Written By: Taotao Zhu
Edited By: Nadia Ho
Thomas Peters / Reuters
The past few decades have seen major changes in the development of China’s security interest law. Most types of security rights have been recognised by the General Principles of the Civil Law 1986, later ratified by the Security Law 1995 and the Property Law 2007
China’s Civil Code, which came into force in 2021, recognised atypical novel security rights that,due to their complicated legal nature and the potential conflicts with numerus clausus, were not legally recognised before. Among these rights, security transfer of title has been subject of recent discourse in China since there are still a large number of ambiguities and arguments on issues including the definition and scope of security transfer of title as well as its perfection and enforcement.
Some argue that it is evident that the current security interest law system cannot cope with novel business transaction models and that it needs to reform like the legislation from other jurisdictions, like the Uniform Commercial Code (“UCC”)
The essay will attempt to clarify the scope of applying security transfer of title from both the perspective of legal interpretation and the academic opinion on regulation, as well as whether other countries' models should be referred to.
The Nature of Security Transfer of Title
In legislative discourse, the definition was given by Article 68 of the Interpretation of the Supreme People's Court of the Application of the Relevant Guarantee System of the Civil Code (“Interpretation”) and Article 71 of the Minutes of the National Courts' Civil and Commercial Trial Work Conference. Article 388 of the Civil Code has generally accepted the validity of atypical security interest contracts with security functions.
From the legal interpretation, the conception of security transfer of title means conveyancing the title of the security asset to the creditor as a means of security. Then when the debtor discharges her payment obligation, the title will be redelivered to the collateral provider. Upon the debtor’s default, the secured creditor will then be entitled to enforce its security by having the right to sell or auction the collateral asset to have obligations discharged. Most importantly, the creditor will have priority over ordinary creditors when the transfer of title has been published, indicating that only when the requirement of publicity has been satisfied, can the security transfer of title be seen as a security interest.
However, the security transfer of title agreement between parties in commercial practice will often be different from the original provision. Firstly, parties may agree upon the article that the transferee will transfer the outright title on the collateral asset to the creditor. When the debtor fails to perform her contractual obligation, the creditor can keep the title without the need for auction or sale.
This type of agreement is popular because the creditor can be secured by holding the property title, and because the loan can be better protected. Its perfection only demands minimum formality requirements in practice.
The common practice diverts from what the legislators expected. One of the fundamental issues raised is whether the creditor can enjoy an outright transferred title of the property in line with the parties’ agreement, or if the agreement should be recharacterised based on the legislation and if a party only has partial rights in the collateral asset.
According to Articles 401 and 428 Civil Code, title-based security as foreclosure collateral is generally prohibited in China, and therefore, the transfer of title, which appears to be an outright transfer, can only act as a security interest per Article 68 Interpretation.
However, since the concept of fiduciary was incorporated into trust law, the nature of the transfer is worth further discussion in relation to trust law. Under Chinese trust law, the trustee, analogous to the creditor in a security transfer of title, is only entitled to single ownership without the right to enjoy the fruits of the collateral asset, and the beneficiary has an obligatory right to the beneficiary interest. At the same time, the notion that ownership can be limited is denied by Chinese property law. Therefore, it is evident that the trust law system seems to be an exception to the traditional civil law system in China. Thus, it may be possible to admit that the secured creditor is entitled to the title of the property in the collateral asset. At the same time, she has a contractual obligation to redeliver the property upon the repayment of the debt.
The Interpretation states that the creditor can only have the right of priority over ordinary creditors (which in essence recognised the character of security interest. However, it does not express the way that ‘the security right will not be perfected’.) when the property transfer has been published.
The first problem comes with the meaning of ‘published’. Specifically, whether it means the publication of normal property title transfer (e.g. the transfer of possession of movable property) or if it refers to the special perfection requirement of security interest like registration. Because the transfer of immovable property in China already has a registration requirement, the only remaining issue is related to movable property.
