Foreign Arbitration for Chinese Companies: the Domestic Rule

A European company once came to my law firm wanting us to assess an arbitration it wanted to bring in Geneva, Switzerland between its China WFOE (the putative plaintiff) and a Chinese domestic company (the defendant) with which it had contracted. The contract provided for arbitration in Geneva and the European company wanted our China attorneys to assess its chances.

We did not like our client’s chances on many grounds and no arbitration claim was ever filed. One of our reasons for not liking our client’s chances is a somewhat obscure Chinese law that often trips up foreign companies with China WFOEs or China Joint Venture entities. The law is commonly called “the Domestic Rule” and it provides that only “foreign-related” disputes can be arbitrated outside China.

I describe this law as “somewhat” obscure because every good Chinese lawyer who represents Chinese companies with foreign investors knows this law well and knows exactly how to use it to give a big advantage to their Chinese company clients; it is only obscure for foreign lawyers. Check your China Joint Venture Agreement and if it provides for internal company disputes between your company and your Chinese joint venture partner to be resolved via arbitration outside China, you have probably been taken for a ride by a Chinese lawyer who knew exactly what she was doing. And this is pretty much the norm when the foreign party in a China Joint Venture makes the massive mistake of using fits joint venture partner’s lawyer to draft the joint venture agreement.

Under Chinese law, for a dispute involving a Chinese company to be viewed as “foreign-related,” it typically must involve at least one of the following:

• At least one foreign party. Note that China WFOEs and Joint Ventures are usually not considered to be a foreign party. Note though that Hong Kong, Taiwan and Macau entities are generally viewed as foreign parties.
• The facts or the subject matter that give rise to the lawsuit occurred or exist outside Mainland China.

If you secure a foreign arbitral award against a Chinese company and you do not have a basis for being able to circumvent the Domestic Rule there is a good chance no China court will enforce your arbitration award. If the Chinese company you are pursuing has assets outside China, you may be fine, but if it does not or if you are seeking to change the operations of a China Joint Venture, your arbitration award will probably prove worthless.

The way to avoid this sort of problem is to draft your contracts to provide for disputes to be resolved in China, either in its courts or before one of its domestic arbitral bodies, such as CIETAC. See CIETAC Arbitration: Different But Fair.

We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.