In December 2012, the China International Economic and Trade Arbitration Commission’s central authority located in Beijing ("CIETAC") ended the year with a bang when it discharged its largest weapon to date in its ongoing dispute with the CIETAC Shanghai Sub-Commission ("CIETAC Shanghai") and the CIETAC South China Sub-Commission ("CIETAC Shenzhen"): It revoked the authority of the sub-commissions to accept and administer arbitration cases.1

Shortly thereafter, the breakaway sub-commissions returned fire, jointly declaring that they were open for business and authorized by their respective local judicial administrative authorities to operate independently.2 In April, CIETAC Shanghai left no doubt that it was crossing the Rubicon when it renamed itself the "Shanghai International Economic and Trade Arbitration Commission."3

These recent developments confirm fears that a truce between CIETAC and the breakaway sub-commissions is unlikely to be forthcoming any time soon. In their wake, they leave growing unanswered questions about existing contracts that specify dispute resolution by the former CIETAC sub-commissions in Shanghai or Shenzhen. They also present an opportunity for foreign companies operating in China4 to reassess and recalibrate their dispute resolution strategies.

Given the lack of recognition of ad hoc arbitration in China and the fact that, at present, CIETAC administered arbitration is practically unavailable offshore, the uncertain status of the sub-commissions thins an already sparse field of options. At a minimum, CIETAC’s apparent inability to resolve its internal conflict should prompt foreign parties, when possible, to consider alternatives to onshore arbitration.

Background of CIETAC Dispute

The revocation marks the new nadir of a dispute that arose in May 2012, when CIETAC issued new arbitration rules ("CIETAC’s New Rules").5 Under CIETAC’s prior rules, the parties to a dispute had the right to decide which body would administer a case – CIETAC in Beijing or one of its sub-commissions – while the secretariats of the sub-commissions were vested with the power to administer these cases. According to CIETAC’s New Rules, the sub-commissions are newly deemed "branches" of CIETAC, which "accept arbitration applications and administer arbitration cases with CIETAC’s authorization." This change effectively mandates that cases be administered by the Secretariat of CIETAC, unless the parties have clearly agreed to the administration by a sub-commission. In other words, a dispute arising from an agreement that simply provides for "CIETAC arbitration" will result in a proceeding administered by the Commission’s Beijing headquarters.

Citing their refusal to apply CIETAC’s New Rules, on August 1, 2012, CIETAC announced that it had suspended its authorization to the Shanghai and Shenzhen Sub-Commissions to administer arbitration cases.6 Members of the international arbitration community who had hoped that the various factions would resolve their differences swiftly were disappointed when at the end of 2012 CIETAC terminated the sub-commissions’ authority to administer cases.

The announcement came at a time when CIETAC had been striving to establish itself as a credible alternative to such dispute resolution fora as the Hong Kong International Arbitration Centre ("HKIAC") and the Singapore International Arbitration Centre ("SIAC"). However, the internal breakdown both casts doubt on the viability of historical agreements that specify CIETAC for dispute resolution and undermines CIETAC’s appeal as a service provider going forward.

Stalemate Casts Doubt on Existing Arbitration Agreements

Parties to existing contracts providing for CIETAC arbitration administered by the Shanghai or Shenzhen Sub-Commissions find themselves in an ambiguous situation. On the one hand, if they submit a dispute to one of the de-authorized sub-commissions, they run the risk that the resulting arbitral award may be challenged and possibly denied recognition and enforcement on the basis that it lacked jurisdiction over the case.

On the other hand, parties that previously agreed to arbitration before the Shanghai or Shenzhen Sub-Commissions and subsequently submit their disputes to CIETAC headquarters also face significant uncertainty. When the parties previously agreed to arbitration administered by the Shanghai Sub-Commission, they could not have foreseen the current stalemate. Accordingly, whether the arbitration agreement should be interpreted as specifying CIETAC (as the central authority claims) or the breakaway sub-commission (as the rebranded "China International Economic and Trade Arbitration Commission Shanghai Commission" maintains) is ambiguous.

