Arbitration Agreements in International Commerce (Part I)

I. Introduction

In general, if no specific agreement exists between domestic parties to civil and/or commercial disputes, one party may file suit against the other and the court will have jurisdiction over the dispute. This is complicated somewhat if the parties to a dispute are not citizens of the same state. The party initiating the action will first have to consider how to serve the complaint and other legal documents upon the opposite party (as a foreigner) (service of process is completed by the court in China). The plaintiff must then consider the complexity and prolonged process of court litigation proceedings; and finally (possibly the most important to the parties) consider whether the court's judgment can or will be effectively enforced. If there are no assets in the state where the court has rendered its judgment, the prevailing party will possibly have to seek enforcement of the judgment in the state to which the losing party belongs. This then gives rise to questions as to whether that state will recognize and enforce the judgment of the other court.

These complications involving sovereignty and diplomatic relations are quite complicated. Accordingly, in more and more commercial transactions, parties are inclined to resolve their disputes through arbitration; it has some advantages that litigation does not. For example, arbitration has the characteristics of privacy and informality, and a system of “one ruling only” helps avoid a prolonged appeal process. The most important point is that the New York Convention (i.e. the Convention on the Recognition and Enforcement of Foreign Arbitral Awards , done at New York, on 10 June 1958) ensures the recognition and enforcement of foreign arbitral awards. Article III provides that:

“Each Contracting State shall recognize arbitral awards as binding and enforce them in accordance with the rules of procedure of the territory where the award is relied upon, under the conditions laid down in the following articles.”

More than 130 countries throughout the world have joined the New York Convention. It is because foreign arbitral awards will be recognized and enforced in most instances that more and more parties to international commercial disputes have submitted their disputes to arbitration without hesitation. A key element however, is that the parties must enter into an arbitration agreement before initiating arbitral proceedings. There will be no arbitration without an arbitration agreement.

II. Meaning and Legal Results of an Arbitration Agreement

In brief, an arbitration Agreement is an agreement entered into by the parties to submit their disputes for settlement by arbitration. Article 7(1) of the UNCITRAL Model Law on International Commercial Arbitration (“Model Law” ) contains a detailed definition of an arbitration agreement, which is

“An agreement by the parties to submit to arbitration all or certain disputes which have arisen or which may arise between them in respect of a defined legal relationship, whether contractual or not. An arbitration agreement may be in the form of an arbitration clause in a contract or in the form of a separate agreement.”

The scope of this definition is very broad and in this definition, all contractual or non-contractual, present or future disputes can be submitted to arbitration. In fact, this helps define the “arbitrability” of disputed matters, i.e. whether the disputes are capable of settlement by arbitration.

In general, all contractual disputes are capable of settlement through arbitration, and most international commercial disputes are contractual disputes. However, with regard to the question of whether non-contract disputes can be resolved through arbitration, we have seen increasing latitude and diversity between the laws of each state. For instance, the United States court did not previously allow the submission to arbitration of disputes relating to Anti-Trust law because this law reflects the public policy of the United States government. It not only affected the disputed parties but also other people. However, the United States Supreme Court held in 1985 in “ Mitsubishi Motors v. Soler Chrysler-Plymouth Inc .” that all disputes in this regard could be submitted to arbitration. In addition, the United States court originally had a negative attitude regarding disputes relating to punitive damages claims. But in 1995, the United States Supreme Court decided in “ Mastrobuono v. Shearson Lehman Hutton Inc. ” that the punitive damages claim might be arbitrated even if the state court excluded such claim from arbitration. This author has been involved in international arbitration that has related to both the United States Anti-Trust law and punitive damages claims.

