
учебный год 2023 / Bu, Security Rights in Property in Chinese Law
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not conduct substantive examination prior to registration; therefore, accuracy of the entries cannot be guaranteed despite the extensive filing requirements. Under Chinese law, registration does not extend the effect of a mortgage to subsequently acquired property and future advances as is the case under the UCC. Consequently, a new registration has to be effected on each occasion if newly acquired property is to be included in the mortgage.
Currently, it is hard to predict how the parties to a security interest will benefit from the filing requirement in practice, since an unregistered security interest in movables is perceived as already having a certain value. As has already been discussed above, much uncertainty surrounds the legal effect of unregistered security interests in movables. Therefore, only in the very rare event of the debtor having no other creditors will the value of an unregistered mortgage on movables be certain. It could be argued that such a mortgage will also have value if the secured creditor is able to prove bad faith on the part of competing creditors.82 However, in the majority of cases this is unrealistic because of the difficulty in discharging the burden of proof. In short, a mortgage in movables as set out in the LoP fails to achieve a balance between security of transaction and efficiency of registration. In China, there are no uniform registration authorities, and electronic filing is unavailable. For business assets, the Administration for Industry and Commerce (AIC) of the place where the enterprise is domiciled is responsible for registration. With respect to other assets, the local notary public is responsible, and for vehicles, the local vehicle administration is the appropriate authority.83 These high transaction costs will not result in more security since the accuracy of the registration cannot be guaranteed, and it is unrealistic for private consumers to verify the title chain. This is because, under Chinese law, registered mortgages in movables are even enforceable against consumers under Chinese law, a rule that will turn out to be impractical as it is unrealistic to expect private consumers to research encumbrances on goods that they purchase in the ordinary course of business. Some leading authors have proposed that all registration requirements be abandoned in relation to security rights in movables.84
4.4Restriction on Disposals
Article 191 LoP, which is a heavily criticized provision, lays down a restriction on the mortgagor’s right to dispose of the charged property. This provision is worded as follows:
During the term of a mortgage, the mortgagor shall use the proceeds obtained from a transfer of the charged property to repay the debt or to put it in escrow,
82Liu Yujie, supra n. 26, 38.
83Articles 42 and 43 of the Law on Security.
84Xiao Huanguo, ‘Conflicts in the Publicity Effect of Movables and Its Solution’, Political Science and Law (Zhengzhi Yu Falü) 10 (2008): 14–15.
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should the transfer be consented to by the mortgagee. The part of the proceeds exceeding the amount of the debt belongs to the mortgagor and if the proceeds fall short of the amount of the debt, the difference should be paid by the debtor.
During the term of a mortgage, the mortgagor is barred from transferring the charged property without the consent of the mortgagee, unless the transferee repays the debt and extinguishes the mortgage.
In essence, Article 191 completely deprives the mortgagor of his right of disposal. The aim of this provision is to protect the mortgagee from detrimental disposals by the mortgagor. However, the restriction is, at the same time, insufficient and excessive. It is insufficient because no relief is available to the mortgagee if he has consented to the transfer but the mortgagor refuses to repay the debt from the proceeds. With his consent to the transfer, the transferee acquires the underlying property freed from the mortgage. In other words, the mortgagee’s consent results in the extinction of the mortgage.
The restriction is excessive in the sense that the legitimate need for the mortgagor to dispose of the property has been ignored and an unreasonable burden on business transactions has been imposed. Basically, the purchaser of an apartment may not subsequently sell it without the bank’s consent where the purchase has been financed by a secured bank loan. For the purpose of protecting the mortgagee’s interests, it would suffice to require that the mortgage remains attached to the property in the event of a later transfer. The transferee being aware of the existence of the mortgage, since its creation requires registration, his interests would not be infringed either.
From the debate among the leading authors, it appears that the legislature originally intended to design a system that combined the continuation of the mortgage on the proceeds as the core with the continuation of the mortgage against the transferee, with redemption rights as a supplement – as modelled on the French and Japanese Civil Codes.85 However, this intention is entirely distorted by the current wording of the law. The leading scholars have attempted to rectify this unfortunate wording by interpreting Article 191 LoP as a voluntary rule, the breach of which does not affect the validity of the transfer.86
4.5Creation of Multiple Mortgages
Although Article 199 of the LoP expressly mentions the priority of creditors’ claims in cases where a property is encumbered with several mortgages, the permissibility of multiple mortgages continues to be regarded as an open question.87 The reason
85Xi Xiaoming, supra n. 3.
86Wang Hongliang, supra n. 28, 30.
87Xi Xiaoming, supra n. 3.
