(By Fan Kun, ICC International Court of Arbitration Bulletin)

Increasing cross-border commercial exchanges and foreign investments have caused arbitration to become more frequently selected as a dispute resolution option in China. In response to this growing demand, China has taken significant steps to improve its arbitration system. Nevertheless, arbitration practice in China still displays many inconsistencies with international norms, causing concern for foreign investors.

This article looks at the practice, problems and prospects of arbitration in China through (i) an overview of the Chinese arbitration system, (ii) a description of the peculiarities of Chinese arbitration practice, (iii) an analysis of the legal obstacles that lie behind those peculiarities, and (iv) a review of past and future reforms.

I. Overview: domestic versus international arbitration in China

Prior to the enactment of its Arbitration Law (the ‘Arbitration Law’), China made a distinction between domestic arbitration and international arbitration.1 This distinction was reflected not only in the nature of the disputes to which arbitration was applied, but also in the institutions that handled the resulting cases. Domestic arbitrations were administered by domestic arbitration bodies, which were affiliated to governmental administrative authorities and issued awards that were not final or binding. Hence, a party could initiate court proceedings if it was not satisfied with an arbitral award. International arbitrations, on the other hand, were administered by one of China’s only two international arbitration institutions: the China International Economic and Trade Arbitration Commission (‘CIETAC’) or the China Maritime Arbitration Commission (‘CMAC’).

The Arbitration Law was enacted in 1994 to help reduce administrative interference and unify international and domestic arbitration in China. It provided for the reorganization of former domestic arbitration bodies placed under administrative authorities and the creation of several new arbitration institutions throughout the country, and as such marked a significant step forward. The new arbitration institutions shall be ‘independent of administrative organs and there shall be no relationship of subordination between arbitration institutions and administrative organs’. Pursuant to the Notice of the General Office of the State Council, domestic arbitration institutions were empowered to administer not only domestic arbitrations but also any international arbitrations that parties agree to submit to them. In reaction to the new competition that arose from this change, CIETAC revised its arbitration rules, with effect from 1 October 2000, so as to extend its jurisdiction to purely domestic disputes that parties agree to submit to it. Domestic cases have since become a substantial part of CIETAC’s caseload. Given that all Chinese arbitration institutions can now accept both domestic and international arbitration cases, subject to the parties’ agreement, the categorization of institutions as domestic or international has become meaningless.

The Arbitration Law nonetheless maintains a distinction between domestic and international arbitration. However, the sole criterion on which the distinction is made is the nature of the dispute, not the jurisdiction of the arbitration institutions. International arbitrations are generally regarded as arbitrations involving a foreign element, while domestic arbitrations are cases without a foreign element. A dispute involves a foreign element if: (i) one or both of the parties is a foreign national or a stateless person, or a company or organization domiciled in a foreign country; (ii) the legal facts establishing, changing or terminating the civil law relationship between the parties occur in a foreign

country; or (iii) the subject of the dispute is situated in a foreign country. Chapter 7 of the Arbitration Law deals specifically with international arbitration. It covers the form of the administering organizations, the qualifications of arbitrators, arbitration rules, the courts involved in the support or supervision of arbitrations, and the grounds on which arbitral awards may be set aside or enforcement refused (which are distinct from those applying to domestic arbitrations).

II. Peculiarities of arbitration in China

The Arbitration Law incorporates many of the principles of modern arbitration. It enshrines (i) party autonomy, meaning that the parties’ submission to arbitration shall be made ‘on the basis of both parties’ free will and an arbitration agreement reached between them’; (ii) denial of court jurisdiction when there is a valid arbitration agreement; (iii) independence of arbitration, including the independence of arbitration institutions and the autonomy of the arbitration agreement; and (iv) the finality of arbitral awards. These principles provide a foundation on which arbitration in Mainland China can develop in line with international standards. There is nonetheless still some divergence between the Chinese arbitration system and international standards. As Peter Chow has pointed out, ‘Chinese arbitration is like Chinese chess—it shares a common ancestry with international arbitration standards, but also has differences that make it unique’. The unique features of Chinese arbitration are reflected in (a) the conduct and (b) the effect of arbitral proceedings.