No matter how the laws of each state de-regulated the “arbitrability” question, certain matters are incapable of arbitration (e.g. those relating to criminal law or others falling within jurisdiction of executive bodies (e.g. taxation, customs). In addition, most states' laws do not allow for the submission to arbitration of matters relating to family law (e.g. divorce, custody). If the parties submit such non-arbitrable matters to arbitration, the result is that the arbitration agreement will be held invalid, and even if the arbitrators make an award, the award will not be enforced due to illegality. As an example, Article 3 of the Arbitration Law of the P.R.C . prohibits submitting to arbitration disputes over marriage, adoption, custody, support and inheritance and administrative disputes that by law should be handled by administrative entities. Article 17 further states that the arbitration agreement shall be regarded as invalid where the matters agreed upon in this agreement are beyond the scope of arbitration as prescribed by law. Articles 70 and 71 also provide that if the parties or the respondent produce(s) evidence proving that the matters decided in the arbitral award fall within the scope of matters that the arbitration commission is incapable to arbitrate, the People's Court shall repeal or decide not to enforce the award after ascertaining the fact. Sub-section 2 of Article V of the New York Convention similarly provides that if the competent authority in the country where recognition and enforcement of an arbitral award is sought finds that the subject matter of the difference is not capable of settlement by arbitration under the law of that country, the said authority may refuse recognition and enforcement of the arbitral award.

The legal result of a valid arbitration agreement is that the jurisdiction of the court is excluded, and the arbitrators are imposed jurisdiction over the disputed matters agreed upon in the arbitration agreement. For instance, Article 5 of the Arbitration Law of the P.R.C . specifies that:

“ Where the parties have entered an arbitration agreement and one party brings a suit in the people's court, the people's court shall not accept it unless the arbitration agreement is invalid. ”

If one dispute falls within the scope of an arbitration agreement but one party files a lawsuit with the court, the other party is entitled to file a motion with the court requesting the court to stay the litigation proceedings and submit the dispute to arbitration. However, the motion to stay the litigation shall not be made too late and, otherwise will be refused by the court. For instance, in accordance with Section 9(3) of the 1996 U.K. Arbitration Act , a party to an arbitration agreement may not make a n application for a stay of legal proceedings after he has taken any step to answer the substantive claim (in those proceedings). Article 8(1) of the Model Law also provides that:

“A court before which an action is brought in a matter which is the subject of an arbitration agreement, shall, if a party so requests not later than when submitting his first statement on the substance of the dispute, refer the parties to arbitration unless it finds that the agreement is null and void, inoperative or incapable of being performed.”

It can be seen that the Model Law requires the application of a stay of litigation proceedings to be made not later than the time of submission of the first statement of substance to the court. But the Arbitration Law of the P.R.C . is different in this respect. Article 26 of the Arbitration Law of the P.R.C . requires that only if the parties submit the arbitration agreement before the first court hearing, the court will reject the suit, and the failure of the parties to make any objection to the court's accepting the suit will be considered as waiver and the court will continue its trial of the suit. In other words, under Article 26, even if the parties to an arbitration agreement submit their substantive statement before the first court hearing, they may still make an objection to the court after submitting the substantive statement and before the first court hearing and request the court to submit the disputed matters to arbitration.

III. Arbitration Agreements - Separation Principle

As defined in the Model Law , an arbitration agreement may be in the form of a separate agreement or in the form of arbitration clause in a contract. In the former situation, the arbitration agreement itself is a separate agreement under which the parties submit their present or future disputes to arbitration. In the latter situation, the question is whether the arbitration clause is valid if the contract is not in existence or invalid. If the arbitration clause is valid, the arbitrators may continue the arbitration proceedings until making the final award (including a decision on the validity of the contract). If the arbitration clause is invalid, it is obvious that the jurisdiction of the arbitrators over the disputed matters is baseless and the arbitration proceedings shall be stopped immediately, and the parties shall submit the disputes to the court. Two questions arise from this: one is who has the power to make a ruling on the validity of the arbitration agreement? The other is whether the arbitration clause can exist independently from the contract?

The question of whether validity exists with regard to either a separate arbitration agreement or the arbitration clause in a contract. This question is a preliminary question in deciding the jurisdiction of the arbitrators. The original arbitration theory is that only the court has the power to decide the validity of a contract and arbitration agreement, and the arbitrators shall not be allowed to decide its jurisdiction. If the parties dispute the validity of the contract and arbitration agreement, the arbitrators shall wait for the court's declaration on whether the contract and arbitration agreement are valid before they decide to move forward with arbitration proceedings. Should that not occur, the parties may apply to the court for an order to stop the arbitrators from further actions. This theory has quite adversely affected international arbitrations, with many cases having to be submitted to the court for a decision on the validity of the contract and arbitration agreement. A new arbitration theory developed over the last decade or two however, holds that the arbitration clause in a contract can be independent of the base contract, leaving the arbitrators not only the power to decide the disputed matters agreed upon in the arbitration agreement, but also the validity of the arbitration agreement. This theory is called the “Arbitration Agreement Separation Principle”. In European continental countries, this is known as the “Kompetenz-kompetenz Principle” (“Competence-competence”).

