Clarifications on issues in security disputes cases

By Wu Jiejiang, Jingtian & Gongcheng
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The Second Civil Tribunal of the Supreme People’s Court released a draft for comment on the minutes of the National Court Work Conference on Trial of Civil and Commercial Cases at www.chinacourt.org on 6 August 2019. The minutes summarize the hot and focus issues that the court system has encountered during trial practice and the corresponding solutions. Offering a unified judgment for all courts in China, it can serve as a reference for judges in the application of the law, and reasoning and arguments.

The minutes consist of 13 parts and part four is dedicated to several issues concerning the trial of security dispute cases. This article will provide a brief overview of the causes of disputes over some issues concerning the rules for a security:

Independence of the security arrangement. It is stipulated in article five of the PRC Security Law that “a security contract should be an accessory contract to the principal contract. When the principal contract is invalid, the security contract should also be invalid. Where an agreement is otherwise reached in the security contract, that agreement shall prevail.” The minutes impose restrictions on the latter half of this provision, that is, “If the parties concerned reach an agreement in the security contract that the security provided will not become invalid when the principal contract is invalid, such agreement will be nullified for disaccord with the accessory character of the security.”

The nullification of the agreement, however, will not affect the validity of the entire security contract. Where the principal contract is valid, the security provider should assume the liability for the security as agreed in the security contract. Where the security contract becomes invalid as a result of the invalidity of the principal contract, the civil liability of the security provider should be determined depending on whether the security provider has fault or not.

Treatment of a mixed security. For the circumstances of both a third-party guarantee and a real security, the Security Law and its judicial interpretation and the Property Law provide as follows. It is stipulated in article 28 of the Security Law that, where an obligation is secured by both a guarantee and a real security, the guarantor should bear the guarantee liability for the obligation other than those secured by a real security. According to article 38.1 of the judicial interpretation of the Security Law, where there is no agreement or no clear agreement by the parties concerned on the scope of the guarantee or real security, the security provider who has fulfilled the liability may have recourse against the debtor or request other security providers to answer for their shares.

It is provided in article 176 of the Property Law that, as regards an obligation secured by both a real security and personal security, where the obligor fails to pay its due debts or any circumstance as stipulated by the parties concerned triggering realization of the security right, the obligee should realize their rights as agreed. If there is no agreement or no clear agreement and the real security is provided by the obligor, the obligor should realize the obligee’s rights by the real security. If the real security is provided by a third party, the obligee may, by the real security or by requesting the guarantor to assume the liability of the guarantee, realize the obligee’s rights. The third party who provides the security has the right, after fulfilling the security liability, to recover payments from the obligor.

As regards whether the security providers have the right to recover against each other, in addition to the right to recover against the obligor, when a certain security provider suffers enforcement, the minutes provide that, a security provider has no right to recover against other security providers, unless the latter reach an agreement on the right to recover against each other in the security contract. This provision disagrees with the aforesaid provision in the judicial interpretation of the Security Law.

Determination of the amount of obligation secured by a maximum security. The minutes defines the amount of obligation to cover the principal obligation, interests, penalties, liquidated damages, the expenses for safekeeping the collateral, and the expenses for realization of the obligation. It is reported that Ma Weihua, the former president of China Merchants Bank, proposed to the central authorities in 2010 that the Supreme People’s Court should provide a criteria for the maximum limit of obligation secured by a maximum mortgage/pledge, that is, whether the maximum amount refers to only the principal or the total of the principal and interest.

Technically, interest and expenses change constantly. In practice, if the amount of the principal reaches the maximum limit, the obligation of the interest and expenses in excess of the maximum limit may not be secured by a maximum mortgage/pledge. Therefore, the obligee should pay attention to the amount of loan principal extended. In addition, there is no clear provision in the minutes on whether the parties concerned may freely agree on the maximum obligation amount in the maximum-security agreement.

Effect of expiry on the limitation of action for the principal. The minutes state that, for the mortgage, pledge over rights and security rights that are announced by registration, the obligee should exercise the real security within the limitation of action on the principal obligation. If the obligee does not exercise the real security or other related rights after expiry of the limitation of action on the principal obligation, the people’s court should support the security provider’s request for confirming elimination and deregistration of the real security.

Article 12 of the judicial interpretation of the Security Law provides that: “The term of security agreed upon by the parties or required by registration authorities shall not affect the continuity of the real security. Within two years after the limitation of action for an obligee’s secured rights expires, the people’s court shall support the obligee’s exercise of his/her real security.” In comparison, the minutes incline to provide more protection to the rights of obligors and security providers.

In addition to the above issues, part four of the minutes also contains the real security over immovables, the real security over movables, new types of securities, and innominate securities. After solicitation for comment on the different stances of social institutions, the official version of the minutes will be released and it is expected to balance the interests of obligees, obligors and security providers.

Wu Jiejiang is a partner at Jingtian & Gongcheng

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