Guiding Case No. 196 (Luck Treat Limited and Shenzhen Zhong Yuan Cheng Commercial Investment Holdings Co., Ltd., A Case Concerning an Application for Confirmation of the Validity of an Arbitration Agreement)¹ (“GC196”) holds that, under Chinese law, an agreement to arbitrate is independently enforceable, even if the agreement was intended to be part of a larger contract that never fully formed.²  Once the parties to the contract exchange an arbitration provision in a manner signifying an agreement to arbitrate, any challenge to the rest of the contract is a question for arbitration. 

For the parties to signify an agreement to arbitrate, the court in GC196 found that the mere proposal of an arbitration provision by one party and the acceptance of the provision by the other was sufficient, even when one of them cautioned that it needed final internal approval for the overall contract. 

“GC196 shows that Chinese law is arguably more favorable to arbitration than the law of the United States, a jurisdiction that, itself, strongly favors arbitration.”

GC196 shows that Chinese law is arguably more favorable to arbitration than the law of the United States, a jurisdiction that, itself, strongly favors arbitration.³  This article compares GC196 with U.S. law and, after identifying how GC196 leaves open a potential door for court challenges to arbitration agreements, discusses the U.S. approach to handling such challenges.

The Reasoning of GC196

GC196 concerned two contracts negotiated between Luck Treat Limited (“Luck Treat”) and Shenzhen Zhong Yuan Cheng Commercial Investment Holdings Co., Ltd. (“Zhong Yuan Cheng”).  Luck Treat sent Zhong Yuan Cheng draft contracts initialed by Luck Treat, simultaneously advising Zhong Yuan Cheng that no final contracts would be signed until Luck Treat internally approved the final versions.  Zhong Yuan Cheng stamped and returned these initialed versions, both of which contained arbitration clauses.  These two parties were ultimately unable to reach final agreement over the two contracts.

After Luck Treat sought to cancel a pending transaction between itself and Zhong Yuan Cheng, Zhong Yuan Cheng applied for arbitration.  Luck Treat sought court confirmation as to the non-existence of an agreement to arbitrate, arguing that no agreement to arbitrate had been formed.  Luck Treat’s challenge was understood by the Supreme People’s Court, the court handling the case, to be, “in a broad sense, a type of objection to the validity of an arbitration agreement”. 

The Court noted that “[t]he independence of an arbitration agreement is a basic legal principle that has been widely recognized”.  According to the Court, such independence means that “an arbitration agreement and the main contract are separable and are independent of each other; their existence, validity, and the lex causae applicable to them are all separable”.  Applying Chinese law to the case at bar, the Court further explained that this basic legal principle is reflected in Article 19 Paragraph 1 of the Arbitration Law, which provides:

An arbitration agreement exists independently; the modification, rescission, termination, or invalidation of the contract shall not affect the validity of the arbitration agreement.

In the Court’s view, regardless of whether the parties had reached full, final contracts, the exchange of initialed, stamped arbitration terms was sufficient to find an agreement to arbitrate.  The Court noted that under Chinese law, “an acceptance becomes effective when its notice reaches the offeror, and a contract is formed when an acceptance becomes effective”.  The Court observed that, as in the case at bar, most arbitration agreements present as contractual clauses rather than freestanding contracts.  These clauses are separable from their main contracts.

The Court concluded that, “[s]ince Luck Treat Company et al. did not claim that there were legal circumstances making the arbitration clauses invalid, it should be determined that there are valid arbitration clauses between the two sides, and the dispute between the two sides should be arbitrated by the Shenzhen Court of International Arbitration”.  Further, because the parties agreed to arbitrate, “there is no need to further determine the issue of whether the contract in this case was formed”, and the matter “should be resolved during arbitration”. 

Comparing GC196 with United States Law⁴

The Supreme People’s Court’s reasoning in GC196 presents an interesting opportunity to compare Chinese law with U.S. law addressing similar issues.

In the United States, as in China, agreements to arbitrate are treated as contracts.⁵  U.S. law is clear that arbitration will not be required in the absence of a contract to arbitrate.⁶  Until a court rules that an agreement to arbitrate exists, there is no requirement to submit to arbitration.⁷  Once it is established that an arbitration agreement exists, just as under Chinese law, “a challenge to the validity of the contract as a whole […] must go to the arbitrator”.⁸  Even if the arbitrator ultimately finds the contract void, the agreement to arbitrate survives.⁹  In addition, “a party’s challenge to another [non-arbitration] provision of the contract […] does not prevent a court from enforcing a specific agreement to arbitrate”.¹⁰  This is because “as a matter of substantive federal arbitration law, an arbitration provision is severable from the remainder of the contract”.¹¹

The role of U.S. courts to decide whether an agreement to arbitrate exists is clearly established in decisions of the U.S. Supreme Court.  “[B]efore referring a dispute to an arbitrator, the court determines whether a valid arbitration agreement exists.”¹²  “To satisfy itself that such agreement exists, the court must resolve any issue that calls into question the formation or applicability of the specific arbitration clause that a party seeks to have the court enforce.”¹³  “[T]hese issues always include whether the clause was agreed to, and may include when that agreement was formed.”¹⁴ 

