In recent years, more and more listed companies use quasi-security measures for credit enhancement. These measures generally take the form of top-ups by the listed company, commitment to debt repayment in the place of the debtor, liquidity support and repurchase liability to ensure realisation of creditor’s rights.
As these measures are different from guarantee, mortgage, pledge and other traditional guarantee measures specified in the Security Law, listed companies generally lay off internal resolution and information disclosure procedures required for providing security for others. This article explores the effect of quasi-security measures adopted by listed companies without internal resolution, by analysing their nature.
Provisions of quasi-security measures generally state as follows: “The person obliged for top-up agrees to take the top-up responsibility to the creditor in respect of the debt repayment liabilities of the debtor,” or, “the person repaying the debt in the place of the debtor shall fulfil corresponding liability of debt repayment in the place of the debtor under the circumstance that the debtor fails to repay the debt”.
Controversies arise over the legal effect of these expressions in both theory and judicial practice. A number of theories, such as the guarantee theory, the debt accession theory and independent contract theory, are developed in respect of the nature of quasi-security measures. Different understandings of their nature affect the determination of their effect.
Guarantee theory. As a mainstream view, it defines quasi-security measures as a type of guarantee. If a listed company is to provide a guarantee to another company, it must submit the proposal to its board of directors, or its general meeting of shareholders, for deliberation and resolution, and timely disclose the information in newspapers and magazines designated by the CSRC (China Securities Regulatory Commission) according to the provisions of the Company Law, the Circular of CSRC on Regulating the External Securities Provided by Listed Company, and other applicable laws and regulations. There is no consensus, however, about the effect of guarantee provided by listed companies without resolution in judicial practice.
There is a view that the above-mentioned provision is administrative, rather than mandatory, and will not invalidate a contract as a result. For this reason, in practice, most courts hold that such security contracts made without resolution are effective.
Another view holds, based on the consideration to the requirements for bona fide counterparty in the Contract Law, that listed companies are open, and the counterparty has the convenience to review the decision-making procedures of a listed company.
Especially, if a financial institution, bound by the obligation of “knowledge”, fails to fulfill due diligence, it would be difficult to prove that the financial institution acts with bona fides. As a result, article 50 of the Contract Law should apply and the company will be released from the security liability.
Independent contract theory. This theory defines quasi-security measures as a type of independent contractual liability. They constitute the liability of direct payment by the obligor to the creditor under the agreed conditions, and are not subordinate to, or dependent on, any other antecedent liabilities. In the judgment of one case, Beijing Second Intermediate People’s Court held that the Co-operation Framework Agreement, which contained top-up contents in the case, was a lawfully formed contract. The contents of the contract should be deemed valid as it did not violate any mandatory provisions of laws or administrative regulations of China.
In the event that quasi-security measures are defined as independent contractual liabilities, their effect will not be affected by the defects of antecedent debts based on the independence of contractual liabilities. As long as the circumstances of void contracts under article 52 of the Contract Law do not exist, the quasi-security measures will be effective. In the meantime, the laws and regulations do not mandatorily provide for the resolution and disclosure procedures of listed companies for execution of contracts. Given this circumstance, the quasi-security measures provided by listed companies without resolution are not defective in effect.
Debt accession theory. Debt accession, also known as concurrent debt assumption, is generally a theoretical concept. In judicial practice, only the High People’s Court of Jiangsu Province elaborated in detail in one summary of discussions, in 2005, that “debt accession refers to the debt assumption by which a third party, the creditor, and the debtor reach a tripartite agreement, or the third party and the creditor reach an agreement, or the third party unilaterally covenants to the creditor, to repay the debt of the debtor, without releasing the debtor from fulfilment of its liabilities”. Some courts hold in their judgments that the letter of commitment that contains commitment to paying the principal and earnings involves the promise to participate in the obligatory relationship, and thus constitutes debt accession.
In the event that the quasi-security measure is defined as debt accession, the debt will be assumed by two or more co-debtors instead of one debtor. As the new debtor involved assumes responsibility for its debt, the debt accession agreement is an independent contract in nature. As discussed above, in the event that the quasi-security measures are defined as debt accession, they will be effective even if they are not subject to resolution of the listed companies.
As the security in disguise provided by listed companies through quasi-security measures to avoid resolution procedures grows in size, it is of realistic significance to have a correct understanding of the nature and effect of such quasi-security measures, so as to protect the interests of shareholders of listed companies and secured interests of creditors. More quasi-security measures of diversified forms will emerge under the drive of extensive demand. We expect a consensus on such quasi-security measures through extensive discussion, and also expect correction and improvement of transaction structures in the future through judicial decisions.
Yao Xiaomin is a partner and Yuan Yuhui is an associate at Lantai Partners