Supreme Court: Several new types of guarantees that are prone to controversy

In addition to the pledge of the right to the proceeds of assets (such as the right to proceeds of infrastructure and public utility projects) that can be included in the pledge of accounts receivable, a judicial policy of appropriate restrictions should be adopted for the pledge of the right to the proceeds of other assets, because this is essentially "one fish and two eats" and improperly magnifies financial risks.

Article 63 of the Interpretation of the Supreme People's Court on the Application of the Relevant Guarantee System of the Civil Code of the People's Republic of China (FaShi [2020] No. 28) stipulates that if a creditor concludes a guarantee contract with a guarantor and agrees to establish a security with property rights that can be secured by laws or administrative regulations, and the parties claim that the contract is invalid, the people's court will not support it. Where the parties have not registered with the statutory registration authority in accordance with the law, and claim that the security has the effect of property rights, the people's court will not support it.

From the perspective of practice, the new types of security that are prone to disputes mainly have the following situations:

1. Pledge of the lease right of the shop. Its transaction mode is: the lender (bank), borrower (merchant) and the shop lessor sign a tripartite agreement, with the merchant's shop lease right as the secured property for preferential repayment of the lender's debts, register the pledge at the shop lessor, and restrict the shop lessee to transfer, sublease or duplicate pledge the shop lease right in any form, and the value of the shop lease right is assessed by the lender and confirmed by the lessor; if the merchant cannot return the loan when due, the lessor pledges the lease right of the shop. The proceeds are used to pay off the merchant's arrears on a priority basis. However, whether the lease right of the shop can be used for pledge is more controversial in practice. In addition, although the pledge of the lease right of the shop is registered with the lessor, there is also great controversy over whether such registration can produce adversarial effect. [1]

2. Pledge of taxi operation rights. The transaction model is that the taxi operating company applies for a loan from the bank, deposits the taxi operation certificate with the bank for safekeeping, and registers the pledge at the vehicle management office. If the taxi operating company is unable to repay the loan when due, the creditor shall dispose of the taxi operation right, and the proceeds shall be used to pay off the debt in priority. However, whether the right to operate a taxi can be used for pledge is controversial in practice. One view was that the right to operate a taxi was a franchise right and could not be used for pledge. Another view is that although the taxi operation right belongs to the franchise right, not all franchise rights cannot be used for pledge, and as for the issue of the taxi operation right being pledged without registration with the statutory registration authority, it is a question of whether the property right has been obtained.

3. Pledge of beneficiary rights of the trust. In the trust relationship, the sum of the various rights enjoyed by the beneficiaries is called the "beneficiary rights", which specifically includes two categories: one is the right of self-interest, that is, the right of the beneficiary to obtain benefits from the trust property; the other is the right of common interest, that is, the right to supervise the trustee. In practice, it is the self-interest right used to pledge, but there are different views on whether the right is a property right, a claim, or another special right. In our view, a distinction should be made between channel trusts and genuine trusts. In a channel trust, the nature of the beneficiary right depends on what rights the settlor enjoys, which may be either a creditor's right or an equity, but it is not a beneficiary right in the sense of the Trust Law, but regardless of its nature, it is not a new type of security. In a real trust, if the beneficiary right is understood as a property right or a claim, the pledge of the beneficiary right is not a new type of security, but if it is understood as a new special right, the parties will use it for pledge and will face the problem of how to apply the law.

4. Pledge of the right to return on assets. In recent years, with the development of financial innovation, there have been cases of financing the right to asset income as the subject of the transaction in financial transactions, including asset securitization and structured asset management plans. But what is the right to return on assets? What is the relationship between it and the underlying asset? Can it be transferred or pledged as separate property distinct from the underlying asset? In practice, there are major controversies. In our view, in addition to the pledge of asset income rights (such as the right to income from infrastructure and public utility projects) that can be included in the pledge of accounts receivable, a judicial policy of appropriate restriction should be adopted for the pledge of other asset income rights, because this is essentially "one fish and two eats" and improperly magnifies financial risks. For example, if the parties pledge their shares and then pledge the dividend rights of the shares, but the effect of the equity pledge has extended to the dividends generated by the equity, the so-called dividend right pledge inappropriately enlarges the scope of the property used for security. [2]

Although the creditor did not acquire a security interest, it does not mean that the secured contract was ineffective. In practice, the property rights agreed upon by the parties often have economic value, and when the guarantee contract is legal and valid, if the creditor requests to discount the price of the property right in accordance with the provisions of the guarantee contract or to be reimbursed with the proceeds of auction or sale, the people's court shall support it. [3]

[1] As for the pledge of rights created by the parties themselves that lack both the basis of local regulations or rules and the lack of statutory registration authorities, such as the pledge of the lease right of the shop, according to the rule that the weight is clear and light, it should naturally not be recognized as having the effect of property rights. ——The Second Civil Trial Division of the Supreme People's Court, Understanding and Application of the Judicial Interpretation of the Guarantee System of the Civil Code of the Supreme People's Court, People's Court Publishing House, 2021 Edition, p. 537.

[2] The Second Civil Trial Division of the Supreme People's Court, Understanding and Application of the Judicial Interpretation of the Guarantee System of the Civil Code of the Supreme People's Court, People's Court Publishing House, 2021 Edition, pp. 534-536.

[3] The Second Civil Trial Division of the Supreme People's Court, Understanding and Application of the Judicial Interpretation of the Guarantee System of the Civil Code of the Supreme People's Court, People's Court Publishing House, 2021 edition, p. 537.