China – Amendments Relating To The Guarantee Arrangement By The Civil Code.

5 November 2020

 

The “Contract” section of the Civil Code[1] which makes systematic improvement and modification to the arrangement of guarantee, has treated the “contract of guarantee” independently as a type of contract and put it into a separate chapter. This article purports to sort out and make a comparison between the key content of “contract of guarantee” in Chapter 13 of the Civil Code, and that under the current guarantee system under the Security Law[2].

 

Security Law	Civil Code
Article 19 (Presumption where the mode of guarantee has not been stipulated or agreement is unclear)   When the parties have made no stipulation on the mode of guarantee or the agreement is unclear, the parties shall bear the guarantee liability jointly and severally.	Article 686 The mode of guarantee includes general guarantee and joint and several guarantee.   When the parties have made no stipulation on the mode of guarantee or the agreement is unclear in a contract of guarantee, the parties shall bear their liabilities as a general guarantee.

Article 686 of the Civil Code has made subversive changes to the presumption rules when the mode of guarantee is unclear. Originally, Article 19 of the Security Law stipulates that when the parties have made no stipulation on the mode of guarantee or that the agreement is unclear, the parties’ liabilities shall be joint and several, but now, Article 686 of the Civil Code has amended the liabilities to that of a general guarantee.

 

The main difference between general guarantee and joint and several guarantee lies in whether the guarantor has the pre-litigation demur right. According to Article 687 sub-paragraph 2 of the Civil Code, “a guarantor under a general guarantee is entitled to refuse to assume guarantee liability unless dispute of the principal contract has been adjudicated or arbitrated and such debtor remains incapable of satisfying the debt despite legal execution having been made against his properties”. A general guarantor is only required to bear the guarantee liability when the debtor has failed to perform his obligation despite legal execution having been made against his properties. Previously, the general guarantor has pre-litigation demur right, and his obligation is therefore a secondary obligation in nature. Where the mode of guarantee is clearly stipulated as joint and several, then according to Article 688 sub-paragraph 2 of the Civil Code, “when a debtor under joint and several guarantee fails to perform his due obligation or any of the circumstances agreed by the parties occurs, the creditor may require the debtor to perform his obligation or require the guarantor to assume guarantee liability to the extent provided under his guarantee”. A guarantor who assumes joint and several liability bears the same liability as the debtor. Thus, the creditor can choose to require either of them to perform the obligation.

 

The Civil Code’s modification of the presumption rules applicable to the mode of guarantee (in the absence of a clear stipulation) is now more conducive to protecting the interest of the guarantor and is more in line with the secondary nature of the guarantee obligation.

 

2. Commencement of the limitation period for general guarantee

 

Security Law	Interpretation of the Security Law[3]	Civil Code
Article 17.2 (General guarantee and pre-litigation demur right)   A guarantor under general guarantee arrangement may refuse the creditor’s demand to perform guarantee obligation before the dispute of the principal contract has been adjudicated or arbitrated, and the debtor remains incapable of satisfying the debt despite execution having been made against his properties.	Article 34.1 If a creditor guaranteed by a general guarantee institutes legal proceedings or applies for arbitration against the debtor before the expiration of the guarantee period, the limitation period for the guarantee contract starts to run from the effective date of the judgment or arbitration award.	Article 694.1 Where a creditor guaranteed by a general guarantee institutes legal proceedings or applies for arbitration against the debtor before the expiration of the guarantee period, the limitation period for the guarantee obligation starts to run from the date when the right of the guarantor to refuse to perform his guarantee obligation is extinguished.

In the Interpretation on the Security Law, the limitation period for general guarantee starts to run from the effective date of the judgment or arbitration award whereas the Civil Code has changed it to “the date on which the right of the guarantor to refuse to perform his guarantee obligation is extinguished”. The reason is that according to Article 17 sub-paragraph 2 of the Security Law, the general guarantor enjoys pre-litigation demur right before “the debtor remains incapable of satisfying the debt despite execution having been made against his properties”, and in such a situation, the guarantor can refuse to assume guarantee liability. There is a definite gap between “the effective date of the judgment or arbitration award” and the time “when the debtor remains incapable of satisfying the debt despite execution having been made against his properties”, during which, due to the existence of the guarantor’s pre-litigation demur right, the creditor would not be able to require the guarantor to assume guarantee liability. If the limitation period starts to run from “the effective date of the judgment or arbitration award”, the creditor’s benefits will be jeopardised, as it may lead to the situation where the limitation period for the guarantee liability might run out even before the creditor can request the guarantor to perform his guaranteed obligation. 

 

The Civil Code’s modification to the starting time of the limitation period for general guarantee eliminates the conflicting logic between the previous rules of limitation for general guarantee and the rules of pre-litigation demur right, making the general guarantee liability system more reasonable and consistent, and more conducive to protecting creditors’ time benefit at the same time. 

 

3. Explicitly stipulates the guarantor’s right of subrogation

 

Security Law	Civil Code
Article 31 (The guarantor’s right of recourse) The guarantor, after assuming his guarantee liability, is entitled to seek indemnity from the debtor.	Article 700 Unless otherwise agreed by the parties, a guarantor who has assumed his guarantee liability, shall be entitled to seek indemnity from the debtor to the extent of the guarantee obligation he has performed, and he enjoys the rights of the creditor against the debtor, but without prejudice to the interests of the creditor.

The guarantor’s right of subrogation means that, after the guarantor pays off the debts on behalf of the debtor, he may step into the shoes of the creditor and enjoys a creditor's rights vis-à-vis the debtor.[4] Article 31 of the Security Law merely stipulates the guarantor’s right of indemnity, but does not clarify whether the guarantor enjoys the right of subrogation, i.e., whether the guarantor can obtain the accessory rights relating to the creditor's rights (such as the residual security rights in relation to the debt). In previous judicial practice, there have been many diametrically opposing cases concerning the issue of whether the guarantor enjoys the right of subrogation. Article 700 of the Civil Code explicitly stipulates that the guarantor enjoys the creditor’s rights against the debtor after performing his guaranteed obligation, affirming the guarantor's right of subrogation, thereby clarifying the issues. At the same time, Article 700 of the Civil Code corresponds with the content of Article 524 sub-paragraph 2[5] and Article 547 sub-paragraph 1[6]of the Civil Code on “Claims assignment”; through semantic interpretation and purposive interpretation, the guarantor’s right of subrogation could be proved as well, thereby providing more comprehensive legal protection for the guarantor to seek indemnity.

[1] Civil Code of the People's Republic of China, issued on 28 May 2020 is not yet effective but will come into force on 1 January 2021.