Ik Wei Chong, Clyde + Co, Shanghai

Ref: Siemens International Trading (Shanghai) Co., Ltd vs. Shanghai Golden Landmark Co., Ltd (2013) Hu Yi Zhong Min Ren (Wai Zhong) Zi No. 2 (27 November 2015) (Shanghai No.1 Intermediate People’s Court).

In a recent case in the Intermediate People’s Court of Shanghai, the Court decided to recognise and enforce a foreign arbitration award in China, even though the arbitration took place in Singapore between two PRC-incorporated companies. This represents a break from past decisions, and has interesting implications for foreign parties operating in the PRC through PRC entities.

The factual background

The dispute concerned a sale and purchase contract entered into between two PRC entities. Both of the entities were wholly foreign owned enterprises (categorized under PRC law as “WFOEs”.

The contract was governed by PRC law, but provided for any disputes to be resolved in Singapore, before the Singapore International Arbitration Centre (SIAC). A dispute arose between the parties, and in 2007 the Buyer commenced arbitration in Singapore against the Seller.

The Seller challenged the tribunal’s jurisdiction, arguing that PRC law did not permit disputes without a “foreign element” to be arbitrated outside of the PRC. The tribunal rejected the Seller’s challenge. The Seller accordingly submitted to arbitration and filed a counterclaim against the Buyer.

In its decision, the tribunal rejected the Buyer’s claims, and issued an award in favour of the Seller. However, the Buyer failed to satisfy the entire award, and in June 2013 the Seller commenced proceedings in Shanghai for the recognition and enforcement of the award.

The Buyer challenged the application on the basis that the dispute had no “foreign element” (both parties were PRC registered entities and the contract was part performed in China). The Buyer argued that because PRC law does not allow for non-“foreign-related” disputes to be arbitrated outside the PRC, the award could not be upheld.

The legal background

Under PRC law, the general rule is that “domestic” disputes can only be arbitrated in the PRC, whereas “foreign-related” disputes may be arbitrated either within or outside the PRC. This means that for domestic disputes, the arbitration must be seated in China and subject to the rules of a Chinese arbitral institution. Awards seated in a jurisdiction outside the PRC which relate to a “domestic” dispute may not be recognised and enforced in the PRC.

PRC law has previously drawn a clear distinction between “foreign-related” disputes and “domestic” disputes. The law provides that a “foreign element” in a case will arise in any of the following circumstances:

  1. a) At least one party to the underlying legal relationship is a foreign national, foreign legal entity, or other organisation or individual without nationality;
  2. b) The usual residence of one or both parties to the underlying legal relationship is in the territory of a foreign state;
  3. c) The subject matter of the dispute is located outside of the PRC;
  4. d) The legal facts establishing, altering or terminating the parties’ relationship occurred outside of the PRC; or
  5. e) Any other circumstances whereby the legal relationship can be regarded as “foreign-related”.

The definition of what constitutes a “foreign-related” dispute appears at first glance to be quite broad. However, in practice, the main test has been whether or not any of the parties to the dispute are foreign parties. If they are then the dispute will be considered to be “foreign-related”. In addition, PRC-incorporated foreign-invested entities (“FIEs”) and WFOEs are considered to be “domestic” entities.

The result is that foreign parties who conduct business in the PRC using FIEs or WFOEs have often been obliged to arbitrate their disputes in the PRC.

The decision  

On 27 November 2015, the Shanghai No.1 Intermediate People’s Court ruled that the dispute was “foreign-related”, and it recognised and enforced the award.

The court acknowledged both parties were incorporated in the PRC and the relevant equipment had been delivered in the PRC and was being held in the PRC. These factors all indicated that this was a “domestic” dispute.

However, the court then considered the final limb of the test – i.e. whether there were any other circumstances that might cause the legal relationship to be regarded as “foreign-related”.

The court held that there were, as the parties were both WFOEs, and they had both been incorporated in the Shanghai Waigaoqiao Bonded Zone, which formed part of the China (Shanghai) Pilot Free Trade Zone (“Shanghai FTZ”). The court held that this differentiated them from ordinary domestic companies, because the source of their registered capital, their ultimate ownership interests, and their business decision-making were all closely connected with foreign investors. The court further held that because the objective of the Shanghai FTZ had been to facilitate foreign investment, particular emphasis should be placed on these factors when considering whether or not they constituted a “foreign element”.

In addition, the Seller had procured the goods in question from abroad and had then stored the goods under bond (no tariff duties were due) in the Shanghai FTZ before transferring them out of the tariff-free zone and delivering them to the Buyer. The court held that this aspect of the contract’s performance bore the features of an international sale of goods, as opposed to an ordinary domestic sale of goods.

The court held that these factors constituted “other circumstances”, and they were sufficient for the legal relationship between the parties to be categorised as “foreign-related”. The arbitration agreement was therefore valid and the court proceeded to recognise and enforce the award.

This decision 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 PRC.

It is also the first known PRC court decision that has shed light on what “other circumstances” might mean, when determining if a contract is “foreign-related”.

The implications

A number of significant implications arise out of this decision. First, it suggests a willingness by the PRC courts to construe the term “foreign-related” relatively broadly, and to permit PRC entities to arbitrate their disputes outside of the PRC, where there are various “foreign elements” in play.

Secondly, it differentiates between the status of companies formed inside free trade zones such as the Shanghai FTZ and companies incorporated on the mainland.

Thirdly, it tends to indicate a more “enforcement friendly” approach to foreign awards.

The decision will therefore be of interest to foreign companies who do business in China through a free zone registered entity and who wish to have foreign arbitration as the dispute resolution mechanism in their contracts.

However, precisely because this decision appears to be the first to shed light on what “other circumstances” might mean, it should be treated with caution at this stage. It is unclear if the decision would have been endorsed by the Supreme People’s Court, had it reached that stage, or if the same reasoning will be followed in the future by other PRC courts. There were also some unusual facts in the case which may have persuaded the court to enforce the award.