A. Conduct of arbitration

1. Determination of arbitral jurisdiction

i) International standards

It is generally accepted that an arbitral tribunal has the power to decide on its own jurisdiction, in accordance with the doctrine of competence-competence. For example, Article 16 of the UNCITRAL Model Law on International Commercial Arbitration provides that: ‘The arbitral tribunal may rule on its own jurisdiction, including any objections with respect to the existence or validity of the arbitration agreement.’

ii) Chinese practice

a) Court versus arbitration institution

The competence-competence doctrine is notably absent from arbitration legislation and practice in China. The power to decide on jurisdiction lies not with the arbitral tribunals but with the courts and the arbitration institutions. Article 20 of the Arbitration Law suggests that the jurisdiction of the People’s Court takes precedence over that of the arbitration institution when one party has asked the People’s Court and the other party the arbitration institution to rule on the validity of their arbitration agreement. According to a Supreme People’s Court Notice of 1998, where challenges against jurisdiction are made to both the court and the institution, the People’s Court shall not accept the case if the arbitration institution has already decided the matter. However, if the arbitration institution has not yet made a decision, the People’s Court should accept the case and instruct the institution to suspend the arbitration. A subsequent document from the Supreme People’s Court entitled ‘Interpretation on Certain Issues Relating to the Application of the Arbitration Law of the People’s Republic of China’, issued in 2006 (hereinafter ‘SPC Interpretation 2006’), took the matter one stage further by providing that once an arbitration institution has made a decision on the validity of an arbitration agreement, no applications can be made to the People’s Court for a ruling on the validity of the arbitration agreement or for the institution’s decision to be set aside. Chinese practice here stands in contrast to the international norm, according to which it is generally considered that an arbitral tribunal is not prevented from making a decision on jurisdiction by the fact that its decision could subsequently be overruled by a competent court. The peculiarity of the Chinese system is that the People’s Court has direct power to decide whether an arbitration agreement is valid. The court’s involvement is not by way of judicial review after the arbitral tribunal has made its decision, but through direct intervention when the challenge is made, provided no decision has yet been made by the arbitration institution. This approach has caused much concern, insofar as it may lead to the removal of the arbitration institution’s power to rule on its own jurisdiction.

b) Arbitration institution versus arbitral tribunal A related issue that deserves attention is the power of arbitration institutions to rule on arbitral jurisdiction. Permanent arbitration institutions and individual arbitral tribunals are generally regarded as having different functions in this regard. The ICC International Court of Arbitration, for example, will make a prima facie determination as to whether an arbitration agreement may exist, but leaves the arbitral tribunal to finally decide whether the arbitration agreement is valid and whether the objection against arbitral jurisdiction is justified. In China, however, only the arbitration institution is authorized to rule on jurisdiction. Clearly, the fact that the arbitrators are ousted from making a final decision on their jurisdiction flies in the face of the competence-competence doctrine discussed above. What happens in actual practice, however, is as follows. Before an arbitral tribunal is constituted, CIETAC issues a preliminary ruling on jurisdiction based on a prima facie assessment (as is the practice of the ICC Court, for example). If, after the arbitral tribunal has been constituted, an objection is made against its jurisdiction, the arbitral tribunal will generally express its view on the jurisdictional objection to CIETAC, which will usually respect that view. If the arbitral tribunal and the arbitration institution have conflicting views on the jurisdictional objection, then the arbitrator may have no choice but to resign from hearing the case, which is a far from satisfactory solution. This situation may also open the door to delaying tactics. A recalcitrant respondent could deliberately delay making a jurisdictional objection until the very last minute, i.e. just before the first hearing. As the tribunal does not have the power to rule on its own jurisdiction, it would have to wait for the arbitration institution’s decision on the challenge before being able to rule on the substance. The efficiency of the arbitration would thereby be impaired and its cost most likely increased.

CIETAC has endeavoured to overcome the drawbacks described above by introducing in its most recent arbitration rules the possibility of allowing arbitral tribunals to decide on their own jurisdiction on the basis of a delegation of power granted by the institution. The practical effects of this reform remain to be seen.

2. Combination of arbitration and conciliation

China has a millennia-long tradition of preferring consensual processes such as conciliation and mediation to the confrontation of litigation. This preference was an important part of Confucian philosophy, which laid emphasis on harmonization and the avoidance of conflict. In this context, litigation was considered to be disgraceful conduct, with the result that mediation was not so much an alternative but rather the cornerstone of China’s legal culture.

The modernization of China’s legal system and the increasing involvement of Chinese citizens in commercial disputes have had the effect of reducing the amount of prejudice against litigation, although it is still regarded unfavourably in many quarters. However, conciliation, with its aim of promoting social harmony by avoiding the permanent destruction of existing relationships, continues to carry great weight in both the legal system and arbitration practice in China.

Prior to the enactment of the Arbitration Law, CIETAC had already adopted the practice of combining arbitration with conciliation, which proved an effective means of resolving many cases. According to Professor Tang Houzhi, Honourable Vice-Chairman of CIETAC, conciliation is applied in almost 50% of arbitration cases, with a success rate of between 40% and 50%.

The Arbitration Law now permits and actively encourages the practice of conciliation during arbitration proceedings. Article 49 of the Arbitration Law allows parties to seek a settlement on their own initiative, notwithstanding the commencement of arbitration proceedings. If successful, they may request the arbitral tribunal to render an award in accordance with the terms of their settlement agreement.

