The Shanghai No.1 Intermediate People’s Court (the Court) recently recognised and enforced an arbitration award, even though the arbitration took place in Singapore between two PRC-incorporated companies (the Decision)1. This ruling could potentially increase the likelihood that PRC entities will be permitted to arbitrate their disputes outside the PRC, when there are relevant “foreign elements”.
Restrictions against PRC entities arbitrating outside the PRC
PRC law has historically drawn a clear distinction between “foreign-related” disputes and “domestic” disputes – “domestic” disputes can only be arbitrated in the PRC, whereas “foreign-related” disputes may be arbitrated within or outside the PRC2.
This distinction is significant for two reasons. First, although the definition of a “foreign-related” dispute is in theory quite broad3, in practice, the main test is whether any of the parties to the dispute are foreign parties – if so, then the dispute will be considered to be “foreign-related”. Secondly, and conversely, PRC-incorporated foreign-invested entities (FIEs) and wholly foreign-owned enterprises (WFOEs) are considered to be “domestic” entities. The result is that foreign parties who conduct business in the PRC using FIEs or WFOEs are often obliged, under PRC law, to arbitrate their disputes in the PRC.In the Decision, however, the Court construed the term “foreign-related” broadly, and enforced a foreign award even though the arbitration took place outside the PRC between two PRC entities.
The dispute arose under a contract for the sale and purchase of equipment between two PRC entities, that were both WFOEs (the Seller and the Buyer). The governing law of the contract was PRC law and the contract provided for arbitration in Singapore before the Singapore International Arbitration Centre (SIAC).
In 2007, following a dispute, the Buyer commenced arbitration in Singapore against the Seller.
The Seller challenged the tribunal’s jurisdiction, arguing that there was no “foreign element” to the contract, and that PRC law did not permit disputes without a “foreign element” to be arbitrated outside the PRC. The tribunal rejected the jurisdictional challenge, following which the Seller introduced its own counterclaims into the arbitration. The tribunal eventually rejected the Buyer’s claims, and decided the dispute in the Seller’s favour.
Enforcement proceedings in the PRC
As the Buyer failed to pay the awarded damages in full, in June 2013, the Seller applied to the Court for recognition and enforcement of the award.
The Buyer challenged the application on similar grounds as the Seller had relied on at the outset of the arbitration, ie, that the dispute had no “foreign element” and therefore the award was invalid as PRC law did not permit non-“foreign-related” disputes to be arbitrated outside the PRC.
The Court issued its Decision on 27 November 2015, ruling that the dispute was “foreign-related”, and recognising and enforcing the award.
The Court’s analysis
The Court acknowledged that the following factors suggested that the contract was not a typical “foreign-related” contract:
- both parties were incorporated in the PRC; and
- the relevant equipment was delivered in the PRC and was (at the time) held in the PRC.
However, on closer examination, the Court concluded that there was a “foreign element” in this case, due to “other circumstances”4:
- First, the parties were both WFOEs that had been incorporated in the Shanghai Waigaoqiao Bonded Zone, which had formed part of the China (Shanghai) Pilot Free Trade Zone (the Shanghai FTZ) since 2013. The Court stated that this made them different from ordinary domestic companies, as the source of their registered capital, their ultimate ownership interests, and their business decision-making were all closely connected to foreign investors. The Court stated that, given the Shanghai FTZ’s objective to facilitate foreign investment, particular emphasis should be given when considering whether these factors constitute a “foreign element”.
- Second, the Seller had procured the equipment (ie, the “subject matter” of the contract) from abroad and then stored it under bond (ie, no tariff duties were due) in the Shanghai FTZ before transferring it out of the tariff-free zone and delivering it to the Buyer. The Court held that this aspect of the contract performance bore some features of an international sale of goods, as opposed to an ordinary domestic sale of goods.
The Court concluded that the above factors constituted “other circumstances” which were sufficient to render the legal relationship between the parties as “foreign-related”. On this basis, it held that the arbitration agreement was valid and proceeded to recognise and enforce the award.
In reaching its conclusion, the Court also took into account that it was the Buyer which commenced the Singapore arbitration and the Buyer, in response to the Seller’s jurisdictional challenge, had always contended that the arbitration agreement was valid5. Furthermore, the Buyer had voluntarily performed part of its obligations under the award, by paying part of the damages awarded. The Court held that the Buyer’s challenge to the recognition and enforcement of the award contravened widely recognised legal principles, such as good faith, estoppel and fairness and reasonableness, and should be rejected.
This Decision is significant for a number of reasons.
First, it goes beyond earlier PRC court decisions, which have held that purely “domestic” disputes, including those involving FIEs and WFOEs, should not be arbitrated outside the PRC6.
Second, this is the first known PRC court decision that sheds light on what “other circumstances” may be considered, in determining if a contract is “foreign-related”. In this regard, the Court’s willingness to construe this factor broadly is a welcome indication that the PRC courts may be prepared, in appropriate circumstances, to allow PRC entities to arbitrate their disputes outside the PRC.
The importance of this Decision should not be overstated and there were some unusual facts, which may have persuaded the Court to enforce the award. It is also unclear if the Decision would have been endorsed by the Supreme People’s Court or if the same reasoning will be followed by other PRC courts in similar situations. Further judicial guidance and clarification will be required, to fully understand the scope of the concept of “foreign-related” under PRC law.
Nonetheless, this Decision does helpfully suggest a willingness by the PRC courts to construe the term “foreign-related” relatively broadly, and to permit PRC entities to arbitrate their disputes outside the PRC, where there are various “foreign elements” in play. The Decision will therefore be of particular interest to foreign parties operating in the PRC through PRC entities, and who are interested in or who have agreed to offshore arbitration.