IA Fundamentals | 5. International Arbitration Agreement (II)

Editor's Note: As enterprises are increasingly engaged in international trade and investment, international arbitration is recognized as the preferred option in the face of cross-border disputes. However, international arbitration, which differs from domestic arbitration with complex procedures, often put parties unfamiliar with its rules at an inherent disadvantage. King & Wood Mallesons’ international arbitration teams are located in Beijing, Shanghai, Shenzhen, Hong Kong Special Administrative Region of China, Sydney, Melbourne, Perth, London, Madrid, Brussels, Dubai, Tokyo, New York and Silicon Valley. KWM International Arbitration Fundamentals is co-hosted by King & Wood Mallesons’ China and Australia international arbitration teams. The purpose of the program is to share knowledge and experience on international arbitration, including international commercial arbitration and investment arbitration, from the perspective of experienced lawyers. Hopefully it will benefit parties engaged in international arbitration. Please comment with any suggestions or ideas.

As we mentioned in the last article of the International Arbitration Fundamentals series, an effective arbitration agreement is essential to contracting parties. It provides jurisdiction for the tribunal and is a prerequisite for the recognition and enforcement of arbitration awards of international arbitration institutions across international territories. Although a clear and complete arbitration agreement itself may not guarantee the smooth progress of arbitration proceedings, an ineffective arbitration agreement that lacks essential elements or contains vagueness, will inevitably mean additional disputes, lengthy procedures, higher costs, and even an unenforceable award.

How do parties who are not familiar with international commercial arbitration draft an effective arbitration agreement? This article will introduce the key points of drafting an arbitration agreement, starting from how to choose model arbitration clauses provided by institutions, and will also provide tips for drafting "tailored-made" arbitration clauses.

I. Choosing institutional arbitration and model arbitration clauses: safety first

As we mentioned in the second article of the International Arbitration Fundamentals series, institutional arbitration is more beneficial to parties with less experience in international arbitration when compared with ad hoc arbitration. The reason is that the arbitration institution will manage the proceedings based on a set of well-established procedural rules, which provide a framework ensuring successful proceedings and reduce administrative burden of the parties.

Chinese entities should try to submit to the arbitration institution agreed by both parties as much as possible instead of using ad hoc arbitration unless necessary. This is to avoid potential uncertainties in ad hoc arbitration agreements caused by a provision in the Chinese Arbitration Law requiring an agreement to the arbitration institution. If ad hoc arbitration is more in line with the needs of the parties due to industry practices and actual circumstances, we recommend agreeing on a seat of arbitration outside Chinese mainland and the laws of a region where ad hoc arbitration is permitted as the governing law of the arbitration agreement.

The meaning of ‘express and clear’ is that the choice of arbitration seat and relevant laws are directly reflected in the arbitration clause without any possibility for a different interpretation. There was a case in which the Chinese court held that the place of arbitration was not clearly agreed on (based on Article 16 of the Interpretation of the Supreme People's Court concerning Some Issues on Application of the Arbitration Law of China[1]). This was because the expression in the ad hoc arbitration agreement in respect of a specific overseas region defined in the contract was flawed, and the parties did not clearly agree upon the applicable laws. As a result, the laws at the locality of the court (i.e. China) shall apply and the ad hoc arbitration agreement was declared invalid.

In practice, one of the advantages of choosing institutional arbitration is that most international arbitration institutions publish their recommended model arbitration clauses on their websites. For parties who are not familiar with international arbitration procedures, it is a safe choice to apply the model arbitration clauses recommended by the selected arbitration institution.

A party would naturally prefer an arbitration institution in its home country, as the procedural rules and arbitrators are more familiar, arbitration and enforcement costs are lower, and local judicial practices are better understood. However, when negotiating arbitration clauses in international transactions, both parties often need to compromise their preference for arbitration institutions in their respective countries or regions and to agree upon a third-party arbitration institution that is acceptable to both.

Generally, when choosing an arbitration institution, the parties should consider the following factors:

1. Place with closest connection with contract

Parties often choose an arbitration institution in the place which has the closest connection with the contract, so as to better preserve evidence and promptly initiate proceedings if a dispute occurs.

