Chapter 9 Law of secured transactions

1 Types of security devices

2 Guarantee

3 Mortgage

4 Pledge

5 Lien

6 Earnest

1 Types of security devices

Types of security devices Types of security devices

Mortgage Pledge Lien Guarantee Earnest

Subject matters

Movable property √ √ √

Immovable property √

Usufruct over immovable

√

Rights √

Money √ √

Credit √

Written contract √ √ √ √

Transfer of possession √ √ √

Publicity Delivery √ √ √

Registration √ √

Illustration:Illustration: Guarantee contract nullified by illegal Guarantee contract nullified by illegal

loan agreement loan agreement Both A and B are enterprises and A granted B a six-month loan of RMB 5 million on 5 January 1995. The interest rate for such loan is twenty (20) percent per month. At the request of B, C provided A guarantee in the form of irrevocable loan guarantee. Such guarantee agreement states that upon the maturity of the loan, the guarantor shall unconditionally pay A the sum of money owed by B to A. Such guarantee is valid as long as B owes money to A. After maturity of the loan, B is unable to repay the loan and fails to do so after repeated push by A. Thus A requested C as the guarantor to repay said debt on 5 March 1996, but C rejected A’s request on the ground that the loan agreement between A and B was null and void. It goes without saying that said loan agreement is null and void since the law prohibits loans among enterprises themselves. Even though the guarantee agreement uses such term as “irrevocable” and “unconditional” implying its independence, the guarantee agreement should be nullified accordingly. Else, it constitutes a leeway for avoiding the foregoing prohibition. Apparently all the parties including A, B and C were aware of such prohibition and to blame for the illegal loan agreement, therefore they should bear civil liability commensurate with their fault.

2 Guarantee

2.1 Concept Illustration:Illustration: Ambiguous guarantee agreement Ambiguous guarantee agreement

On 15 October 1995, Hongguang Company obtained a loan of RMB 8 million from the bank guaranteed by Investment Company. The guarantee provision signed by the responsible person and sealed by the guarantor states: “If Hongguang Company cannot repay the loan on schedule, our company is willing to bear full responsibility”. The deadline of repayment was 1 May 1996 upon maturity of which Hongguang Company was unable to make repayment. The bank thus requested the Investment Company to repay the debt, which was rejected by the guarantor on the ground that the creditor should seek repayment from the debtor first. Can the guarantor do so? No. In the first place the term “full responsibility” in the guarantee clause suggests joint and several guarantee. Secondly even regardless of such term, the un-clarity of the guarantee clause imposes joint and several liability on the guarantor.

2.2 Creation

2.2.1 Qualified guarantor • Financial competence: natural, legal person or other economic entities• State organs: N• Institutions or social organizations of public interests: N

Illustration:Illustration: County government cannot act as guarantor County government cannot act as guarantor A Company owed B Company RMB 60000, and they executed an three-month repayment agreement guaranteed by the county government jointly and severally. After this A Company was ordered bankruptcy upon approval by said government. Thus B Company requested the county government to make repayment based on the guarantee agreement. Can the creditor do so? No. The guarantee agreement should be set aside since the county government is unqualified guarantor. Apparently the parties including the county government have fault for the nullity, thus they should bear the respective liability based on their fault. It is very important to note that what the government bears is liability for nullity of guarantee rather than guarantee liability.

2.2.2 Necessity of an agreement (1) category and amount of the principal creditor's right to be

guaranteed(2) time limit for the debtor to perform his debt(3) mode of guarantee(4) scope of guarantee(5) duration of guarantee(6) other matters deemed as necessary to be agreed upon by b

oth parties

Invalid agreement: (1) parties to principal contract maliciously collude so as to cheat the guarantor to tender guarantee(2) creditor of principal contract resorts to such means as dece

it and compulsion in making the guarantor to tender guarantee under the condition against his true intention

Illustration:Illustration: Loan guarantee nullified by cheating Loan guarantee nullified by cheating Mr. Du obtained a loan RMB 20000 from the Credit Co-operative. After the loan agreement the Credit Co-operative requested him to provide guarantee for fearing that he cannot fulfill his repayment obligation. In order to obtain the guarantee for said loan, the staff of the Credit Co-operative utilized one of his former classmates to seal on the contract without consulting the responsible person of the villager commission, nor explaining the consequence of the guarantee. The villager commission’s accountant, i.e. the classmate of the staff of the Credit Co-operative did not report the case to his leader and sealed on the contract. After this the Credit Co-operative submitted the loan contract to the notary public and obtained notarization. Upon expiration of loan repayment, Mr. Du was unable to make repayment as expected, and the creditor thus deducted RMB 50000 from the account of the villager commission. Upon leaning of this, the villager commission sued the creditor for the return of the foregoing money on the ground that they did not know the guarantee at all. Can the villager commission win? Yes. Even though the loan contract with the seal of the villager commission in the guarantor’s column was notarized, the guarantee should be nullified because the villager commission’s seal was obtained through undue manners and the guarantor did not have the intention to act as the guarantor at all. Thus the villager commission shall not assume any guarantee liability and the money illegal deducted by the creditor shall be returned to it.

