arbitrations conducted in the jurisdiction, including matters as to the validity of the arbitration agreement. But in China, this question has long been mixed up and discussed with the separate topic of “opening arbitration market to foreign arbitral institutions”, although the Chinese arbitration market has long been opened up by allowing[8] Chinese parties to contracts with a foreign element[9] to choose foreign arbitral institutions.
In this case, with a view to cooperating on exportation of automotive parts, local assembly and sales in Egypt, Zhongxing Automobile Manufacturing Co., Ltd. (“ZX Automobile”, a Chinese company) and Automotive Gate FZCO (“FZCO”, a UAE company) successively entered into a CKD and Agency Agreement (“CKD Agreement”) and a Technical Cooperation Agreement (“TC Agreement”) in 2007. The two agreements provided in the arbitration clauses that any dispute shall be submitted to the International Chamber of Commerce (“ICC”) for arbitration and settled in China. The original texts of the arbitration clauses are as follows:
Act 14.1, CKD Agreement
“In case of breach of any article of this agreement by either of the parties, both Parties agree to put best efforts to remedy by negotiation. Otherwise, both Parties agree to arbitration as per the International Chamber of Commerce and held in CHINA .”
Act 10.4, TC Agreement
“Any dispute, controversy or difference which may arise between the parties out of or in relation to this Agreement or for the breach thereof shall be settled amicably by the parties, but in case of failure, it shall be finally settled in CHINA by arbitration pursuant to the Rules of the International Chamber of Commerce whose award shall bind the parties hereto.”
Disputes arose between the two parties during the course of performance of the agreements. In May 2011, ZX Automobile applied to the Shijiazhuang Court, which is the competent court where ZX Automobile is located, for a declaratory relief to confirm that the above-quoted arbitration clauses were invalid under Chinese law. Since FZCO is a foreign company with its registered office in UAE, its refusal to accept service of documents caused long delay of the court procedure.
In October 2011, relying on the arbitration clauses, FZCO initiated arbitration proceedings to the Hong Kong office of the ICC (Case No. 18228/CYK), and not unexpectedly, ZX Automobile almost immediately raised its objection to jurisdiction of the ICC Court of Arbitration and informed the ICC of the existence of the aforementioned pending lawsuit. In the following arbitral proceedings conducted under the auspices of the ICC, both parties had different views on the meaning of “China”. FZCO suggested that China includes Hong Kong, so Hong Kong should be designated as the seat, which would make the arbitration agreements valid and enforceable, while ZX Automobile insisted that “China” does not include Hong Kong in the sense of arbitral seat. Under the authority given by Article 14(1) of the ICC Arbitration Rules (1998)[10], the sole arbitrator appointed by the ICC court selected Hong Kong as the seat. As mentioned above, under the procedural law governing the arbitration (the lex arbitri), i.e. Hong Kong law, it is perfectly acceptable for arbitration institutions headquartered in places other than Hong Kong to conduct arbitration and render enforceable arbitral awards. The tribunal made an award on this basis and ZX Automobile applied to the High Court of Hong Kong for annulment of the award (Case No. HCCT 8/2013) under the Hong Kong Arbitration Ordinance, but the application was eventually denied by the High Court of Hong Kong.
For the purpose of enforcing the ICC award (with Hong Kong as the seat), FZCO accepted service of process of the above-mentioned declaratory relief case which had long been pending before the Shijiazhuang Court, allowing the procedure to continue. In July 2018, seven years after accepting the lawsuit, the Shijiazhuang Court found the arbitration agreement invalid according to Chinese law. Before rendering the ruling, the Shijiazhuang Court had reported the case all the way up to and consulted with the Supreme People's Court through the “internal reporting system” in the Chinese arbitration regime designed to ensure the Supreme People’s Court’s ultimate control over, among others, the validity issues of foreign-related (such as the present case) arbitration agreement. In other words, the decision made by the Shijiazhuang Court as such is a non-appealable, final and conclusive decision. The holding has made it almost impossible for the ICC award to be recognized and enforced in China.