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for this is that, under the Law on Security, the amount of the secured claim is not allowed to exceed the value of the charged property. It is assumed that this condition will rarely be met in the case of multiple mortgages, and consequently, the conclusion can be drawn that multiple mortgages are barred. Only the so-called remaining amount mortgage is permissible under the Law on Security, this being a mortgage created on the remaining value of the charged property where the senior mortgage does not exhaust the full value of the charged property. It has not yet been clarified whether Article 199 refers to such remaining amount mortgages or to multiple mortgages, although scholarly opinion and financing practice have confirmed the permissibility of both types.88 In the absence of clear rules, local registration authorities decide at their own discretion and on the basis of their own interpretation whether to accept or reject the registration of multiple mortgages. These disparities in practice and the inconvenience thereby caused to business transactions call for the introduction, by the legislature, of a set of rules explicitly regulating multiple mortgages.
In fact, the Chinese legislature has shown excessive zeal in its prohibition of multiple mortgages and has overlooked the fact that junior mortgagees are perfectly able to assess the risks associated with a mortgage of inferior rank, given that information regarding encumbrances on real estate is in the public domain. The ban on mortgages with inferior priority is not only an unnecessary restraint on the freedom to contract but is also inconsistent with the provision regarding priority ranking. If all encumbrances were to have the same priority rank, Article 194 of the LoP would lose any reason for its existence. Under this provision, the mortgagor and mortgagee may amend the priority rank of a mortgage; if the amendment is conducted without another mortgagee’s consent, this may not work to the detriment of those mortgagees.
4.6Floating Charge
The floating charge has its origins in English law and refers to a non-possessory mortgage which may be charged on all present and future immovables, movables, and claims. Under Articles 181 and 189 LoP, enterprises, single business operators, and agricultural business operators are allowed to grant a floating charge on the entirety of the current and future movables held by the businesses they are operating, such as equipment, raw materials, semi-finished products, and products, in order to secure a claim. The beneficiaries are normally banks. The creation of a floating charge usually requires a written agreement and registration with the local AIC, being the authority responsible for commercial registers. To avoid an unnecessary burden for business operators, lack of registration will only render the floating charge ineffective against a bona fide third party.89
88Wang Liming, supra n. 21.
89Article 189(1)(2) LoP.
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The effect of a failure to register requires further clarification. Does it mean that the chargor will lose his priority on the proceeds if a property covered by the floating charge is sold or encumbered with another mortgage, as is suggested by the leading writers? This construction is problematic, because a purchaser will acquire the property free of encumbrances anyway if the purchase occurs at a reasonable price in the ordinary course of business, regardless of registration.90 This results from the very nature of floating charge. Since the assets of the chargee float, the property in question will be freed from the charge once it leaves the chargee’s control. The charge becomes firmly attached to the property only upon default by the debtor. It is subject to discussion whether a mortgage has actually been created prior to crystallization.91 Naturally, Article 189 LoP is itself not flawless either. Considering the restriction on the mortgagor’s right of disposal within the meaning of Article 191 LoP, an explicit exemption from Article 191 seems appropriate, since the floating charge merely represents a special type of mortgage and Article 191 would apply without such an exemption. Second, the creation of another mortgage on a property for the benefit of a third party would be subject to the consent of the chargor of the floating charge, assuming the condition that, without registration, the floating charge has already been validly created has been met. However, exactly at this point the term ‘having no effect against a bona fide third person’ does not offer a clear clue. In any event, a floating charge is doubtlessly valid in the extremely rare event of the debtor chargor having only one creditor chargee.
Bearing in mind its common law origins, the decision by the Chinese legislature to incorporate the concept of floating charge into the LoP can truly be described as courageous. By contrast, scholars in other civil law jurisdictions have shown themselves rather wary of such attempts.92 In China, account must be taken of the fact that the floating charge had actually already been used in practice, albeit less frequently, before it was incorporated by the LoP. In other words, the introduction of this legal construct was not a purely academic issue. However, the few precedents used to obtain international financing in the past have been somehow quoted as a multiplier, and as a result, the need of Chinese banks to be provided with this security instrument93 was in the author’s view unreasonably magnified. Nevertheless, the incorporation of floating charge into Chinese law was done neither smoothly nor precisely due to critiques regarding its incompatibility with basic principles of property law such as specificity.94
90Article 189(2) LoP.
91To avoid erosion of the value of a floating charge, the parties may agree upon contractual restriction clauses.
92Sjef van Erp, supra n. 9, 408–409.
93Xu Donggen, Comparative Study of Legal Questions on Floating Charge (2007), 180.
94Ibid., 180–185.
