July 2022
Yanting Pei and Teresa Huang
With ever-increasing friction in cross-border transactions, it is undoubtedly important to carefully design dispute resolution clauses in contracts. Provisions on governing law, which are often skimped on during negotiation, have become a very important part of contract review in today’s constantly changing international situation. For trading parties from different countries or regions, the selection of the appropriate governing law should also be an important element in the drafting and review of dispute resolution clauses. Therefore, this article only briefly summarizes the issues concerning the choice of governing law in cross-border transaction contracts for your reference.
I. What laws may be involved in choosing the applicable law in cross-border transactions?
In general, if court litigation is selected to resolve disputes over a cross-border transaction, it is usually sufficient to consider the substantive law for the resolution of issues per se, i.e., the law of the specific country or region that will apply and the applicability of relevant international treaties.
However, to consider whether court decisions can be enforced across borders and avoid the burden of multiple levels of litigation, international arbitration is often chosen as the primary means of dispute resolution for cross-border transactions. When international arbitration is chosen, several dimensions of law may be generally involved in determining the governing law, including:
(1) The law governing the validity of the arbitration agreement
(2) The law governing the arbitration proceedings
(3) The substantive law governing the contractual rights and obligations
(4) International treaties, international practices, and arbitration rules
(5) The law governing the recognition and enforcement of arbitral awards
To sum up, issues of substantive law will arise on the one hand and numerous other issues concerning procedural law will emerge on the other.
II. What are the consequences of failure to stipulate the applicable law?
1. Consequences of failure to stipulate the substantive law
If there is an express agreement in the contract on the region whose law will apply, such agreement is typically respected by the court or arbitration tribunal,[1] unless the agreement violates some mandatory legal provisions or is contrary to the public policy of a place.[2]
If no substantive governing law is agreed upon in the contract, the court or arbitration tribunal will need to find the appropriate law to serve as the basis for dispute resolution in accordance with the conflict of laws guidelines of private international law.[3] Generally speaking, national laws[4] are guided by one or a combination of the following principles in finding the applicable law:
(1) The principle of closest connection, i.e., the application of the law that has the closest connection with the contractual rights and obligations.
(2) The principle of characteristic performance, i.e., the law of the place of habitual residence of the party whose performance best reflects the characteristics of the contract.
(3) The principle of the place of closer connection, i.e. the application of the law of another country or region if the contract has a closer connection with that country or region.
Under the guidance of such principles, the law of the place where the seller is located, the contract is signed, the subject matter is located, the contract service is provided, the transportation service is provided, the real estate is located, etc., may generally be eventually determined as the governing law. For example, in the case of the disputes arising from the international goods sales contract among XX Jiang, XX Wei, and Hou Sai (Zhejiang Jinhua Intermediate People’s Court (2016) Zhe 07 Min Zhong No. 5602), the court held that the party that can best reflect the characteristics of the contract is the seller, and the seller’s domicile，i.e. the plaintiff’s domicile is in this country. Therefore, the case should be adjudicated by applying the law of the People’s Republic of China. In the case of the disputes arising from the financial loan contract between Weihai Fuhaihua Liquid Chemical Co., Ltd. and Shandong Branch of China Great Wall Asset Management Co., Ltd. (Supreme People’s Court (2018) Zui Gao Fa Min Zhong No. 168), the court held that since the contract, which is a natural person guarantee contract involved in this case, was signed and performed both within the People’s Republic of China, the law of the People’s Republic of China is the law most closely connected with the contract in this case. In the case involving the contract disputes between Beijing Yingtai Jiahe Biotechnology Co., Ltd. and Bioredox Inc., a US company, (Beijing High People’s Court (2013) Gao Min Zhong Zi No. 1270), the court held that the case pertains to an intermediary contract legal relationship, and Yingtai Jiahe, which, as an intermediary party, accepted the intermediary service and paid the intermediary fee, can best reflect the characteristics of the contract. Therefore, the law of the place where Yingtai Jiahe is domiciled, i.e. the Contract Law of the People’s Republic of China should apply. In another case involving the legal service contract disputes with Tianwei New Energy Holdings Limited (Beijing High People’s Court (2014) Gao Min (Shang) Chu Zi No. 04917), the court held that the trustee in this case was a law firm registered in the United States and providing U.S. legal services related to cross-border acquisitions, and the transaction to which the legal services relate was the acquisition of a U.S. listed company and the settlement of the transaction was in the U.S. In addition, Tianwei New Energy also believes that the legal services provided by the law firm should be evaluated pursuant to the standards under the U.S. law. Therefore, the law that best reflects the essential characteristics of the legal service contract in this case and is most closely related to this case is the U.S. law.