“[…] Chinese law and U.S. law differ in one key respect […]”

In GC196, the court undertook steps similar to those described in the preceding paragraph and determined the existence of an agreement to arbitrate.  As mentioned above, the court concluded that because the parties agreed to arbitrate, “there is no need to further determine the issue of whether the contract in this case was formed”.  Under similar facts, an American court applying state-specific contract law may not have found such an agreement,¹⁵ even though U.S. courts must resolve any “ambiguities as to the scope of the arbitration clause itself […] in favor of arbitration”.¹⁶  In other words, Chinese law and U.S. law differ in one key respect: challenges to the existence of a contract as a whole are considered by U.S. courts and these courts consider the lack of formation of such a contract as the lack of a meeting of the parties’ minds on the subject of arbitration.

Challenges to the existence of a contract, which are considered by U.S. courts, must not be confused with challenges to the legal validity of a contract, which are resolved in arbitration.  For example, in K.F.C. v. Snap Inc., a minor agreed to Snap Inc.’s terms of service for the social media website, Snapchat.¹⁷  When she sued for violations of privacy, Snap Inc. moved to compel arbitration based on an arbitration provision in the terms of service.  The minor argued the arbitration provision should not bind her because she was under 18 when she agreed to the terms of service.  The trial court ordered the matter to arbitration, holding that the arbitrator, not a court, must decide whether the plaintiff’s youth was a defense to contract enforcement.  The appellate court upheld the trial court’s ruling, finding that the minor’s challenge went to the validity of the contract, rather than its existence, because youth was a defense to enforcement under state law.  The challenge was, therefore, for the arbitrator to determine. 

What Does Guiding Case No. 196 Not Say?

As described in GC196, the crux of Luck Treat’s challenge to arbitration was that it never entered final contracts and, therefore, the arbitration provisions contained within draft contracts were unenforceable.  The Court noted that Luck Treat “did not claim that there were legal circumstances making the arbitration clauses invalid”.  GC196 therefore leaves room for situations in which a party disputes the validity of an arbitration clause.

In the United States, while an arbitrator may, as explained above, determine the validity of a contract as a whole, a challenge directed to the arbitration provision itself must be heard by a court.¹⁸  For example, a court would review a claim that an arbitration provision was obtained by fraud in the inducement.¹⁹ 

A U.S. court’s authority to hear a challenge directed to the arbitration provision is rooted in federal law, which allows the court to “consider […] issues relating to the making and performance of the agreement to arbitrate”.²⁰  Federal law only allows the court to review this narrower scope of issues because if a court is allowed to review and address other areas of the contract, the court would potentially invade areas reserved by the parties for arbitration.  Therefore, in Buckeye Check Cashing, Inc. v. Cardegna,²¹ where parties to a contract with an arbitration clause challenged the validity of the contract as a whole, without challenging the validity of the arbitration provision itself, the Court found that it should be up to the arbitrator to determine whether a contract containing an arbitration clause was valid.

Conclusion

To the extent that GC196 suggests that an exchange of an arbitration provision between the parties may be sufficient to require arbitration, this principle may exceed even liberal American policy favoring arbitration.  Nevertheless, GC196 largely resembles U.S. law in two respects: (1) arbitration clauses are to be treated as severable and independent, and (2) when a contract contains an arbitration provision, a challenge to the validity of the contract must go to arbitration.  Under U.S. law, in a scenario not presented by GC196, a court would still review a challenge to the formation or validity of the arbitration provision itself. 

An important takeaway from the above comparison of GC196 with U.S. law is that companies affected by GC196 may fear discussing arbitration in negotiations to avoid the risk of being forced into arbitration.  In GC196, although Luck Treat sent the documents containing the arbitration provisions with a qualifying cover email, stating that internal approval would be required, the GC196 opinion contains no explicit analysis as to any legal effect of this qualification.  Rather, the Supreme People’s Court focused on the stamped exchange of the initialed language, finding that these actions created an enforceable contract.  At a minimum, to avoid arbitration, it appears that companies in positions like Luck Treat should not initial any arbitration language and should explicitly state that no arbitration clauses or stand-alone arbitration agreements are presented as an offer.

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^† The citation of this article is: Tyler Atkinson, Guiding Case No. 196: Supreme People’s Court Adopts a Liberal Approach to Arbitration While Leaving Room for Unexplored Situations, SINOTALKS.COM^®, SinoForum&Foresight™, May 31, 2023, https://sinotalks.com/sinoforumforesight/202305-tyler-atkinson-arbitration-china.

The original, English version of this article was edited by Nathan Harpainter and Dr. Mei Gechlik.  The information and views set out in this article are the responsibility of the author and do not necessarily reflect the work or views of SINOTALKS^®.

