1. What are the principal securities lenders will require borrowers to provide?

In China, the bank loan has long been the major – if not unique – property finance resource. Since 2011, real estate loans have been tightened up following the central government's policy attempting to control soaring property prices in major cities. Real estate trust and property funds are increasingly important in the property financing sector in China.

Under Chinese law, there are preconditions before banks or trust companies may grant loans. Such preconditions require that the project company should have obtained the land use right and planning related licences and that the project owner has injected at least 30% of the total project investment. In the meantime the borrowing of money from private funds does not need to fulfil such statutory preconditions. In addition China puts more restrictions over financing by foreign invested real estate companies.

To mitigate the risks, Chinese lenders usually ask for one or more of the following securities:

• mortgage over the land use right, buildings, and/or building under construction;
• pledge of the project owner's equity in the project company (share pledge);
• assignment or pledge of the anticipated income or premium from the project;
• suretyship.

2. What statutory provisions apply to such securities?

The key statutory law stipulating securities is the PRC Security Law. As the law only provides rather general provisions, the judicial interpretations issued by the Supreme People's Court in 2000 play a very important role in security law judicial practice. Further, concerning mortgages of real property, the Property Right Law also provides the principal provisions.

Various regulations, measures, rules, and circulars issued from time to time by administration authorities as well as local governments also form an extremely important part of Chinese law. Such administrative and local rules usually deal with the implementing details for certain trades of the securities, for example real property mortgage, share pledge, third party guarantee etc. Therefore one needs to look into all such rules in order to get a full picture of how a specific security is regulated under the law and implemented in practice.

3. What are the formal requirements for the establishment of such securities? Does the establishment of a share pledge require their “cession by security”?

First of all, a security agreement is usually viewed as a contract addressing complex legal relationships and therefore needs to be concluded in writing. Further, Chinese law and legal practice so far still does not acknowledge independent security in domestic transactions, meaning that any type of security, even after establishment, is dependent on the main debt, i.e. the loan contract. Invalidity of the respective loan contract may invalidate the security agreement.

To establish a real property mortgage, the following preconditions need to be met (Arts 180, 184, 185, and 187 of the Property Right Law):

1. There shall be a written mortgage agreement with necessary provisions including specification of the secured debt, the mortgaged real property, as well as scope of the security interest etc.
2. The mortgagor shall have the right to set a mortgage on such real property;
3. The real property shall not be prohibited from being mortgaged by laws or administrative regulations (e.g. land ownership in China is prohibited from mortgaging);
4. The mortgage must be registered with the competent authority to effectively set up the mortgage.

It is also possible to provide mortgage security by means of vessels, aircraft, automotive vehicles, large machinery or equipment etc. A legally valid and binding mortgage over such “moving” assets is established at the time when the contract becomes valid. However, if the mortgage is not registered with the competent authority (which may not always be the same one), it might not bind a bona fide third party (Art. 188 of Property Right Law).

To establish a share pledge, below the following preconditions need to be met (Arts 208, 210, 223, and 226 of the Property Right Law; Art. 5 of the RPC Measures for Registration of Share Pledge):

1. There shall be a share pledge contract in written form with necessary provisions including specification of the secured debt, the pledged shares, scope of the security interest, and delivery time etc.
2. The pledger shall have the right to pledge the share;
3. The share shall be transferable and pledgeable in accordance with the law (e.g. the shares frozen by court shall not be pledged before the freezing order is lifted);
4. The share pledge is approved by commercial authority (applicable for pledging with shares of a foreign invested company);
5. The share pledge must be registered, jointly by pledger and pledgee, with the competent authority to effectively set up the share pledge.

There is no “cession by security” or similar concept/practice under PRC law.

To assign or set up a pledge via income or account receivables, the following preconditions need to be met (Arts 208, 210, 223, and 228 of the Property Right Law):

1. There shall be a written contract with the necessary provisions including specification of the secured debt, the pledged shares, scope of the security interest, and delivery time etc.
2. The pledge must be registered with the credit reference service institution (e.g. Credit Reference Center of People's Bank of China) to effectively set up the pledge.

Suretyship under Chinese law is where a third party (usually an affiliate of the debtor) promises, in case the debtor is not able to repay the loan, to perform the repayment obligations. There needs to be a suretyship contract concluded between at least the surety and the creditor. No further registration is required, unless a cross-border suretyship is involved.

Suretyship is legally divided into two types, general suretyship and suretyship of joint and several liability. Under a general suretyship, the creditor may only claim for suretyship liability against the surety after it has exhausted the legal remedies and it still is not able to recover the debt; whilst under a surety of joint and several liability, the creditor may choose to claim, at any time during the suretyship term, against either or both of the surety and debtor for debt recovery.

4. What claims are secured? For what amount? In the case at issue, does the novation of the underlying debt lead to the maintenance/ extinguishment of the securities assisting the original debt?

According to the Chinese Property Right Law, secured claims and the amount thereof (unless otherwise agreed by the parties) shall include the following:

1. principal of the loan plus applicable interest,
2. contractual or statutory penalty,
3. damage claims,
4. expenses for safekeeping of the property used as security and expenses for enforcing the security.

The scope of security may be freely negotiated by the parties in the contract.

