With the 2008 Olympics looming and growth at 10.7% last year (12% in Beijing), China's economic boom shows few signs of slowing down. The heavy influx of foreign investment means new disputes as well as deals.

Foreign investors entering developing nations often prefer arbitration rather than submitting directly to the jurisdiction of the local courts and unknown quantities, both cultural and legal.

It's not only foreign investors who are preferring arbitration in China. According to its last published statistics, the Beijing Arbitration Commission (BAC) accepted 1796 cases in 2004 – yet only 83 were 'foreign-related'. The rest were domestic – the bulk dealing with either sales of goods (42%) or construction contracts (24%).

The Hong Kong International Arbitration Centre's latest statistics also suggest an arbitration boom in China.

Bridging the culture gap

In recent years, foreign investors and legal commentators have expressed concern about the difference of treatment that arbitration receives under Chinese law compared with other leading arbitration jurisdictions. Yet significant change is underway in China.

Last October, the Supreme People's Court issued Judicial Interpretation 2006-07 of the Arbitration Law, which demonstrates movement towards recognised international standards by re-interpreting the Arbitration Law. It also:

- adopts a more liberal approach to form and manner requirements for a valid written arbitration agreement;

- helps cure defects that might otherwise render arbitration clauses void;

- recognises the separability of arbitration agreements from underlying contracts, so bringing the Chinese approach into line with the United Nations Commission on International Trade Law and other leading arbitration jurisdictions;

-l reinforces the finality of arbitration by providing that a party cannot retrospectively resist enforcement through seeking to challenge an award on the grounds that the arbitration agreement is invalid when it has made no such challenge within the relevant arbitration; and

- permits Chinese courts to sever and set aside part of a defective award, where they consider the same possible.

While this represents significant progress, there remain some distinguishing features in the Chinese approach to arbitration.

Potential pitfalls

- Mode of arbitration. Foreign investors should be wary of agreeing to ad hoc arbitration, which is not formally recognised in China. Further, parties to a domestic Chinese contract must select a Chinese arbitral institution, and – prima facie – contracts concluded in China by Chinese-incorporated foreign investment enterprises are domestic unless clear foreign subject matter or performance abroad is proven.

However, awards made in domestic Chinese arbitrations may be appealed to the Chinese courts and reviewed on their merits. They do not enjoy the finality of foreign or foreign-related awards, which are not susceptible to review on their merits by the Chinese courts.

- Intervention by the Chinese courts. Some tension still exists between the approach of the Chinese courts and the recognised international practice whereby arbitral tribunals rule on their own jurisdiction. While arbitral tribunals in China may rule on their own jurisdiction, the People's Court also retains jurisdiction until the first hearing of the arbitration tribunal has taken place but must reject any challenge to validity if the issue has already been decided by an arbitration institution.

- Local protectionism versus recognition and enforcement. As in many developing jurisdictions, the courts in the capital have greater experience of dealing with the recognition and enforcement of arbitral awards than other Chinese courts. The decision record of regional courts in centres accustomed to international trade may be perceived as more predictable than those in outlying provinces. Beijing recognises that local protectionism is still a significant problem in China – in some regions, local officials appear reluctant to enforce Chinese court judgments against local businesses.

In the context of arbitration, the 2006 interpretation directs that applications to enforce arbitral awards should be made to the Intermediate People's Court where the respondent is domiciled or where the property subject to enforcement is located. In practice, parties with arbitration awards often seek enforcement in local Chinese jurisdictions considered experienced in arbitration-related matters – such as Beijing – if the debtor has assets there, rather than get drawn into enforcement proceedings in the debtor's hometown jurisdiction, where the debtor may possess more influence. This can lead to a tug of war between the parties concerning the proper jurisdiction of enforcement.

Foreign rules in a Chinese seat

One recent international arbitration between a Chinese state-owned entity and a foreign investor saw the China International Economic and Trade Arbitration Commission (CIETAC) apply the International Chamber of Commerce rules chosen by the parties and an award made this year on the counterclaim. This decision demonstrates the viability of using foreign arbitration rules in a Chinese seat arbitration administered by CIETAC. However, the use of foreign arbitration rules can entail certain additional procedural hurdles within the proceedings where the parties are at odds concerning the interpretation and application of the chosen foreign rules – namely, the possible need for additional procedural rulings from the arbitrators or CIETAC.

In Shangdong Machinery v Modern Jordanian & ors [2005], the Beijing Second People's Intermediate Court upheld a CIETAC award notwithstanding a Chinese law challenge by the domestic party concerning the form and language of evidence considered by the arbitral tribunal.

This decision shows the Beijing Courts drawing a distinction concerning the non-applicability of certain Chinese law evidential requirements to arbitration. It accords with widely accepted practice in international arbitration, whereby arbitral tribunals and institutions set their own rules of procedure.

Private investment disputes

In Lion Dragon v Beijing Smartdot [2006], a dispute arose concerning an investment agreement that failed to obtain government approval. The foreign investor claimed damages in arbitration against the Chinese party but was unsuccessful. The Beijing Second People's Intermediate Court refused an application by a foreign investor to set aside the ensuing CIETAC award, holding that, notwithstanding the importance to China of foreign investment, an investment agreement dispute between corporate entities was contractual in nature and did not violate the Chinese social and public interest.

This decision, while unfavourable to the foreign investor, appears to draw an appropriate distinction between private contractual arrangements and the protection of the public interest.

The Chinese preference

The CIETAC arbitration rules and BAC arbitration rules contain well-established provisions promoting conciliation and, in practice, parties do frequently attempt conciliation. Chinese and foreign commentators agree this combination of arbitration with conciliation hints strongly at the Chinese preference for resolving disputes amicably, in private rather than in public and without scandal or loss of reputation or face, which might damage the guanxi (relationship).

While the confidential nature of conciliation within arbitration offers some comfort, parties that remain engaged in contested arbitration proceedings even after conciliation may have doubts: could information communicated privately by the other side to arbitrators during conciliation later influence the views of the arbitral tribunal? The CIETAC rules are silent on this point, while the BAC rules provide that the chairman may approve a request for a change of arbitrator after unsuccessful conciliation, if made by both parties.

The ongoing challenge will be to preserve the momentum of recent change to keep pace with accession to the World Trade Organisation and ever-increasing levels of international trade.

Nicholas Tse is a barrister at Gide Loyrette Nouel. This article was written with the assistance of the firm's Beijing office.