2.3 Guarantee liability

2.3.1 Scope of guarantee

Principal creditor right, interests, liquidated damages, compensation for loss and damage and expenses for realization of creditor rights.

2.3.2 Two or more guarantors

Jointly and severally responsible

Illustration:Illustration: Likang Hotel and Baoli Trading Company jointly Likang Hotel and Baoli Trading Company jointly liable liable

Mr. Lin obtained a loan RMB 1 million from the financial company guaranteed by Likang Hotel and Baoli Trading Company. The guarantors stated in the loan contract sealed by them: “If Mr. Lin is unable to make repayment, they may make repayment on his behalf.” Later on Mr. Lin was unable to make repayment, the creditor requested one of the guarantors, i.e. Likang Hotel to make repayment and bear liabilities of contractual violation. The Likang Hotel argued that: (1) the creditor should request Mr. Lin to make repayment first; (2) if Mr. Lin was really unable to repay the loan, the Baoli Trading Company should be jointly liable and it can only assume 1/2 of the obligation since there were two guarantors. The first argument is correct since this is a general guarantee. The creditor shall enforce against the property of the debtor first. Only in the case where the debtor’s property is insufficient to fulfill the obligation, the creditor can enforce against the property of the guarantor. The second argument cannot stand because they fail to agree their respective share of liability in the guarantee agreement. Thus both Likang Hotel and Baoli Trading Company should assume joint and several liability, and the creditor may choose any of them to sue.

2.3.3 Duration • Express provision prevails.• Else, 6 months from date on which term for performance

of principal debt expires

2.3.4 Ultra vires guarantee by legal person’s branches Without authorization in writhing by legal person or beyond authorized scope, null and void in whole or in parts beyond the authorized scope.

2.3.5 Debtor’s bankruptcy

Participate in its property distribution

3 Mortgage

3.1 Subject matters

(1) buildings and other objects fixed on land owned by the mortgager

(2) machines, means of transport and other property owned by the mortgager

(3) use-right of the State-owned land, buildings and other objects fixed on land, which the mortgager has the right to dispose

(4) State-owned machines, means of transport and other property, which the mortgager has the right to dispose according to the law

(5) land use rights of barren mountains, barren valleys, waste hills and waste sands, which the mortgager has contracted according to the law and the contract-offering party agrees on the mortgage

(6) other property which may be mortgaged according to the law

3.1.1 Mortgageable

3.1.2 Non-mortgageable property

(1) land ownership (2) use-rights of such collectively-owned land as farmland, ho

mestead, land allotted for personal needs and hilly land allotted for private use

(3) education facilities, medical and public health facilities and other facilities for public interests of institutions and social organizations

(4) property with unclear ownership and use-rights or at dispute

(5) property which is attached, arrested or supervised and controlled according to law

(6) other property which may not be mortgaged according to law

3.2 Creation

3.2.1 Eligible subject matters

3.2.2 Necessity of an agreement (1) category and amount of the principal creditor right to be guaranteed(2) term for debtor to pay his debt(3) designation, amount, quality condition, location, status of

ownership and status of use rights of the mortgaged things

(4) scope of guarantee(5) other matters and items deemed necessary by the parties

3.2.3 Registration Registration and registration authorities Registration and registration authorities

Subject matters Registration authorities Validity

Mandatory Land use rights without buildings Land authorities No validity unless registered. Urban real property County government

departments or above Rural enterprise buildings

Forestry Forestry department

Aircraft and automobile Vehicle registry office

Enterprise equipment & other movable property

AICs

Vessel Vessel registry office No action against third party. Optional All non-mandatory subject matters Notary Public

3.2.3.1 Types of registration 3.2.3.2 Registry office 3.2.3.3 Consequence

• Mortgage is not effective until properly registered. • Exception: vessel mortgage

3.3 Effect of mortgage

3.3.1 Scope of mortgage • Default rule: principal creditor right, interests, liquidated damages, compensatory damages and expenses for the realization of mortgage.• Parties can either enlarge or reduce its scope

3.3.2 Existing lease survives the mortgage

3.3.3 Changes in the mortgaged things • Notification.

3.3.4 Superiority to guarantee • Mortgage prevails over the guarantee.

Illustration:Illustration: Mortgage over the land use rights prevails Mortgage over the land use rights prevails

over guaranteeover guarantee In May 1995 Huanyu Real Estate Company obtained loan RMB 20 million from the plaintiff mortgaged by the land use rights and aboveground buildings in the city central area, which was registered with the registry office. The plaintiff also requested Huanyu to additional guarantee and Huanyu agreed. Thus at the request of Huanyu the Investment Company agreed to guarantee for the loan and signed and sealed on the loan contract. The guarantee clause state: “The guarantor is willing to assume joint and several liability.” Upon expiration of the loan repayment, i.e. 1 June 1996, Huanyu was unable to make repayment. The plaintiff found that the land use rights mortgaged by Huanyu had other unregistered mortgages, thus directly requested the Investment Company to make all the repayment. Is the plaintiff entitled to do so? No. Since the mortgage coexists with the guarantee, the plaintiff should enforce against the mortgaged property first. If there is any insufficiency, the plaintiff may then request the Investment Company to make such payment.