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Judging from the following aspects, the question that could be asked is whether the introduction of the floating charge was a premature decision. First, the LoP only incorporated the floating charge without laying down any rules governing enforcement proceedings. Actually, the issue of enforcement was to a large extent ignored during the lawmaking process. Second, the enforcement of floating charges is inherently linked to bankruptcy law. If the chargee were entitled to appoint an administrative receiver to take over the management and control of the business, this would inevitably lead to a conflict with the provisions of the Law on Bankruptcy, which govern the appointment of bankruptcy administrators. In this regard, the Chinese Law on Bankruptcy fails to specify how such a conflict in bankruptcy proceeding can be at all avoided. On the contrary, the chargor will be denied priority under Article 109 of the Law on Bankruptcy, pursuant to which only the person who had an interest in the property in question before bankruptcy proceedings were opened is entitled to a preferential settlement from the proceeds yielded by the property. The charged property only freezes at the moment when bankruptcy proceedings are opened, and not before that. Third, the LoP removes real estate – which represents the most valuable assets of a business – from the scope of the floating charge, so that the latter’s value is limited. The reason for excluding real estate is probably to avoid an outright conflict with the need to register the creation of mortgage on real estate.
As has been mentioned from the outset, it is alleged that the floating charge as stipulated in the LoP also contains elements of the business charge applied in Japanese law. However, the enterprise charge operates differently from the floating charge. The creation of an enterprise charge requires the compilation of a detailed list of all assets held by the enterprise as well as the registration of this list.95 Any change of assets in the list is subject to amendment of registration. On the other hand, such a list is alien to the floating charge, the underlying assets of which are precisely ‘floating’.
5.Pledge
Compared to a mortgage, a pledge is less important and therefore yields fewer controversial issues. There has been an intense debate on the recently introduced pledge on accounts receivable. As is the case with the floating charge, the LoP confines itself to merely stipulating the permissibility of this type of pledge without setting out further detailed rules regarding its creation and enforcement. Article 228(1) suggests that a pledge on accounts receivable is created upon registration of the pledge agreement with credit rating institutions. Under the Registration Measures of Pledges on Accounts Receivable adopted by the Chinese Central Bank in 2007, credit rating institutions within the meaning of Article 228 refer to the credit rating agency of the
95 Hans-Peter Marutschke, Einführung in das japanische Recht, 2nd edn (2009), 138.
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Chinese Central Bank. However, it cannot be unambiguously concluded that failure to effect registration results in the total invalidity of the pledge or only partial invalidity against a bona fide third person.96 This issue was left open in the Registration Measures of Pledges on Accounts Receivable as well. The function of the credit rating institutions has not been stipulated either.
The pledge relating to fee-collecting rights is a special type of pledge on accounts receivable. This form of security is widely used in the financing of large infrastructure projects such as highways, tunnels, bridges, and ports, which can generate revenue by collecting fees from users. 97 An explicit provision in this regard was removed from the final text of the LoP and is currently mentioned in the Registration Measures of Pledges on Accounts Receivable.
6.Bona Fide Acquisition of Security Rights
The rules on bona fide acquisition of rights in rem deal with one of the fundamental issue of property law. As a rule, conveyance of title requires that the transferor has the right to dispose of the title. In the absence of such a right, the conveyance is invalid and the proprietor is entitled to realize the property. However, under certain circumstances, it may be impractical or excessively costly for a transaction party to research the title chain. With bona fide acquisition, the legislature seeks to strike a balance between the need to facilitate trade in property and the protection of the proprietor’s interests. Before the enactment of the LoP, the Chinese legislature had already recognized bona fide acquisition through Article 89 of the Judicial Interpretation of the General Principles of Civil Law. However, this provision is not complete; nor does it have a generally binding effect.
Currently, bona fide acquisition of rights in rem is uniformly regulated by Articles 106–108 LoP, regardless of whether the rights affected are rights in movables or in real estate, or whether they are held in full ownership or represent limited rights in rem. Article 106 of the Property Rights reads as follows:
the proprietor is entitled to recover the immovable or movable property, if it was transferred by a non-titleholder to the assignee; except otherwise provided by law, the assignee has obtained the title to the immovable or movable property, if following conditions are met:
(1)The assignee was in good faith at the moment of the assignment of the immovable or movable property;
(2)The assignment took place at a reasonable price;
(3)The assigned immovable or movable property has been either registered or delivered to the assignee in accordance with the law.
96Xi Xiaoming, supra n. 3.
97Wang Liming, supra n. 21.
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The original proprietor is entitled to claim compensation from the non-titleholder in case where the assignee has acquired the title to the immovable or movable property according to the previous paragraph.
The previous two paragraphs are applicable to bona fide acquisition of other rights in rem mutatis mutandis.
At a minimum, the bona fide acquisition of security rights in rem has thus been made available in Chinese law – at least in theory. However, the exact scope of Article 106(3) remains unclear. Both the leading writers and the courts have given recognition to the bona fide acquisition of mortgage rights and pledge rights. This has not been the case with regard to liens, because the acquisition of the latter takes place by operation of law, not by a transaction, which is an essential condition for bona fide acquisition in general.
