Risks Related to Shares is the Guarantee for a Loan

Zhu borrowed 2 million from Wang, and transferred 20% of Company A’s shares to Wang for guarantee. Zhu also promised if he failed to repay the loan on time, the loan should be converted into shares, which means Wang could have the ownership of shares. As Zhu failed to repay, Wang informed Zhu that the loan should be converted into shares. However, Zhu argued that the agreement on the guarantee is a fluidity clause, which was invalid.
In practice, if a debtor uses shares as the guarantee for the loan, normally, the debtor would enter into a written hypothecation contract with the creditor and handle the hypothecation registration procedure in accordance with the “Guarantee Law” and the “Property Law”. According to the relevant provisions, the pledger and the pledgee should not agree that the ownership of the hypothecated property shall be transferred to the creditor in case the pledger’s claim is not satisfied after maturity of the debt. Upon the expiration of the deadline of repayment, the pledgee can be paid off, with the agreement of the pledger by converting the hypothecated assets into money or proceeds acquired by auction, or sell off of the assets. In view of this, the guarantee related to shares has 2 characteristics, (a) the ownership of the share shall not be transferred; (b) the fluidity clause shall be invalid.
In this case, the ownership of Zhu’s share has been transferred, which is different from the hypothecated shares. In fact, in the civil law, such action is the so-called concession guarantee, which refers to a debtor transfers the mortgaged property to a creditor, and both parties agree that where the debtor pay back the debt on time, then the creditor shall return the mortgaged property, otherwise, the creditor could keep the ownership of the mortgaged property.
However, the current Chinese “Guarantee Law”, “Property Law” and other relevant laws have not stipulated the concession guarantee. So, in the practice, there are different opinions on the validity of the concession guarantee. The majority judgements of the relevant cases would confirm the validity of the concession guarantee, because the courts believe such agreement has not violated any laws or mandatory provisions of administrative regulations. Such as (2010) Zhen Shang Zhong Zi No. 74, (2014) Min Min Zhong Zi No.360, Supreme People’s Court (2013) Min Er Zhong Zi No.33, (2015) Min Shen Zi No. 3620, etc., it shall be noted that all these cases are the concession guarantee related to shares. And there are also a few judgements of the relevant cases would deny the validity of the concession guarantee, because the courts believe there is not legal basis. Such as (2015) Zhe Min Ti Zi No. 69, (2014) Su Shen San Min Shen Zi No. 0411, it shall be noted that all these cases are the concession guarantee related to real estate. It is noteworthy that Zhejiang High People’s Court has different opinions on the concession guarantee due to different mortgaged property.
Even if the concession guarantee related to shares could be affirmed valid for the majority situation, there are still many different opinions on the similar fluidity clauses in the judicial practice. From the history of the guarantee, there is a concern that the fluidity agreement might not be performed or implemented by the judicial authorities, there are some opinions which would against the validity of such agreement. Therefore, the author thinks the concern shall not be applied to determine the validity of such agreement. If it is obviously unfair, the pledgee could ask the court to adjust in accordance with the “Contact Law” and other relevant regulations. It is a pity that there are still many different judgements on the similar cases.
For example, Issue No.16 of the “People’s Judiciary Case” 2014 has reported a concession guarantee case related to shares which was judged by the Jiangsu High People’s Court. In the case, the court pointed out, “Although the fluidity clauses in the loan agreement is invalid, it shall not affect the validity of the guarantee. After the debtor has repay the debt, the debtor is entitled to ask the creditor to return shares. In the case, (2015) Liao Min Er Zhong Zi No.00266, the court pointed out, “Both parties entered into the share transfer contract because of the loan contract, although the share transfer had been registered, both parties still confirmed the share transfer contract was the guarantee for the loan contract. Since Yongxing Company is still operating the target company, the share transfer contract shall not be deemed as a fluidity agreement. Yongxing Company failed to repay the debt, and now it requires the court to withdraw the share transfer contract by the excuses as significant misconception, and obviously unfair, because it did not provide evidence to prove, the court decides to reject its claim. In the case, (2010) Zhe Shang Zhong Zi No.74, the court pointed out, “For the 30% of hypothecated share, the debtor agreed that if he failed to repay the debt, the creditors Wu and Lin could obtain the ownership of the relevant share, such agreement had violated the forbidden provisions in the “Property Law”, so such agreement is invalid. For the 20% of the concession guarantee share, Yinqiao wanted to obtain the loan and guarantee the performance of the cooperation framework agreement signed by Huiheng and Fuchun, so Yinqiao had transferred those 20% shares. The court of the first instance decided that those 20% shares is the consideration for the loan lent by Lin and Wu, so the share transfer agreement is valid. And this decision is not improper.” In view of this, the court has confirmed the validity of the concession guarantee related to shares.
Therefore, if a debtor proposes to provide shares for guarantee, the creditor shall make clear about the guarantee. Because the hypothecated shares and the concession guarantee shares are different.
If a creditor chooses the hypothecated shares, then both parties shall not agree on the fluidity clauses, and the debtor shall handle the registration procedure. On the other hand, if a creditor chooses the concession guarantee shares, in the absence of laws and regulations, both parties should stipulate the rights and responsibilities in detail, such as the rights of the creditor related to the ownership of the shares, the method and procedure to implement guarantee while the debtor fails to repay, a nd so on. In addition, since it is still uncertain on the fluidity agreement related to the concession guarantee shares, it would be better to stipulate that the debtor shall not exercise the shareholder’s right before the maturity of the debt, and the debtor shall perform this article in real.