3.3.5 Extinction

• Creditor rights terminate, so cease to exist the mortgage

• Mortgaged property is destroyed, the mortgage relationship also terminates

3.4 Realization of mortgage rights

Sequence of mortgages over the same thing Sequence of mortgages over the same thing

Compulsory registration Optional registration

Earlier registration prevails √ √

Earlier contract prevails √

Pro rata allocation for the same sequence

√ √

4 Pledge

4.1 Creation 4.1.1 Eligible subject matters (1) draft, cheque, promissory notes, bonds, deposit certificates, warehouse receipt and B/L (2) shares and stocks duly transferable according to law (3) property rights in the exclusive use rights of trademark, patent

rights and the copyrights transferable according to law (4) other rights which may be pledged according to law

4.1.2 Written agreement (1) category and amount of principal creditor right to be guaranteed (2) time limit for debtor to pay his debt (3) name, quantity, quality and descriptions of the pledged things (4) scope of the guarantee(5) time for transfer and delivery of pledged things (6) other matters and items deemed necessary by parties

4.1.3 Delivery or registration

Effective time & manner of publicity

Manner of publicity Valid upon

delivery Valid upon registration Delivery Registration

Movables √ √

Drafts, cheques, promissory notes, bonds, deposit certificates, warehouse receipts, B/L

√ √

Shares and stocks √ √

IP √ √

4.2 Effect of pledge

• Default rule: principal creditor right, interests, liquidated damages, compensatory damages, custodian costs of the pledged things and expenses for the realization of mortgage

• Parties can either enlarge or reduce its scope.

4.3 Realization of pledge rights

5 Lien

5.1 Possessory lien

5.1.1 Creation and termination

5.1.2 Effect and realization

• Lienor is duty bound to properly maintain and keep the things under lien since it has possession of it. If its loss or damage is attributable to lienor’s improper custody, lienor shall bear civil liability.

• At least two (2) months grace period. • Failure in grace period, creditor may keep things under lien after valuation, or enjoying priority in receiving proceeds of auction or sale of the things under lien.  

5.2 Marine liens

5.2.1 Scope

(1) payment claims for wages, other remuneration, crew repatriation and social insurance proceeds made by the master, crew members and other members of the complement in accordance with the relevant labor laws, administrative regulations or labor contracts

(2) claims in respect of loss of life or personal injury occurred in the operation of the vessel

(3) payment claims for tonnage dues, pilotage dues, harbor dues and other vessel's port charges

(4) payment claims for salvage payment (5) compensation claims for loss of or damage to property resultin

g from tortuous act in the course of the operation of the vessel

5.2.2 Sequence

• Such marine claims shall be satisfied in the above sequence.

• Terminates:

(1) marine claims attached by marine liens have not been enforced within one year from their existence without

no suspension or discontinuance(2) vessel in question has been subject matter of compulso

ry sale by the court(3) the vessel has been lost

5.2.3 Marine lien v possessory lien

Marine lien v possessory lien Marine lien v possessory lien

Marine lien Possessory lien

Scope Five specified marine claims

Ship building and repairing costs

Lienor Five types of specified claimants

Ship builder and repairer

Possession as precondition ╳ √

Priority Prevail over possessory lien.

Inferior to marine lien.

Time limit for its exercise 1 year 2 years

Suspension & discontinuance in counting time limit

╳ √

6 Earnest

Illustration:Illustration: Earnest is subordinate to principal Earnest is subordinate to principal

contract contract On 1 December 1992, Mr. Xu agreed to sell and Mr. Zhong agreed to Mr. Xu car for RMB 15000. They also agreed on an earnest of RMB 3000, and Mr. Zhong paid it as agreed. They agreed to delver the car to Mr. Zhong after Mr. Xu had completed another long distance journey. When Mr. Xu came back, they went to the registry office to handle the title change procedures. They were told that the car was incapable of resale since it should be discarded as scrap. Thus Mr. Zhong sue Mr. Xu for the double return of the earnest. Can Mr. Zhong succeed? No, Mr. Zhong can only request the return of the earnest rather the double amount. The reason is that the principal contract has not formed yet due to the improper subject matter, thus the earnest contract has not formed accordingly. Mr. Zhong can only request the return of the earnest based on Mr. Xu’s pre-contract fault and liability.

Illustration:Illustration: A Company should return the double A Company should return the double amount of earnest amount of earnest

A Company agreed to sell and B Company buy 5000 sets of color TV. The sales contract should be notarized and B should pay 15 percent of the total price within ten days of notarization. They did not handle notarization for said contract, but B paid the earnest as agreed, which was accepted by A. Upon expiration of the term of delivering TV, A was unable to deliver the goods, thus B sued for the double return of the earnest. However A only agreed to return the earnest rather the double amount by arguing that the contract has not formed since it had not been notarized. Is A’s argument correct? No. A should return the double amount of the earnest, since the principal contract has legally formed. The reason is that A accepted the earnest, which demonstrated that A gave up the condition of notarization.