CIETAC Arbitration Clauses: Tips and Pitfalls

By Howard Yinghao Yang of Morgan Lewis & Bockius

There have been several significant developments which affect the way in which arbitration is conducted at the China International Economic and Trade Arbitration Commission (CIETAC), the world's largest arbitration centre in terms of the number of cases received1. CIETAC adopted new arbitration rules (the New Rules) in May 2005 and the Certain Interpretations of Chinese Arbitration Law Application (the New Interpretations), issued by the Chinese Supreme Court, became effective in September 2006. The Chinese courts have also made a series of groundbreaking decisions on arbitration law over the past few years. What is the impact of these changes for practitioners involved in drafting clauses for arbitration under CIETAC?

Validity of Inaccurate Clauses
Judicial decisions in recent years have demonstrated that the Chinese courts take a formalistic approach to determining the validity of an arbitration clause. An otherwise valid arbitration clause can be held null and void on minor technical grounds, such as an inaccuracy in stating the name of the arbitration institution, even though all parties involved clearly knew which institution was referred to.

In the 2001 Yang Guang Da case, the Supreme Court Civil Division Four, No.41, held the arbitration clause to be invalid because it described CIETAC in Beijing as the “CIETAC Beijing branch”, which technically is wrong, since CIETAC's headquarters are located in Beijing, and there is no CIETAC branch in Beijing.

In the 2004 Shanghai Yan Qi Lights case at the Supreme Court Civil Division Four, No.7, an arbitration clause to submit disputes to the “Qingdao economic and trade arbitration commission” was held invalid because the institution's name should have been referred to as the “Qingdao arbitration commission”, even though this is the only arbitration commission in the city of Qingdao and the parties clearly had it in mind when the clause was drafted.

This form-over-substance attitude is not only in conflict with the general practice of international arbitration, but also in violation of Article 125 of the Contract Law (中华人民共和国合同法)of the People's Republic of China (the Contract Law), which requires a court to seek the parties' true intention in interpreting a contract.

The New Interpretation has four of its 31 articles addressing the issue of arbitration clause validity (See articles 3, 4, 5 and 6). These articles shows that the Supreme Court will reverse its past decisions on this issue and take a more liberal attitude in that as long as an arbitration clause points to a particular arbitration institution, any inaccuracy in the name given shall not affect the validity of the arbitration clause. This not only saves sloppily-drafted but otherwise viable arbitration clauses, but also gives lawyers more flexibility in drafting arbitration clauses.

Choice of Applicable Law
A breakthrough of the New Interpretation is that it permits the application of foreign law to an arbitral award made in China. The New Interpretation's Article 16 provides “[t]he validity of a foreign related arbitration clause shall be determined according to the law to which the parties have subjected it or, failing any indication thereon, according to the law of the country where the award was made”.

This choice of law is applicable only to an arbitration agreement (i.e., the clause(s) of the contract relating to arbitration) and should not be confused with the substantive choice of law applicable to the whole agreement. Under Article 126 of the Contract Law, a foreign-related contract can be governed by a foreign law, but such foreign law only applies to the substantive aspects of the contract. The determination of the validity of the arbitration clause, however, is based on procedural law and therefore would not be governed by the general choice of law for the contract.2 Before this New Interpretation, foreign procedural law, including arbitration law, was never allowed to be applied in the Chinese courts.

If a lawyer intends to take advantage of this breakthrough and draft a clause for a CIETAC arbitration to be governed by a foreign law, he/she should bear in mind that this is a standalone choice of law clause and efforts should be made to distinguish this choice of law from the general choice of law for the contract.

In the arbitration choice-of-law contract clause, practitioners may wish to consider including statements such as “without limiting the generality of the substantive choice of law clause” or “notwithstanding the provision of substantive choice of law clause”, if the choice of the substantive law and arbitration are different.

Flaws in CIETAC's Model Clause
CIETAC has recommended the use of the following clause to stipulate that all arbitration will be conducted at CIETAC: “Any dispute arising from or in connection with this Contract shall be submitted to CIETAC for arbitration which shall be conducted in accordance with the Commission's arbitration rules in effect at the time of applying for arbitration. The arbitral award is final and binding upon both parties.”

However, as several recent cases have revealed, this clause has a significant flaw in that the term 'CIETAC' could refer to three administratively independent institutions. The confusion comes from CIETAC's organizational structure. As Chart 1 shows, CIETAC is headquartered in Beijing and has two sub-commissions, located in Shanghai and Shenzhen, respectively.

