Article

Factual Summary: On 23 March 2001, Buyer and Seller entered into a long-term agreement for fiber products. Under this agreement, during the period from 1 October 2001 to 31 March 2007, Seller agreed to provide 4,200 kg fiber products per month to Buyer at a price starting at 75 Japanese Yen per gram and sliding to 65 Japanese Yen per gram five years later. In the agreement, there was an arbitration clause providing that all disputes arising from it would be resolved by arbitration in Tokyo pursuant to Arbitration Rules of the Japan Commercial Arbitration Association.

On the execution of the agreement, Bank issued an irrevocable revolving LC in favor of Seller, the terms of which were consistent with that of the purchase agreement. However, after issuance of LC, the price of fiber products in the global market dropped dramatically to 22 Japanese Yen per gram. Buyer tried to negotiate with Seller to reduce the price for the agreement. After several rounds of negotiations, the reduced price was still much higher than the market price. Buyer alleged that there was material fraud in the price clause in the purchase agreement, within the fraud exception under LC law. Therefore, Buyer sued Seller, alleging that the purchase agreement is void and that payment under the LC should be prevented.

Seller objected to the jurisdiction of the court, arguing that since there was a valid arbitration clause in the purchase agreement, this case should be resolved by arbitration and that the court did not have jurisdiction.

First Instance: Decision of Tianjin High People's Court:

The trial court concluded that it had the authority to exercise jurisdiction over the case and rejected the objection raised by the Seller. It concluded that the LC is only a settlement instrument for the underlying transaction, it is an autonomous instrument which is not affected by the underlying transaction. In this case, the Buyer's allegation was that there was material fraud in the underlying contract, which can constitute an exception to the independence principle. In such a case, the court should issue an injunction to prevent the LC payment. Therefore, as this case was a LC dispute rather than a contract dispute, the court had jurisdiction regardless of the arbitration clause in the purchase agreement. Furthermore, since application of the fraud exception is subject to material fraud in the underlying transaction, the underlying transaction dispute should be tried together with the LC dispute.

Second Instance: Decision of Supreme People's Court

The appellate court stated that two separate claims existed in this case: that the purchase agreement should be void; and that the price fraud in the purchase agreement constitutes LC fraud exception.

As application of fraud exception is subject to material fraud in the underlying transaction, as a general rule, the LC dispute might be handled together with the underlying transaction dispute. However, such a rule cannot be applied in this case. The underlying contract of this case, i.e., the purchase agreement provided that all disputes arising from the agreement should be resolved by arbitration in Tokyo. Such an arbitration clause was valid and enforceable under PRC Law. Thus, according to relevant provisions in PRC Civil Procedure Law, the court cannot exercise jurisdiction over the purchase agreement and there is no legal basis for the court to handle the underlying contract dispute and LC dispute together. As such, the civil ruling issued by the court of first instance shall be vacated. In Seller's written appeal, it argued that since the LC dispute arose from the underlying contract, the whole case should be resolved by arbitration. This argument was rejected for the following reasons:

First, as the court of first instance had correctly pointed out, the LC is an autonomous instrument which is not affected by the underlying transaction. Thus, although the underlying transaction should be resolved by arbitration, the court shall have the authority to exercise jurisdiction over the LC dispute in this case.

Second, in this case, since the Buyer's claim seeking for a court injunction to prevent LC payment is based on Seller's alleged material fraud in the underlying transaction, the Seller is the defendant while Issuer is a third party. As Issuer is not a party to the purchase agreement, it is not bound by the arbitration clause in such agreement. Therefore, should the case be submitted to arbitration, the Buyer's claims could not be resolved completely.

To conclude, the Supreme People's Court rendered its ruling as follows:

1. Civil ruling issued by Tianjin High People's Court was vacated;

2. Since Tianjin High People's Court had no jurisdiction over the purchase agreement, the Plaintiff's claim alleging that such agreement should be void was rejected;

3. Tianjin High Prople's Court had the jurisdiction over the LC dispute among Tiandatiancai, Shin-Etsu, and Citic Bank.

[JS/YW/cbw]

* JIN Saibo is a partner with Zhonglun Law Firm (Beijing office) and YANG Wantao is a partner with Zhonglun Law Firm (Shanghai office).

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