Does an invalid arbitration clause equal no arbitration clause?

Facts

Company A and Company B entered into an agreement which contained an arbitration clause specifying that any dispute arising from or in connection with the agreement would be submitted to the Fushun Arbitration Commission in Shandong Province or a people's court with jurisdiction.(1)

After Company A materially breached its obligations under the agreement, Company B filed for arbitration before the arbitration commission. Company A attended the arbitration hearing and submitted its statement of defence, along with evidence. After the arbitration commission rendered its award, Company A requested to have the award rescinded by the Fushun Intermediate People's Court, claiming that the arbitration clause contained in the agreement was invalid, as it stated that the dispute could be submitted to the arbitration commission or a people's court.

Decision

The court found that Company A had failed to dispute the validity of the arbitration clause or the arbitration commission's jurisdiction over the dispute within the mandatory timeframe specified in Article 20(2) of the Arbitration Law, which had been heard and ruled on by the tribunal.

As a result, although the arbitration clause was invalid on the grounds that it allowed disputes to be resolved through arbitration or litigation, the court ruled that the award was final and binding, as Company A had raised no objection to the validity of the arbitration clause within the mandatory timeframe; therefore, the companies had reached a consensus on arbitration through their implied acts.

Article 7 of the Judicial Interpretation on the Arbitration Law stipulates that an arbitration clause(2) will be invalid if the parties to the agreement agree that disputes may be resolved either through arbitration before an arbitration commission or through litigation before a people's court, unless one party files for arbitration and the other party fails to object within the timeframe specified in Article 20(2) of the Arbitration Law.

Article 20(2) of the Arbitration Law stipulates that a party's objection to the validity of an arbitration agreement must be raised prior to the arbitral tribunal's first hearing.

In the case at hand, the arbitration clause explicitly provided that the companies could submit any dispute to either an arbitration commission or a people's court. Instead of objecting to the validity of the arbitration clause, Company A fully participated in the arbitral proceedings. As such, Company A and Company B effectively agreed to adopt arbitration as the appropriate dispute resolution method. Therefore, the award was final and binding.

Invalid arbitration clause versus no arbitration clause

Article 58 of the Arbitration Law lists 'no arbitration clause' as a reason for a people's court to rescind an award.(3) Further, Article 18 of the Judicial Interpretation on the Arbitration Law stipulates that an arbitration clause which a court rules to be invalid or rescinded should be deemed to constitute 'no arbitration clause' under Article 58.

Thus, while it appears that an invalid arbitration clause is tantamount to having no arbitration clause, this is not the case. This is because Articles 7 and 18 of the Judicial Interpretation on the Arbitration Law set out two circumstances under which an arbitration clause will be considered invalid:

Article 7 refers to invalid arbitration clauses as invalid by their nature.
Article 18 sets out that an arbitration clause will be considered invalid only where specifically ruled as such by a people's court after a party files a claim in this regard.

Thus, the legal effect of an arbitration clause that is invalid by its nature is different than having no arbitration clause, which includes arbitration clauses that the people's courts have ruled as invalid.

When an arbitration clause allows for dispute resolution through arbitration or litigation, it will be invalid by its nature. The legal effect of this invalidity is that it fails to preclude the jurisdiction of the people's court. As a result, the jurisdiction of the arbitration commission could be excluded if either party submits the dispute to a people's court and the jurisdiction of the people's court could be excluded if either party chooses arbitration to resolve the dispute and the other party raises no objection to the validity of the arbitration clause before the arbitral tribunal's first hearing.

If the dispute is submitted to the people's court by one party, the arbitration clause would be ruled as invalid for allowing for both arbitration and litigation and the dispute could be heard and decided only by the people's court. All of the rules and provisions in connection with civil litigation would apply to the dispute.

However, if the dispute is submitted to the arbitration commission by one party and the other party does not object to the validity of the arbitration clause prior to the arbitral tribunal's first hearing, the parties will be considered to have excluded the jurisdiction of the people's court with their implied acts. The party that fails to object within the stipulated time cannot request to have the award rescinded by a people's court on the grounds that the arbitration clause is invalid.

The Supreme People's Court made this position clear in an 18 May 2009 decision regarding a contract dispute between three companies. The court held that the arbitration clause in question, which provided for either arbitration or litigation, was invalid and would be found as such as soon as one of the companies brought the dispute before the people's court.(4)

On the other hand, an agreement has no arbitration clause, this means that the parties never reached a consensus on resolving disputes through arbitration. The legal effect of this is that there would be no grounds for the parties to submit any disputes to an arbitration commission.

Comment

If parties agree to use arbitration as their dispute resolution method, they should specify which arbitration commission they intend to use in the applicable arbitration clause.

If parties have already enacted an arbitration clause which allows either arbitration or litigation, and one party has submitted the dispute to the arbitration commission, the other party should object to the validity of the arbitration clause prior to the arbitral tribunal's first hearing. Otherwise, after the award is rendered, the parties will be bound by it even if a claim is filed with a people's court to have the award rescinded on the grounds that the arbitration clause is invalid.

For further information on this topic please contact Weiwei Gu or Kelly Cao at Global Law Office by telephone (+86 10 6584 6688) or email (guweiwei@glo.com.cn or kellycao@glo.com.cn). The Global Law Office website can be accessed at www.glo.com.cn.

Endnotes

(1) See "Ruling on the Application for Rescinding the Award between Fushun Jialong PAP Doors & Windows Co, Ltd and Liaoning Zhongwei Real Estate Development Co, Ltd", (2016) Liao 04 Min Te 18.

(2) An arbitration clause may be contained in a contract concluded by the parties or any other form of written agreement providing for the settlement of disputes by arbitration reached by the parties.

(3) Article 58 of the Arbitration Law provides that a party may request to have an award rescinded by the intermediate people's court in the place where the arbitration commission is located if they can prove that:

there is no arbitration agreement;
the matters ruled on in the award exceed the scope of the arbitration agreement or are not arbitrable;
the formation of the arbitral tribunal or the arbitral proceeding did not meet the statutory requirements;
the evidence on which the award relied was forged;
the other party withheld evidence which affects the impartiality of the arbitration; or
the arbitrators demanded or accepted briberies, committed illegal acts for personal gain or perverted the law in the course of the arbitration.

In addition, if the people's court finds that the award violates public policy, it will be rescinded.

(4) See "Reply of the Supreme People's Court of the People's Republic of China to the Request on the Validity of the Arbitration Clause of the Contract Dispute Case among Yanzhou Haoke Weibo Mining Engineering Company, A WEBER SA and SOFIROL SA", [2009] Min Si Ta Zi 19.

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