Judicial exceptions to abstract principle of ‘negotiable instruments’

By Yao Xiaomin and Guo Xiaohan, Lantai Partners
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Disputes over negotiable instruments have long been a major type of commercial dispute. According to records on the China Judgment Online, an official website, the number of civil cases with “dispute over negotiable instruments” as the cause of action nearly doubled from 2017 to 2021. Among such cases, those involving the abstract principle of negotiable instruments mostly concern the determination of a “real transaction relationship”. Transactions behind negotiable instruments, circulated in complex commercial activities, are not always strictly consistent with their endorsement and may involve other unrecorded parties. Some instruments were not based on real transactions at all.

This article analyses judicial judgment views on a “real transaction relationship” in disputes over negotiable instruments, with a focus on exceptions to the abstract principle.

CURRENT LAWS AND REGULATIONS

Yao Xiaomin, Lantai Partners
Yao Xiaomin
Partner
Lantai Partners

Article 10 of the Law of Negotiable Instruments; article 2 of the Provisions of the Supreme People’s Court on Several Issues Concerning the Trial of Disputes over Negotiable Instruments; article 10 of the Measures for the Implementation of Administration of Negotiable Instruments; article 92 of the Measures for Payment and Settlement; and article 35 of the Measures for the Administration of Electronic Commercial Draft Business all provide that a “real transaction relationship” must exist for negotiable instruments.

China’s legislative support on negotiable instruments does not focus on the absolute abstract principle, and the underlying relationship between the immediate parties will still affect the legality of the transaction.

After the promulgation of the Minutes of the National Working Conference on the Trial of Civil and Commercial Cases by Courts, acquiring negotiable instruments without a real transaction background will directly lead to the invalidity of the transfer. If private discounting is involved, it would even be subject to criminal investigation.

TRIAL ON EXCEPTIONS

As China’s legislative and judiciary systems support the relative abstract principle of negotiable instruments, a real transaction relationship is applied differently in judicial practice. Whether the holder substantially has legal rights to negotiable instruments does not depend entirely on the “holding” of them. The following are circumstances that may impede a holder’s legal rights to negotiable instruments in court review, leading to exceptions to the abstract principle.

Guo Xiaohan, Lantai Partners
Guo Xiaohan
Associate
Lantai Partners

The holder of a negotiable instrument has a direct creditor-debtor relationship with the debtor and failed to perform the stipulated obligations. In accordance with article 13 of the Law of Negotiable Instruments, and article 14 of the above-mentioned provisions, one exception to the abstract principle is that “the holder of a negotiable instrument has a direct creditor-debtor relationship with the debtor, and fails to perform the stipulated obligations”.

In Sinorack Storage Equipment v Dongning Heizun Biotechnology (2020), the court ruled that the holder did not fully fulfil the contractual obligations involved in the underlying transaction of the disputed negotiable instrument, as proven by the debtor, which was in line with the exceptions to the abstract principle. Thus, the debtor was exempted from its obligations related to the negotiable instrument.

The issue, acceptance, delivery, endorsement and transfer of negotiable instruments are suspected of involving illegal acts. According to article 8 of the above-mentioned provisions: “If the issue, acceptance, delivery, endorsement and transfer of a negotiable instrument are suspected of involving fraud, theft, coercion, intimidation, violence and other illegal acts, the holder shall be responsible for proving the legality of the negotiable instrument.”

In the right of recourse dispute of Quanzhou Yuanbing Commerce v Quanzhou Yuanan Investment and Zijin Mining Group Gold Jewelry (2020), the court ruled that the holder and debtor of the negotiable instrument were affiliates and interested parties, making it impossible to effectively prove that the two companies had a real transaction relationship, or if any consideration was paid.

The holder had clear knowledge of the fact that the draft involved could not be accepted on time when it obtained the negotiable instrument. Therefore, the court decided the holder did not enjoy rights to the negotiable instrument.

No consideration was paid for the transfer of negotiable instruments. According to article 10 of the Law of Negotiable Instruments: “A negotiable instrument shall be acquired for certain consideration.” In Nanjing Shuangjia Coating v Jialin Construction Group (2021), the court held that Jialin transferred a negotiable instrument by endorsement to Shuangjia to cash the negotiable instrument, and Shuangjia failed to pay the consideration to Jialin after obtaining it, which damaged Jialin’s rights and violated the Law of Negotiable Instruments. Therefore, Jialin had the right to request Shuangjia, the holder, to return the price for, or rights associated with, the negotiable instrument.

Private discounting. According to article 101 of the above-mentioned minutes, private discounting is invalid. In Henan Honghui Industrial and Liu Youchang v Henan Ruilin Construction (2021), the court held that discounting of negotiable instruments falls under activities subject to licensing of the nation, and if the legal holder obtained “discounting” of a negotiable instrument from a party lacking the legal qualification, the act should be invalid.

Some courts have different understandings. In a dispute over right of recourse in Shanghai Fengshun v Shijiazhuang Sanshan (2020), the court held that the minutes did not constitute judicial interpretation, hence could not be used as a basis for judgment.

SUMMARY

A negotiable instrument is a type of right-creating security, and the resultant rights and obligations are determined by the contents recorded within. In disputes over negotiable instruments, courts tend to pay more attention to the abstract principle and literal meaning of the negotiable instrument, to which the burden of proof should be limited, unless the debtor has other defences.

When the form of a negotiable instrument meets statutory requirements, it should generally be presumed that the holder legally enjoys the rights associated with it.

When the debtor mounts a lawful defence, it should produce evidence to substantiate any exception to the abstract principle of negotiable instruments. Verification of a real transaction is therefore significant to both the right holder and the debtor to the negotiable instrument.

Yao Xiaomin is a partner and Guo Xiaohan is an associate at Lantai Partners

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yaoxiaomin@lantai.cn

guoxiaohan@lantai.cn

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