It is also possible for the conciliation to be conducted by the arbitral tribunal. Article 51 of the Arbitration Law provides that the arbitral tribunal may carry out conciliation prior to rendering an award, and shall conduct conciliation proceedings if both parties so request.

i) Conciliation statement or consent award?

If conciliation leads to a settlement agreement, the parties have two ways of formalizing the terms of their agreement: either through a written conciliation statement or by way of a consent award. Both are based on the express terms of the settlement. They are signed by the arbitrators, sealed by the arbitration institution and served on both parties. Article 51 of the Arbitration Law provides that a conciliation statement shall have the same legal effect as an arbitral award.

The main difference between a written conciliation statement and a consent award is that a consent award becomes effective immediately after being rendered whereas a written conciliation statement, which is not an award, becomes binding upon the parties only when they have signed for its receipt. If a party changes its mind before signing, the arbitral tribunal will pursue the proceedings and render an award. There are also implications with regard to enforceability. In the case of a consent award, the party seeking enforcement may institute proceedings in a Chinese court or, if appropriate, seek enforcement overseas on the basis of the New York Convention. A written conciliation statement, on the other hand, is not an enforceable ‘award’ (unless the country in which enforcement is sought defines the term very broadly). For this reason, parties concerned about the enforceability of their settlement agreement may prefer to opt for a consent award.

ii) Failure of the attempt at conciliation

Should an attempt at conciliation fail, the conciliator will return to being an arbitrator and the arbitration proceedings will resume. The rules of both CIETAC and the Beijing Arbitration Commission provide that any view, statement or proposal expressed by the parties during the conciliation process shall not be invoked as a ground for any claim, defence or counterclaim in the subsequent arbitration proceedings.

The Chinese practice of allowing arbitral tribunals to act as conciliators has caused concern amongst some Western practitioners, especially those from the common law system, who fear that the conciliator-arbitrator’s impartiality in the subsequent arbitration proceedings could be compromised. However, an increasing number of legal experts believe that, if proper precautions are taken, the two types of proceedings can be successfully combined, giving arbitral proceedings a more consensual spirit and leading to fruitful cross-fertilization between Western and Chinese models of dispute resolution.

B. Effects of arbitration

As stated by Tao Jingzhou, ‘[a] meaningful arbitral award is conditional upon an effective and reliable enforcement mechanism. In China, as elsewhere, this task lies beyond the remit of the arbitration tribunal.’ If one party refuses to honour an arbitral award, the winning party will have no alternative but to seek enforcement in a competent court.

1. Types of awards The procedure for enforcement in China depends on the type of the award: ‘domestic’, ‘international’ or ‘foreign’.

Foreign awards are those rendered outside Mainland China (i.e. those rendered in cases where the place of arbitration is located outside Mainland China, including in Hong Kong, Macao and Taiwan). Awards rendered within Mainland China will be considered either domestic awards or international awards, depending on whether there is a foreign element present. Foreign investors should be aware that Foreign Invested Enterprises (‘FIEs’, including China-foreign equity joint ventures, China-foreign cooperative joint ventures and wholly-owned foreign enterprises) are treated as Chinese entities under Chinese law. Therefore, disputes involving FIEs are considered as domestic, unless there are other foreign elements present.

The enforcement of international and foreign arbitral awards is generally subject to the purely procedural condition that no irregularities have occurred in the arbitration process. When it comes to enforcing domestic awards, on the other hand, Chinese courts are allowed to review both procedural and substantive issues.

i) Domestic awards

Article 58 of the Arbitration Law sets out the grounds on which domestic awards may be set aside by the People’s Court, namely: (i) there is no arbitration agreement; (ii) the matters decided exceed the scope of the agreement or are beyond the authority of the arbitration institution; (iii) the formation of the tribunal or the arbitral procedure was not in conformity with the statutory procedure; (iv) evidence on which the award was based was forged; (v) the other party withheld evidence sufficient to affect the impartiality of the arbitration; (vi) the arbitrators have committed embezzlement, accepted bribes, conducted malpractice for their personal benefit or perverted the law; or (vii) the award proves to be contrary to the social and public interest. The list of grounds on which the enforcement of domestic awards may be refused broadly coincides with that above, but includes two additional grounds, namely that (i) there has been a definite error in the application of the law; or (ii) there is insufficient evidence to verify the facts.