When international treaties and international practices are involved, they are typically determined based on whether the country whose law is the governing law has joined such international treaties or by considering the provisions of the national law on the application of international treaties or international practices after the governing law is determined. For the application of the United Nations Convention on Contracts for the International Sale of Goods (CISG) in this country, as the Supreme People’s Court pointed out in the contract disputes between ThyssenKrupp Metallurgical Products Gmbh and Sinochem International (Overseas) Pte. Ltd. ([2013] Min Four Zhong Zi No. 35), if both parties failed to exclude the application of the CISG, the CISG shall automatically apply first. For UCP, INCOTERMS, and other international practices, Article 10 of the Civil Code of this country provides that they may serve as practices to supplement the absence of legal requirements.
In summary, it can be inferred that failure to agree on the substantive governing law can bring a lot of uncertainty to the dispute resolution, which sometimes may lead to an outcome not necessarily desired by the parties.
2. Consequences of failure to agree on the procedural law
In that case, is a contract clear if it is agreed in the contract that “this contract shall be governed by the such and such”?
Generally speaking, in case international arbitration is chosen to settle disputes, if the contract stipulates that “this contract shall be governed by the such and such law,” it is likely that the parties are merely deemed to have agreed on the governing law for the resolution of the substantive issues of the contract, but not on the arbitration agreement itself.[5] Under such circumstances, there are generally the following possibilities: (1) the presumption that the substantive law agreed upon by the parties will apply; (2) the law of the seat of arbitration, which is the arbitration jurisdiction agreed upon between the parties and is not necessarily the venue of arbitration, will apply; and (3) the law of the place of the arbitral institution will apply. Which of the above laws is to be applied may have to be decided by the arbitral tribunal or the enforcing court in accordance with the provisions related to arbitration under the law of the seat of arbitration.
For this country, the Supreme People’s Court pointed out in its Reply to the Request for Instructions on Determining the Validity of Arbitration Agreement ([2006] Min Four Ta Zi No. 1) that, according to years of judicial practice and the principles established by the Supreme People’s Court’s Minutes of the Second National Work Conference on Foreign-Related Commercial and Maritime Trials, the governing law applicable to the settlement of contractual disputes as agreed by the parties in the contract cannot be used to determine the validity of foreign-related arbitration clauses. If the parties have expressly agreed on the law applicable to the validity of the arbitration clause in the contract, the law expressly agreed by the parties shall apply; if the parties have not agreed on the law applicable to the validity of the arbitration clause but on the seat of arbitration, the law of country or region of the seat of arbitration shall apply. Only when the parties have not agreed on the law applicable to the validity of the arbitration clause and have not agreed on the seat of arbitration or the seat of arbitration is not clear does the law of the forum, i.e. the law of this country, apply as the governing law applicable to the validity of the arbitration clause. This is also confirmed by Article 18 of the Law of the People’s Republic of China on the Choice of Law for Foreign-Related Civil Relationships, which provides that if the parties do not choose the law applicable to the arbitration agreement, the law of place of the arbitration institution or the law of the seat of arbitration shall apply. If the parties have not chosen the arbitration institution, or if the arbitration institution or the seat of arbitration cannot be clarified, the validity of the arbitration clause can be confirmed by applying the law of the People’s Republic of China pursuant to Article 16 of the Interpretation of the Supreme People’s Court on Several Issues Concerning the Application of the Arbitration Law of the People’s Republic of China and Article 12 of the First Interpretation of the Supreme People’s Court on Several Issues Concerning the Application of the Law of the People’s Republic of China on the Choice of Law for Foreign-Related Civil Relationships.