The original purpose of this structure was to make arbitration more convenient for disputing parties, as the CIETAC rules required that CIETAC arbitration hearings take place only in the cities in which CIETAC had a physical presence. By establishing the sub-commissions, people could choose to go to Shenzhen or Shanghai for their arbitration hearings, instead of travelling to Beijing.

While this requirement was abolished by the New Rules, CIETAC's rules are not clear on which institution the parties should go to if the arbitration clause merely says the arbitration shall be submitted to CIETAC.

At least one published case held that the choice of CIETAC could refer to any of the three institutions in the CIETAC group (See Shanghai Second Intermediary Court Decision No.435 in 2000 on the Shanghai Guangfa Trading arbitration).

To make matters worse, Article 2(8) of the New Rules says if a dispute is submitted to CIETAC, the claimant filing the case should have the right to choose which specific commission will handle the dispute.

Case Study: Problems in CIETAC Clauses
The case of China National Metal Products Import/Export Company vs. Apex Digital, 379 F.3d 796, 2004 (the DVD Player Case) reveals how the flaws in CIETAC's rules and organizational structure could play out.

Apex Digital (Apex) is a California corporation with its principal place of business in Ontario, California. Apex imports consumer electronic goods from China which it sells under its own brand name to retailers in the US. Between July and September 2000, Apex and Chinese company China National Metal Products Import/Export Company (Metal) entered into a series of sales contracts for DVD players.

Each of the contracts contained the following identical arbitration clause: “All disputes from or in connection with this Contract shall be submitted to the China International Economic and Trade Arbitration Commission (“CIETAC”) for arbitration which shall be conducted by the Commission in Beijing or by its Shenzhen Sub-Commission in Shenzhen or by its Shanghai Sub-commission in Shanghai at the Claimant's option in accordance with the Commission's arbitration rules in effect at the time of applying for arbitration. The arbitral award is final and binding upon both parties.”

This clause, in essence, combines the CIETAC model clause and the New Rules Article 2(8), because the term “CIETAC” may refer to any of the three commissions and the one who files the claim first is given the right to choose the forum. That sowed the seeds for subsequent troubles.

In late 2000, Apex notified Metal that a large number of its DVD players were defective and it began withholding payments on invoices, which caused Metal to file an attachment application in the US District Court for the Central District of California. On March 6 2001, Apex commenced arbitration proceedings by filing a Statement of Claim concerning nine of the purchase orders at the Shanghai sub-commission; the case was accepted. Just one week after, Metal felt it probably would fare better if the case was conducted in Beijing, so it filed its own Statement of Claims concerning eight of the same purchase orders with CIETAC in Beijing.

Apex objected to Metal's application and asserted that Metal's claim should be consolidated into the Shanghai arbitration as a counterclaim. CIETAC rejected Apex's objection and concluded that CIETAC could entertain the two arbitrations separately. It reasoned the arbitrations were not “entirely the same”, noting the Shanghai arbitration involved one additional contract.



As it turned out, the Beijing arbitration panel ruled for Metal in May 2002. To seek enforcement of the Beijing award against Apex, Metal filed the application in the US District Court. Apex contested Metal's application by questioning the validity of the Beijing proceeding and argued that only one proceeding, the Shanghai arbitration, should have taken place.

The District Court ruled against Apex, which the Ninth Circuit affirmed, because at the enforcement stage, the remedies a US court could dispense were very limited and it had to defer to CIETAC's internal rules to determine the validity of arbitral awards.

A critical factor in the DVD player case was CIETAC Beijing's willingness to accept and hear the case, even though it was aware that a case between the same parties which was based on substantially the same facts was in process in Shanghai.

Although CIETAC Beijing and the two sub-commissions are members of the same family and theoretically should be able to coordinate well with each other, increasing cases reveal that their relationship is complicated and possibly competitive, rather than cooperative. One theory is that they actively compete for fees. If so, this could explain their behaviour in the DVD Player Case.

Another case of the same spirit which also illustrates the competition between CIETAC Beijing and its sub-commissions is the Yang Guang Da arbitration, at Supreme Court Civil Division Four, No.41 in 2001 (Seafood Restaurant Case). Once again, a dispute with the same facts and between the same parties was simultaneously heard by CIETAC Beijing and South China sub-commission, and received opposite rulings. The case was covered in the media and was harshly criticized for its ridiculous results.

Lessons for Arbitration Clauses
For arbitration clause drafting purposes, probably the most important lesson from the DVD Player Case and Seafood Restaurant Case is that the clause should always specify one and only one institution in the CIETAC group and the parties may also want to expressly exclude the application of Article 2(8) of the New Rules.


