【Case Brief】

Natural persons A and B established a long-term debtor-creditor relationship with each other under which B would transfer money to A upon A’s request and receipt of A’s promissory note. The amount of the loan varied, but between 2011 and 2012 the loan amount exceeded RMB 200,000,000. In January 2012 A and B concluded a loan contract under which A would borrow RMB 60,000,000 from B and C Company would guarantee the loan. A brought the contract affixed with both A and B’s signatures back to his company, affixed C Company’s official seal and then send it to B. After a dispute arose we investigated and discovered that A was working as C Company’s manager, and that A was the uncle of C Company’s Managing Director who had participated in the company’s operation over a long period. The guarantee issue was neither discussed nor agreed upon by either C Company’s Board of Directors or its General Assembly of Shareholders; in fact the seal was affixed to the contract without authorization. B was not aware of these circumstances.

This is a private lending dispute involving a long term debtor-creditor relationship. The issues in dispute are as follows:

  1. Whether or not the guarantee clauses are valid

Article 16 of the Company Law provides that, “Where a company intends to invest in another enterprise or provide a guaranty for another person, a resolution must be passed by the company's Board of Directors, General Assembly of Shareholders or General Meeting of Shareholders, and it must comply with the company’s Articles of Association. Where the Articles of Association prescribe any limit on the total amount of investments or guarantees allowed, or on the amount of a single investment or guarantee allowed, the amount of such investment or guarantee shall not exceed the prescribed limits. Where a company intends to provide a guarantee to any shareholder or actual controller of the company, a resolution shall be passed by the General Assembly of Shareholders or by a General Meeting of Shareholders.”

“No shareholder referred to in the preceding paragraph or under the control of the actual controller referred to in the preceding paragraph shall participate in voting on any matter described in the preceding paragraph. Any such resolution shall be passed by a majority vote of the other shareholders attending the meeting.”

It is clear that if a company intends to provide a guarantee to any shareholder or actual controller of the company, a resolution must be passed by the General Assembly of Shareholders or by a General Meeting of Shareholders. This is true regardless of whether or not the company’s Articles of Association allow a guarantee procedure for shareholders or actual controllers -- if the company intends to provide a guarantee to its shareholder or actual controller, it must comply with the legal procedures mandated by the Company Law. A guarantee that does not comply with such legal procedures is invalid unless otherwise ratified by the General Assembly of Shareholders or by the Board of Directors. Meanwhile, Article 16 of the Company Law also provides that “No shareholder referred to in the preceding paragraph or under the control of the actual controller referred to in the preceding paragraph shall participate in voting on any matter described in the preceding paragraph. Any such resolution shall be passed by a majority vote of the other shareholders attending the meeting. If the shareholder or actual controller to be guaranteed participates in the voting, the guarantee will also be invalid.”

In this case, even though A was not the actual controller, as the uncle of C Company’s Managing Director and a manager operating a private company with lax operating standards, he could easily access C Company’s seal and affix it to the contract without authorization. C Company’s seal was affixed to a loan contract that was not discussed or approved by its Board of Directors, General Assembly of Shareholders or General Meeting of Shareholders. Article 16 provides that where a company intends to invest in any other enterprise or provide a guarantee to any other person, a resolution shall be passed by the company's Board of Directors, General Assembly of Shareholders or General Meeting of Shareholders pursuant to the company's Articles of Association. This is a mandatory term, breach of which will render the contract void. Accordingly, the author believes that the guarantee term of A and B’s loan contract should be deemed void because it was not approved in accordance with C Company’s Articles of Association by its Board of Directors or by its General Assembly of Shareholders.

  1. In the event of the invalidity of the Guarantee Term, how can B’s legal rights be protected?

Article 50 of the Contract Law provides that, “Where the statutory representative or the responsible party for a legal person or other organization oversteps his/her authority and concludes a contract, such act of representation shall be effective except where the opposite party knows or ought to have known that he/she is overstepping his/her powers.” In this case, voiding the guarantee term would result in failure to protect B’s legal rights. Under this circumstance, the question is whether the apparent authority clause under contract law applies here to ensure the validity of the guarantee.

In practice, the apparent representation system was drafted to maintain the stability and security of transactions by protecting bona fide third parties. This was done because substantive examinations of transactions are not as easy to undertake as formal examinations are. Consequently, Article 50 should not be applied to protect parties other than bona fide third parties. Nevertheless, the procedure and powers of a guarantee must be performed because “ignorance of the law is no excuse” -- both the guarantor and the creditor are deemed to be aware of the contents of the law and they are obligated to conform their conduct to its requirements.

A bona fide third party not only enjoys rights but is also burdened with obligations. In practice, only those who are unaware, even after performing due diligence, of the fact that the scope of the representation exceeded the representative’s authority, are entitled to be treated as bona fide third parties. According to Article 16.1 of the Company Law, creditors must demand to see the Articles of Association of the company that is signing the guarantee contract so that they can confirm whether or not the company has the power to provide the guarantee and whether the guarantee was approved in accordance with legitimate company procedures.  Creditors must also demand that the guarantor present a company approval resolution that conforms to its Articles of Association and applicable law.

In this case, it was reasonable for B to doubt the authenticity and validity of the seal because no C Company responsible party other than A appeared during the entire signing process --  A alone brought the loan contract back to C Company and returned it to B with a sealed affixed. B failed to properly examine the transaction. If B examined only the authenticity of the company seal but didn’t examine its legitimacy or validity, the signing process was legally flawed, B is not a bona fide third party, and the guarantee contract is legally void. 

If C Company refused to ratify the guarantee it should have been deemed invalid. If that happened, who should bear B’s loss -- A or C Company? In accordance with the P.R.C. Contract Law, a contract concluded in the name of a principal by a purported agent who has no power of agency, who is exceeding his agency authority, or whose power of agency has expired, shall have no legally binding force against the principal unless the principal ratifies it, and the purported agent shall be liable. Likewise, if directors or managers provide an unauthorized guarantee in the name of their company, then no legal relationship is created between the creditor and the company, the guarantee contract is void, and liability lies with those who signed the contract. In an unauthorized agency, directors or managers have failed to perform their duties and the company’s rights need to be protected. Under these circumstances, the unauthorized agent should bear the loss, meaning that A should compensate B for B’s loss. 

Under these circumstances only the guarantee term should be voided, and other terms not in violation of mandatory law should remain legally binding.