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Note: Shanghai Alcatel-Lucent Company, Ltd. (Seller/Applicant) and Joint Stock Company Uztransgaz (Buyer/Beneficiary) entered into a Supply and Installation Contract. An arbitration clause in the contract stated that “any and all disputes arising from or in connection with the contract shall be settled through arbitration … [and that] the people’s court shall not have jurisdiction over such a case.” The contract required Seller/Applicant to provide independent guarantees to assure performance subject to Uniform Rules for Demand Guarantees (URDG) 458 (1992) in favor of Buyer/Beneficiary. To satisfy this requirement, Export-Import Bank of China, Shanghai Branch (Guarantor) issued two independent guarantees in favor of Buyer/Beneficiary upon the application of Seller/Applicant.

When a dispute arose, Seller/Applicant sued Buyer/Beneficiary and Guarantor to stop payment. The Shanghai High People’s Court entered judgment against Buyer/Beneficiary, stopping payment. On appeal, the Supreme People’s Court of the PRC, Chen, J., denied the application for retrial.

Seller/Applicant asserted in its original complaint that it had fulfilled its obligations and that Buyer/Beneficiary not only owed it money under the contract, but was likely to demand payment under the performance guarantees.

Buyer/Beneficiary argued that the Shanghai High People’s Court erred in its characterization of the dispute as involving the tort of fraud. Buyer/Beneficiary argued the dispute involved breach of contract and the contract provisions stipulated that any disputes should proceed through arbitration, depriving the trial court of jurisdiction. Buyer/Beneficiary also argued that confirmed facts by both parties entered in the trial court’s order regarding their underlying obligations would interfere with the jurisdiction of the arbitration tribunal in resolving actual contract disputes.

In opposition to Buyer/Beneficiary’s request for retrial, Seller/Applicant argued that the trial court had jurisdiction over the dispute because has it alleged fraud, which was a tort. Additionally, Seller/Applicant argued the trial court correctly exercised its jurisdiction because the legal relationships of the independent guarantees were separate from the underlying obligations of the contract. Finally, Seller/Applicant argued that the inclusion of substantive issues and facts surrounding the evidence of its fraudulent allegations against Buyer/Beneficiary in the trial court’s order should not be barred by the arbitration clause in the underlying contract during the retrial hearing.

The Supreme People’s Court dismissed Buyer/Beneficiary’s request, noting that Article 265 of the Civil Procedure Law of the People’s Republic of China provided “[i]n the case of an action concerning a contract dispute or other disputes over property rights and interest, … if the contract is signed or performed within the territory of the People’s Republic of China, …the people’s court in the place where the contract is signed or performed …or where the torts are done shall have jurisdiction.” The court concluded that Guarantor was not bound because the arbitration clause covered disputes arising between the two parties and not between a party and an independent third party.

Additionally, the opinion concluded that jurisdiction over the dispute by the court would not affect the jurisdiction of the arbitration tribunal regarding the underlying contract in accordance with its arbitration clause because fraud is an exception to the principle of independence for arbitration tribunals.

In concluding that the trial court correctly determined its jurisdiction for the tort dispute, the opinion noted the independent character of the two guarantees, citing URDG 458 (1992) Article 2 (b) for this proposition. Because the guarantees are independent, the opinion concluded that, “[t]he arbitration clause provided in the underlying contract has no binding force on disputes over the independent guarantees, including the contract dispute arising from the legal relationship of independent guarantee between the beneficiary and the guarantor, and the dispute of tort arising from the legal relationship of independent guarantee between the guarantor, the beneficiary and the applicant.” Contrasting disputes regarding the underlying transaction which are subject to the arbitration clause and the independent guarantees to which the Guarantor was a party, the opinion noted “[t]he nature of the legal relationships and the parties to these two types of disputes are different. Therefore, the current dispute is not covered by the arbitration clause in the underlying contract.”

On the final issue regarding jurisdictional interference of the arbitration tribunal the opinion stated: “The principle of independence is the cornerstone for maintaining the operational mechanism “pay first, argue later” in the law of independent guarantee. The fraud rule, which denies the principle of independence, is just an exception in exceptional circumstances. Therefore, even if it is necessary for the court to look into part of the facts in the underlying contract in order to find out if fraud can be established in the guarantee, the court will not have a comprehensive investigation into the dispute of the underlying contract. The scope of the investigation is very limited. Therefore, the jurisdiction over this dispute by the court will not affect the jurisdiction of the arbitration tribunal over the underlying contract in accordance with the arbitration clause. Moreover, it is not necessary for the court dealing with this dispute to wait for the result of the arbitration tribunal.”

[GJL/MJK]

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The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of the ICC or Coastline Solutions.