Thus far, no solution has been found to the question on whether the bona fide requirement is attached to possession or to registry entry when it comes to the bona fide acquisition of security rights. In terms of the bona fide acquisition of mortgages, the assignee is required by the courts to show that he has exercised due care, for instance, by having verified the ownership of the charged property by such means as checking the purchase invoice and the relevant entries in the books of the grantor.98
It is questionable whether the other conditions set by Article 106(1) (reasonable price and delivery/registration) are applicable mutatis mutandis. In terms of the first precondition, that is, reasonable price, one leading writer has proposed that, in order to assess the reasonableness of the consideration, the creation of security interests shall be judged in conjunction with the underlying secured transaction, because consideration is rarely paid separately for the creation of the security.99 As far as the passing of possession or registration is concerned, it can be assumed that this requirement is applicable if it is the prerequisite for the valid creation of the relevant security interest such as mortgage in immovables or pledge in movables. In terms of mortgages in real estate, registration only brings about the relevant effect against a bona fide third person; it is undisputed that bona fide acquisition is effective against anyone if it has been registered.
Disagreement exists as to whether an unperfected mortgage in movables may be the object of bona fide acquisition. If the answer to this question is in the affirmative, one may further ask whether such an unperfected mortgage acquired in good faith is effective against the owner. Under Articles 188 and 189 LoP, a mortgage acquired in good faith, but which has not yet been registered, is ineffective against
98Liu Guixiang, ‘Innovations in the Property Act Regarding Security Rights In Rem and Several Questions Faced by Judicial Practice (Part I)’, <http://hn.hncyfc.com/index.php/article/fxfg/2010-04- 05/21652.html>.
99Tu Changfeng, supra n. 5, 57.
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a bona fide third party. At first sight, this might appear to be somewhat strange, because any mortgage that is unenforceable against the owner probably has no value at all. In essence, it deals with a value judgment, namely as to whom – that is, the owner or the unperfected mortgagee – deserves greater legal protection. The leading authors are divided on this point.100 The LoP provides no indication in this regard, so that the question is now left to the judiciary.
A derivative acquisition of security interests in rem separated from the secured claim by good faith can be excluded under Chinese law, because security interests are strictly accessory to the principal claim and a bona fide acquisition of monetary claim is rejected. Should the assignment of the principle claim be void or voidable, the security interest will return to the assignor.
7.Concluding Observations
China has struggled to construct a modern system of property law for some decades now. The various issues of security rights in property discussed in this article show that the LoP has failed to create a coherent legal regime setting out clear and precise rules that govern property transactions. Judged against the fundamental requirements of property legislation, namely legal certainty and predictability, the LoP comes as a disappointment. Decade-long efforts have yielded a patchwork of often incomplete, impractical, inconsistent, or ambiguous legal rules. In this sense, the disappointment experienced by Chinese scholars is understandable.
However, where must the blame lie for this frustrating outcome? The mixed borrowings? A lack of prudence or of thorough deliberation? The preference for minimalism shown by the Chinese legislature? Or the downgrading of property law codification from a genuine lawmaking activity to a symbolic act, bearing in mind the interruption of the legislation process by the debate on the relationship between the protection of private ownership and state ownership?101 Probably all these factors have made a contribution.
Chinese legal scholars are currently faced with the challenge of rectifying this newly created, but malfunctioning, property legislation. Is it an attainable goal to rectify it at all? The very first step will probably be to identify how the legal rules of foreign origins were transformed in the borrowing process and to clarify confusion and misunderstandings among the leading writers. Then, elaborate rules are to be added to make concepts that were isolated and borrowed from other legal systems function in the Chinese setting. The most challenging work is to finally turn the incompatible parts into an internally coherent and consistent system.
100For details, see Bu Yuanshi, ‘Der gutgläubige Erwerb im chinesischen Sachenrecht – ein Beispiel für die Rechtsrezeption in China’, ZVglRWiss 108 (2009): 326.
101For details, see Bu Yuanshi, supra n. 2, § 14, 11–14 with further references.
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It is probably highly controversial to contend that it must be a historical accident that China took the German civil law as its model. However, in reality, the Chinese mentality differs considerably from its German counterpart. At one particular Sino-German conference on property law, which dealt with the codification of property law in 2001, one of the German participants raised the question as to what happens to rights of land use on residential apartments once they have expired after seventy years. The most senior Chinese participant astonished the German colleague by answering thus: ‘we (all participants of this conference) don’t know either. And we don’t really worry because we will not live that long and see this problem materialize. Leave this question to the future generations, they will definitely find a solution’. That is the Chinese approach, at least in the current economic and social transitional period. Only when the Chinese legislature will have learned to think in the longer term will the quality of Chinese law accomplish a real quantum leap.
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