One complexity brought by the New Rules is that since it no longer requires the CIETAC hearing be conducted at CIETAC's office, statements such as “to have CIETAC arbitration in Beijing [Shanghai] [Shenzhen]” is no longer sufficiently clear to determine the institution, as one can request CIETAC Beijing/Shanghai/Shenzhen to conduct the hearing in another city.

Another lesson from the two cases is that practitioners should watch for the consolidation issue in CIETAC arbitration. It shall be noted that although it is not desirable, as in the DVD Player case, for CIETAC to allow two parallel arbitrations to proceed on substantially the same underlying dispute, such behaviour is not illegal. As such, Apex could not successfully question the validity of the Beijing award.

To date, the consolidation of arbitration cases is still a vacuum area under Chinese law. Neither the Arbitration Law of the People's Republic of China nor the New Rules have any provision regulating it. Unless the contracting parties involved agree on the consolidation of cases after any dispute arises, the only way under the current law to get CIETAC to consolidate the cases would be to have a clause beforehand which expressly agrees to the consolidation of any cases concerning the transaction.

CIETAC Arbitrations Outside China
Fortunately, the New Interpretation gives contracting parties the option to use arbitration forums other than CIETAC, provided the parties can agree on which specific institution to use at the time of arbitration or if there is a determination mechanism in the contract which identifies a specific institution.

Previously, CIETAC was the only allowed arbitration forum and if an arbitration clause stipulated the use of multiple arbitration institutions it would be held null and void.

Under the old rules, the venue of arbitration under CIETAC was limited to three cities: Beijing, Shanghai or Shenzhen. This restriction has been lifted by the New Rules, so, theoretically, a CIETAC arbitration can take place anywhere in the world.

However, practitioners are advised to avoid Hong Kong and other venues outside mainland China. If a CIETAC arbitration takes place outside mainland China, it may cause some unexpected problems at the judicial review stage because of the way arbitral awards are classified under the Chinese law.

The judicial awards are classified into four categories: domestic awards, foreign-related awards, awards under the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York Convention), and Hong Kong awards. See Table 1 for the key differences between these awards.

Among these four categories of awards, some of the differences are quite substantial, while others are merely procedural and minor. However, since any award needs to be classified before a court can determine which set of rules should apply to it, any uncertainty related to the classification may cause significant troubles, as the next case study shows.

Case Study: Confusion in Classifying Awards
The case of Wei Mao International vs. Shanxi Tianli Industrial (the WeiMao Case)3 illustrates how an International Chamber of Commerce (ICC) arbitration award made in Hong Kong caused confusion at the Chinese courts on the way to classify the award.

In June 1998, Shangxi Tianli Industrial (Tianli) entered into a sales contract in Hong Kong with Wei Mao Trading (Weimao). The contract contained the following arbitration clause: “All disputes in whatever form arising naturally out of and/or interpretation or performance of the contract shall be referred to arbitration in Hong Kong in accordance with the rules of the International Chamber of Commerce and the English Law...”

During the course of the contract, a dispute arose and Weimao submitted the dispute to arbitration in Hong Kong by the ICC International Court of Arbitration. The arbitration hearing was held in March 2000 and the ICC arbitrator made an award in Weimao's favour in October 2001.

Weimao applied to the Tai Yuan Intermediate People's Court (the Intermediate Court) to enforce the award. The Intermediate Court refused to enforce the award, on the grounds that the award contravened the social public interest.

In accordance with the pre-reporting system, the Taiyuan court reported its decision to and requested confirmation by the Shanxi Provincial People's High Court (the Shanxi High Court). The Shanxi High Court held that the award should be classified as a Hong Kong award and thus be governed by the Arrangement Concerning Mutual Enforcement of Arbitral Awards between the Mainland and the Hong Kong Special Administrative Region (the Arrangement).

The Shanxi High Court said the award was invalid under the Arrangement and reported the case to the Supreme Court to get approval for its intended refusal to enforce the award. The Supreme Court held that the award should be classified as a New York Convention award and that the Arrangement was therefore the wrong basis for enforcement. Since the Intermediate Court's purported grounds of refusal did not fall within provisions of the New York Convention, Tianli's application to refuse enforcement was therefore dismissed.

The classification of the Weimao award by the Supreme Court as a New York Convention award has been criticized as confusing the concept of a legal seat with an administrative seat4. Although the Supreme Court may have erred in this respect, there is another theory that could better explain the source of the disagreement between the Intermediate Court and Supreme Court on their classification.

