Taking Security and Guarantee in Cross-border Asset Finance Transactions: Greater Clarity from the PRC Civil Code

Recent developments in certain types of security interests: expanded scope

The latest legal developments in the PRC relating to security interests in the context of cross-border asset financing include:

• Security over sufficiently identifiable future receivables - The PRC Civil Code^[2] provides for a pledge of both existing and future receivables.  Lenders may agree with a pledgor, as a condition precedent to a loan facility, to pledge receivables which may not exist at the time of execution of the pledge, provided the future receivables are sufficiently identifiable. The future receivables should be sufficiently identifiable such that at the time of enforcement the scope of the receivables is ascertainable.
• Security over fluctuating cash deposits in onshore bank accounts - The SPC Interpretation^[3] clarified that security over cash deposits may be created over a lender-controlled deposit account and fluctuations of the account balance in the deposit account do not in themselves invalidate the security.  Whether effective security is created over cash deposits depends on designation and control, rather than whether it is a fixed balance.
• Possible recognition of security assignments - Security assignments were not recognised as a form of security interest under the now-abolished PRC Property Law.  However, the PRC Civil Code leaves open the possibility of security assignments. According to the SPC Interpretation, where the debtor or a third party transfers property (which in a broad sense, includes contractual rights^[4]) to the creditor to secure the indebtedness of the debtor and such transfer is notified to the public, such arrangement is recognised as “atypical security arrangement” and the creditor would have priority over the transferred property and be entitled to the payments generated from such transferred property where the debtor fails to discharge the debt.  

Unified registration system for security over movable assets and rights: lower costs and faster processes

In the past, creating security over different types of movable assets and rights could encounter delays and give rise to increased costs because of the registration requirements of different PRC authorities. 

The PRC Civil Code abolished these complex rules. Under the new regime, the Credit Reference Centre of PBOC operates a nationwide electronic uniform registration system for the registration of security over movable assets and rights. Security over certain assets (including ships, aircraft, motor vehicles, equity interests, fund units, bonds and intellectual property rights) remain subject to separate registration systems^[5].

Consent for disposal of mortgage property: clearly set out and put on public notice

In the past, lenders could generally control the transfer of mortgaged property because the PRC Property Law provided that any transfer of mortgaged property by the mortgagor would be subject to the mortgagee’s consent.  However, Article 406 of the PRC Civil Code changed the consent requirement to mere notification to the mortgagee. 

It is now crucial for lenders to:

• specify in the mortgage agreement that the mortgagee’s consent is required for any transfer of the mortgaged property, and
• record such consent requirement upon registration of the mortgage, failing which the lender may lose priority rights over the mortgaged property against bona fide third party purchasers of the mortgaged property.

Stricter conditions for guarantees

Where the financing involves a guarantee, lenders must pay attention to the requirements including terms, consent, notification and corporate resolutions:

• Written consent from the guarantor if the guaranteed obligations are increased - the guarantee will not apply to the increased portion of the obligations unless the guarantor provides written consent to amend the facility agreement.^[6] If the amendment reduces the guarantor’s obligations, the guarantor is bound to guarantee the amended (and reduced) obligations.
• Any term stipulating that a guarantee is an independent obligation is void - a term in the guarantee stipulating it constitutes an obligation independent of the validity of the underlying facility agreement is void under PRC law, because a guarantee is conditional upon that validity. ^[7]
• The guarantor must be notified of any transfer in loan participation - if a lender transfers all or part of its loan participation, it must serve a notice on the guarantor in order for the transfer to be binding on the guarantor (assuming the loan facility does not prohibit any transfer without the guarantor’s written consent).^[8]
• Corporate resolutions from an onshore company providing guarantee and/or security - As a general rule, it is recommended that the provision of guarantee or security be authorised by corporate resolutions, subject to a few exceptions such as signing of the guarantee and/or security document by the shareholders of a non-listed company, constituting not less than two -thirds of shareholder voting rights.

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Disclaimer: This alert is provided for general information purposes only and does not constitute legal advice.

References

[1]  The PRC Civil Code (中华人民共和国民法典) and the SPC Interpretation (最高人民法院关于适用《中华人民共和国民法典》有关担保制度的解释) came into force on 1 January 2021.

[2]  Article 440(6) of the PRC Civil Code

[3]  Article 70 of the SPC Interpretation

[4]  Note that the enforceability of security assignment of contractual rights remains to be tested in the PRC.

[5]  For example, the Civil Aviation Administration of China remains as the registration authority with respect to rights and interests to and in aircraft.

[6]  Article 695 of the PRC Civil Code

[7]  Article 682 of the PRC Civil Code

[8]  Article 696 of the PRC Civil Code