The Civil Code of the People’s Republic of China (“PRC”) (中华人民共和国民法典) (the “PRC Civil Code”) and the Judicial Interpretation of the Supreme People’s Court regarding the Taking of Security (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）(the “SPC Interpretation on Security”) came into force on 1 January 2021. The PRC Civil Code and the SPC Interpretation on Security are expected to have a significant impact on loan transactions in the PRC and credit support provided under those transactions. Their impact goes beyond loan transactions in the PRC, and offshore lenders should consider how the PRC Civil Code and the SPC Interpretation on Security may affect their loans involving the PRC. In this Alert, we highlight a few implications of the PRC Civil Code and the SPC Interpretation on Security on guarantees and security involving the PRC granted in favour of offshore lenders.
1. What is the PRC Civil Code and why is it an important piece of legislation?
The PRC Civil Code is the first PRC legislation that carries the title “code”. It consists of seven parts, namely, General Provisions, Property Rights, Contracts, Personal Rights, Marriage and Family, Succession, Tort Liability and Supplementary Provisions, with a total of 1,260 articles. The PRC Civil Code introduces significant changes to the existing civil legislation and judicial interpretation in the PRC. It abolished, amongst other laws, the General Provisions of the PRC Civil Law, the PRC Marriage Law, the PRC Security Law, the PRC Contract Law, the PRC Property Law and the PRC Tort Liability Law.
2. What is the SPC Interpretation on Security?
Under PRC Law, judicial interpretations issued by the Supreme People’s Court have full legal force. The SPC Interpretation on Security sets out a comprehensive framework for the interpretation of the PRC Civil Code relating to the taking of security, including guarantees, mortgages, liens, pledges, factoring, finance leasing and retention of title. The SPC Interpretation on Security aims to provide practical guidance, and facilitates the uniform application of the PRC Civil Code by the PRC courts.
3. What are the implications for offshore lenders?
The PRC Civil Code and the SPC Interpretation on Security have significant impact on onshore loan transactions. Offshore lenders must pay close attention because of the impact on guarantees provided by onshore obligors or security granted over onshore assets in connection with offshore, or cross-border, loans. We set out below diagrams that illustrate some common financing structures involving offshore lenders with credit support which are now subject to the PRC Civil Code and the SPC Interpretation on Security:
a. Offshore loan facility with onshore guarantee (Neibaowaidai (内保外贷))
b. Cross-border loan facility from offshore lenders to an onshore borrower with security from an onshore security provider
c. A typical “onshore/offshore structure” with security over onshore assets
Some of the key implications are set out below.
4. Key implication #1:
When you amend a facility agreement, always obtain written consent from the guarantor if the guaranteed obligations are increased
It is not uncommon for the terms of a guarantee to stipulate that any amendment to the underlying facility agreement does not require consent from or notice to the guarantor for the obligations of the guarantor under the guarantee to remain effective with respect to the amended underlying facility agreement. The issue is, despite such a term in a guarantee, should a lender require consent from a guarantor if the guarantor’s obligations will be increased as a result of the amendment to the underlying facility agreement?
Article 695 of the PRC Civil Code provides that if the borrower and the lender amend a facility agreement without the consent of the guarantor in writing, and if such amendment increases the guarantor’s obligations, the guarantee will not apply to the increased portion of the obligations as a result of the amendment. However, if the amendment reduces the guarantor’s obligations, the guarantor is bound to guarantee the amended (and reduced) obligations. Any amendment to the tenure of the loan will not affect the guarantor’s obligations, unless the consent of the guarantor in writing to the amendment to the loan tenure is obtained.
Whilst offshore lenders will welcome the clear stipulation in the PRC Civil Code that a guarantor’s obligations are not discharged altogether as a result of an amendment of the facility agreement, it is essential that written consent be obtained from the guarantor where an amendment of a facility agreement will lead to an increase of the guaranteed obligations or an extension to the term of the loan facility, even if the guarantee provides otherwise.
This is a more definitive requirement than the “purview of the guarantee” principle developed under English law that offshore lenders may be more familiar with, which, in essence, provides that a guarantor is only bound by an amendment to the primary contract if the contract so amended remains within the “purview” of the original contract. The application of such principle is highly fact specific.
5. Key implication #2:
Any term stipulating that a guarantee is an independent obligation is void
There was previously some ambiguity under PRC law as to whether a term in a guarantee which provides for the guarantee to remain valid and enforceable as an independent obligation, despite the invalidity of the underlying facility agreement to which the guarantee relates, would be enforceable in the PRC.
Article 682 of the PRC Civil Code provides clarity on this issue. The Article provides a guarantee is conditional upon the validity of the underlying facility agreement. If the underlying facility agreement is null and void, so too is the guarantee relating to it, unless otherwise provided for by law. Therefore, any term in the guarantee which stipulates that the guarantee constitutes an obligation independent of the validity of the underlying facility agreement is void under PRC law.
