Cautions related to guarantees provided by third parties

Guarantee is one of the important means to ensure the recovery of creditor’s rights. When a third party provides a guarantee for a debtor, the creditor shall carefully assess whether the guarantee is valid and enforceable. So, as a creditor, what are cautions related to guarantees provided by third parties?

Firstly, from the perspective of the guarantee subject, when a third party provides a surety guarantee, it is necessary to confirm its capacity to provide the guarantee. This issue involves two aspects:(1) Is the subject prohibited from acting as a guarantor? and (2) Are there any legal preconditions for this subject to prove the guarantee?

Regarding the former, Article 683 of the “Civil Code” stipulates two categories of subjects who are prohibited from acting as a guarantor. The first category is the government agencies with legal person status must not act as guarantors, except where loans from foreign governments or international economic organizations are used in the form of a sub-loan with the approval of the State Council. The second category is the non-profit legal person or unincorporated organization for the purpose of public welfare shall not be a guarantor. Additionally, Articles 5 and 6 of the “Interpretation of Supreme People’s Court on Application of the Security System under the Civil Code” (hereinafter referred to as the “Interpretations”) further refine and expand the scope of restrictions, that is, except for the explicitly specified exceptional circumstances, guarantee contracts provided by residents’ committees or villagers’ committees are invalid. 

Regarding the latter, Article 15 of the “Company Law” states that, “Where a company intends to invest in any other enterprise or provide guaranty for any other person, such matter shall, in accordance with the articles of association, be decided by the board of directors or the shareholders’ meeting. If the articles of association prescribe any limit on the total amount of investments or guaranties, or on the amount of a single investment or guaranty, the aforesaid prescribed limit shall not be exceeded. Where a company provides a guaranty for any shareholder or actual controller of the company, it shall be subject to a resolution of the shareholders’ meeting. The shareholder as mentioned in the preceding paragraph or the shareholder controlled by the actual controller as set forth in the preceding paragraph shall not participate in voting on any matter as prescribed in the preceding paragraph. Such matter shall be adopted by more than half of the voting rights held by other shareholders present at the meeting.” Article 135 stats that, “Where the amount of any major asset purchased or sold or any guaranty provided to others by a listed company within one year exceeds 30% of the total amount of its assets, a resolution shall be made by the shareholders’ meeting and adopted by the shareholders representing two thirds of the voting rights who are present at the meeting.” Therefore, if the guarantor is a company, it is necessary to ensure compliance with legal preconditions, including the required voting procedures for providing guarantees, guarantee limits, voting subjects and so on. Although the “Interpretations” has stated rules in dealing with the defects in violating Article 15 of the *Company Law* (such as safeguards for good-faith creditors), it is still recommended to avoid procedural defects to eliminate risks.

In practice, when accepting a surety guarantee from a company, two key points should be implemented: (1) Request the counterparty to provide the latest articles of association stamped by the archives department of the registration authority to confirm the voting procedures, subjects, and guarantee limits. and (2) Verify the authenticity of the resolution signatures, such as through screen recording for individual shareholders’ signatures by special apps, such as Unitrust Time Stamp Authority and so on. 

In addition to confirming the third party’s capacity to provide guarantees, it is also necessary to review the third party’s creditworthiness for surety guarantees, such as solvency, litigation history and so on. 

Secondly, from the perspective of guarantee methods when a third party provides a property guarantee, it is necessary to confirm the nature, ownership, and priority of the property. Property guarantees include mortgages and pledges. Article 399 of the *Civil Code* stipulates six types of properties that cannot be mortgaged, which are properties with unclear or disputed ownership or use rights, and properties legally sealed, seized, or supervised, and etc. Article 49 of the Interpretations states that, “Where an illegal building is mortgaged, the mortgage contract shall be invalid, unless the legal procedures have been gone through before the end of the court debate in the trial of first instance.” Therefore, when accepting property guarantees, it is essential to confirm whether the subject matter falls within the statutorily prohibited mortgage scope. It is recommended to verify the status of mortgaged or pledged properties before the transaction, such as, checking the real estate register to confirm ownership and whether there are seals, seizures, mortgages, or established habitation rights; and conducting on-site visits to check for tenancy, possession by others, or seals. For property guarantees such as real estate, equity, or equipment, there are corresponding registration platforms, such as real estate transaction centers, SAMR system, and the China Securities Depository and Clearing Corporation (CSDC), so it is recommended to conduct the registration procedure timely, which can help creditors to avoid losing priority of compensation and the right to oppose good-faith third parties. 

Finally, the terms of the guarantee contract are also important, such as the scope of guarantee, guarantee period, and guarantee method. For example, if the guarantee method is not agreed as joint liability, it is deemed a general guarantee; if the guarantee period is not agreed, it shall be deemed as 6 months from the expiration of the principal debt performance period; or if there is no agreement prohibiting the mortgagor from transferring the property, the mortgagor may transfer the property.