Foreign Law or Chinese Law?

Does foreign law or Chinese law apply to contracts and other civil relationships? Can the parties involved choose which law is applicable? In China, these questions are answered by the PRC Law on the Application of Laws to Foreign-Related Civil Relations (the “Law”), which took effect on 1 April 2011.

As always, when a new law has to prove itself in practice certain issues need further improvement, clarification and interpretation. Therefore, on 28 December 2012 the PRC Supreme People’s Court (“SPC”) promulgated the Interpretation (I) on Several Issues concerning the Application of the “Law of the People’s Republic of China on the Application of Laws to Foreign-Related Civil Relations” (“Interpretation”). The Interpretation took effect on 7 January 2013. The most significant clarifications are the following:

1. Definition of foreign-related civil relations

In China, the question of whether or not any law other than Chinese law applies only arises in foreign-related civil relationships. Since the Law does not define these, reference needs to be made to the SPC's Opinions on Several Issues concerning the Implementation of the General Principles of the Civil Law (“Opinions”). The Opinions define a foreign-related civil relationship as any of the following circumstances.

a) Where one or both parties are foreign citizens, foreign legal persons or other organisations or stateless persons;
b) Where the subject matter is located outside the territory of the PRC; or
c) Where the legal facts which give rise to, modify or terminate the civil relationship occur outside the territory of the PRC.

The following circumstances have now been added by the Interpretation:

a) Where the habitual residence of one or both parties is outside the territory of the PRC; or
b) Other circumstances that may be deemed foreign-related civil relationships.

In the Opinions, “habitual residence” is defined as the place where a natural person has been living for over one year consecutively and that functions as the centre of his/her daily activities at the time of the occurrence, modification or termination of the foreign-related civil relationship, other than in the case of medical treatment, labour secondment, business, etc.

The above two new options broaden the scope of when foreign law can be applied to civil relationships instead of Chinese law.

2. Permissibility to choose the applicable law

According to the Law, the parties may, in accordance with relevant legislation, expressly select the law governing their foreign-related civil relationship. The Interpretation further clarifies that where PRC law does not explicitly allow the parties to choose the applicable law for a foreign-related civil relationship, but the parties still choose the applicable law, such choice of law will be deemed invalid by the People’s Court. Fortunately, the PRC Contract Law, PRC Maritime Law, PRC Civil Aviation Law and the special provisions of the Law allow the parties to choose the applicable law for a foreign-related civil relationship in many areas of international trade and business.

3. Neutral law

According to Article 7 of the Interpretation, where a party claims that the choice of law is invalid on the grounds that the law chosen by the parties in the agreement has no actual connection with the foreign-related civil relationship in dispute, such claim will not be upheld by the People’s Court. This aims to eliminate a misunderstanding that sometimes occurs in practice, namely that the governing law agreed in a contract should be connected to the civil relationship in dispute. However, as confirmed by the Interpretation, this is not the case. In this regard, the Interpretation is in line with common international trade practice relating to choosing a completely neutral law.

4. Clarification on mandatory provisions

Article 4 of the Law expressly states that where PRC law contains mandatory provisions in respect of a foreign-related civil relationship, such mandatory provisions must be exclusively applied. Examples are joint venture contracts. Chinese law expressly states that joint venture contracts are subject to PRC law. The Interpretation further stipulates that cases where there is a public interest, foreign-related cases concerning labour protection, food and public health safety, environmental safety, financial safety, such as foreign exchange control, anti-monopoly and anti-dumping must be governed by Chinese mandatory provisions.

5. Anti-circumvention

According to the Opinions, if parties evade mandatory laws and standards of the PRC, such acts will not constitute a reason to apply the law of a foreign country as governing law. The Interpretation provides further clarification by stating that the People’s Court shall hold that the laws of a foreign country are not applicable if one party creates a link to the foreign-related civil relationship on purpose in order to circumvent the application of the mandatory provisions of the laws and administrative regulations of the PRC.

It remains to be seen if this will have any impact on certain actual practices, e.g. the intentional inclusion of foreign parent companies of foreign-invested enterprises in China (“FIEs”) into contracts between FIEs and the latter's Chinese contract partners for the sole reason of avoiding Chinese law. Chinese law is mandatory for domestic contracts between Chinese companies, including FIEs. In light of the above, it is advisable for business operators to scrutinise their contractual practice and their existing contracts.

The Interpretation aims to shed light on a number of practical issues encountered during implementation of the Law. In addition to the major items above, it also covers the relationship between the Law and other laws, choice of law during a civil dispute, proof of foreign law, citing an international treaty in a contract which has not been ratified by the PRC and temporal application of the Law.

The Interpretation only covers the general principles of the Law. According to the SPC, a further interpretation of special provisions of the Law may be formulated in the future. Such an interpretation, when it comes, should be closely examined by companies doing business in China as it will certainly have an impact on other important issues concerning international business law.