Releasing guarantors from liability

In disputes over loan and guarantee contracts, there are situations where the guarantor will not be liable due to the invalidity of the guarantee contract.

There are also situations where, although the contract is valid, a court will release a guarantor from its liability on specific grounds, despite the contract being valid.

But how can a guarantor distinguish and assert grounds for release from liability?

Company A, a listed company, entered into a three-year loan contract with a bank in 2003. Company B guaranteed the loan, jointly and severally, for two years from the day immediately following the date on which the loan was to fall due (the guarantee term expiring in 2008).

After the loan was made, the bank transferred claim to the loan to company C. In 2006, company C acquired approximately 40% of the equity of company A. Company C, which was the creditor, thus had actual control of company A.

Despite this, after the loan fell due, company A did not repay the principal of the loan to company C, despite recording good business performance and having adequate funds. Instead it paid only the interest on a regular basis. Company C did not take legal action, but rather issued payment reminder notices to company A and company B each year, purposefully to extend the applicable limitation period.

Since the beginning of this year, company A’s business performance has deteriorated. Company B fears that company C may sell its shares in company A, then take legal action demanding that company B bear the guarantee liability.

What strategy should company B take to address this legal risk, and can it claim grounds for release from its liability?

Case analysis

It is incumbent on company B, as the guarantor, to analyse the relevant contracts for possible legal defects which may be grounds for reducing or releasing it from liability.

In this case, the loan was made and procedures were properly followed. Both contracts represented the true intention of the parties, did not violate any laws and should therefore be deemed lawful and valid.

When the bank transferred the claim to the current creditor, company C, it notified the guarantor, company B. There were no defects in the transfer procedures. Accordingly the transfer of the claim should be deemed valid, and company B was not released from its liability as guarantor.

Although the creditor, company C, obtained actual control of the debtor, company A, the two retained independent personalities. The claim and debt under the loan contract did not vest in the same party, and were thus not merged or extinguished.

After acquisition of the claim, company C asserted its rights against company B in the form of written payment reminders during the term of the guarantee. The limitation of actions on the claim secured by party B was not exceeded.

After receiving the reminder notices from company C, company B did not repay the loan on company A’s behalf. Accordingly, company B did not secure any right of recourse against company A.

Options

Based on the foregoing, the following three options to resolve the difficulty faced by company B may be considered:

• Passive option: urging company A to repay the principal and interest, so as to reduce or release company B’s liability as guarantor. In this option, company B is passive. As company C controls company A, it is likely that if company C sells its equity in company A, it will take legal action against company B seeking to recover the loan. As company A’s financial position has deteriorated, company B may be unable to obtain compensation even if it seeks recourse against company A in future.
• Active option: company B repays the loan to company C on company A’s behalf, securing a right of recourse against company A, while also applying for preservation of company A’s assets and instituting a recovery action against company A for its loss. In this option, company B must advance a large amount to repay the debt, and also risks that company A may become insolvent during the recovery process. Furthermore, providing the required property security when taking property preservation measures against company A will increase company B’s risks and burden.
• Ideal option: company B takes legal action to terminate the guarantee contract. The grounds for termination would be that the creditor and the debtor agreed to change the term for performance of the principal debt obligation without the written consent of the guarantor. According to article 30 of the Supreme People’s Court Several Issues Concerning the Application of the PRC Security Law Interpretations, in such circumstances the original term of the guarantee should remain unaltered (and, in this case, therefore expired in 2008).

This option is naturally difficult to implement, as company B does not possess direct evidence of company C and company A extending the term for performance of the debt obligations. However, as company A paid interest but not principal after the debt fell due, it can be surmised that there was an arrangement for the extension of repayment between the parties. As company A is a listed company, the resolutions of its shareholders’ meeting and board of directors, and other such documents are publicly available, and if company B can, after a thorough examination of the evidence, obtain evidence that company C expressly or implicitly agreed to company A extending repayment, it should have a chance to make a case for release from guarantee liability.

In short, taking this option may help to resolve company B’s difficult situation, and even if it proves unsuccessful, the risks faced by company B will not increase as a result.

Xu Dang is a lawyer at Dacheng Law Offices