China’s top court publishes guiding cases on security enforcement

SPC provides clarity on security law issues

China’s market for secured financing transactions was further advanced on 19 November 2015 by two guiding cases from the Supreme People’s Court (SPC), providing much needed clarity on issues relating to the validity and enforcement of security over PRC infrastructure project concessions and PRC bank accounts.

Enforcement of security over future income stream

One of the cases concerns a loan for a waste water treatment project in Fuzhou. The project’s income stream, consisting of fees payable by the awarding government authority, was pledged as security for the loan. The concessionaire defaulted on the loan and the creditor bank sought payment of the waste water treatment fees directly from the authority (the municipal construction bureau).

The court decided in favour of the bank and ruled that the authority should pay the fees to the bank directly, recognising, as a general point, the difficulty of liquidating, auctioning or selling a right to a future income stream (such as a project concession). The decision thus provides a welcome alternative to the general enforcement principle of PRC security law of converting the collateral into value or selling the collateral by way of auction or private sale. In its decision, the court noted that the authority had accepted the obligation to pay the bank directly in the event of the concessionaire’s default, as it was party to the security agreement between bank and concessionaire. The court noted, however, that a reasonable sum had to be withheld from the fee payments to the creditor bank to enable the concessionaire to continue to operate the water treatment plant without disruption to the plant’s water treatment activities.

Security over a fluctuating account balance

The second case considered the general rule under the SPC’s 2000 judicial interpretation on the PRC Security Law that funds in a bank account which has been pledged to a creditor must be ascertained and identified. The case concerned a debt service reserve account with the lending bank, into which the borrower was required to place deposit payments which it received from its finance guarantee business from time to time and the balance in the account had to be at least 10 per cent. of the outstanding balance. A key argument of the borrower was that the funds in the pledged account did not meet the test of ascertainability and identification as the account balance regularly fluctuated. Funds had been withdrawn by the lender from time to time to discharge the loan or to make refunds to the borrower when the account balance was in excess of the 10 per cent. reserve.

The court ruled that a fluctuating balance in a pledged account does not, in and of itself, invalidate the pledge. The fluctuation in this case was not fatal to the security, as the debit and credit transactions in the account were not made for any purpose unrelated to the debt service reserve (such as to discharge business expenses).

The court proceeded to find that valid security over the account had been created and the test of ascertainability and identification had been met for the following reasons:

  • the account was maintained with the lender;
  • no withdrawal from the account could be made without the lender’s consent;
  • the security agreement permitted the lender to unilaterally apply the funds to discharge unpaid loan amounts; and
  • the debt service reserve had been set at a fixed proportion of the outstanding loan.

Security Law of the People’s Republic of China

Interpretations of the Supreme People's Court on Several Issues Concerning the Application of the Security Law of the People's Republic of China

Guiding Case No. 53 – Loan Agreement Dispute, Fuzhou “Wu Yi” Branch of Fuzhou Straits Bank v. Changle Ya Xin Waste Water Treatment Co., Ltd., and Fuzhou City Works Co., Ltd.

Guiding Case No. 54 – Enforcement Dispute, Agricultural Bank of China Anhui Branch v. Zhang Da Biao and Anhui Changjiang Finance Guarantee Group Co., Ltd.