As shown in the table above, the classification of awards is not based upon a uniform standard. Foreign-related awards employ a nationality test, which means if an award is made by an arbitration institution of Chinese nationality (such as CIETAC), it would be classified as a foreign-related award. By contrast, Hong Kong awards employ a territory test, which means that any award made within the territory of Hong Kong would be classified as a Hong Kong award, irrespective of the nationality of the arbitration institution.

The most complicated are New York Convention awards, which, under the Civil Procedure Law of the People's Republic of China, employ a nationality test. This means that an award made by any foreign arbitral institution, irrespective of the location of the legal seat, would be considered a New York Convention award in China. However, China is also under a treaty obligation to observe the New York Convention which, conversely, employs a territory test. By the New York Convention's territory test, any award made outside China and within one of the contracting states of the Convention shall be treated as a New York Convention award.

In the Weimao Case, the ICC's award in Hong Kong could be simultaneously classified as a Hong Kong award, as it is made within the territory of Hong Kong (Intermediate Court's definition), and as a New York Convention award, as it is made by an arbitral institution of a foreign nationality (Supreme Court's definition). The root of the trouble is the conflict between the different tests for the classification of awards.

For the purpose of drafting clauses for CIETAC arbitration, the conflicting tests could make some foreign-related CIETAC awards doubly classified (See Table 2). Therefore, practitioners shall be aware of the risks of classification and be prepared to run into troubles similar to those experienced in the Weimao Case if Hong Kong or other places outside mainland China are chosen as the venue for a CIETAC arbitration.

Comparative Value of Domestic Awards
As shown in Table 1, the substantial differences between domestic awards and the other three types of awards are the level of scrutiny they would receive at a judicial review stage and whether the pre-reporting mechanism applies to the awards.

All awards, except for domestic awards, would only receive a review on procedure by the courts, which means the courts would not second-guess the arbitration panel's decisions on both fact determination and law application. In addition, all other awards are entitled to the pre-reporting mechanism. The pre-reporting mechanism requires a reviewing court to obtain the Supreme Court's approval to set aside any award.

As seen in the Weimao Case, in order to set aside the ICC award, the Intermediate Court needed to report its decision to the Shanxi High Court and then to the Supreme Court for approval. Such a pre-reporting mechanism effectively prevents courts from easily throwing out an arbitration decision and helps make arbitration a meaningful choice of dispute of resolution. In 2002, for example, about 80% of the cases in which the intermediate and high courts contemplated refusing enforcement were overturned by the Supreme Court in favour of enforcement.

Domestic awards enjoy neither of these advantages. Domestic awards are defined as awards from domestic arbitration where all parties are domestic entities and the transaction involved does not contain a foreign element. Therefore, in a situation where the transaction is between two wholly-owned subsidiaries of international corporations, if the subsidiaries are registered Chinese entities, it is very likely that the only form of arbitration available to them is domestic arbitration, which will render domestic awards with all the undesirable features discussed above.

However, the liberalization of the CIETAC venues and the conflicting classification tests may offer a way around the domestic awards situation. Suppose there are two conflicting parties which are domestic entities. In their arbitration agreement, they decide to have a CIETAC arbitration and choose a city outside mainland China (say, San Francisco) as the venue of arbitration. If the CIETAC arbitration panel in San Francisco makes an award, how would Chinese law classify it?

According to Table 1, this award could be classified both as a domestic award and as a New York Convention award, because any award made in a state which is party to the New York Convention is a New York Convention award, irrespective of the nationality of the arbitral institution.

In this double classification situation, since the law based on international treaty prevails when a conflict of law takes place, the classification as a New York Convention award (which is based on international law) should win, giving this award a better reviewing standard and pre-reporting mechanism. Admittedly, this plan to work around the domestic awards situation could be regarded as too aggressive. We should wait to see if it really works out in practice.

The author would like to thank Michael Anderson, a partner at Morgan Lewis & Bockius, for his guidance and valuable comments on the article. The author also wishes to thank Steve Nelson, a partner at Dorsey & Whitney, for providing the draft New Interpretations and Hong Kong arbitration data. Howard Yinghao Yang can be contacted at: [email protected]

Endnotes
1 See statistics at www.hkiac.org.
2 Similar distinctions also exist in other legal systems. See Albert Jan van den Berg's discussion of a similar clause in the Convention on the Recognition and Enforcement of Foreign Arbitral Awards, in The New York Arbitration Convention of 1958, p. 293.
3 See 'A Review of the Enforcement of Hong Kong Awards in Mainland China' by James Lee in Asian Dispute Review, April 2006, p. 52-55.
4 Ibid.

Table 1: Key Differences in Judicial Awards

1 Civil Procedure Law of the People's Republic of China, Article 217.

2 Ibid.