Going Global – China's Arbitration Reforms in 2019

In the intervening years, China experienced significant economic development and became an integral player in global business and trade. In the last few years, China embarked on two international, high-value projects: the Belt and Road Initiative (BRI) and the Greater Bay Area (GBA). Both projects involve Chinese companies going into business with foreign parties in areas from infrastructure to technology. To modernize Chinese arbitration in line with international best practice to facilitate this business, boost the nation's credentials as an arbitration venue, and expand the options available to foreign-related arbitration users, China enacted two significant reforms in 2019:

• Shanghai opening up its FTZ to allow foreign arbitral institutions to administer cases

• Mainland courts began granting interim relief to Hong Kong-seated arbitration

Shanghai Opening Up

On Oct. 21, the Shanghai Municipal Bureau of Justice released the Measures for the Administration of the Establishment of Business Offices in the Lingang New Area of the China (Shanghai) Pilot Free Trade Zone by Foreign Arbitration Institutions (the Measures) (境外仲裁机构在中国(上海)自由贸易试验区临港新片区设立业务机构管理办法). The Measures state that qualifying foreign arbitral institutions will be allowed to set up business offices in the Lingang area of Shanghai's pilot Free Trade Zone (FTZ) and administer foreign-related arbitration cases. Civil or commercial disputes in the areas of international commercial, investment and maritime affairs are eligible for the purposes of the new Measures (Article 14).

Roughly the size of Hong Kong, Lingang was added to the Shanghai FTZ in August, the first of its kind in China with more favorable tax and regulatory requirements than other parts of the country. Meg Utterback, a New York-based partner at King & Wood Mallesons, explained that the arbitration opening up is part of a broader strategy to lure foreign investment to Shanghai.

"For some time now, there has been internationalization [in the Shanghai FTZ] including opportunities for foreign firms to set up joint-ventures (JV) with local Chinese firms," she said. "The idea is that if you're going to have international parties operating in the FTZ, then you want to give them the opportunity to arbitrate their disputes in a way that they are relatively comfortable and familiar with, both in terms of the process and the institutions."

Foreign parties are naturally more familiar with international arbitral institutions such as the International Chamber of Commerce (ICC). However, China's arbitration market has always been closed to such institutions (with a few exceptions) as arbitral institutions in China must be domestic according to the Arbitration Law (Articles 10, 66). Moreover, Chinese parties can only arbitrate outside mainland China if the dispute has a foreign element, such as those involving foreign citizens or issues located outside China.

Domestic disputes in China can therefore only be arbitrated by domestic institutions. Awards issued by foreign arbitral institutions seated overseas for a domestic dispute without a foreign element are not enforced by Chinese courts. The Measures do not change that, but they do provide domestic parties the new option of having an arbitration administered by a foreign arbitral institution in China, whose awards are then enforced by Chinese courts.

For example, two wholly foreign-owned enterprises in China will be permitted to arbitrate a dispute onshore through a foreign arbitral institution for the first time, as long as the dispute is foreign-related. Previously, if they wanted a foreign arbitral institution to administer their case, they would have to go offshore.

"It is very clear now that foreign arbitration institutions that meet certain criteria can go into Lingang and apply for business licenses to set up a 'business office'," Utterback said. "Previously those institutions only had representative offices [in Shanghai] and could only market their offshore services. Now there are opportunities onshore."

Prominent international arbitral institutions with such offices in Shanghai include the ICC and the Hong Kong International Arbitration Centre (HKIAC). Both are considering their next steps in light of the Lingang reforms – an important step in the Chinese government's plan to develop Shanghai into an "Asia-Pacific arbitration center."

In addition to award recognition, the Supreme People's Court (SPC) has said that foreign arbitral institutions in Lingang will also have the power to apply for interim relief from mainland courts. However, there will still be restrictions on what the institutions can do onshore as the Measures state that cases must still be foreign-related (Article 2) and that foreign arbitral institutions must be well-known and more than five years old.