¹ The Editorial Board of SINOTALKS^®, Guiding Case No. 196: Luck Treat Limited and Shenzhen Zhong Yuan Cheng Commercial Investment Holdings Co., Ltd., A Case Concerning an Application for Confirmation of the Validity of an Arbitration Agreement, SINOTALKS.COM^®, SinoRules&Cases™, Mar. 10, 2023, https://sinotalks.com/sinorulescases/guiding-case-196 (hereinafter “Guiding Case No. 196”).  This English version of Guiding Case No. 196, together with related explanatory notes, was prepared by the SINOTALKS^® team.  Unless stated otherwise, the content of this Guiding Case as referenced in this SinoForum&Foresight™ article is based on this English version of Guiding Case No. 196. 

For the original, Chinese text of Guiding Case No. 196 and related explanatory notes prepared by the Editorial Board of SINOTALKS^®, see 丝络谈™编辑委员会，指导性案例196号：《运裕有限公司与深圳市中苑城商业投资控股有限公司申请确认仲裁协议效力案》，丝络谈™，丝络规则与案例™，2023年3月10日，https://sinotalks.com/sinorulescases/guiding-case-196-chinese。 

² Guiding Case No. 196, supra note 1, Main Points of Adjudication, Paragraph 2:

An arbitration clause exists independently; its formation and validity are independent of and separable from other clauses of the contract. Where, in the course of entering into a contract, the parties negotiated for an arbitration clause and agreed to submit [disputes] to arbitration, the formation and validity of the arbitration clause are not affected by whether or not the contract has been formed.

³ In Epic Systems Corp. v. Lewis, 138 S. Ct. 1612 (2018), the U.S. Supreme Court explained that early English and American common law courts were hostile to arbitration and “routinely refused to enforce agreements to arbitrate disputes”.  Viewing arbitration as a means to offer “quicker, more informal, and often cheaper resolutions for everyone involved”, “Congress directed courts to abandon their hostility and instead treat arbitration agreements as ‘valid, irrevocable, and enforceable.’”  Id. at 1621. 

The Supreme Court continued to state, with reference to its earlier decisions, that there is “a liberal federal policy favoring arbitration agreements” (Moses H. Cone Memorial Hospital v. Mercury Construction Corp., 460 U.S. 1, 24 (1983)).  Moreover, the Supreme Court pointed out that courts must defer to the procedures chosen by the parties in their agreement to arbitrate.  “[W]e have often observed that the Arbitration Act requires courts ‘rigorously’ to ‘enforce arbitration agreements according to their terms, including terms that specify with whom the parties choose to arbitrate their disputes and the rules under which that arbitration will be conducted.’ American Express Co. v. Italian Colors Restaurant 570 U.S. 228, 233 […] (2013) […].”  Epic Systems Corp., supra at 1621.

⁴ The primary statute governing arbitration in the United States is the Federal Arbitration Act, codified in Chapter 1 of Title 9 of the United States Code.

⁵ “[A]rbitration is a matter of contract.” Rent–A–Center, West, Inc. v. Jackson, 561 U.S. 63, 67 (2010).

⁶ “[A] party cannot be required to submit to arbitration any dispute which he has not agreed so to submit.”  AT & T Technologies, Inc. v. Communications Workers of America, 475 U.S. 643, 648 (1986).

⁷ AT & T Technologies, Inc., supra note 6, at 649 (“Unless the parties clearly and unmistakably provide otherwise, the question of whether the parties agreed to arbitrate is to be decided by the court, not the arbitrator [Citation]”.) 

⁸ Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440, 449 (2006). 

⁹ Prima Paint Corp. v. Flood & Conklin Manufacturing Co., 388 U.S. 395, 403–404 (1967). 

¹⁰ Rent–A–Center, West, Inc., supra note 5, at 70.

¹¹ Buckeye Check Cashing, Inc., supra note 8, at 445.

¹² Henry Schein, Inc. v. Archer & White Sales, Inc., 139 S. Ct. 524, 530 (2019) (citing 9 U.S.C. § 2). 

¹³ Granite Rock Co. v. International Brotherhood of Teamsters, 561 U.S. 287, 297 (2010) (citing Rent–A–Center, West, Inc., supra note 5, at 68–70).

¹⁴ Id. at 297. 

¹⁵ See, e.g., Eigles v. Kim, 2011 WL 3651802, at *7 (D. Md. 2011) (the back-and-forth exchange of a Draft Partnership Agreement containing an arbitration provision, but which was never fully executed, was insufficient to establish a meeting of the minds on the subject of arbitration, notwithstanding legal principles favoring arbitration).

¹⁶ Volt Information Sciences, Inc. v. Board of Trustees of Leland Stanford Junior University, 489 U.S. 468, 476 (1989).

¹⁷ K.F.C. v. Snap Inc., 29 F.4th 835 (7th Cir. 2022).

¹⁸ Prima Paint Corp., supra note 9,at 400. 

¹⁹ Id. at 403-404. 

²⁰ Id. at 404. 

²¹ Buckeye Check Cashing, Inc., supra note 8.

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