This has significant ramifications for parties to agreements with such clauses who find themselves in a "CIETAC" arbitration, as the losing party may later argue in court that CIETAC lacked jurisdiction to administer the case or that the award is invalid because the parties agreed to arbitration by the Shanghai Sub-Commission rather than CIETAC itself. Accordingly, parties to such agreements face the difficult decision of whether to proactively amend their arbitration clauses to provide for arbitration by CIETAC’s central authority or some other institution prior to any dispute arising. Such decision will be informed by the value of the contract, the duration of the agreement, and (perhaps most importantly) the relationship between the parties, among other factors.

Options for New Arbitration Agreements

When negotiating new arbitration agreements, (non-Chinese) foreign parties who could avail themselves of an offshore arbitration institution (as discussed below) but might have considered CIETAC as a reasonable compromise should think twice before choosing an institution embroiled in an internal squabble. Although each transaction involves unique factors and considerations, when weighing the available dispute resolution options in China, we believe that companies generally should keep in mind the following principles.

Options When PRC Law Governs

Due to their general lack of familiarity with the Chinese legal system and its perceived procedural deficiencies, historically, the majority of foreign companies doing business in China have preferred to settle disputes abroad. However, unless they meet the requirements for a "foreign-related" contract, agreements involving Chinese parties must be governed by PRC law7 and disputes arising therefrom settled by onshore litigation or arbitration.8 Conversely, contracts between a Chinese and foreign entity with a "foreign element" allow the parties to choose a non-PRC governing law and a non-PRC dispute resolution mechanism. Generally speaking, under PRC law, contracts with a "foreign element" arise only where one or more of the following conditions are met:

  1. One or both parties to the contract are foreign nationals, stateless persons, or foreign legal persons;
  2. The subject matter of the contract is located in a foreign country; or
  3. The act that gives rise to, modifies, or extinguishes the rights and obligations under the contract takes place in a foreign country.9 (For example; a contract for the sale of goods in China between two Chinese individuals that is executed in a foreign country might satisfy this condition.)

The performance of certain types of contracts within the territory of the People’s Republic of China must be governed by Chinese law, even if "foreign-related":

  1. Contracts for PRC-foreign equity joint ventures;
  2. Contracts for PRC-foreign contractual joint ventures;
  3. Contracts for PRC-foreign cooperation in the exploration or exploitation of natural resources;
  4. Contracts for the transfer of shares in a PRC-foreign equity joint venture, PRC-foreign contractual joint venture, or wholly foreign-funded enterprise;
  5. Contracts for the operation by a foreign natural person, foreign legal person, or any other foreign organization of a PRC-foreign equity joint venture or a PRC-foreign contractual joint venture formed within the PRC;
  6. Contracts for the purchase by a foreign natural person, foreign legal person, or any other foreign organization of share equity held by a shareholder in a non-foreign-funded enterprise within the PRC;
  7. Contracts for the subscription by a foreign natural person, foreign legal person, or any other foreign organization to the increased registered capital of a non-foreign-funded limited liability or company limited by shares within the PRC; and
  8. Contracts for the purchase by a foreign natural person, foreign legal person, or any other foreign organization of assets of a non-foreign-funded enterprise within the territory of the PRC.10

It is worth noting that even in cases where a contract is technically "foreign-related," if the counterparty is a PRC government entity, foreign parties are likely to meet resistance to dispute resolution options outside the PRC.

Onshore Litigation vs. Arbitration

Under Chinese law, disputes arising out of contracts that are not "foreign-related" must be resolved either through litigation or arbitration in the People’s Republic of China. Here again, one size does not fit all.

Under certain circumstances, it may be preferable to use litigation instead of arbitration to resolve a dispute. Given the clear distinctions in experience and sophistication of the courts and judges across jurisdictions, it is difficult – if not impossible – to generalize about the quality of the Chinese judicial system. However, as a general matter, intermediate level courts in major cities in the PRC tend to be better situated to hear disputes with foreign parties than their counterparts outside major metropolitan areas.

Any decision to choose litigation in the PRC should be based upon a review of the totality of the contractual arrangements. One important factor is the type of agreement; certain types of disputes, such as labor disputes and some intellectual property-related disputes, initially fall within the exclusive jurisdiction of administrative agencies. Other key issues that merit consideration include, but are not limited to: (i) the identity of the parties; (ii) the location of the party’s assets and/or the location of the subject matter; (iii) the location where the contract will be performed; (iv) the value/size of the contract; (v) whether the foreign entity will hold a secured interest in the subject matter of the contract; and (vi) whether intellectual property is involved.