Decision and Reasons
The Shijiazhuang Court held that:
The case shall be regarded as an application for determination (declaratory) of the validity of a foreign-related arbitration agreement. Both arbitration agreements in this case were signed in 2007, which was before the implementation of the Law of the People's Republic of China on the Application of Foreign-related Civil Relations. Therefore, Article 14 of the Supreme People's Court’s Interpretation of Certain Issues in the Arbitration Law of the People's Republic of China[11] should be applied to determine the law applicable to the examination and determination of validity of such arbitration agreements. The parties did not specify the governing law for the arbitration agreements. The place of arbitration agreed by the parties is China, while the mainland, Hong Kong Special Administrative Region, Macao Special Administrative Region, and Taiwan Region are different jurisdictions, the differences may lead to different perspectives towards the validity of the arbitration agreements. Given that both parties had different views as to the meaning of the seat of arbitration and no consensus could be reached, this court is of the view that the parties had no clear agreement on the seat of arbitration. In this case, Chinese law, being the law under which the application for the declaration was brought, should be applied to decide the validity of the arbitration agreements.
According to the Chinese translation texts of the arbitration agreements, the parties agreed to apply the arbitration rules of the ICC, but did not expressly stipulate an arbitration institution to administer the arbitration. When the parties signed the arbitration agreements in 2007 and when the Chinese court proceedings started in 2011, the applicable arbitration rules were the ICC Arbitration Rules (1998), and under these Rules, the parties’ simple agreement on the Rules would not lead to the designation of the ICC as the institution administering arbitral proceedings. Neither did the parties reach a supplementary agreement on the arbitration institution. Therefore, according to Article 18 of the Arbitration Law of the People's Republic of China, both arbitration agreements are deemed to be void.
Comments
Under the UNCITRAL Model Law[12] and the New York Convention[13], the law to which the parties have subjected the arbitration agreement, or failing such choice of law, the law of the place where the arbitral award was made should be applied to determine the validity of the arbitration agreement. In this case, the Shijiazhuang Court did not apply Hong Kong law, i.e. the law of the place where the ICC arbitral award was made, to determine the validity of the arbitration agreements. Without setting out sufficient reasons why Hong Kong law was not applicable to this effect, the Shijiazhuang Court held that Chinese law should be applied to the arbitration agreement, since no applicable law was expressly agreed upon by the parties to the arbitration agreement. Nor did the Shijiazhuang Court touch upon the rather controversial designation of Hong Kong by the ICC as the seat when the arbitration agreements designated China as the seat and its implications on the Shijiazhuang Court’s decision. This seems contrary to the above principles of the UNCITRAL Model Law or treaty obligations undertaken by China under the New York Convention.
Also, the Shijiazhuang Court did not discuss or otherwise deal with the question whether an arbitration agreement designating both foreign arbitral institution and Chinese seat is enforceable in China. Rather it conducted a contractual interpretation on the true intention of the parties to the arbitration agreements. In this respect, the Shijiazhuang Court was not persuaded that the simple designation of the ICC rules was enough to satisfy the requirements of Article 16 of the Arbitration Law of the People’s Republic of China and consequently nullified the arbitration agreements.
This case is significant because it effectively allowed Chinese courts, through declaratory relief, to nullify an arbitration agreement even where under that same arbitration agreement the parties have pleaded over this issue in the arbitral proceedings outside China and subjected this issue to competent court in the foreign seat of arbitration. In other words, on hearing the declaratory relief for the validity of the arbitration agreement, neither the decision rendered by the foreign tribunal under the principle of Kompetenz Kompetenz, nor the decision given by the court of foreign seat with supervisory jurisdiction over the arbitration, was treated as binding on Chinese courts (i.e. given res judicata effect).
Quite to the contrary, the Chinese court’s decision on the declaratory relief in this case (issued before and as a separate court proceeding to any enforcement proceeding under the New York Convention) on the validity of arbitration agreements effectively made the foreign arbitral award unenforceable in China.