2. Location of the arbitration institution

When considering the location of the arbitration institution, parties consider not only cultural and institutional factors that may affect the legal results, but also geographic factors such as distance and travel costs. The best choice is when the parties are familiar with the legal system of where the arbitration institution sits and when the arbitration institution is not too far away.

3. Preservation and enforcement

Parties consider the location of the other party’s property and think about a place which makes it easier to preserve and enforce the other party’s property. Property preservation orders issued by overseas arbitration institutions are difficult to enforce in Chinese mainland. However, since the Arrangement Concerning Mutual Assistance in Court-ordered Interim Measures in Aid of Arbitral Proceedings by the Courts of the Mainland and of the Hong Kong Special Administrative Region came into effect, the property preservation orders issued by some arbitration institutions in Hong Kong SAR can be effectively enforced in Chinese mainland, which makes arbitration institutions in Hong Kong SAR more attractive to parties outside China.

4. Arbitration rules

Parties should pay attention to the default provisions in the arbitration institution's rules on specific matters such as the composition of tribunal, costs and procedures.

For more information on how to choose a suitable international arbitration institution, please refer to the article Tailor-made Decision on a Suitable International Arbitration Institution written by KWM partner Liu Yuwu and others.[2]

II. "Customized" arbitration clause: look out for landmines

From the various international arbitration cases we have acted in over recent years, it seems that parties are paying more attention to arbitration clauses and applicable laws. Especially in complicated transaction projects, transaction lawyers and counsels of both parties will carry out multi-rounds of negotiation in respect of the dispute resolution clauses, including the various elements of the arbitration clauses, in order to protect their interests to the greatest extent possible in case of any future dispute. Our international arbitration team is often engaged by colleagues from our corporate department during the negotiation of transaction documents to advise on arbitration clauses, especially on how to choose the place of arbitration, arbitration institution and applicable substantive laws.

After making a decision on which arbitration institution to select, the parties can draft “customized” arbitration clauses by making additions, deletions, changes and replacements to the model arbitration clauses of the selected arbitration institution, and agree on the applicable laws, the seat of arbitration/arbitration procedure, venue of arbitration, number of arbitrators, constitution of arbitration tribunal, language and many other elements that can be covered in the arbitration agreement.

If well-customized, the preferences and interests of both parties will be maximized. However, if the parties do not fully understand the legal significance of the various elements of the arbitration agreement, causing a lack of essential elements or unclear content, the result might be additional disputes and procedural delays or even invalid arbitration agreement or unenforceable arbitration awards.

Terminology can be ambiguous too: There are three different types of ‘applicable laws’, namely the law applicable to substance of parties’ dispute; the governing law for the validity of an arbitration agreement; and, the procedural law applicable to arbitral proceedings. There are three different legal meanings of the word ‘location’: the location of the arbitration institution; the seat of arbitration; and, the venue of arbitration. Therefore, when agreeing on any of the above terms, even slightly unclear wording might lead to ambiguous interpretations. The cross-jurisdictional nature of international arbitration agreements also means that different interpretations of an element in the arbitration agreement in different jurisdictions may lead to completely different legal consequences.

In one international arbitration case we acted in, the arbitration agreement read as follows:

“Governing Law & Dispute Resolution

Any dispute arising from or in connection with this Contract shall be submitted to China International Economic and Trade Arbitration Commission (CIETAC) for arbitration which shall be conducted in accordance with Hong Kong laws. The arbitral award is final and binding upon both parties.”

This arbitration agreement provides for two elements. First, CIETAC shall be the agreed arbitration institution. Second, the arbitration should be “conducted” in accordance with Hong Kong laws. The two parties did not clearly agree on the seat of arbitration, and it just so happens that the CIETAC is headquartered in Chinese mainland and has a branch in Hong Kong SAR. Much argument was wasted during the arbitration process on the interpretation of this clause.

One interpretation is that Hong Kong law is the governing law for substantive disputes. As there’s no provision in the arbitration clause that the seat of arbitration should be Hong Kong SAR, and according to the CIETAC arbitration rules, the case should be governed by CIETAC Beijing when the parties involved have not expressly agreed to submit the case to any CIETAC branch. Therefore, the seat of arbitration should be Beijing and the arbitration procedural law should be the laws of Chinese mainland.

