Financial security in commercial bank auto supply chains 

Commercial banks help to finance the automobile supply chain through their funding of auto dealers to buy vehicles from manufacturers. They do this based on mortgaging/pledging of vehicles and the certificates of supervised vehicles, backed by dealers’ sales. As creditors, lenders focus on the creation and realisation of security rights.

Common security means

The creation and effectiveness of vehicle pledge under the mode of third-party on-site supervision. Vehicle pledge is the most important guarantee for bank claims in the finance business of the automobile supply chain. With vehicles for sale as general movable property, the creation of a pledge must meet the requirements of a “written pledge contract” and “delivery of the pledged property” in articles 427 and 429 of the Civil Code.

In practice, after signing a written pledge contract, banks usually entrust a third party to rent the dealer’s premises or warehouse as the supervisor of pledged property to conduct on-site supervision over the pledged vehicles. On the premise of possession of vehicles, banks allow pledged vehicles to be dynamically replaced or to be replaced with new ones within a certain value range.

As the bank does not directly possess the pledged property and the property is stored in the pledgor’s premises, the most important question for the bank is whether possession of the vehicle is realised. In accordance with article 63 of the Minutes of the National Working Conference on the Trial of Civil and Commercial Cases by Courts, whether the creditor and the supervisor create an entrusted relationship and whether the pledged property is delivered will affect the judgment of the effectiveness of the pledge under the Civil Code, thus affecting the realisation of the pledge. In the financial loan contract dispute of Bank of Dalian v Kulun Banner-based Zuoyuan Sugar Industry, the pledgor, Jinzhou-based Zuoyuan Sugar and Food, did not transfer the pledged property, refused to let the supervisor in, and even expelled the supervisor, and the pledged property was still actually controlled and dominated by the pledgor, so the court held that the pledge was not created according to law.

According to the requirements of the Civil Code on the creation of pledges, in view of the requirement for third-party on-site supervision, banks should focus on the establishment of entrusted supervision and the delivery of vehicles, and ensure effective control over the vehicles.

Opposing effect of vehicle floating mortgage registration and its tracing effect on buyers. At the same time as drawing up vehicle pledges, to prevent the risk that the pledge is not effectively created, banks usually require dealers to take out floating mortgages on vehicles. According to the effectiveness rules of a mortgage on movable property and the rules regarding buyers in normal business activities under the Civil Code, the following issues require attention in setting up vehicle floating mortgages:

. Only when a vehicle is registered as a mortgage can it take effect against a bona fide third party. In accordance with article 403 of the Civil Code, the mortgage on movable property adopts registration antagonism, and the mortgage is created when the mortgage contract enters into effect. Without registration, the mortgage may not be asserted against a bona fide third party, so registration must be made in time through the public unified registration system for movable property financing of the central bank’s Credit Reference Centre.

. A bank mortgage has no retroactive effect on buyers engaged in normal business activities. Although mortgage registration gives the mortgage the effect against a bona fide third party, in accordance with article 404 of the Civil Code, for the buyer who has paid a reasonable price and acquired the mortgaged property in the ordinary course of business, the mortgage has no retroactive effect and is not limited by whether the buyer is bona fide or not.

An unregistered mortgage, then, can’t be asserted against a bona fide third party, and a registered mortgage can’t be asserted against buyers in the ordinary course of business. Therefore, vehicle mortgage offers weak protection of claims, so it should not be used as the only security.

Supervision of the vehicle certificate has no security effect. The vehicle certificate is required for vehicle registration and proves the roadworthiness of the auto when leaving the factory. With supervision over the vehicle certificate as a risk control measure, banks usually require dealers to redeem the corresponding certificates with vehicle sales payments to ensure the realisation of bank claims. However, it should be noted that since the vehicle certificate does not have the attribute of property and cannot be transferred separately, it is not a certificate of rights that can be pledged. A bank’s supervision over the certificate is not a pledge, and so such supervision cannot replace pledges and mortgages on vehicles.

Risk control measures

As mentioned earlier, in the finance business of the automobile supply chain, the pledge and mortgage on property secured by vehicles are the main guarantees for banks to realise their claims. Therefore, commercial banks should focus on the effectiveness of their pledges and mortgages.

Commercial banks should take the following risk control measures:

(1) Clarify the delivery and possession procedures of pledged property under the third-party on-site supervision mode, establishing the entrusted supervision relationship between banks and supervisors through agreements, and requiring dealers to deliver pledged vehicles to supervisors;

(2) establish strict control measures for pledged vehicles, including examination and verification of pledged vehicles, supervision and release of vehicle certificates, and outbound control of vehicles, and clarify the responsibility of supervisors for improper supervision; and

(3) avoid taking the vehicle floating mortgage as the only way to secure the claims in order to prevent the bona fide third party and the buyer from claiming the vehicles.

Yao Xiaomin is a partner and Wang Yao is an associate at Lantai Partners