Chinese Law Prof Blog

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George Washington University Law School

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Saturday, July 23, 2005

Supreme People's Court nullifies guarantors' contract rights

In an effort to improve the books of the Big Four banks, the Chinese government has established asset management companies (AMCs) whose function is to buy non-performing loans (NPLs) from the banks at full face value (paid for by bonds whose interest payments the AMCs can't meet, but that's another story) and then sell off the debt. One problem, however, is that it is not always easy simply to replace one creditor with another. If the debt has a guarantor, there may be a contractual provision requiring the guarantor's approval before the guarantee will be transferred along with the debt.

Not only can it be troublesome to secure this approval for every single loan that is being transferred -- we are talking about large packages of NPLs here -- but the guarantors could also use this opportunity to demand something extra as the price for allowing the transfer to go through. (This of course is something one could say they bargained for.)

Into the breach has stepped the Supreme People's Court (SPC). In a notice dated May 30, 2005 entitled "Supplementary Notice on Issues Relating to Acquisition and Disposition by Financial Asset Management Companies of Non-Performing Loans from Banks" (最高人民法院关于金融资产管理公司收购、处置银行不良资产有关问题的补充通知), the SPC solved the problem by simply announcing that such contractual provisions would not be honored: "Provisions in the guarantee contract respecting the need to obtain the agreement of the guarantor for changes in the contract shall not have binding effect when the creditor transfers the debt" (担保合同中关于合同变更需经担保人同意的约定,对债权人转让债权没有约束力).

Although it is a safe bet that this measure by the SPC was approved by authorities higher up, it is unfortunate evidence of a continuing preference for the quick and expedient solution over one that respects legal forms and procedures. Whether overturning guarantors' expectations and imposing new obligations on them in this way is wise policy is a question I won't address; there is nothing I can think of legally speaking that would prevent the Chinese government (broadly defined to include the National People's Congress and its Standing Committee) from doing so. But the Supreme People's Court does not have the power simply to declare invalid contractual rights that arose the Contract Law, a piece of legislation passed by the National People's Congress. It makes no pretense here of interpreting the Contract Law; it simply nullifies guarantors' existing rights -- indeed, it imposes an obligation on them that they did not have before -- in order to advance a policy goal.

Incidentally, the SPC is not the only body that does this. The State Council did the same thing in the late 1990s to secured creditors; I wrote about it here.

This posting is open for comments.

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Comments

It's my first time to leave comment on your blog, pleasure!

Here is one type of argument seems to support the Supplementary Notice of the SPC: the change in the identity of parties is not a change in the "content of the contract",(合同主体的变更并非合同内容的变更). To transfer the NPL to AMC involves merely identity change of the creditor, and does not per se affect rights and obligations of the debtor and (the abstract) creditor (even when thinking of the debtor's right to set-off as aginst the original creditor, under PRC Contract Law s.83, this set-off is not broken at all).

Nevertheless, the provisions whose validity are nullified by the SPC are those regarding "change of contract" -- it catches both "change of parties" and "change of content". Even if SPC intended to use the argument offered in the above paragraph, its Supplementary Notice has used a too broad term. It covers a part that cannot be justified even by the argument aforementioned.

I tend to agree that, for a contract under which party A has already performed its obligations (i.e., bilateral executory contract becoming a unilateral executory contract), it's OK for party A to transfer its credit right to a third person without obtaining the agreement of party B (see PRC Contract Law ss.79-83). However, I can see that paragraph (2) of s.79 would pose a big challenge to SPC Supp. Notice.

Posted by: Simon Xi Zhang | Jul 27, 2005 9:55:31 PM

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