The Civil Code and title of property: A banker’s perspective

By Yang Guang and Xu Xiaoxuan, Lantai Partners

Property right is the basis for civil subjects to carry out many civil legal acts, and plays a structural basic value in the civil law system. The Civil Code first determines the Title of Property Right after the General Provisions. Generally speaking, the Title of Property Right inherits most of the provisions of the Property Law and Security Law, and their judicial interpretations.

Yang Guang Lantai Partners property
Yang Guang
Lantai Partners

But it has also made some substantial adjustments, which will have a far-reaching impact on social and economic life. This article, from the perspective of the banking business, especially from the protection of bank rights, responsibility regulation and realization of rights and interests, interprets and analyses the key contents of the Title of Property Right, and puts forward corresponding strategic suggestions.

Right of habitation. The Civil Code newly creates the right of habitation, introducing this right into the Chinese civil law system for the first time. The Civil Code defines the right of habitation as “the usufruct to occupy and use another’s housing unit so as to meet the needs of living”. Unless otherwise agreed by the parties, the right of habitation shall be created free of charge, and shall not be used for lease, transfer or inheritance.

Xu Xiaoxuan Lantai Partners property
Xu Xiaoxuan
Lantai Partners

It should be noted that even if a housing unit subject to the right of habitation can be transferred, it is necessary to protect the rights and interests of the person having the right of habitation. Therefore, when reviewing the status of related real estate, banks should not only inquire about ownership, judicial seizure, mortgage, etc., but also pay attention to inquiring whether the property has been registered under the right of habitation.

It is not recommended to accept the mortgage of a property with the right of habitation as a strong security measure. If the right of habitation is registered after the property is mortgaged, although the mortgage priority is not affected, it increases the difficulty of realizing the mortgage to a certain extent. Therefore, banks should strengthen the post-loan management of the individual mortgaged property and regularly check the registration of the right of habitation of the property.

Innominate security contract. Article 388 of the Civil Code for the first time recognizes the validity of the innominate security contract with security function legally. Innominate security usually includes transferring security, title retention, financial leasing, factoring, etc. The valuation adjustment mechanism (VAM), making up the balance, repo-to-maturity or conditional repurchase, liquidity support, confirming storage transaction, etc., involved in the Minutes of the National Working Conference on the Trial of Civil and Commercial Cases by Courts, issued in 2019, might also conform to the elements of innominate security contracts.

The Civil Code provides a richer choice of credit structure for banks to carry out credit business. When exploring the innominate security mode, banks should pay attention to the liquidity and disposability of secured property, the authenticity of underlying transactions, the internal resolution procedures of innominate security, and the security registration procedures (if applicable).

Fluidity clause. The Property Law establishes the rules of a prohibiting fluidity clause, but absolute prohibition is not conducive to maximizing the value of secured property. Articles 401 and 428 of the Civil Code do not directly restrict the parties’ agreement on the fluidity clause with the expression, “shall not”, but they make it clear that creditors can only get priority in repayment for the secured property according to law.

Although the Civil Code takes a more moderate attitude on the issue of fluidity clause, if the bank agrees with the debtor on a fluidity clause in its mortgage and pledge business, the fluidity clause is likely to be decided invalid, or not legally binding, by the people’s court. It should be noted that the provision, “creditors can only get priority in repayment for the secured property according to law” should still be based on the premise that the mortgage (pledge) right has been effectively established.

Mortgage does not affect the original leasehold relations. The Property Law provides that, “In case the mortgaged property has been leased before the conclusion of the mortgage contract, the original leasehold relations shall not be affected by the mortgage”, but does not define the standard of, “the mortgaged property has been leased”. In practice, the mortgagor and the lessee may create the false appearance of “leasing first and mortgaging later” through an inverted lease contract, which harms the interests of the mortgagee.

Article 405 of the Civil Code clarifies that the provision that, “the original leasehold relations shall not be affected by the mortgage” needs to meet two preconditions: “there is an effective lease contract”; and “the possession of the mortgaged property has been transferred” before the creation of mortgage. As the mortgagee, the bank can decide whether there are other prior rights in the mortgage through due diligence and on-the-spot inspection, and secure the evidence that the possession of the mortgaged property has not been transferred for rights protection. If the lessee has occupied or used the mortgaged assets, the bank should require the mortgagor to eliminate the defect, or provide other security as soon as possible.

Transfer of mortgaged property. The Property Law prohibits the mortgagor from transferring the mortgaged property without the consent of the mortgagee, which reduces the circulation value of the mortgaged property to a certain extent. Article 406 of the Civil Code clarifies the mortgage transfer rules: (1) if there is an agreement between the mortgagee and the mortgagor, the agreement shall apply; (2) if there is no agreement, the mortgagor may transfer the mortgaged property without the consent of the mortgagee, but shall notify the mortgagee in time; and (3) the transfer of mortgaged property does not affect the effect of mortgage right.

If the mortgagee can prove that the transfer of mortgaged property may damage the realization of mortgage right, it may demand that the transfer price be paid off or deposited in advance. It is suggested that the bank should clearly stipulate in the mortgage contract that the mortgagor may not transfer the collateral without the consent of the bank, and the transfer here is not limited to buying and selling, but also includes barter, gifts, and taking shares through investment.

It should be noted that what validity the agreement reached between the mortgagee and the mortgagor to restrict the transfer of mortgaged property has, whether it can operate against the buyer, and what the standard of “timely notification” is, need to be further clarified through judicial interpretation.

Yang Guang is a partner and Xu Xiaoxuan is an associate at Lantai Partners

Yang Guang Xu Xiaoxuan Lantai Partners property

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