Novation of the underlying debt without prior consent by the guarantor does lead to extinguishment of the securities assisting the principal debt. Under Chinese law, the security shall be dependent on the principal debt. If there is novation of the underlying debt without prior consent by the guarantor, the security cannot be automatically assigned to guarantee the new debt but rather a new security shall be created (Arts 175, 192, and 204 of the Property Right Law).

5. Is it possible to “divert” such securities (namely, the securities in rem) in order for them to act as collateral for other claims, should the original Loan Agreement be terminated?

Under Chinese law, a security contract is attached to a specific principal (loan) contract (Arts 172 and 192 of Property Right Law). Accordingly a security may not be diverted independently from the secured loan contract and secure other claims. For example, for property conveyance in China, the related mortgage always needs to be first released by the original owner and then re-mortgaged by the new owner for financing purposes.

For maximum amount securities (mortgage or pledge), the securities cover all debts incurred during a designated period or even before (if agreed by the parties) the designated period (Arts 203 and 222 of the Property Right Law).

For real property mortgages, re-mortgaging the same property to a third party used to be explicitly prohibited (Art. 35 of PRC Guaranty Law). This prohibition seems to have been liberalized by judicial interpretation (Arts 50 and 51 of SPC Guaranty Law Interpretation). However, since the later published PRC Property Right Law is silent on the topic, the legal validity of re-mortgage is not yet entirely clear (speech by Mr Song Xiaoming, Judge of People's Supreme Court, at an international property right law seminar), and in practice such re-mortgaging is often restricted by banks such that it is available only “within the remaining value”.

6. What rights does a share pledge attribute to the pledgee? Are there any arguments against exercising such rights? What are the formal requirements for its establishment?

There is no specific provision regarding rights of pledgees in cases of share pledge.

As general pledge rules are applicable to both movables and rights, pledgees are entitled to:

1. Possession of the pledged property (Arts 208 and 229 of the Property Right Law);
2. Collection of the fruits out of the pledge property accrued from the pledged property, unless otherwise stipulated in the pledge contract (Art. 213 of the Property Right Law).

From the perspective of share pledge by publicly listed companies, “fruit” is specified to include “shares offered to shareholders for free and dividends etc.” and such incurred fruit shall be jointly pledged (Art. 35 of PRC Measures for Administration of Share-Pledged Loans of Securities Companies).

A pledgee is not allowed to use or dispose of the pledged property, unless otherwise agreed by the pledgor (Art. 214 of the Property Right Law).

Arguments for exercising such rights include (i) challenging the preconditions as specified in Question 3 above for establishment of such pledge, or (ii) excluding the right to collect fruits via mutual agreement (Art. 213 of the Property Right Law).

For the formal requirement to establish a valid share pledge, please refer to Question 3 above. It was not until 2008 that China issued the regulations relating to the registration of share pledges (Measures for the Registration of Share Pledge with Industry and Commerce Administration Authorities effective as of 1 October 2008). Before that, all companies in China in which foreign companies had invested had great difficulties in officially setting up a share pledge.

7. Will securities be automatically preserved, should the Borrower's debt be restructured?

Chinese law provides that during the restructuring period of a debtor, realization of the securities shall be suspended. However, in case there is possible damage or significant depreciation in value of the collateral, which may impair the secured creditor's right, the secured creditor may apply to the people's court to resume his right to realize the security (Art. 75 of the PRC Enterprise Bankruptcy Law effective as of 1 June 2007).

8. In the case of default, how will the securities in rem be enforced?

The parties may agree on how to realize the securities (Art. 195 of the Property Right Law).

In case no agreement is reached, the parties may file an application to the people's court for realization of the securities in rem (Arts 195 and 220 of the Property Right Law) in one of the following two ways.

1. When there is no civil right dispute over the security or the secured debt, the parties may file for the “special procedure for realization of securities in rem” at court (“Confirmation Procedure”). After confirming that the request is “in conformity with the law”,² the court shall issue a ruling to sell/auction the property, based on such ruling and the parties may apply to court for execution (i.e. sale/auction of the property (Arts 179, 196, and 197 of the PRC Civil Procedure Law)).
2. When there is civil right dispute, the parties first need to file a normal civil case with the court to decide on the civil rights (“Litigation Procedure”). Based on the judgment, the parties may apply to court for enforcement of the judgment (Art. 224 of the Civil Procedure Law).

9. What is the average overall duration for the enforcement of a mortgage following enforcement proceedings?

For the Confirmation Procedure, it takes a maximum of 30 days for the court to issue the ruling after accepting the case, and a maximum of six months to enforce such ruling.

For the Litigation Procedure, it normally takes six months for the first instance trial, three months for the second instance trial (in case of an appeal), and a maximum of six months for the court to enforce the judgment.

In practice the above timeline may be substantially extended if additional procedures are incurred.

10. Are banks entitled to enforce a mortgage directly/through a receiver without having recourse to the competent court? What is the average overall duration of such proceedings?

In case the principal debt cannot be repaid, banks may mutually agree with the mortgagor (or in case of receivership, the receiver) to realize the mortgage. After failure to reach an agreement between the bank and the mortgagor (or in case of receivership, the receiver) to transfer the mortgaged property via mutual agreement, the bank shall file an application to court for enforcement.

Average duration: as provided in Question 9.

11. What taxes and levies apply to the establishment of such securities and to their cancellation?

In general under Chinese law, there is no tax incurred in the establishment and cancellation of any securities.