Another interpretation is that Hong Kong law is a procedural law and therefore the seat of arbitration agreed by both parties is Hong Kong SAR. As a result, the CIETAC Hong Kong branch should have jurisdiction over the case.

What further adds to the complexity of the case is that although both parties are overseas entities, the contract clearly states that the place of signing is Chinese mainland. Therefore, even if it is finally determined that the seat of arbitration should be Hong Kong SAR, a court in Chinese mainland may have jurisdiction over an application for recognition of the effect of an arbitration agreement (pursuant to Article 2 of the Provisions of the Supreme People's Court on Several Issues concerning Trying Cases of Arbitration-Related Judicial Review.[3])

Because of the complicated situation and after multiple rounds of procedural disputes, the two parties finally chose to settle the case before arbitration.

In the review after the case, we found the caused the ineffectiveness of this arbitration agreement was that the two parties confused the meaning of several elements, such as governing law for substantive dispute, arbitration procedural law, and arbitration procedure rules. During the negotiation, there were several rounds of amendment to the clear and effective model clauses drafted by CIETAC. The original independent clause for governing law for substantive dispute was deleted, and the text in the model clause which provided for arbitration procedural rules was directly replaced with "Hong Kong law" without a clear definition, resulting in the missing and mixed-up of elements in the arbitration agreement, as illustrated below:

“Governing Law & Dispute Resolution

1. The governing law of this contract is Chinese law.

2. Any dispute arising from or in connection with this Contract shall be submitted to China International Economic and Trade Arbitration Commission （CIETAC） for arbitration which shall be conducted in accordance with Hong Kong Lawsthe CIETAC's arbitration rules in effect at the time of applying for arbitration. The arbitral award is final and binding upon both parties.”

In this regard, we suggest that when drafting a “customized” arbitration agreement, the parties should first identify the location of the arbitration institution and expressly make it the seat of arbitration. The arbitration procedural law will automatically be the laws of the seat of arbitration. There is no need to refer to any other applicable laws in the arbitration agreement/arbitration clause. The governing law for substantive dispute shall be clearly stipulated in a separate contract as far as possible.

After that, the parties can rest assured that they can further agree on such elements as the venue of arbitration, the number of arbitrators, the composition of arbitration tribunal and language. These elements will not have a substantial impact on the effectiveness of the arbitration agreement. An important thing to notice is that the venue of arbitration should be clearly distinguished from the seat of arbitration.

Major international arbitration institutions generally value user experience feedback and are increasing their flexibility to adapt to the requirements of the parties. In many arbitration institutions, the arbitration rules of another arbitration institution agreed by both parties can be used to govern the arbitration process. Facing COVID-19 pandemic and other factors that hinder the movement of people, flexible agreements on a venue outside the place of arbitration or technology assisted tribunal may be increasingly accepted by international arbitration participants.

Ideally, a Chinese party and a foreign party should be able to agree to a venue of arbitration in China while the arbitration institution and the place of arbitration provided in the arbitration agreement are both outside of China.

III. Summary

In summary, we suggest that the parties pay attention to the following issues when drafting an arbitration agreement:

1. Use institutional arbitration to the extent possible. If ad hoc arbitration must be used, a country/region outside the Chinese mainland where ad hoc arbitration is recognized should be expressly and clearly identified as seat of arbitration. The laws of a jurisdiction where ad hoc arbitration is recognized should be identified as the governing law of the arbitration agreement.

2. Choose to apply the model arbitration clauses drafted by international arbitration institutions as much as possible.

3. Try not to delete or modify the institutional model arbitration clauses. Some procedural details can be added. If necessary, the agreement may provide for some other elements such as number of arbitrators, language, composition of the tribunal and venue of arbitration.