There are different academic perspectives on publicity of normal property title transfer. For example, if the parties agreed to use constitutum possessorium (constructive possession) as the method of delivery of movable property, the publicity requirement cannot be satisfied as there is no way for the third party to have any knowledge about the transfer.
With the existence of ‘charge over movable property’, the problem may not be as difficult to solve. Charge over movable property is a special non-possessory security interest. It is traditionally not recognised by the civil law system. Reason being that security interest as a property right should be a right in rem, meaning the right holder can invoke the right against the world, which is also the reason why the publicity requirement is essential in the property right. However, charge over movable property does not have any publicity element. In China’s property law, charge over movable property is valid as a security interest when the collateral agreement is made, however, it can only be set up against a bona fide third party when it has been registered.
It is evident that charge over movable property is an exception to legal tradition. Perhaps it is not hard to have another similar exception in terms of the publicity requirement.
Nevertheless, as mentioned above, the Supreme Court deliberately chose to use the phrase ‘have the priority’ rather than directly recognise security transfer of title as a security interest. It may be implied that there is uncertainty even within the Supreme Court itself about the nature of this atypical security interest as well as the role of publicity requirement in its regulation.
According to the legislation, the enforcement method of security transfer of title is clear. However, when the parties select a different approach, more issues will surface.
One issue here is that the security transfer of title agreement is,in essence, a foreclosure agreement of collateral, which is why the Supreme Court has emphasised that it can only be valid when the creditor has the obligation to sell a collateral asset.
The justification of the prohibition is that foreclosure can sometimes leave the creditor with the opportunity to exploit the debtor where profiteering may occur. In academia, there have been numerous arguments that the prohibition should be relaxed. Some argue that the prohibition is already more relaxed than it was at the time of Security Law 1995 as Articles 401 and 428 Civil Code only invalidate the security interest agreement rather than the security interest as a property right itself. Others argue that the problem of profiteering can be addressed when the legislation clearly regulates the margin of the profit, which refers to the UK’s regulation model of ‘margin’ in secured transactions. This argument is worth considering as it does not completely delete the prohibition, and because it respects the free will of the parties without denying the validity of the agreement directly.
It should be clear that the foreclosure of security transfer of title in China is still prohibited by law, but that there may be some scope for theoretical discussion.
There are many controversies between security transfer of title and traditional security interest which hinders the legislator from providing a clearer position about it. Therefore, some argue that there should be reform with reference to unitary security interest regulation–for example, Article 9 UCC.
Article 9 has remarkable influence on security interest regulations around the world, including the model secured-transactions laws, like the Legislative Guide on Secured Transactions. Article 9 abandoned the distinction of traditional security interest and instead, applied to ‘any transaction, regardless of the transaction's form, in which personal property secures an obligation’. It is a convenient and facilitative device that allows parties to create their own approach to secure a loan. The publicity form within Article 9 is also simple and clear, in that the creditor need only either take possession of the collateral property or make a public filing to have her rights against competing property claimants.
However, there are some concerns regarding the particular model. The most prominent being that it is a significant deviation from the current legal system, which is basically derived from the continental legal system. It might be argued that ‘development of modem secured transactions laws has often resulted in a blurred distinction between civil law and common law’. The question that should be considered is whether it is worth taking a completely different approach to address the current problem, and the answer will likely be negative. The current exception made for security transfer of title as well as other atypical security is workable and interpretable with no actual need for a thorough change in the system. The cost of reverting the legal and education system will outweigh probable theoretical merits. A final point is the vague guidelines set up by UCC.
As stated above, Article 9 can be applied to transactions with different forms even if it has barely any connection with the security interest itself.
In summation, from the understanding of the provisions, it is relatively clear that the security transfer of title means transferring the title as a means for security whilst the title is not seen as genuinely transferred. It is valid as a security interest when the property title has been transferred with publicity. Nevertheless, it is clear that there is ample space for further research and legislation. The unitary approach to security interest established by Article 9 UCC may not be the best reference for China, but it may be helpful to review the World Bank’s suggestion of a market-oriented approach in relation to the parties’ intention within the current scope of security interest law in China.
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