In practical terms, and putting aside whether this particular decision was rightly decided and consistent with the New York Convention, foreign parties should ensure that they have a properly drafted and enforceable arbitration clause which does not allow application of Chinese law by Chinese courts (such as in this case) by expressly stating the applicable law for the arbitration clause and the seat of arbitration. In this case, if Hong Kong had been expressly agreed as the seat of arbitration and Hong Kong law also expressly selected as the applicable law for the arbitration agreement then there would have been no scope for the Shijiazhuang Court to exercise its declaratory jurisdiction in this way.
【Endnote】
[1] Erk Nadja, Parallel Proceedings in International Arbitration. A Comparative European Perspective [J] (Kluwer Law International 2014), 146.
[2] Section 2 (1), English Arbitration Act (1996): The provisions of this Party applying where the seat of the arbitration is in England and Wales or Northern Ireland.
Section 32 (2), English Arbitration Act (1996): An application under this section shall not be considered unless-
(a) it is made with the agreement in writing of all the other parties to the proceedings, or
(b) it is made with the permission of the tribunal and the court is satisfied-
(i) that the determination of the question is likely to produce substantial savings in costs,
(ii) that the application was made without delay, and
(iii) that there is good reason why the matter should be decided by the court.
[3] Section 72 (1), English Arbitration Act (1996): A person alleged to be a party to arbitral proceedings but who takes no party in the proceedings may question-
(a) whether there is a valid arbitration agreement,
(b) whether the tribunal is properly constituted, or
(c) what matters have been submitted to arbitration in accordance with the arbitration agreement, by proceedings in the court for a declaration or injunction or other appropriate relief.
[4] Section 1032(2), German Code of Civil Procedure: Until the arbitral tribunal has been formed, a petition may be filed with the courts to have it determine the admissibility or inadmissibility of arbitration proceedings.
[5] Article 12, the Interpretation of the Supreme People's Court on Certain Issues relating to Application of the Arbitration Law of the People's Republic of China
[6] The Intermediate People's Court a) at the location of the arbitration institution as provided for in the arbitration agreement, b) at the place where the arbitration agreement was concluded, or c) at the place of residence of either the applicant or the respondent.
[7] For avoidance of doubt, excluding Hong Kong, Macao and Taiwan.
[8] Article 128, the Contract Law of the People’s Republic of China: Parties to a foreign-related contract may, in accordance with an arbitration agreement, apply to a Chinese arbitration body or other arbitration body for arbitration.
[9] Article 1, the Interpretation of the Supreme People’s Court on Several Issues Relating to Application of the Law of the People’s Republic of China on Application of Laws to Foreign-related Civil Relations (I): Under any of the following circumstances, the People's Court may determine a civil relation as a foreign-related civil relation-
(1) Where a party concerned or both parties concerned is/are (a) foreign citizen(s), (a) foreign legal person(s) or any other organization, or a Stateless person(s);
(2) Where the habitual residence of a party concerned or both parties concerned is located outside the territory of the People's Republic of China;
(3) Where the subject matter is located outside the territory of the People's Republic of China;
(4) Where the legal facts that trigger, change or terminate the civil relation take place outside the territory of the People's Republic of China; or
(5) Any other circumstances that can be determined as foreign-related civil relations.
[10] Article 14(1), the ICC Arbitration Rules (1998): The place of arbitration shall be fixed by the ICC Court unless agreed upon by the parties.
[11] Article 14, the Interpretation of the Supreme People’s Court on Several Issues Relating to Application of the Law of the People’s Republic of China on Application of Laws to Foreign-related Civil Relations (I): Where the parties concerned do not choose any law applicable to their foreign-related arbitration agreement or do not agree on an arbitration institution or the place of arbitration, or their agreement thereon is unclear, the People's Court may determine the binding effect of the arbitration agreement by applying the laws of the People' s Republic of China.
[12] Article 36.1(a) (i) UNCITRAL Model Law. (For avoidance of doubt, China has not yet adopted the Model Law so it is not a Model Law regime).
[13] Article V(1)(a), the New York Convention.