Extract taken from 'The Lending and Secured Finance Review' – edition 5

Credit support and subordination

i Security

The legal framework for taking security in China was first established in 1995 by the Security Law, supplemented by the Judicial Interpretation of the SPC on Certain Issues Concerning the Application of the Security Law. In 2007, the Property Law came into effect, which improved the security law regime by allowing more types of assets for security, and simplifying the process for perfection and enforcement of security. There are three types of securities in China:

  1. Mortgages: can be created on either immovable or movable properties, including land, buildings, aircraft, ships, cars, raw materials and finished products. A mortgage must be evidenced in writing. The mortgaged property remains in the mortgagor's possession. The mortgagee enjoys priority over the mortgaged property in the event of the mortgagor's insolvency, but ownership of the mortgaged property will not be transferred to the mortgagee.
  2. Pledges: can be created in respect of movable properties or rights. Rights that can be pledged are limited to proprietary rights, including bills, certificates of bonds, certificates of deposit, warehouse receipts, bills of lading, fund units, shares, proprietary rights under intellectual properties or receivables. To create a pledge, a written contract must be signed and the pledgor needs to transfer to the pledgee possession of the pledged movables or title documents representing the rights. If the rights are not evidenced by title documents but by registration at a relevant authority, such as for fund units, shares and intellectual property, the pledge must be registered at the same registration authority.
  3. Liens: are created by law under limited situations. The beneficiary of the lien must take possession of the property in a lawful manner, otherwise it will not be entitled to the security rights over the property.
Real estate

Security over real estate is created by way of a mortgage. Real estate that can be mortgaged refers to buildings and other fixed objects on the land; land use rights; and buildings under construction.

Chinese law distinguishes between the ownership of land and the right to use land. All land in China is either state-owned or collectively owned. Land ownership cannot be mortgaged. A land use right is granted by the state to entitle a person to the exclusive use of a piece of land for a specified purpose within a specified term. The maximum term that can be granted for the right to use a piece of land varies from 40 to 70 years.

Security interests created over the real estate shall become effective upon completion of the mortgage registration. Registration of the mortgaged real property shall be made with the real estate registration authority at or above county level.

Tangible movable properties

Security over tangible movable properties can be created by way of either a mortgage or a pledge.

Pursuant to Article 180 of the Property Law, movable property that can be mortgaged includes machinery, equipment, raw materials, semi-products and products that the mortgagor is legally entitled to dispose of. Article 181 of the Property Law further provides that by entering into a written contract an enterprise a mortgagor may create a mortgage over its existing and future acquired machinery, equipment, raw materials, semi-products and products. To perfect the mortgage, it shall be registered with the company registration authority. In the absence of the mortgage registration, the security interest so created cannot defend against competing claims of a bona fide third party.

Machinery, equipment, raw materials, semi-products and products as movable properties can also be pledged. To create an effective pledge, the movable properties shall be transferred to the pledgee's possession. Possession can be either physical or constructive. As banks will not take physical possession of movable properties, a pledge is usually created by a collateral management agreement to be entered into with a warehouse keeper.


Security over shares is created by way of a pledge. The perfection procedure will be different between shares of listed companies and non-listed companies. Listed companies are registered and cleared at the securities register – the China Securities Depository and Clearing Corporation Limited (CD&S). The pledge of listed shares shall therefore be registered with the CD&S. A pledge of non-listed company shares shall be registered at the company registration authority.

Financial instruments

Security can be created over the bill of exchange and the promissory note by way of a pledge. The Negotiable Instruments Law defines a bill of exchange as an instrument signed by the issuer to order the payer to unconditionally pay a fixed sum to the payee or the bearer of the instrument at sight or at the specified date. A promissory note is defined as an instrument signed by a bank undertaking to unconditionally pay a fixed sum to the payee or the bearer of the instrument at sight.

An endorsement with remarks of the pledge must be made on the bill of exchange or promissory note to perfect the security interest. In the absence of this endorsement, the pledge created over the bill of exchange or promissory note cannot defend against the competing claim from a bona fide third party.


Security over receivables is created by way of a pledge. A receivable is defined as the right to request a payment arising out of the provision of goods, services or facilities, including the right to claim present or future monetary payment and interest thereof. Typical forms of receivables that can be pledged are as follows:

  1. claims arising from sales, including the sale of goods, the supply of water, electricity, gas and heating, and the licence to use intellectual property;
  2. claims arising from a lease, including that of movable assets or real properties;
  3. claims arising from the provision of services;
  4. toll rights arising from real properties, including highways, bridges and tunnels; and
  5. claims arising out of loans or other credit facilities.

