Special procedure on security rights a ‘bright spot’ for creditors

The special procedure for realising security rights that appears in the new Civil Procedure Law came into effect on 1 January 2013, and has become one of the bright spots in the law. Even though various legislation gives security rights holders the right to preferentially receive payment from the proceeds derived from an auction or liquidation (collectively referred to as disposal) of the collateral, such holders, in realising their rights, had to go through a litigation procedure and first had to pay high litigation costs, making for heavy relief costs.

The special procedure set forth in articles 196 and 197 of the new Civil Procedure Law simplifies this procedure: once the court finds that the applicant’s application is in compliance with the law, it may directly render a ruling for the disposal of the collateral, and the applicant may apply to a court for enforcement on the strength of the ruling; additionally, it is not necessary to pay a case acceptance fee to initiate the special procedure, and a case is generally concluded within 30 days.

Implementation prospects

It is expected that corresponding detailed rules will be issued in future to fill in the gaps in the Civil Procedure Law. Due to an outbreak of disputes in its jurisdiction, Zhejiang Provincial Higher People’s Court was the first to issue its Opinions on Trying Cases Involving the Realisation of Security Rights.

It is clear from Zhejiang’s experience that the features of such cases include the following: (1) the applicant is usually a bank, credit co-operative or other such financial institution, and the respondent usually an insolvent company; and (2) in almost all cases the security rights to be realised are mortgage rights and the collateral is fixed assets (premises, land use rights, etc.). As the special procedure prompts an influx of financing disputes, banks and other such financial institutions will become the greatest beneficiaries.

Scope of applicants

The Civil Procedure Law specifies that an application for the special procedure shall be submitted by “the security rights holder or other person with the right to request realisation of the security rights”. An article entitled “Understanding and Application of the Procedure for Cases for the Realisation of Security Rights” appearing in the People’s Court Daily on 9 December 2012 expresses the opinion that the term “security rights holder” mainly means mortgagees, and the phrase “other person with the right to request realisation of the security rights” means pledgors and debtors whose property is encumbered by a lien; mortgagors, pledgees and lien holders do not qualify as applicants.

However, this author disagrees and is of the opinion that “security rights holder” here shall include mortgagees, pledgees and lien holders. The reasons are: first, articles 219 and 236 of the Property Law and the Security Law specify that pledgees and lien holders have the right for disposal of the collateral; second, part 4 of the Property Law lists mortgagees, pledgees and lien holders as security rights holders; finally, with respect to the realisation of security rights, the means of relief made available by the Property Law to pledgees and lien holders do not markedly differ from those made available to mortgagees.

The Zhejiang opinions list security rights holders and collateral providers as applicants for special procedure. However, this author holds some doubts as to whether a mortgagor is qualified to apply for the special procedure.

As pledges and liens, which are based on possession of the subject matter of the pledge or lien, are not subject to a term of existence, the pledgee or lien holder lacks the motivation to promptly exercise its rights and as such could hold the collateral for a long period of time, resulting in its loss of value and thereby harming the interests of the pledgor or debtor. Accordingly, a pledgor or debtor whose property is encumbered by a lien has the right to apply for disposal of the collateral.

In contrast, a mortgagee does not have the collateral in its possession and the mortgage rights must be exercised within the statutorily specified period of time. Accordingly, if a mortgagee is lax in the exercise of its rights, this will not harm the interests of the mortgagor. Under such a circumstance, including mortgagors among the list of applicants runs counter to the intent of the legislation.

Attachment

In the case of a pledge or lien, attachment is generally not an issue. The most recent amendments nevertheless remain silent on whether it is possible to apply for attachment in a special procedure for the realisation of mortgage rights. Therefore, if the statutory requirements are satisfied, applications for attachment should be permitted in special procedures for the realisation of mortgage rights.

Some are of the opinion that, considering that laws and judicial interpretations already specify remedies in the event that a mortgagor disposes of the mortgaged property without authorisation, and that a security rights holder’s restricting the transfer or disposal of the collateral would run counter to the intent of the security system, the actual significance of attachment is rather limited.

However, it should be noted that where mortgaged property is transferred without the consent of the mortgagee: (1) if the mortgage has been registered, the mortgagee can still exercise its mortgage rights, but there is a strong possibility that the transferee will raise an objection.

Similarly, the transferee may exercise its right of elimination, but the overly early exercise of such right may harm the mortgagee’s interest in the amortisation schedule; or (2) if the mortgage has not been registered, the mortgage rights cannot stand up against the transferee, and even if the mortgagor assumes liability, the mortgagee has already lost the benefits of the security.

These circumstances compel a mortgagee to adopt last minute remedies after the damage occurs, thus increasing its litigation burden and the costs of protecting its rights. Accordingly, an applicant for the special procedure should not look askance at the possibility and effect of attachment.