In a Hong Kong or English law governed guarantee, it is common for a guarantee obligation to include an indemnity from the guarantor to establish the obligation of the guarantor is independent of the underlying facility agreement. It remains to be seen whether such an indemnity, if incorporated into a PRC law guarantee, is valid as an independent obligation in light of Article 682 of the PRC Civil Code.
6. Key implication #3:
When you transfer your loan participation, always notify the guarantor
A typical syndicated facility agreement will set out the conditions of transfer or assignment of loan participations, including whether consent from, or notification to, an obligor is required.
Article 696 of the PRC Civil Code provides that if a lender transfers all, or part of, its loan participation, notice must be served on the guarantor for the transfer to be binding on the guarantor (assuming the loan facility does not prohibit any transfer without the guarantor’s written consent).
In practical terms:
- if there is a prohibition on transfer, always obtain the written consent of the guarantor (and the borrower where appropriate); and
- if there is no prohibition on transfer, notice should always be given to the guarantor, whether or not the facility agreement provides for notice to be given to the guarantor.
In addition to giving notice to a guarantor, the borrower and any security provider in connection with a transferred loan facility must be notified pursuant to Article 546 of the PRC Civil Code and Article 20 of the SPC Interpretation on Security respectively.
7. Key implication #4:
Require corporate resolutions from an onshore company providing guarantee and/or security unless one of the exceptions applies
The PRC Civil Code and the SPC Interpretation on Security provide clarity on the circumstances where corporate resolutions are required to be passed by a company providing a guarantee or security. As a general rule, it is recommended that the provision of guarantee or security be authorised by corporate resolutions unless one of the following exceptions applies:
- issuance of a letter of credit by financial institutions or granting of a guarantee and/or security by licensed guarantee companies (担保公司);
- granting of a guarantee or security by a non-listed company for the operation of wholly owned subsidiaries; and
- consent by way of signing of the guarantee or security document by the shareholders of a non-listed company, constituting not less than two thirds of shareholder voting rights.
For a listed company or a publicly disclosed subsidiary of a listed company, it is essential that a public announcement be made by the listed company in connection with the passing of corporate resolutions for the granting of a guarantee or security.
8. Key implication #5:
Security over future receivables if sufficiently identifiable
Article 440(6) of the PRC Civil Code provides for a pledge of both existing and future receivables. This means that lenders may agree with a pledgor to take a pledge over receivables which may not exist at the time of execution of the pledge. The future receivables should be sufficiently identifiable such that at the time of enforcement the scope of the receivables is ascertainable.
9. Key implication #6:
Taking security over cash deposits in onshore bank accounts – fluctuating balance possible
Many market participants took the view previously that, in order to create security over cash deposits in a bank account in the PRC, the balance in the bank account had to be fixed, and any fluctuation in the account risked rendering the security ineffective.
Article 70 of the SPC Interpretation on Security provides much needed clarification on the rules surrounding the creation of security over cash deposits, including:
- security over cash deposits may be created over a designated deposit account controlled by the lender or a deposit account opened with the lender; and
- a fluctuation of the account balance in the deposit account does not in itself invalidate security over the cash deposits therein.
Whether effective security is created over cash deposits will therefore depend on designation (专门化) and control, rather than whether it is a fixed balance. While this is a welcome change that provides more flexibility to borrowers and lenders in structuring a security package for loan facilities, offshore lenders should be aware that it does not mean consideration in taking security over cash deposits under PRC law is equivalent to taking security over cash deposits under English law (where many different forms of security, such as fixed or floating charge, may be created depending primarily on control by the secured creditor over the cash deposits).
10. Key implication #7:
Unified registration system in connection with security over onshore movable assets and rights
In the past, security over different types of movable assets and rights were required to be registered with different registration authorities in the PRC. This usually led to delays in fulfilling conditions precedent under loan facility agreements and increased legal and other costs. The PRC Civil Code abolished these complex rules and made way for a unified registration system for movable assets and rights.
Under the new regime, the Credit Reference Centre of the People’s Bank of China (the “PBOC Registry”) operates a nationwide electronic uniform registration system for the registration of security over movable assets and rights. All registrations can be completed online by registrants.
Specifically, security over the following types of assets can be registered at the PBOC Registry:
- manufacturing equipment, raw materials, semi-finished products and finished products;
- accounts receivables;
- certificates of deposit, warehouse receipts and bills of lading;
- finance leases;
- retention of ownership, and
- other registrable security interest over movable assets and rights.
However, security over the following types of assets are still subject to separate registration systems, namely, motor vehicles, ships, aircraft, bonds, fund units, equity interest and intellectual property rights.
Offshore lenders should familiarise themselves with the new streamlined registration system when dealing with security over movable assets and rights in the PRC.