The following is a comparison of the general advantages and disadvantages of litigation versus arbitration in China.

  1. Cost: Arbitration is generally characterized by relatively higher costs, particularly with three-member tribunals. However, while the judges in court proceedings are free, a fee proportionate to the amount of the claim is required.
  2. Time: In practice, CIETAC arbitration proceedings can move slowly despite the fact that CIETAC’s internal rules stipulate that claims should be decided within six months of acceptance. Some cases take several years to reach decisions, while court cases frequently go to trial within several months.
  3. Experience: Arbitrators involved with international arbitration typically possess a higher level of training and greater expertise compared with their counterparts in PRC courts. However, in recent years, the quality of the judiciary has improved due to the administrative requirement that judges receive law degrees. Here again, judges in intermediate level courts in major cities tend to be more experienced than their counterparts in smaller venues.
  4. Enforcement: Arbitral awards issued in China must follow PRC Civil Procedure Rules. International arbitral awards are enforced either according to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards or the Hong Kong/China Enforcement Arrangement.11 When enforcing judicial judgments, PRC courts do not have contempt powers for parties that refuse to follow court orders, which inhibits their powers of enforcement. On the other hand, in practice, it is usually easier to obtain temporary restraining orders in the course of litigation than in arbitration.12

Options When PRC Law is Not Mandated

Foreign Arbitration vs. Litigation

Where a "foreign element" can be established, parties are free to choose to resolve the dispute via foreign arbitration or litigation. Because of its physical proximity to and close business ties with mainland China, in addition to its well-established legal system, the favored jurisdiction for agreements with PRC counterparties is frequently Hong Kong.

When deciding between Hong Kong-based arbitration or litigation, parties should consider several factors. While China and Hong Kong have a reciprocal arrangement for the enforcement of commercial judgments,13 it is generally more limited in scope than the regime for enforcing arbitral awards. For example, certain matters, such as judgments relating to Sino-foreign Equity Joint Venture or Cooperative Joint Venture contracts, are reserved for the exclusive competence of PRC courts (whereas a Hong Kong arbitral tribunal would not be so restricted). In addition, under the treaty, the grounds for objecting to the enforcement of foreign judicial decisions are broader than those for foreign arbitral awards.

As noted above, a separate bilateral agreement governs the enforcement of arbitral awards between Hong Kong and China.14 Here, the grounds on which enforcement of arbitral awards may be denied are limited to certain serious procedural issues and principles of public policy. Pursuant to an established reporting system, mainland courts at the intermediate level are authorized to order enforcement for foreign awards. Should they refuse, such refusal is subject to a referral procedure to the Supreme People’s Court. This system does not apply to Hong Kong judicial decisions. Accordingly, while arbitration in Hong Kong is not without its issues, on balance, it tends to be the foreign dispute resolution option of choice.

It, therefore, comes as no surprise that HKIAC handles the bulk of disputes arising out of "foreign-related" contracts.15 Nevertheless, HKIAC, despite its geographic advantage for some parties,16 is not the only attractive regional option. In 2012, SIAC experienced a 25% increase in its caseload on the previous year,17 largely driven by disputes involving Chinese parties.18 International Chamber of Commerce arbitration or UNCITRAL ad hoc arbitration with a seat in Hong Kong or Singapore are other common alternatives.19

Conclusion

Being limited to PRC dispute resolution mechanisms in non-"foreign-related" contracts, like constraints on the degree of foreign investment in many domestic industries, has long been one of the hurdles to doing business in China. Where foreign parties not limited to onshore options may have considered CIETAC as a viable alternative to offshore arbitration in the past, the current controversy should persuade them to hold out for alternatives farther afield. And where such options are ultimately unavailable for commercial reasons, they may be forced to reconsider their "avoid at all costs" approach to the PRC judicial system. A thoroughly modernized and internationalized Chinese arbitration option would be a welcome addition to the commercial landscape. However, the fact that CIETAC’s central authority and its sub-commissions appear unable to bridge the widening rift between them does not bode well for China’s best hope to fulfill that mandate.