PRC adopts commercial exception to state immunity

The PRC has passed a new law which will apply the "restrictive" approach to foreign state immunity with effect from 1 January 2024.  As a result, foreign states will not be granted immunity from suit or execution in the PRC in respect of certain commercial activities and assets.  The PRC government has indicated that the same approach should apply in Hong Kong and Macau.

The Foreign State Immunity Law was adopted by the Standing Committee of the National People's Congress ("SCNPC") on 1 September 2023.  A statement by the Ministry of Foreign Affairs of the PRC said the law aimed to improve the PRC's state immunity system in line with international practice.

The new law marks a departure from the "absolute" doctrine of immunity previously followed by the PRC (which does not provide any exception for commercial activities).  The PRC joins many other jurisdictions in adopting the restrictive approach (including the USA, the UK, India, Singapore, Australia, New Zealand and most member states of the European Union).

Parties involved in PRC-related transactions with foreign states will now benefit from a number of express exceptions to the immunity of foreign states.  In addition to the "commercial activities" exception, foreign states will not be granted immunity where there is an express or implied waiver, in certain arbitration-related court proceedings, and in specific categories of dispute.  These exceptions, along with other key provisions of the new law and its application to Hong Kong and Macau, are discussed in detail below.

Which entities are entitled to immunity?

The starting position under the new law is that "foreign states" enjoy immunity from the jurisdiction of the courts of the PRC (Article 3) and their property enjoys immunity from execution (Article 13), subject to the exceptions discussed below.

The definition of a "foreign state" includes the foreign state itself along with organs or component parts of the foreign state (such as a government department).  It also includes organisations or individuals who (i) are authorised by the foreign state to exercise sovereign power and (ii) carry out activities based on such authorisation (Article 2).

Importantly, foreign State-Owned Enterprises ("SOEs") which carry out commercial activities and do not have sovereign functions will not be entitled to immunity in the first place.  A counterparty of such a foreign SOE should therefore be able to sue the foreign SOE in the PRC courts, and execute against its assets located in the PRC, without having to rely upon one of the exceptions to immunity discussed below.  This is consistent with the previous position under PRC law and with the stated policy of the Central People's Government.

Commercial activities exception

The most significant exception to immunity is the new "commercial activities" exception, which applies to both immunity from suit and immunity from execution.  In summary:

• Immunity from suit.  A foreign state will not enjoy immunity from the jurisdiction of the PRC courts in respect of lawsuits in relation to commercial activities which meet two requirements (Article 7).  First, the commercial activities must be conducted with an organisation or individual of any other state, including the PRC (and the exception therefore will not apply as against a foreign state in respect of commercial activities undertaken with organisations and individuals of that foreign state).  Second, the commercial activities must either take place within the territory of the PRC or (if not) produce "direct influence" within the territory of the PRC.
• Immunity from execution.  A foreign state will not enjoy immunity from execution against its property located within the territory of the PRC, where that property is used in commercial activities, execution is for the purpose of enforcing a judgment or ruling of a PRC court and the property is connected to the proceedings (Article 14(3)).  Certain categories of property are expressly excluded from the concept of property used for commercial activities (Article 15).  These include property used for the official business of diplomatic missions, military property and central bank property (Article 15).

For these purposes, "commercial activities" are defined as "transactions of goods or services, investments, loans, and other activities of a commercial nature other than those in the exercise of sovereign power" (Article 7).

It is for the relevant PRC court to determine whether activities are commercial in nature and whether property is used for commercial activities (having regard where appropriate to the excluded categories of property mentioned above).  In doing so, the court shall take both the nature and purpose of the activities into account (Article 7).

Arbitration-related proceedings

Arbitration proceedings are not directly affected by state immunity, because they do not involve the exercise of jurisdiction by the courts of one state over another state.

Nevertheless, the law establishes important new exceptions to the immunity of foreign states from the jurisdiction of the PRC courts in various types of arbitration-related proceedings (Article 12).  These are proceedings in relation to: the validity of an arbitration agreement; the recognition, enforcement or setting aside of an arbitral award; and other arbitration-related matters prescribed by law to be reviewed by the PRC courts.

As a threshold requirement, the underlying dispute must arise out of commercial activities between a foreign state and an organisation or individual of any other state (including the PRC).

If that requirement is met, the foreign state will not have immunity from jurisdiction in relation to the categories of arbitration-related court proceedings mentioned above where:

• The dispute is referred to arbitration pursuant to a written arbitration agreement. Unlike the general "commercial activities" exception to immunity from suit under Article 7 (described above), there is no territorial requirement, i.e. the relevant commercial activities do not need to take place within the territory of the PRC or produce "direct influence" within the territory of the PRC; or
• The foreign state has agreed in writing, for example in an international investment treaty, to submit the dispute to arbitration.

