On April 30, 2003, Party A and Party B signed Mortgage Contract 1. This contract provided that Party B must pledge his real property against his debts of RMB 25, 000, 000, and must pay off the mortgage between May 15, 2003 and May 14, 2004. The Real Estate Registration Authority examined the mortgage and approved it for registration on May 14, 2003. However, on May 13, 2004, Party A and Party B signed Mortgage Contract 2, which provided that Party B must continue pledging the aforesaid real property for the same debt but was entitled to delay performance to the period between May 13, 2004 and May 12, 2005. Accordingly, the Real Estate Registration Authority cancelled the first mortgage registration on May 14, 2004 and examined and approved the second mortgage registration on May 20, 2004. Nevertheless, Party B was unable to pay off the debt before the deadline. When Party A attempted to foreclose the mortgage on the real property, he discovered that the real property was subject to a 20-year leasehold in favor of Party C. A fierce dispute arose among the three parties, and a court was ultimately asked to decide whether or not Party A was entitled to foreclose on the mortgage without remaining subject to Party C’s leasehold.
The issue in dispute, in the author’s view, was the effect that the expiration of the mortgage registration exerted on Party A’s mortgage rights, not the conflict between the mortgage and the leasehold.
- Establishment and Termination of Mortgage Rights
A mortgagee is a creditor of the debtor or a third party who owns the secured property, but is not entitled to transfer possession of it. If the debtor defaults on the mortgage agreement through non-payment or breach of other terms, the mortgagee is entitled to sell the secured property and claim priority over the sales proceeds.
Mortgages, as typical security interests, are very popular because they offer mortgagees the advantage of claim priority without transferring possession of the secured property. However, the second advantage also sometimes disadvantages the third parties, because they often initially fail to realize that the property is mortgaged, leading to conflicts among mortgagees, mortgagors, other creditors, and assignees of the mortgaged property. The mortgage registration system was established in order to resolve these conflicts.
Academic and professional circles continuously debated the relationship between mortgage registration and mortgage rights, especially the question of whether mortgage registration is a validity requirement or simply a litigation tool. The debate changed in 2007 with the enactment of the PRC Real Property Law (Property Law) was enacted. The Property Law formally established the principle that mortgage registration is required to establish a mortgage on real property, vessels, aircraft and usufruct rights, and to use it as a litigation tool for claims against other types of mortgaged property.
For a long time academics have researched the question of how mortgages are established. Much less attention has been given to the issue of how mortgages are terminated. Mortgage rights, like other civil rights, are subject to certain restrictions on the duration of their existence as well as certain conditions on establishment and termination. In current Chinese jurisprudence neither the Guarantee Law nor the Property Law provide explicit rules for the determination of mortgage rights. In theory, mortgage rights may be terminated by the destruction or lost of irreplaceable collateral; the termination of primary claims; the fulfillment of the mortgage terms and the expiration of the mortgage term. Among these, expiration of the mortgage term raises the most frequent and most contentious disputes.
- Mortgage Registration Term vs. Mortgage Term
In practice, registration authorities always ask mortgage registrants to confirm a clear term of registration (for example, real estate registration authorities include “Date of Approval”, “Date of Establishment” and “Date of Termination” in the section “Other Information About the Real Estate”). A problem arises from the question of whether the termination date of the mortgage registration is the same as the termination date of the mortgage itself – in other words, whether the registration and the mortgage are co-extensive in duration.
It is clear that the registration term is not co-extensive with the mortgage term when the registration serves only as a litigation tool, because it only influences its rivalry effect; However, mortgages that must be registered as a precondition to their establishment (such as real property mortgages) become legally effective on the date of registration. Does this imply that the mortgage expires when the registration expires?
The author doesn’t think so. For mortgages that must be registered prior to establishment, such as real property mortgages, the term of the mortgage and the term of the registration are quite different in character, even though the terms of both are calculated from the registration approval date.
The “mortgage term” refers to the duration of the mortgage rights, and it is subject to conflicts that have arisen in current Chinese law. Article 12.2 of the Judicial Interpretations of the Supreme People's Court on Certain Issues Regarding the Application of the P.R.C. Securities Law (the “Securities Law Interpretations”) provides that a People's Court must support a creditor's enforcement of his security rights for a period of two years after the expiration of the limitation period that restricts his right to file a lawsuit under the agreement to which the security relates. Article 202 of the Property Law provides that a mortgagee must exercise his mortgage rights before the expiration of the limitation period applicable to the principal obligee, and that otherwise the mortgage rights will become unenforceable by the People's Court. The author asserts holds that according to principles of legal interpretation, the Property Law must prevail because it was enacted in 2007, later than the enactment of the Interpretations of the Securities Law (in 2000), endowing it with superior legal status.
The mortgage registration term is a procedural rule provided by the mortgage registration authorities requiring mortgagees to periodically pay for renewal of their registrations. It may also require them to reassess the securities underlying mortgages subject to long-term registration. In practice, the “Establishment Date” and the “Conclusion Date” of the mortgage registered by the registration authorities are always consistent with the performance period of the principal creditors’ rights. However, even if the mortgage exceeds the “Conclusion Date”, the mortgage should still not be considered terminated. Even then, the mortgagee is still entitled to claim priority over a third party creditor, and the mortgage registration authority has no authority to cancel the mortgage based on expiration of registration term. It is for these reasons that Article 12.1 of the Securities Law Interpretations provides that the term of a security agreed upon by the parties or required by the registration department has no legally binding force against the continuity of the security.
- Case Analysis
Let’s go back to the case I introduced at the beginning of the article. Party C argued that the according to registration records the mortgage on the real estate was approved on May 20, 2004, while he leased the house on May 8,2004. According to Article 190 of the Property Law, where a mortgaged property is leased before a mortgage contract is entered into, the mortgage rights shall not impact the original leasehold relationship. Where a mortgaged property is leased after the establishment of mortgage rights, the leasehold relationship may not interfere with the registered mortgage rights. Accordingly, Party C’s lease should not be affected by Party A’s mortgage.
The author does not find Party C’s argument persuasive. Party A and Party B signed Mortgage Contract 1 on April 30, 2003 based on Party A’s claim for RMB 25,000,000. The mortgage was approved and registered by the registration authority on May 14, 2003, upon which Party A’s mortgage was established. When Party C and Party B signed the house lease agreement, the mortgage was still outstanding and in force. According to the principle of the effect of acquisition in good faith, Party C should have learned of the mortgage on the real estate prior to establishing his lease, meaning that his lease should not be allowed to challenge Party A’s mortgage. It is true that the registration authority cancelled the first mortgage on May 14, 2004. However, Party A and Party B signed Mortgage Contract 2 for the same real estate and for the same creditor-debtor relationship. It renewed Mortgage Contract 1 and guaranteed the same creditor’s rights notwithstanding that they were independent in form. Accordingly, Party A’s mortgage was never extinguished even though its registration term was interrupted, and Party C had no right to claim priority for its leasehold, since it was established before the second mortgage registration.
Even if we regard Mortgage Contract 1 and Mortgage Contract 2 to be independent of each other and contain two independent mortgage rights, they merely reflects that a new mortgage was established by Mortgage Contract 2 when it was approved on May 20, 2004 (to replace the prior mortgage based on Mortgage Contract 1, which mortgage was terminated for cancellation of registration). Consequently, Party C’s leasehold, though prior in time to the second mortgage, was not able to challenge the first mortgage.
The author would like to point out that if a third party leased the house between May 14, 2004 and May 20, 2004 (not Party C), such third party’s leasehold would enjoy priority because the mortgage, although valid, lost its effectiveness against the third party when its registration was cancelled.