At present, the “Arbitration Agreement Separation Principle” has been adopted as part of the general arbitration laws in most countries, with some limitations. This principle is accepted in Article 7 of the 1996 U.K. Arbitration Act , which specifies:

“ Unless otherwise agreed by the parties, an arbitration agreement which forms or was intended to form part of another agreement (whether or not in writing) shall not be regarded as invalid, non-existent or ineffective because that other agreement is invalid, or did not come into existence or has become ineffective, and it shall for that purpose be treated as a distinct agreement. ”

Even if the arbitrators confirm their jurisdiction and make an award, Article 67 of the U.K. Arbitration Act gives the parties the right to apply to the court to challenge any award of the arbitral tribunal as to its substantive jurisdiction, or for an order declaring that an award made by the tribunal on the merits is to be of no effect, in whole or in part, because the tribunal did not have substantive jurisdiction. Article 16(1) of the Model Law provides that:

“an arbitration clause which forms part of a contract shall be treated as an agreement independent of the other terms of the contract”, and that

“[T]he arbitral tribunal may rule on its won jurisdiction, including any objections with respect to the existence or validity of the arbitration agreement”.

However, Article 16(3) of the Model Law specifies that if the arbitral tribunal rules on the jurisdiction objection as a preliminary question that it has the jurisdiction, any party may, within 30 days after having received notice of that ruling, ask the court to ultimately decide this matter. Like the 1996 U.K. Arbitration Act and the Model Law, the Arbitration Law of the P.R.C. also accepts the “Arbitration Agreement Separation Principle” ( see Article 19). It does, however, contain different provisions concerning who has the power to rule on the validity of an arbitration agreement. Article 20 of the Arbitration Law of the P.R.C . provides that:

“Where the parties have objections to the validity of arbitration agreement, they may apply for decision by the arbitration commission or the people's court. Where one party applies for decision by the arbitration commission while the other party applies to the people's court, this matter shall be decided by the People's court.”

IV. Written Form Requirements of Arbitration Agreements

In general, a contract may be in verbal form or in written form. Article 10 of the Contract Law of the P.R.C . accepts a contract in verbal form. However, the arbitration agreement in international commercial arbitration is required to be in writing in most instances, with a verbal agreement usually being deemed insufficient. Such requirement is contained within the arbitration laws of territories where the major arbitration institutions of the world are located. For instance, Section 5(1) of the 1996 U.K. Arbitration Act specifies that:

“ The provisions of this Part apply only where the arbitration agreement is in writing, and any other agreement between the parties as to any matter is effective for the purposes of this Part only if in writing. ”

Section 2AC(1) of the Hong Kong Arbitration Ordinance provides that:

“An agreement is not an arbitration agreement for the purposes of this Ordinance unless it is in writing.”

Section 4(3) of the Singapore Arbitration Act of 2001 also states holds that except as provided, an arbitration agreement shall be in writing.

Both Article 16 of the Arbitration Law of the P.R.C . and Article 7(2) require that the arbitration agreement be made in writing. In fact, the provisions regarding written form requirements of arbitration agreements contained in each country's and region's arbitration laws accommodate the requirement of the New York Convention. Sub-section 1 of Article II of the New York Convention specifies that:

“Each Contracting State shall recognize an agreement in writing under which the parties undertake to submit to arbitration all or any differences which have arisen or which may arise between them in respect of a defined legal relationship, whether contractual or not, concerning a subject matter capable of settlement by arbitration.”

