New PRC Civil Code: impact on guarantees
The new Civil Code of the People’s Republic of China came into effect from 1st January, 2021, bringing in numerous changes to the rules governing civil disputes in China. Of particular relevance to Members are the changes to the rules relating to guarantees, which we consider in more detail below.
Previously, guarantee contracts were governed by the Guarantee Law of the PRC. This statute has now been replaced by chapter 13 of the Civil Code of the PRC (“the Civil Code”), supplemented by the Interpretation of the Supreme People’s Court on Application of the Civil Code of the People’s Republic of China in Respect of the Guarantee System (“SPC Interpretation of Guarantees”).
Key changes worth noting
Claim against guarantor or debtor first?
There are two kinds of guarantees under PRC law: a general guarantee, under which the parties agree that the guarantor will only be liable to pay in the event that the debtor fails to perform the underlying obligation; and a joint and several liability guarantee in which the parties agree that the guarantor and the debtor shall undertake joint and several liability for the underlying obligation.
The creditor will only be able to claim against the guarantor in the first instance if the guarantee is expressly agreed to be subject to joint and several liability.
The new Civil Code makes it clear that in the absence of express agreement, the guarantee will be treated as a general guarantee only (Article 686 of the Civil Code). This reverses the pre-Civil Code rule that the default position is joint and several liability if there is no express agreement otherwise.
It is therefore recommended that Members expressly agree joint and several liability when drafting guarantees.
Circumstances where a creditor can claim against a guarantor in the first instance under a general guarantee
Theoretically, under a general guarantee the creditor is only able to claim against the guarantor after an attempt to enforce a claim against the debtor’s property, except in certain circumstances. The Civil Code has now introduced several additional circumstances in which creditors can claim against the guarantor in the first instance under a general guarantee (Article 687 of Civil Code).
These include circumstances where the whereabouts of the debtor is unknown and no property is available for enforcement; where the People’s Court has granted the debtor’s application for bankruptcy; where the creditor has evidence showing that the debtor’s assets are not sufficient to fulfil all its obligations or the debtor has lost its capacity to fulfil its obligations; or where the guarantor has waived its defence that a claim should be made against the debtor first.
In addition, in practice a creditor is entitled to commence legal proceedings against a debtor and guarantor together in the same lawsuit even under a general guarantee. Under such circumstances, the court will make it clear in its judgment that the guarantor will be liable only for the portion that remains outstanding after enforcement against the debtor’s assets (Article 26 of the SPC Interpretation of Guarantees).
Time limit for enforcing a guarantee
The Civil Code extends the time limit for general civil disputes to three years. This also applies to claims under a guarantee.
There is also another time-related provision applicable to guarantees, namely the “guarantee period”. Under the Civil Code, in the absence of an explicit agreement between the parties the guarantee period is six months from the date when the principal debt fell due. Under the old regime, this period was two years. In many cases, parties will agree a guarantee period which is longer than the default position of six months. However, if the parties agree in the guarantee that this guarantee will be valid until the debt been fully satisfied, such clause provision will be treated as invalid for lack of clarity and the default six month period will apply. Members are therefore advised to agree a clear and definite guarantee period in the guarantee.
The interaction between the guarantee period and the limitation period is different for general guarantees and joint and several liability guarantees (see Article 693 and 694 of Civil Code):
(1) General guarantee:
A creditor will only be able to preserve its rights to claim against a guarantor if it commences legal proceedings against the debtor within the guarantee period.
Upon satisfaction of the above, the three-year limitation period for a claim against a guarantor will start to run from the date on which the guarantor’s right to refuse to undertake the guarantee liability is extinguished. In other words, the three-year time bar will be triggered if enforcement against the principal debtor’s asset fails to satisfy the debt. Article 28 of SPC Interpretation of Guarantees provides detailed explanation on this trigger point.
(2) Joint and several liability guarantee:
For this kind of guarantee, the creditor only needs to request the guarantor to perform its obligation (rather than commence any proceedings) within the guarantee period in order to protect time.
If the creditor satisfies this requirement, then the three-year limitation period will start to run from the date when the creditor requests the guarantor to honour its liability.
A copy of the PRC Civil Code can downloaded below. Members are invited to contact the Club with any queries regarding the issues discussed above.