The Property Law authorises the PBOC to register a receivables pledge. The PBOC launched an online registration system to enable the pledgee to conduct the registration.

No security can be created over any contractual rights except for the pledge of receivables.

Intellectual property rights

Security can be created over intellectual property rights by way of a pledge. Intellectual property rights include patents, trademarks and copyright. A pledge over intellectual property rights shall be registered at the National Intellectual Property Administration.

Cash deposits

Cash is in general characterised as a special type of movable asset under Chinese law. According to the judicial interpretation issued by the SPC, cash may be delivered to the creditor as security and the creditor shall have priority in applying this cash towards the satisfaction of an obligation owed to the creditor, provided that the cash is 'fixed' in the form of special accounts, sealed deposits or security deposits.

An alternative practice is to create a pledge over a certificate of deposit, which is issued by the deposit-taking bank. The certificate of deposit shall be transferred to the pledgee's possession to perfect the pledge.

Other than a pledge over a cash deposit or a certificate of deposit, no security can be created on a bank account.


Security can be created over a vessel by way of a mortgage, even if the vessel is still under construction. Mortgage over a vessel that is in excess of 20 tons shall be registered with the vessel registration authority at the vessel's nationality port.


Security can be created over a civil aircraft by way of a mortgage. The mortgage shall be registered with the Civil Aviation Administration. In the absence of registration of the mortgage, the security interest so created cannot prevail against competing claims to which a bona fide third party is entitled.

ii Guarantees and other forms of credit supportGuarantees

A guarantee refers to an agreement between the guarantor and the creditor that when the debtor fails to perform its obligation under the loan agreement, the guarantor will take the responsibility of repayment. There are two types of guarantees: a general guarantee and a guarantee with joint and several liability.

A general guarantee will require the beneficiary first to exhaust available remedies against the debtor, to the extent of obtaining a judgment or an arbitral award.

A guarantee with joint and several liability is not conditional on obtaining a judgment or an arbitral award against the obligor. When the obligor fails to perform his or her obligations, the beneficiary may require the guarantor to perform the obligations.

Both forms permit the guarantor to enjoy the obligor's rights of dispute under the underlying contract. That means that they are not independent guarantees.

Independent guarantees

The SPC issued Provisions on Certain Issues involving Trials of Independent Guarantee Disputes, effective from 1 December 2016, to acknowledge the increasing use of independent guarantees by Chinese banks and other financial institutions in China-related transactions.

This is the first set of rules governing the issue, operation and enforcement of independent guarantees under Chinese law. It defines an independent guarantee as a written commitment of a bank or a non-bank financial institution to pay a specified or capped amount to a beneficiary upon a demand for payment, and the presentation of certain documents that satisfies the requirements specified in the guarantee. This follows the general principles in the Uniform Rules for Demand Guarantees (International Chamber of Commerce publication No. 758).


Quasi-security is uncommon, although the following alternative structures have been used frequently in practice:

  1. factoring: banks use factoring to facilitate financing certain assets or commodity-based transactions;
  2. hire purchase: banks use hire purchase to finance leasing transactions over equipment or ships;
  3. certain assets or commodity-based transactions: banks may use retention of title as a credit support; and
  4. a separate negative undertaking letter: although uncommon, in some bilateral loans, banks may require a negative pledge provision in the loan agreement.
Credit insurance

Credit insurance is frequently used nowadays, in particular, in project finance under the Belt and Road Initiative. The China Export & Credit Insurance Corporation is the key provider of credit insurance in China and it has been very active in cross-border finance transactions.

iii Priorities and subordinationContractual subordination

Contractual subordination of debt is possible. However, its validity is questionable because, according to a basic statutory principle, all unsecured creditors are treated equally (pari passu) on the debtor's insolvency. It is therefore probable that during the bankruptcy proceedings courts will not uphold a contractual subordination.

Intercreditor arrangements

In a syndicated loan, the lenders may enter into an intercreditor agreement to govern the relationship between lenders, such as mechanisms for the provision of loans and the voting procedures for deciding key issues. However, in practice, an intercreditor agreement is uncommon in China. It is more common for the provisions governing the relationship between the lenders to be directly set out in the syndicated loan agreement.