Judgment trends of real right-related disputes under the Civil Code

Although financial dispute cases often take financial loan contract disputes and other creditor’s right disputes as the cause of action, the key issues and the focus of wrestling between the parties often end up focusing on the property used for security and enforcement, which makes real rights under the Civil Code, which comes into effect in January, one of the most important legal bases for financial dispute cases. In this article, the author sums up three key clauses of the section on real rights, with a view to predicting and forecasting any judgment trend of the focus of financial disputes under the norms of the Civil Code.

Mortgaged property transfer

As to whether mortgaged property can be transferred, article 406 of the Civil Code makes subversive legislative changes, clearly providing that “the mortgagor can transfer the mortgaged property” without the consent of the mortgagee, and at the same time clearly specifying that a mortgage runs with the mortgaged property: “Mortgage is not affected if the mortgaged property is transferred.” After the effectiveness of the Civil Code, if the mortgagor transfers the mortgaged property without the consent of the mortgagee, a completely different judgment result may be made with respect to the effect on real right.

Taking case [2018] Ji Min Shen No. 2534 as an example, the court held that the mortgagor’s transferring the mortgaged property without the consent of the mortgagee does not necessarily make the transfer invalid. Before the mortgage on the mortgaged property has been eliminated, unless the transferee agrees, and can pay off the debt to eliminate the mortgage, the court will not support the request to go through the formalities of real right change.

If the case occurs after the Civil Code comes into force, the mortgagor can freely transfer the mortgaged property without any other agreement between the parties, and the formalities for changing the real right are not subject to the elimination of the mortgage on the property. The real right can still be changed without affecting the mortgage on the mortgaged property, even if the mortgaged property is transferred without the consent of the mortgagee. If the mortgagee is able to prove that the transfer of mortgaged property may damage the mortgage, the mortgagee may request the mortgagor to pay off the debt with the proceeds obtained from such transfer in advance, or set aside the proceeds.

Innominate security laws

Article 388 of the Civil Code does not directly use the expression, “innominate security”, but provides that “contracts on the provision of security include mortgage contracts, pledge contracts and other contracts with security functions”. That is, it confirms that security interest is no longer limited to traditional mortgage and pledge, but also includes “other contracts with security functions”, and “for other registrable security interest, the rank of repayment shall be subject to mutatis mutandis (change what needs to be changed) in the provisions of the preceding paragraph”. With the incorporation and upgrading of innominate security in the Civil Code, the security function of innominate security has a clear legal basis in terms of creditor’s rights, and the effectiveness of real rights.

Before the Civil Code comes into force, innominate security was not a statutory way of security, and there was no clear basis for whether the provision of article 16 of the Company Law, “subject to the resolution of the shareholders’ meeting”, applied. Taking the case [2020] Zui Gao Fa Min Shen No. 2155 as an example, the court held that the assignment by way of security involved in this case was an innominate security in the form of the pre-sale contract of commercial housing between the parties.

Whether article 16 of the Company Law is applicable to the innominate security is not clear. Although the pre-sale contract has not been resolved by the company, as a form of security it is valid for maintaining transaction safety and transaction efficiency. After the effectiveness of the Civil Code, “other contracts with security functions” are also included in the scope of security contracts.

Innominate security will have laws to follow, and different judgment results may be made in this case: As a form of security, the pre-sale contract of commercial housing should be subject to resolution of the company’s competent body in accordance with article 16 of the Company Law. If the security is provided without the resolution of the competent body, it is necessary to distinguish whether the creditor is in good faith when concluding the contract to determine the validity of the contract, and the pre-sale contract is not necessarily valid.

Mortgage and pledge co-exist and the rank of repayment is determined by sequence of notice. In accordance with article 79 of the Interpretations of Security Law, when both mortgage and pledge are created on the same chattel, mortgage absolutely takes precedence over pledge, regardless of the order of establishment and the notice method. After the Real Right Law comes into effect, all chattel mortgages adopt registration confrontation doctrine, which is a great change from the previous registration validity doctrine of specific chattel mortgages.

Since then, there has been a dispute in judicial practice on how to determine rank of payment when mortgage and pledge are created on the same chattel, and the core of the dispute is whether article 79 of the Interpretations of Security Law continues to apply. Article 415 of the Civil Code confirms that registration and delivery, as notice methods, have the same legal effect, and changes the provision that registered mortgage takes precedence over pledge.

When the court tries the case of rank of payment of mortgage and pledge on the same property, there will be clear legal provisions to invoke, which is conducive to equal protection of mortgage and pledge. The above-mentioned change also clearly warns the mortgagee to check whether there is a previously registered mortgage, and whether there is a previously established pledge before creating a mortgage, to carefully judge the possibility of realising the mortgage.

A first for China, the Civil Code is sure to have a far-reaching impact on social and economic life after its formal entry into force. Financial cases frequently occur in social and economic life. Under the influence of the Civil Code, the main focus of disputes, and the rules of adjudication of financial cases, are bound to change. Thus, it is necessary to pay close attention to the relevant judicial trends.

Yang Guang is a partner and Yuan Yuhui is an associate at Lantai Partners