Effectiveness and application of transferring guarantee

By Wang Qing and Li Yunshi, Lantai Partners
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The innovation and iteration of the transaction structures of accommodation of funds are accelerating. Traditional means of guarantee such as mortgage, pledge and guaranty can no longer fully fit the complex interest patterns of civil and commercial transactions, so non-traditional guarantee structures created for special purposes between transactional parties have become more popular, and the mode of transferring guarantee by transferring the ownership of the subject matter to achieve the purpose of guarantee has also emerged.

Judicial acceptance

transferring guarantee
Wang Qing
Partner
Lantai Partners

Although there is no clear definition of “transferring guarantee” in the existing laws and regulations, we can get a glimpse of the attitude of judicial judgment towards transferring guarantee from the publicly effective judicial judgment documents. The Supreme People’s Court, in its ruling of MINSHEN No. 4165 (2018), defined transferring guarantee as an “atypical guarantee system, namely a debtor or a third party, to guarantee the debtor’s debts, transfers the rights such as the ownership of the guaranteed subject matters to the secured party, so that the secured party shall, within the scope of the purpose of the guarantee, return the guaranteed subject matter to the debtor or the third party after the debt is paid off, or be repaid for such subject matter in priority when the debt is not performed.”

In MINZAI No. 335 (2017), the Supreme People’s Court also clearly states the two elements of transferring guarantee, namely, the guarantor has the ownership of the guaranteed subject matter and transfers their ownership to the secured party.

Acceptance of Validity

transferring guarantee
Li Yunshi
Associate
Lantai Partners

Although transferring guarantee is not defined as the statutory guarantee method in the Property Law, Guaranty Law and other relevant laws and regulations, article 24 of the Provisions of the Supreme People’s Court on Several Issues concerning the Application of Law in the Trial of Private Lending Cases has defined the nature of transferring guarantee as, “it is a transaction in name but a guarantee in essence”.

The Supreme People’s Court, in its judgment No. 940 (2017), also held that the contract for creating a new security interest shall be legal and valid on the basis of not violating article 52 of the Contract Law. Therefore, as transferring guarantee serves as an innovative guarantee method, its effectiveness is usually recognized on the premise that other matching transaction arrangements do not violate the law and regulations.

Although the judicial judgment has actually given a certain application space to transferring guarantee, it should be noted that, since transferring guarantee is a non-statutory form of guarantee, its protection for creditors is still limited by the perfection of the transaction structure itself and the judge’s recognition of this mode in a case. At the same time, considering that the way that transferring the ownership of the subject matter in accordance with transferring guarantee may cause the possibility that some clauses may be deemed invalid, the validity of the core clauses should be paid attention to in setting up the transaction arrangement so as to avoid the occurrence of “stepping on the red line” of clauses.

In practice, the invalidation of transferring guarantee is mostly caused by the fact that the fluidity clause (the property belongs to the creditor when the debtor fails to perform the debt) violates article 211 of the Property Law. Although reviewing the published judgment documents, it can be seen that the invalidity of the fluidity clause does not mean the invalidity of transferring guarantee contract, but considering the integrity of the contract it is impossible to rule out the possibility that the judicator may invoke the fifth paragraph of article 52 of the Contract Law to determine the invalidity of the contract.

At the same time, the invalidity of some clauses may even affect the overall design arrangement of the contract. In the design of transferring guarantee clauses, special attention should be paid to the realization of transferring guarantee. For example, it is expressly agreed that when the debt cannot be paid off, the repayment should be made by way of buy-back, external reasonable transfer, or auction of the subject matter. The above mode is generally adopted in judicial precedents.

In addition, another important unresolved issue of transferring guarantee is the uncertainty of priority, that is, whether the creditor under transferring guarantee has the priority to be compensated for the purchase price, after which the subject matter is realized. On the basis of existing jurisprudence, the Supreme People’s rulings on MINSHEN No. 4165 (2018) and MINZAI No. 335 (2017) classified transferring guarantee as atypical guarantees in which the secured party has priority in compensation when the inherent meaning of transferring guarantee is interpreted, which to some extent recognizes that transferring guarantee has the same priority in compensation as other statutory guarantee means.

However, on the basis of the legal principle of registration and opposition in civil law, as there is no statutory registration department of transferring guarantee, whether the arrangement of transferring ownership alone opposes the bona fide third party lacks basis.

From the view of practical operation, when the secured party accepts transferring guarantee, it may apply for registration from the registration department based on the status of the subject matter at that time, so as to achieve the effect of publishing and opposing against bona fide third parties, such as industrial and commercial registration of changes in the transferring guarantee of equity, advance-notice registration in the transferring guarantee of real estate or transfer registration of accounts receivable, etc. This kind of registration arrangement can also strengthen judgment on the priority of repayment of transferring guarantee indirectly.

Generally speaking, although there is no explicit stipulation on transferring guarantee in the existing guarantee legal system of China, it has been widely used in various transaction arrangements, and judicial organs have also taken a positive attitude towards its effectiveness and protection. As a participant in a specific transaction, when setting a transfer guarantee clause, more attention should be paid to avoiding violation of the effective legal provisions, and at the same time more appropriate ways can be found in the arrangement of possession and disposal of the subject matter, so as to safely and effectively realize the purpose of differentiated transaction.

Wang Qing is a partner and Li Yunshi is an associate at Lantai Partners

transferring guarantee

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