However, if the written form requirement is emphasized too much, the arbitration agreement will be regarded as not in existence in many instances, and there will be no arbitration. Accordingly, the current trend is that the written form requirement is explained more and more broadly, which is reflected in amendments to the Hong Kong Arbitration Ordinance , Section 5 of the 1996 U.K. Arbitration Act and Section 4 of the Singapore Arbitration Act of 2001 . Though almost all provisions of the Model Law are incorporated into the Hong Kong Arbitration Ordinance to govern international arbitration in Hong Kong, an amendment was made in 1996 to have Section 2AC apply instead of Article 7(2) of the Model Law . It can be seen from a comparison of the two that Article 7(2) of the Model Law requires the arbitration agreement to be “signed” by the parties while Section 2AC contains no such requirement. Under Section 2AC(2) of the Hong Kong Arbitration Ordinance , a written agreement exists if:

(a) the agreement is in a document, whether signed by the parties or not; or

(b) the agreement is made by an exchange of written communications; or

(c) although the agreement is not itself in writing, there is evidence in writing of the agreement; or

(d) the parties to the agreement agree otherwise than in writing by referring to terms that are in writing; or

(e) the agreement, although made otherwise than in writing, is recorded by one of the parties to the agreement, or by a third party, with the authority of each of the parties to the agreement; or

(f) there is an exchange of written submissions in arbitral or legal proceedings in which the existence of an agreement otherwise than in writing is alleged by one party against another party and is not denied by the other party in response to the allegation.

An analysis of the above provisions may be found in pages 23 and 24 of the Hong Kong Arbitration Guideline . The above provisions give the broadest definition on the written form requirements for an arbitration agreement, and also accommodate the most development of communication technology (e.g. electronic data exchange, electronic mail). For instance, an arbitration agreement recorded through emails shall obviously fall within the scope of the written agreement mentioned above.

There is a very simple provision in Article 16 of the Arbitration Law of the P.R.C. with regard to the written form requirement in arbitration agreements. The arbitrators or the court must refer to other laws and regulations when deciding whether the arbitration agreement meets the written form requirement. After the Contract Law took effect in 1999, the provisions regarding written form requirements of contracts contained in Article 11 of this Law become the standard for judging whether the arbitration agreement meets the written form requirement. In similar fashion to Section 2AC(2) of the Hong Kong Arbitration Ordinance , the provision regarding the written form requirement contained in Article 11 of the Contract Law is also very broad and favorable to the development of arbitration. This was further confirmed by the Supreme People's Court in its “ Several Provisions Concerning Handling Arbitration Involving Foreign Concerns and Foreign Arbitration By The People's Court (Draft”). Article 15 of this Draft provides that:

“The arbitration agreement involving foreign concerns shall be in writing. Whether the agreement is in writing shall be decided in accordance with Article 11 of the Contract Law.”

Further, Article 16 specifies that:

“Though the arbitration clause in a contract entered into by the parties shall be regarded as invalid, it shall be concluded that the parties have reached a valid arbitration agreement if one party applies to the arbitral institution or arbitral tribunal for arbitration while the opposite party does not make any objection on the validity of the arbitration clause and submits its statement of substance. ”

The Model Law was adopted by the United Nations Commission on International Trade Law on 21 June 1985. The purpose of the Model Law was to provide a standard arbitration law for each state in order to resolve the conflicts and differences in the current arbitration laws of every state in the world. Some countries and regions have adopted, in whole or in part, the Model Law. For instance, Hong Kong incorporated the Model Law into Section IIA of its Arbitration Ordinance to govern international arbitration proceedings conducted in Hong Kong. However, some international commercial arbitration experts (e.g. Phillip Yang ) are of the opinion that the power imposed by the Model Law upon arbitrators is too great and the court's intervention with arbitration is quite limited, which may not be favorable to the healthy development of international commercial arbitration.

Article 7(2) of the Model Law provides that: “The arbitration agreement shall be in writing. An agreement is in writing if it is contained in a document signed by the parties or in an exchange of letters, telex, telegrams or other means of telecommunications which provide a record of the agreement, or in an exchange of statements of claim and defence in which the existence of an agreement is alleged by one party and not denied by another. The reference in a contract to a document containing an arbitration clause constitutes an arbitration agreement provided that the contract is in writing and the reference is such as to make that clause part of the contract.”

Compiled by Dr. Michael J. Moser and Teresa YW Cheng, S.C., J.P., Published by Law Press in 2004.

Article 11 of the Contract Law provides that: “ A writing means a document of contract, letter or electronic message (including telegram, telex, facsimile, electronic data exchange and electronic mail), etc. which is capable of expressing its contents in a tangible form. ”

on the validity of the arbitration clause and submits its statement of substance. ”

-- To Be Continued --