Shanghai FTZ Paves the Way for Arbitration Reform in China

June 20, 2014 Posted by China Briefing Reading Time: 5 minutes

SHANGHAI – Last week, Shanghai University of Finance and Economics inaugurated a new research center for the study of alternative dispute resolution (ADR), especially as pertaining to the Shanghai Free Trade Zone (FTZ). The inauguration ceremony, which drew academics and legal professionals, was hailed as an important step in promoting the Rule of Law in China. While ADR, including mediation and arbitration, should be quite familiar to foreign businesses operating in China, knowledge of the Shanghai FTZ’s distinctive ADR mechanism is less widespread. To remedy this, here we provide a refresher on ADR in China and introduce the FTZ’s specific reforms in this regard.

Alternative Dispute Resolution

While there is no universally agreed-upon definition of ADR, it is generally taken as referring to non-litigation methods of dispute resolution, most often involving third-party intervention. ADR is principally divided into mediation and arbitration. The difference between the two is that while both involve the appointment of one or more third-party(s) to aid in the resolution of a dispute, mediation is a far less interventionist process.

In terms of typical costs and the length of procedures, mediation is at the lower end of the spectrum, followed by arbitration, with litigation being the most expensive and lengthiest of the three (a trade-off, however, comes with respect to the enforceability of outcomes). For many foreign business executives, the independent nature of arbitration bodies in China is also an attractive feature of this type of resolution mechanism, as it avoids the caprices of Chinese judges.

Ironically, “alternative” dispute resolution in China is hardly so, and instead functions as a standard precursor to litigation. This is indeed a peculiar feature of ADR in China, where mediation is often combined with both litigation and arbitration in an attempt to avoid more formal proceedings.

Arbitration

Arbitration in China is governed by the Arbitration Law of 1995, which requires that arbitration agreements contain three elements in order to be considered valid: (1) the parties’ expressed intention to resolve disputes through arbitration; (2) the types of dispute eligible to be decided via arbitration; (3) and the arbitration body that will handle the dispute.

Other than these requirements, parties are granted considerable autonomy in customizing their arbitration agreements. Based on mutual agreement, they may specify what language arbitration will be conducted in (the default is Chinese), the number of arbitrators, where arbitration will take place, and the arbitration rules that will govern the proceedings. The ability to select a foreign arbitration forum, however, only applies to contracts designated as “foreign-related”—which does not include those concluded between Chinese companies and the Chinese subsidiaries of foreign companies, as the latter are considered Chinese legal entities.

The country’s largest arbitration body is the China International Economic and Trade Arbitration Commission (CIETAC)—headquartered in Beijing and with sub-commissions in Shenzhen, Shanghai, Tianjin and Chongqing, a branch office in Hong Kong and 26 liaison offices across China. The organization amended its rules 6 times between 1988 and 2005 to greater conform to international best practices and increase the autonomy of the parties involved and enjoys a generally positive reputation among foreign parties with experience in dispute resolution in China.

Today, CIETAC handles more arbitration cases annually than any other arbitration body worldwide. Arbitrators are selected from a list from over 500 qualified individuals, both Chinese and foreign. The latter, however are not permitted to interpret PRC law, but rather must rely on their PRC co-counsel to do so. An arbitration tribunal typically consists of three arbitrators, with one selected by each party and a third appointed by the arbitration body itself.

Shanghai FTZ

The Shanghai Free Trade Zone (FTZ) represents the forefront of ADR in China, in keeping with the zone’s general atmosphere of pilot measures facilitating foreign investment and specific emphasis on legal reform. Following the split of the Shanghai International Arbitration Center (SHIAC) from CIETAC in 2012, SHIAC published an independent set of Arbitration Rules, which took effect on May 1, 2014.

Under the Rules, arbitration is administered in the FTZ by SHIAC, with actual hearings conducted by a subordinate body, the China (Shanghai) Pilot Free Trade Zone Court of Arbitration. Significantly, the Rules allow for non FTZ-related cases to be arbitrated according to the FTZ Rules based on the agreement of the parties involved. The Arbitration Rules issued by SHIAC were later given legal backing by Shanghai No. 2 Intermediate People’s Court via its publication of a related set of “Opinions.”

Specifically, the FTZ’s arbitration mechanism introduces the following reforms:

Firstly, the Zone introduces an emergency arbitration system, through which interim measures may be processed by an emergency tribunal composed of a SHIAC-appointed arbitrator. This must be applied for between SHIAC’s initial acceptance of a case and the official formation of an arbitration panel.
Second, disputing parties may enter into a hybrid mediation/arbitration (med-arb) arrangement, in which arbitration is first preceded by a mediation process for identifying parties’ respective demands and possible solutions. Here, the person of the mediator may not overlap with that of the arbitrator later in the process. If mediation fails to reach an agreement, an arbitrator is then empowered to render a decision and issue an award as per usual.
Third, the FTZ’s arbitration mechanism allows for arbitrators to be chosen from outside of the roster maintained by SHIAC, provided they satisfy certain qualifying criteria. Otherwise, SHIAC maintains an approved list of arbitrators from which it retains the right to appoint a chair arbitrator absent the agreement of the disputing parties.
Fourth, parties to disputes concerning sums of money greater than RMB100,000 but less than RMB1,000,000 can apply for a summary procedure that is both faster than conventional arbitration and entails lower service fees; elsewhere in China, summary procedure applies only to amounts not exceeding RMB500,000.
Fifth, Shanghai No. 2 Intermediate People’s Court has enacted special regulations for efficiently reviewing arbitration appeals related to the FTZ. Specifically, these set time limits on the court’s acceptance of appeals and issuance of decisions and compel the court to expedite the process for commercial disputes of less than RMB100,000.

Overall, the FTZ’s distinctive arbitration mechanism introduces several reforms favorable to foreign businesses operating in China, particularly SMEs. Of these, the ability to designate arbitrators from outside an official roster is perhaps the most significant and will go a long way toward boosting confidence in ADR in China. Meanwhile, the introduction of a faster and more flexible dispute resolution mechanism should come as welcome news to businesses eager to avoid the mess of drawn-out legal battles.

Asia Briefing Ltd. is a subsidiary of Dezan Shira & Associates. Dezan Shira is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in China, Hong Kong, India, Vietnam, Singapore and the rest of ASEAN. For further information, please email china@dezshira.com or visit www.dezshira.com.

Stay up to date with the latest business and investment trends in Asia by subscribing to our complimentary update service featuring news, commentary and regulatory insight.

Related Reading

Guide to the Shanghai Free Trade Zone
In this issue of China Briefing, we introduce the simplified company establishment procedure unique to the zone and the loosening of capital requirements to be applied nation wide this March. Further, we cover the requirements for setting up a business in the medical, e-commerce, value-added telecommunications, shipping, and banking & finance industries in the zone. We hope this will help you better gauge opportunities in the zone for your particular business.

Doing Business in China
The China Briefing Business Guide to Doing Business in China is the definitive guide to one of the fastest growing economies in the world, providing a thorough and in-depth analysis of China, its history, key demographics and overviews of the major cities, provinces and autonomous regions highlighting business opportunities and infrastructure in place in each region. A comprehensive guide to investing in China is also included with information on FDI trends, business establishment procedures, economic zone information and labor and tax considerations.