"[T]he limitation to disputes with a foreign-related element makes this development of limited use to international parties," Morrison Foerster's Singapore-based partner Craig I. Celniker and Hong Kong-based partner Sarah Thomas wrote in a client alert. "Foreign arbitral institutions are already able to lawfully administer such disputes outside mainland China."

King & Wood Mallesons' Utterback highlighted some procedural uncertainties that still remain surrounding the setup of the arbitral institutions themselves. "Certainly, [questions remain about] how the business offices will be set up, their tax status, what exactly they will be allowed to do, what it means when [the Measures say] that arbitrations will be conducted in accordance with PRC law, and how they will have to abide by PRC law."

Despite these uncertainties, she believes the opening up represents a significant development for Chinese arbitration because of the convenience it brings. Companies operating in Shanghai or the wider region might prefer arbitrating their cases closer to where they are based for convenience's sake. Even having an arbitration in nearby Hong Kong incurs significant costs and time for visa processing, she points out.

Certainly, the impact of the Measures would be greater had this established for the first time an official channel for cases administered by foreign arbitral institutions to be supported by interim relief from mainland courts. That is not the case however due to a new groundbreaking arrangement involving Hong Kong.

Hong Kong Relief

On Apr. 2, the SPC and the Hong Kong government signed the Arrangement Concerning Mutual Assistance in Court-ordered Interim Measures in Aid of Arbitral Proceedings (the Arrangement) (关于内地与香港特别行政区法院就仲裁程序相互协助保全的安排).  The Arrangement allows parties to a Hong Kong-seated arbitration to seek interim relief from mainland courts. Previously, mainland courts only handed down interim measures orders for domestic China-seated arbitrations. Now parties to Hong Kong-seated cases may also apply for property, asset and conduct preservation orders, the first foreign jurisdiction allowed to do so.

"This is a significant breakthrough and indicates closer cooperation between mainland China and Hong Kong in arbitration matters," said Joe Liu, Deputy Secretary-General of HKIAC, one of six Hong Kong arbitral institutions "qualified" to tap the benefits of the new Arrangement.

Until now, mainland courts had no legal basis for granting interim measures in support of offshore arbitration. Nor do they recognize interim measures granted by foreign arbitral tribunals as they are not considered final awards for the purposes of the New York Convention. As a result, offshore arbitration with a Chinese element has been problematic as there is little recourse if a Chinese counterparty is uncooperative.

"For example, in an arbitration, it might take some time before a party obtains the final award," Liu explained. "During the arbitration, if a party knows that the other party is taking actions to cause prejudice to the arbitral process, transferring assets, or destroying key evidence in mainland China, having access to interim measures to preserve assets, evidence and conduct by the mainland Chinese courts is very powerful. They can also be used as a tool to put pressure on the other party to settle the dispute."

However, significant limitations still remain. The Arrangement does not apply to ad hoc arbitrations (those without an arbitral institution involved); only cases administered by one of the six qualified arbitral institutions are eligible for interim relief support. Moreover, relief is limited to evidence, asset and conduct preservation, whereas local courts in Hong Kong also grant injunctions to "maintain or restore the status quo pending determination of the dispute."

HKIAC has received 11 applications for seeking interim relief since the Arrangement came into effect in October, with five of them already approved by mainland courts. "Our experience is that some PRC courts have acted quickly to grant applications to preserve assets," Liu said. "This will be an important factor for parties involved in China-related transactions to consider when selecting a forum to resolve their disputes."

As Hong Kong is now the only offshore jurisdiction able to secure interim measures from mainland courts, the city's attractiveness as an international arbitration seat will only be boosted – especially among parties to cross-border transactions with a Chinese element. The Arrangement gives Hong Kong a strategic advantage over other jurisdictions, such as Singapore, as an arbitration seat for BRI-related disputes, Liu said.

"[BRI involves] investment mostly in high risk, emerging jurisdictions where Chinese investors and their local partners might not be comfortable arbitrating or litigating in each other's home jurisdictions." He added that Hong Kong's geographical location, strong rule of law and abundance in legal talent make the city the ideal dispute resolution venue for BRI-related disputes.