ii) International awards

As far as international awards are concerned, the scope of the court’s review is limited to a number of procedural matters. The grounds for setting aside and denying enforcement of an international award are identical and are found in Articles 70 and 71 of the Arbitration Law (both of which refer to Article 260.1 of the Civil Procedure Law). Those grounds are as follows: (i) there is no arbitration clause in the parties’ contract and no subsequent written arbitration agreement between them; (ii) the party against which the application for enforcement is made was not given notice of the appointment of an arbitrator or of the initiation of the arbitration proceedings or was unable to present its case due to causes beyond its responsibility; (iii) the formation of the arbitral tribunal or the arbitration procedure was not in conformity with the rules of arbitration; or (iv) matters covered in the award lie outside the scope of the arbitration agreement or the arbitral tribunal was not empowered to deal with them. Due to ambiguity in the wording of the relevant legislation, it is unclear whether international awards may be set aside or refused enforcement on the ground of their being contrary to ‘social and public interest’, as provided in Article 260(2) of the Civil Procedure Law.

iii) Foreign awards

Foreign awards may be recognized and enforced in China on the basis of either international agreements or treaties to which China has acceded or the principle of reciprocity. The New York Convention is the principal international treaty applicable for this purpose in China. Article V of the New York Convention provides an exhaustive list of the grounds on which the recognition or enforcement of an award may be refused. These grounds are limited to matters of procedure. The ‘public policy’ ground has worried many commentators because of the risk of its being misinterpreted for the purpose of denying recognition or enforcement. However, publicly available information suggests that Chinese courts have not used this ground to deny enforcement of a foreign arbitral award.

2. Different standards of review

There has been debate over the need to distinguish between international and domestic arbitrations, so as to subject the former to less strict control than the latter. In China, different standards of review apply to domestic, international and foreign awards. The Chinese courts’ power to review domestic arbitral awards with regard to their substance is particularly significant for disputes involving FIEs. As explained above, FIEs are considered as domestic companies, even if they are wholly-owned by foreign investors. This means that an arbitration between a China-incorporated subsidiary of a German company and a China-incorporated subsidiary of a US company would be considered domestic, provided no other foreign elements are present. Accordingly, the arbitral awards rendered in such an arbitration would be open to substantive review by a Chinese court from which an enforcement order is sought. The application of different standards to the enforcement of different types of awards has led to confusion, with some courts erroneously setting aside or refusing enforcement of international awards after reviewing the substance of the award. For instance, in the case of Hong Kong Huaxing Development Company v. Xiamen Dongfeng Rubber Manufacturing Company, the Xiamen Intermediate People’s Court denied enforcement of a CIETAC award on the ground that the main evidence in support of the facts was insufficient under Article 217 of the Civil Procedure Law. There was a foreign element present in this case, as one of the parties was a company domiciled in a foreign country (Hong Kong, Macao and Taiwan are considered foreign in this context), so it should have been treated as an international arbitration. The grounds for denying enforcement of international awards are clearly set forth in Article 260(1) of the Civil Procedure Law and are limited to procedural matters. The court’s review of the merits and its reference to Article 217 of the Civil Procedure Law were thus questionable. This risk is expected to diminish as legislation improves and judges become better informed.

3. Reporting system

Another concern relating to enforcement is local protectionism by lower courts. To reduce the risk of decisions being invalidated because of local protectionism and lower court corruption, in August 1995, the Supreme People’s Court issued a document entitled ‘Notice of the Supreme Court Regarding the Handling by the People’s Court of Certain Issues Relating to International Arbitration and Foreign Arbitration’, establishing a centralized report and review system (the ‘Reporting System’). Under this system, where the Intermediate People’s Court considers that an international award or foreign award ought not to be enforced, it must first report its finding to the Higher People’s Court. In turn, should the Higher People’s Court concur with the Intermediate People’s Court, it must submit an approval advice to the Supreme People’s Court. The Intermediate People’s Court may not refuse enforcement until the Supreme People’s Court issues a determination. The same Reporting System applies where the Intermediate People’s Court considers that the arbitration agreement is invalid or incapable of being enforced. In other words, for international cases, a lower court cannot deny the validity of an arbitration agreement without the prior examination and confirmation of the Supreme People’s Court. Subsequently, in April 1998, the Supreme People’s Court issued another notice establishing a Reporting System specifically applicable to any decision by lower courts to set aside an international award. This mechanism effectively serves to ensure that an international award may not be set side by a lower court without the prior examination and confirmation of the Supreme People’s Court.

The above Reporting System has had a very positive effect in practice. It is said to ‘have significantly bolstered the confidence of foreign investors in fear of local protectionism’. However, there are concerns that it may lead to significant delays in proceedings, as no time limit is set for the completion of the process. Further, there are no provisions on liability or on compensation due to the parties when the lower court fails to comply with the reporting requirements. As noted by one commentator: ‘[t]he centralized report and review system is merely an interim measure designed to safeguard the legitimate rights and interests of the holders of arbitral awards in an environment of local protectionism. Over time, as such problems recede and the rule of law takes hold, the need for this type of mechanism will ultimately subside.’

(Edited by: China West Lawyer)