Other exceptions to immunity from suit

There are also exceptions to immunity from suit in the following cases:

• Express waiver.  Where a foreign state waives its immunity in writing by explicitly accepting the jurisdiction of a court of the PRC with respect to a particular matter or case pursuant to an international treaty, a written agreement or written documents submitted to the court, written documents submitted to the PRC through diplomatic channels, or in some other manner by which it explicitly accepts the jurisdiction of the court (Article 4).
• Implied waiver.  Where a foreign state is deemed to accept the jurisdiction of a PRC court, for example because it brings a lawsuit or participates in a lawsuit as a defendant and raises a substantive defence or counterclaim (Article 5).  No such implied waiver will arise simply because a foreign state participates in a lawsuit in order to claim immunity, its representatives appear as witnesses before a PRC court, or it consents to the application of PRC law in any matter (Article 6).
• Specified categories of dispute.  A foreign state will not have immunity from suit in respect of: claims under certain types of labour or service contract which are wholly or partially performed within the territory of the PRC (with certain exceptions) (Article 8); personal injury and property damage claims in respect of acts committed in the PRC (Article 9); certain types of property dispute including in relation to immoveable property located in the PRC, the donation, bequest or inheritance of moveable or immoveable property by the state, and the management of trust property or bankruptcy property (Article 10); and certain types of intellectual property cases (Article 11).

Immunity from execution 

While there are relatively wide and varied exceptions to immunity from suit, the exceptions to immunity from execution are much narrower.  These are limited to: (i) execution against certain property used for commercial activities (discussed above); (ii) cases of express waiver, where a foreign state waives its immunity from execution in writing pursuant to an international treaty, a written agreement or written documents submitted to the court; and (iii) property which has been allocated or designated for execution purposes (Article 14).

Moreover, a waiver of immunity from suit will not automatically give rise to a waiver in respect of execution (Article 13).  The mere fact that a litigant is able to bring proceedings and obtain a court judgment or arbitral award against a foreign state, therefore, does not mean that it will necessarily be able to successfully obtain execution against the assets of that state.

Other notable provisions

Other notable provisions of the new law include the following:

• Reciprocity.  In addition to the exceptions mentioned above, the law adopts the principle of reciprocity (Article 21).  Where a foreign state grants to the PRC and its property a level of immunity which is lower than that set out in the law, the principle of reciprocity applies.  Accordingly, this provision will only ever operate to reduce, not increase, the protection afforded to a foreign state.
• International treaties prevail.  Where the provisions of an international treaty concluded or acceded to by the PRC differ from those of the law, the provisions of the treaty shall prevail (save those on which the PRC has announced reservations) (Article 22).
• Special court procedures.  The law makes provision for certain procedural matters in cases involving foreign states, including in relation to the service of documents (Article 17), default judgments (Article 18), and certification of factual issues by the Ministry of Foreign Affairs of the PRC (Article 19).

Application to Hong Kong and Macau

Although the law does not make any express provision as to its territorial application, it is clear that the restrictive immunity approach which it adopts will apply to the Hong Kong and Macau Special Administrative Regions.

In a media interview immediately following the promulgation of the new law, an official of the Legislative Affairs Commission of the SCNPC confirmed that Hong Kong and Macau should follow the state immunity rules and policies set out in the new law.

This is consistent with the position previously taken by the SCNPC in the interpretation which it provided to the Hong Kong Court of Final Appeal in the landmark case of Democratic Republic of the Congo v. FG Hemisphere Associates LLC (FACV Nos 5, 6 & 7 of 2010), to the effect that the principles of state immunity should apply uniformly within the whole territory of the PRC.  The PRC adopted the absolute doctrine of state immunity at that time, without any commercial exception, and hence the Court of Final Appeal, applying the interpretation of the SCNPC, held that absolute immunity must also apply in Hong Kong.  Applying this reasoning, restrictive immunity should apply in Hong Kong once its adoption by the PRC takes effect from 1 January 2024.

Comment

This is the first time the PRC's policy on state immunity has been comprehensively set out in a legal instrument, providing welcome clarity and accessibility in relation to this important issue.

The adoption of the new law is a watershed moment for state immunity rules in the PRC, including the Hong Kong and Macau Special Administrative Regions.  The PRC had previously been a strong adherent of the absolute doctrine of immunity, and was the most significant jurisdiction to continue to apply it.

Although the PRC signed the UN Convention on Jurisdictional Immunities of States and Their Property (which applies the restrictive doctrine of immunity) in 2005, it has not ratified the Convention and the Convention has not yet entered into force.  In the Congo case (mentioned above), the Central People's Government (whose position on immunity was set out in letters submitted to the Hong Kong court on its behalf) stated that the signature by the PRC of the Convention did not change the PRC's adherence to the doctrine of absolute immunity.  It remains to be seen whether the PRC will proceed to ratify the Convention in light of the new law adopting the restrictive doctrine.

As a practical point, it would be advisable for parties entering into commercial contracts with foreign states and state entities (including contracts which provide for disputes to be resolved by arbitration) to include a provision confirming that the contract is of a commercial nature and arises out of commercial activities which (where applicable) will take place or produce a direct effect in the PRC.  This should help to maximise such parties' prospects of being able to rely upon the commercial activities exception and (where relevant) the exceptions in relation to arbitration-related proceedings before the PRC courts.

This article has been updated since it was originally published to reflect additional points of detail and our latest analysis.

This article has been authored by Herbert Smith Freehills Kewei, a joint operation between Herbert Smith Freehills LLP and Kewei Law Firm based in the Shanghai Free Trade Zone.