New rules govern the mortgaging or pledging of assets to foreign parties

China’s ongoing campaign to restrict bank-sector lending is creating a funding squeeze for businesses across the country. As a result, many PRC-based subsidiaries of foreign companies that are experiencing cash-flow problems have resorted to borrowing from their offshore parent or some other offshore entity in order to mitigate funding pressures. In doing so, they may be asked to provide security to the offshore organization in the form of a guarantee, mortgage or pledge of their assets. How can this be done?

Mortgaging of immovables

Various laws and regulations apply. Pursuant to: (1) the PRC Security Law, (2) the Supreme People’s Court Several Issues Concerning the Application of the PRC Security Law Interpretations, (3) the Measures for the Administration

of Security Provided to Foreign Parties by Domestic Organizations Detailed Implementing Rules (Detailed Rules), and (4) the PRC Property Law, if the mortgaged property is immovable, the mortgage should be registered with the local real estate authority, at which point the mortgage rights in the property are established. Failure to register will mean the right is unenforceable.

The authority in charge of registration of mortgages of land-use rights is the land authority that issued the land-use rights certificate. If the mortgage relates to industrial buildings, commercial buildings, residential buildings, the mortgage registration authority is generally the real-estate trading authority. Searching the register for any mortgaged interests may be done in accordance with relevant procedures.

Mortgaging of movables

Under the PRC Security Law, the PRC Property Law, the Detailed Rules, and the State Administration for Industry and Commerce Measures for the Registration of Mortgages of Movables, movables that are both mortgageable and often mortgaged include motor vehicles, production equipment, raw materials, semi-finished products and finished products.

Motor vehicles If the mortgaged property is a motor vehicle, the mortgagor is required to register the mortgage with the vehicle administration section of the local public security authority. Mortgage rights are established once the mortgage agreement comes into effect. If a mortgage is not registered, a bona fide third-party buyer of the asset cannot be challenged. Registration information can be searched but in general the procedure is not as convenient as when conducting searches for immovables. Some regions impose strict restrictions on who can search vehicle-mortgage information.

Equipment and similar movables If the mortgaged property comprises a domestic organization’s equipment and/or other movables (ie, production equipment, raw materials, semi-finished products, or finished products), the mortgage must be registered with the Administration for Industry and Commerce (AIC) of the place where the property is located, and the mortgage rights are established once the mortgage contract enters into effect. Again, in the event that the mortgage is not registered, sales to bona fide third-party buyers cannot be challenged. AICs will register the right in accordance with the Measures for the Registration of Mortgages of Movables. Details relating to equipment mortgages or similar movables may be searched at local AIC offices.

Pledges of domestic rights

Pursuant to: (1) the PRC Security Law, (2) the PRC Property Law, (3) the Detailed Rules, (4) the PRC Company Law, (5) the Changes in Equity Interests of Investors in Foreign Investment Enterprises Several Regulations, (6) the Registration by Administrations for Industry and Commerce of Pledges of Equity Measures, (7) the Registration of the Pledge of Exclusive Rights to Use Registered Trademarks Procedural Regulations, (8) the Registration of the Pledge of Patents Measures, and (9) the Registration of the Pledge of Copyrights Measures, domestic organizations are entitled to pledge shares and stocks that are legally transferable, as well as exclusively held property rights in trademarks, patents and copyrights.

Pledges of equity Pledges must be created by written contract. If shares registered with a securities depository and clearing organization are pledged, pledge rights are established once the securities depository and clearing organization carries out the pledge registration. Where other equity is pledged, pledge rights are established once the AIC registers the pledge. Unregistered pledges are not enforceable. Registration of equity pledges and of the release of equity pledges in accordance with the Measures for the Registration of Pledges of Equity must be performed at AICs, except where the securities depository and clearing organization is required to register particulars of a pledge of shares. Registered equity pledges may be searched in accordance with relevant rules.

Pledge of exclusively held intellectual property rights Pledges must be created by written contract, and are established once registered by the competent authority. Unregistered pledges are unenforceable. Where pledges involve trademarks, they should be registered with the Trademark Office of the State Administration for Industry and Commerce in accordance with the Registration of the Pledge of Exclusive Rights to Use Registered Trademarks Procedural Regulations. Pledge information is publically searchable.

Patent pledges are registered with the State Intellectual Property Office in accordance with the Measures for the Registration of the Pledge of Patents. Applications for registration of pledge contracts are filed with the Patent Market Section of the Patent Work Administration Department of the China Patent Office. Relevant information is made available to the public in the patent pledge contracts register.

Copyright pledges are registered with the National Copyright Administration in accordance with the Registration of the Pledge of Copyrights Measures, and registration information is publicly searchable at the local copyright office, unlike registrations relating to trademarks and patents, where searches must be performed at the offices of state-level authorities.

Security provided to foreign parties

When a mortgage is created over immovables or movables, or a pledge is created in favour of a foreign party, the borrower must also register with the local foreign exchange control authority (and comply with any applicable requirements) once the mortgage rights or pledge rights are established. In such cases, it is generally necessary to provide documents such as a Domestic Organization Foreign Debt Agreement Execution Form, a Letter of Intent Concerning a Master Debt Contract Under Security Provided to a Foreign Party, etc. However, because both procedures and required documents can vary from place to place, inquiries as to appropriate local practice should first be made at the local foreign exchange control authority.

Gillian Miao is an associate at Martin Hu & Partners (MHP Law Firm)