"One-Stop Shop"

Announced in 2013, China's BRI involves billions of Chinese capital being invested in over 60 countries. In June 2018, the SPC established two China international Commercial Courts (CICC) to handle the expected increase in China-related cross-border disputes as a result of the BRI.

Central to the commercial courts' mission is the promotion of different dispute resolution methods, not just arbitration. The courts work with both international mediation and arbitration institutions to give parties to BRI transactions a variety of dispute resolution options including litigation, mediation and arbitration.

In 2019, significant progress was made on this "one-stop shop" plan. In August, China along with 45 other countries signed The United Nations Convention on International Settlement Agreements Resulting from Mediation (the Singapore Convention). The Singapore Convention will facilitate the enforcement of mediated settlement agreements across borders. China does not currently enforce mediated settlement agreements from overseas jurisdictions.

China has also signaled its support for litigation as a dispute resolution method for cross-border transactions. In July, the Hague Conference on Private International Law finalized the Convention on the Recognition and Enforcement of Foreign Judgments in Civil or Commercial Matters (the Hague Convention). The Hague Convention requires its contracting countries to enforce court judgments handed down in states that have ratified the convention. Although China is yet to sign the Convention, it was instrumental in the drafting process with the most delegates involved (21 members).

The lack of enforcement of foreign judgments and mediated settlement agreements has contributed to the popularity of arbitration in China-related cross-border disputes as China is bound by the New York Convention. With the emergence of both the Singapore Convention and the Hague Convention, such disputes are set to shift from an arbitration-heavy model towards a combination of arbitration, litigation and mediation.

2020 outlook

Nevertheless, arbitration remains the most popular dispute resolution method for China-related transactions today. With the Chinese economy increasingly opening up to foreign investors and the BRI springing up growing numbers of cross-border business disputes, significant reforms are needed to bring China's arbitration regime up to international standards. Updates to the PRC Arbitration Law are central to this, HKIAC's Liu said.

"[The Law] is one of the restrictions on the further development of arbitration practice in mainland China. If you don't change the law, there's only limited room for you to revolutionize your practice."

There are signs that the government is sympathetic. In September 2018, it was announced that China's parliament will review and amend the Arbitration Law within five years. Liu wants to see amendments that codify the concept of "seat" for Chinese arbitration.

"The seat of arbitration traditionally is not a concept recognized by [PRC] law," Liu explained, pointing out that the Lingang Measures do not specify whether cases administered by foreign arbitral institutions in Lingang will be China-seated for this reason. "Traditionally the PRC courts look at the location of the arbitral institution to determine the nationality of the arbitral award and proceedings. Only in recent years, where there's been an exchange of information between the PRC and foreign arbitration communities, has the concept of seat been imported into China."

King & Wood Malleson's Utterback highlights the need for amendments to reflect China's increasingly international arbitration landscape. "There are issues about… whether the [administrative] rules of particular [foreign] institutions will adequately mesh with the PRC Arbitration Law." These include differences over fee structures and procedures, in part due to the common law tradition of international arbitration in contrast with the civil law tradition of Chinese arbitration.

Edward Liu, Hong Kong-based legal director at Hill Dickinson, does not believe the Arbitration Law is out of date however. He points to the use of judicial interpretations by the SPC as a powerful driver of evolution in China's arbitration regime over the years, including the Lingang Measures and interim measures Arrangement with Hong Kong, neither of which required changes to the Arbitration Law.

"The law has to be amended, but it's not that urgent," said Liu, who has spoken to judges at the SPC specializing in foreign-related cases. "On the other hand, the Chinese judiciary will remain very pro-arbitration, not only because the current system is operating well but also because China is keen to further improve its business environment ranking as recognized by the World Bank." The World Bank's latest report has China ranked 31^st in the world in 2018-19 for ease of doing business, a significant improvement from 46^th the previous year.

"I'm quite confident that we will not see any change in that trend," Liu said.