In summary, if the parties have not expressly agreed on the arbitration procedure law and the law governing the arbitration agreement, the prevailing practice is to make a determination based on the law of the seat of arbitration. However, this may lead to uncertainty as to the applicable law and run counter to the intent of the parties. For example, “ad hoc arbitration” is not supported under the Chinese law. If the parties wish to resolve their disputes through “ad hoc arbitration,” their hope may be dashed in the event that the law applicable to the arbitration agreement has not been agreed upon and the validity of the arbitration agreement will ultimately be determined under the Chinese law.
III. What are the key points in the choice of governing law?
Based on the foregoing reasons, it can be concluded that the absence of an agreement on the governing law (either substantive or procedural governing law) may lead to uncertainty as to the law under which all disputes will ultimately be resolved, resulting in uncertainty as to the outcome. Therefore, attention should be paid to the following contents when a contract is drafted or reviewed:
1. Determine whether the transaction has foreign-related factors, since the choice of foreign law as the applicable law without foreign-related factors is not allowed under the Chinese law.
2. Determine the manner of dispute resolution, and if disputes are to be resolved through court litigation, it is necessary to consider which court will have jurisdiction, whether a judicial decision will be enforced, how to respond to a lawsuit if it is brought outside of this country by the other party, etc.
3. If the dispute is settled by international arbitration, pay attention to the law applicable to the arbitration agreement, the seat of arbitration, the name of the arbitration institution, the law applicable to the arbitration procedure, etc., in terms of the substantive law. Generally speaking, the arbitration tribunal will automatically apply the law of the seat of arbitration to regulate the entire arbitration procedure, and it is not recommended to choose an arbitration procedure law that is inconsistent with the law of the seat of arbitration if it is not necessary, as it will bring about an onerous procedural burden.
4. Pay attention to the exclusion of the conflict rules when choosing the substantive law.
5. Preference may not always be given to the application of the law of the Chinese mainland, and the law appropriate to the resolution of disputes should be chosen to the greatest extent possible
6. It is recommended to specifically exclude the application of an international treaty whose application is not desired.
In conclusion, in the context of the changing international situation, there may be more and more obstacles to the smooth performance of cross-border transaction contracts. Therefore, early planning of dispute resolution is also part of the preparation for rainy days to reduce losses. It is hoped that this article is conducive to the dispute resolution planning of enterprises.
(The authors’ opinions do not represent the position of this law firm.)
[1] Investigation shows that although the governing law was specifically agreed in some of CITEC’s arbitration cases, still the arbitration tribunal did not apply it. See Shixueh Hu: Application of Law to Disputes over International Goods Trade – Research on the Actual Arbitration Cases and Experiences of QETAC during 1996-2006, Beijing Arbitration [J], Issue 87, 2014
[2] For example, pursuant to Article 4 of the Law of the People’s Republic of China on the Choice of Law for Foreign-Related Civil Relationships, if there are mandatory provisions in the laws of the People’s Republic of China on foreign-related civil relations, the mandatory provisions shall be directly applied (including those involving the protection of labor rights and interests, food or public health safety, environmental safety, financial security such as foreign exchange control, anti-monopoly and anti-dumping, and other circumstances that should be considered as mandatory); and Article 5 of this law also provides that the laws of the People’s Republic of China shall be applied if the application of foreign laws would harm the social and public interests of the People’s Republic of China. In addition, pursuant to Article 467 of the Civil Code of China, the laws of the People’s Republic of China shall apply to contracts of Sino-foreign joint ventures and Sino-foreign cooperative ventures, and Sino-foreign cooperative contracts for the exploration and development of natural resources performed in the territories of the People’s Republic of China.
[3] For example, the Supreme People’s Court pointed out in the Circular on Several Issues to Be Noted in the Trial and Implementation of Foreign-Related Civil and Commercial Cases (Fa [2000] No. 51) that the civil and commercial laws should be applied in strict accordance with the conflict rules, so as to effectively protect the legitimate rights and interests of domestic and foreign parties in an open, fair, timely, and equal manner in accordance with law.
[4] For example, Article 41 of the Law of the People’s Republic of China on the Application of Foreign-Related Civil Relations provides that if the parties do not choose the law applicable to the contract, the law of the place of habitual residence of the party whose performance obligations best reflect the characteristics of the contract or another law most closely connected with the contract shall apply.
[5] Nigel Blackaby and Constantine Partasides QC with Alan Redfern and Martin Hunter, Redfern and Hunter on International Arbitration, Sixth Edition, Oxford University Press, 2015.