Risks, dispute points with pledging special movable property

By Yao Xiaomin and Sun Yangyang, Lantai Partners
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Special movable property refers to movable objects with a large economic value and infrequent changes in ownership, the examples of which are enumerated in the Civil Code to include ships, aircraft and motor vehicles. This article analyses key elements of pledging special movable property and dispute points in practice to assist financial institutions to effectively create and realise pledge rights.

CREATING A PLEDGE RIGHT

According to articles 225 and 429 of the Civil Code, a pledge right of special movable property becomes effective by delivery and enforceable against third parties upon registration.

Yao Xiaomin, Lantai Partners
Yao Xiaomin
Partner
Lantai Partners

(1) Concluding the pledge contract in writing. According to article 427 of the Civil Code, the parties, in order to create a pledge right, shall conclude a pledge contract in writing that reflects their expression of the true intent without any invalidity as stipulated in the Civil Code.

(2) The delivery of the pledged property. In the case of actual delivery and simple delivery, the pledgee’s actual possession of the pledged property may constitute a valid delivery. In the case of delivery under instruction, in addition to indirectly possessing and controlling the pledged property through a third party in place of the pledgor, the pledgee also needs to ascertain whether he or she has actual control over the pledged property in combination with legal formalities and control procedures.

KEY POINTS IN PLEDGE DISPUTES

Disputes over pledges on special movable property mostly occur in the pledge process of motor vehicles, but they can also serve as references for the less common pledges of ships and aircraft.

  1. Is the pledge validly created?
    • No written pledge contract is signed. In Zhou v Ni (2021), the creditor claimed that the debtor had pledged a ship to him or her, but failed to provide evidence such as a written pledge contract to substantiate the claim. Hence the court did not support the creditor’s claim for priority of repayment.
    • A motor vehicle was pledged as security for the loan and delivered. In Hu v Yu and Tong (2010), Yu issued a loan note to Hu containing, “This loan is secured by a pledge of Yu’s car,” and the car had been delivered to Hu already. The court characterised the case as a dispute over the pledge contract.
    • The delivery of a car licence only. In China Cinda Asset Management v Ning Xia YiHe Tongda Automobile Sales & Service et al (2021), the court held that a car licence was only a legal document certifying the qualification of the whole car, which neither had the attributes of property right nor could be sold off, and delivery of the car licence alone could not constitute the creation of a car pledge.
    • The third-party regulation of pledge of special movable property. In Bank of Communications (Guangzhou Huangpu sub-branch) v Handan Qishun Automobile Trading (2020), the pledged vehicle was sold privately by the custodian, resulting in the pledgee being out of actual possession of the pledged property, thus preventing the pledge from being created and realised.
  2. Bona fide acquisition of pledge rights. When the pledge right of a motor vehicle involves bona fide acquisition, there is a possibility that the court will not support the claim of bona fide acquisition if only the right of possession or registration is obtained, such as in the case of Hu v Yu and Tong (2010).
  3. Security interests share a “co-opetition” (co-operation between competing companies) relationship. As all security interests claims have priority of repayment, a conflict of effectiveness will arise in the event of co-opetition of security interests. In Guo v Fu and Hao (2019), the mortgage was registered and the pledge right was effective by the delivery of the pledged property, so the order of repayment for different security interests should be determined depending on whether their public notices were issued, and their time of issuance.
  4. Realisation of the pledge right. In Franklin Company v Yao (2011), the court held that the pledgee had a pledge of a motor vehicle and could realise the pledge right by means of auction, sale or discount, but was not entitled to have the vehicle registered in the pledgee’s name.

PRACTICAL ADVICE ON PLEDGES

Sun Yangyang, Lantai Partners
Sun Yangyang
Associate
Lantai Partners

Combined with the above-mentioned analysis of the elements for establishing a pledge of special movable property and relevant dispute points, financial institutions should pay attention to the following points when handling a pledge of special movable property.

(1) Check if any other security is created on the property before creating a pledge over it. When accepting a pledge, financial institutions should investigate and verify the ownership of the property, and any information and data of the special movable property through all possible channels.

(2) Sign a valid written pledge contract. In addition to signing the pledge contract in writing and clearly agreeing on the terms stipulated in article 427 of the Civil Code, financial institutions should focus on how the pledgee delivers the pledged property and related documents, and the restrictions on the creation of secondary security on the pledged property.

(3) Completion of effective delivery and registration of the pledged property. The delivery of special movable property may be accomplished through actual delivery, summary delivery or delivery under instruction, but neither by nominal possession nor by delivery of the property’s licence alone. Financial institutions may consider adopting “indirect possession via a third party”, and require the pledgee to deliver the relevant licences of the pledged property and complete pledge registration to protect the effectiveness of the pledge and reduce the risk of secondary mortgage or resale.

(4) Legal realisation of the pledge. The realisation of the pledge should be based on the existing legal provisions and the intention of building the pledge system. To realise pledge rights financial institutions may: auction or sell the pledged property to fully realise its value; or reach an agreement with the pledgee for a discount on the pledged property without prejudice to the interests of other pledgees.

Yao Xiaomin is a partner and Sun Yangyang is an associate at Lantai Partners

Lantai Partners
29th Floor, Tower B, Disanzhiye Mansion
A1 Shuguang Xili, Chaoyang District
Beijing 100028, China
Tel: +86 10 5228 7777
Fax: +86 10 5822 0039
E-mail:

yaoxiaomin@lantai.cn

sunyangyang@lantai.cn

www.lantai.cn

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