4. If it is necessary to delete or modify the core elements of the institutional model arbitration clauses, the seat of arbitration must be agreed in clear terms and distinguish itself from the location of the arbitration institution and the venue of arbitration. Because the seat of arbitration has particularly important legal significance:

a)

The court of the seat of arbitration shall supervise and administer the arbitration procedure in accordance with the local arbitration procedural law and has the power to review and revoke the arbitration award;

b)

It is natural to use the law of the seat of arbitration as the arbitration procedural law. We don’t recommend agreeing on other arbitration procedural laws as it may cause difficulties in practice;

c)

Unless otherwise agreed by the parties, the law of the seat of arbitration is also the law governing the validity of the arbitration agreement;

d)

The seat of arbitration determines the nationality of the arbitration award and therefore affects whether the award will be recognized and enforced in other jurisdictions.

5. If there is a need to agree on the governing law for substantive disputes, it should be agreed in a clause independent of the arbitration agreement/arbitration clause using very clear language as far as possible.

6. If parties agree to use Chinese mainland as the seat of arbitration for foreign-related arbitrations, they should make a clear agreement on the governing law of the validity of the arbitration agreement. Try to choose the governing law of a jurisdiction that is more relaxed and friendly to the validity of the terms of an international arbitration agreement, such as the laws of the Hong Kong Special Administrative Region, in order to ensure the stability of the effectiveness of the arbitration agreement.

Arbitration agreements are often regarded as not the most important part in transactions. However, in practice, there are many ambiguous arbitration agreements due to lack of attention or misunderstanding of the elements of the arbitration agreement, which ultimately leads to loss of significant benefits.

Parties who are engaged in international business should make plans for arbitration agreements in advance based on the characteristics of their industries and businesses and their main business areas. It also helps to keep records of well-drafted arbitration agreements that have been case-tested so that they can be used in major transactions with a tight time frame. If the transaction involves a lot of negotiations and amendments on the arbitration agreement, professional legal advice should be obtained as soon as possible to ensure the validity of such an agreement.

Footnotes:

[1] Article 16 of the Interpretation of the Supreme People's Court concerning Some Issues on Application of the Arbitration Law of the People's Republic of China: The examination of the effectiveness of an agreement for arbitration which involves foreign interests shall be governed by the laws agreed upon between the parties concerned; if the parties concerned did not agree upon the applicable laws but have agreed upon the place of arbitration, the laws at the place of arbitration shall apply; if they neither agreed upon the applicable laws nor agreed upon the place of arbitration or the place of arbitration is not clearly agreed upon, the laws at the locality of the court shall apply.。

[2]https://www.kwm.com/zh/cn/knowledge/insights/how-to-choose-the-most-appropriate-international-arbitrator-20150731

[3] Article 2 of the Provisions of the Supreme People's Court on Several Issues concerning Trying Cases of Arbitration-Related Judicial Review: For cases where an application is filed for recognition of the effect of an arbitration agreement, an intermediate people's court, or a special people's court, in the place where the arbitral institution as stipulated in the arbitration agreement is located, or where the arbitration agreement is entered into, or in the place of domicile of the applicant or the respondent, shall have jurisdiction.

References:

1. IBA Council, IBA Guidelines for Drafting International Arbitration Clauses, Oct 7, 2010.

2. Gary B. Born, International Commercial Arbitration, Second Edition, Kluwer Law International, 2014.

3. Nigel Blackaby and Constantine Partasides QC with Alan Redfern and Martin Hunter, Redfern and Hunter on International Arbitration, Sixth Edition, Oxford University Press, 2015.

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Authors

Shining Guo

过仕宁

Partner

Dispute Resolution

[e-mail]

Ms. Shining Guo specializes in dispute resolution, especially in cross-border commercial dispute resolution. Ms. Guo is proficient at assisting Chinese and foreign clients with complex commercial disputes, and she has handled many influential arbitration cases before major international arbitral institutions, which includes the HKIAC, ICC, SIAC, FOSFA, CIETAC, as well as ad hoc arbitrations in Hong Kong SAR and London, in respect of joint venture shareholders’ disputes, financial derivative disputes, product liability disputes, sale of goods disputes, bill of lading, charterparty and shipbuilding contract disputes. She also represents clients in recognition and enforcement of foreign arbitral awards in China. Additionally, Ms. Guo has participated in several litigation cases before the UK and the US courts.

Mengtao Mao 

毛孟涛

Associate 

Dispute Resolution

Thanks to intern Jin Xiaojia and Li Junya for their contribution to this article.