A guarantee issued by a Chinese entity to secure contractual obligations or repayment of debt is not an unfamiliar subject for people in the shipping industry. The uncertainty for a foreign party with Chinese guarantees, is that as the guarantee is given in a foreign currency (usually in United States dollars), it may well be subject to the foreign exchange control regulations in the People's Republic of China (PRC or China). This can present problems when it comes to enforcement. The Chinese guarantor may deny liability on grounds that the guarantee is invalid if it has not been approved by (or registered with) China's State Administration of Foreign Exchange (SAFE), or if the guarantee has not been issued with proper corporate authorisation, in accordance with the Chinese guarantor's articles of association, or internal rules. Although the effectiveness of the guarantee is a matter of Chinese law, the guarantee contract itself is usually governed by English law and subject to jurisdiction of the English courts, or London arbitration. As such, disputes may find their way to London, for resolution under English law, with evidence of Chinese law being adduced, where necessary.
SAFE approval – is it still required?
The starting point is whether a guarantee needs SAFE approval. Previously, under the Measures for the Administration of External Guarantee Provided by Domestic Institutions 1996 (the 1996 SAFE Measures), all "external guarantees" were required to be approved by SAFE. An external guarantee means an undertaking, in writing, by an institution within China to a party outside China that if the debtor fails to pay the debt when it falls due for payment, the guarantor will make payment upon demand. The guarantor may be a Chinese financial institution, a Chinese enterprise or a foreign-invested enterprise. A domestic enterprise can provide external guarantees only for its foreign subsidiary or for an enterprise in which it holds equity for a share of the debt, in proportion to the equity it owns; and if a guarantor provides an external guarantee without SAFE's approval, the guarantee is invalid.
This requirement was subsequently relaxed. The latest SAFE Notice Concerning the Administration of Foreign Security Provided by Domestic Institutions (the 2010 SAFE Notice) provides that there is no limit on the quota of non-financing foreign security provided by a Chinese bank qualified to engage in the business of issuing guarantees. These banks need not apply to SAFE for approval on a case-by-case basis, provided the relevant risk management provisions of the regulatory authorities are complied with.
Non-financing foreign security means foreign security other than security for the performance of underlying contracts of a debt financing nature. These include, for example, quality guarantees, project completion guarantees, tender guarantees, advance-payment guarantees, deferred payment guarantees and performance guarantees under contracts for the sale and purchase of goods. It is our view that refund guarantees in respect of shipbuilding contracts and letters of undertaking for payment of hire under charterparties, also fall within this category and, therefore, case-by-case approval should not be required. Chinese banks are still, however, required to register such guarantees with SAFE in the usual way.
Notwithstanding the changes made by the 2010 SAFE Notice, guarantees provided by Chinese non-banking institutions, or guarantees provided by Chinese banks for an underlying contract of a debt financing nature, are still subject to quota limits, or case-by-case approval (as the case may be), from SAFE, under the 2010 SAFE Notice.
Effectiveness of guarantees without SAFE approval
Under Chinese Contract Law 1999, a contract is null and void if it violates the mandatory provisions of Chinese law and administrative regulations. "Administrative regulations" is a defined term under Chinese law. It means those administrative regulations issued by the State Council, rather than by local governments or ministries of the State Council. It is suggested that the 1996 SAFE Measures are not "administrative regulations", as they are issued by SAFE and not the State Council. Therefore, breach of the 1996 SAFE Measures does not necessarily make a guarantee null and void. Conversely, maybe an equally strong argument that SAFE regulations should not be neglected merely because they are not administrative regulations, since they safeguard China's foreign exchange control policy.
In reality, one is more concerned with the question whether, if the guarantee is invalid under Chinese law for lack of approval by SAFE, will the guarantor will still be liable for payment to the beneficiary? Under article 7 of the Interpretation of Guarantee Law by the Supreme People's Court (2000), the guarantor and debtor assume joint liability for the beneficiary's loss if the principal contract is valid, provided the guarantee contract is invalid through no fault on the part of the beneficiary. If the beneficiary and the guarantor are both at fault, the guarantor's portion of civil liability will not exceed half of the debtor's unpaid debt. A beneficiary will, therefore, do his own due diligence and check whether the guarantee needs to be approved by SAFE and if so whether such approval has been granted before accepting it. If the beneficiary fails to conduct such due diligence, he may be regarded as partially at fault himself and will not be able to recover the full amount of the guaranteed debt.
In the English courts
The English courts have recently considered a Chinese guarantor's liability under a guarantee which had not been approved by SAFE, in Emeraldian Ltd Partnership v Wellmix Shipping Ltd and another (The Vine) [2011] 1 Lloyd's Rep. 301. In this case, the Chinese guarantor denied liability on the basis that the guarantee was signed by a member of staff allegedly without proper corporate authorisation. Mr Justice Teare made the following findings of fact in relation to Chinese law in his judgment.
In China, the fact that an overseas guarantee is issued without the authorisation of SAFE does not result in the unenforceability of the civil liability otherwise arising from the guarantee...the liability may not in a strict sense be "classified as guaranteed liability in nature"...but it appears to be a liability which is, in a real sense, "based on the guarantee contract"... In these circumstances it does not appear ... that English public policy requires the court to refuse to enforce a guarantee governed by English law which was issued in China in breach of the local law.
Although the judge's comments on Chinese law, above, are findings of fact which may not be binding in later cases, they do serve to illustrate the English court's approach to the issue and will, most probably, influence other judges and arbitrators considering the same point.
Enforcement in China
It is not clear whether a foreign award which stipulates that a guarantee which has not been approved by SAFE is enforceable can actually be enforced in the PRC. The PRC is a signatory to the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York Convention 1958).
One argument is that enforcement of such a foreign award would violate Chinese law - particularly if it were necessary to purchase foreign exchange in order to satisfy liability under the award - and would therefore fall within the public policy exception (rendered in China as public and social interest) of Article V of the New York Convention 1958, rendering the award unenforceable in China.
Two recent judicial responses from China's Supreme People's Court to its lower courts have shown that this may not necessarily be the result. The first is the Reply of Supreme People's Court Concerning Applications Filed by ED&F Man (Hong Kong) Co Ltd for Recognition and Enforcement of the Arbitration Award Made by London Sugar Association (2003) concerning a futures contract which would be invalid under Chinese law. The second is the Reply of the Supreme People's Court Concerning Refusal to Recognise and Enforce the Arbitration Award Made by the Arbitration Institute of the Stockholm Chamber of Commerce (2001) concerning a Chinese state-owned corporation which had assumed liability for the debt of another company without SAFE approval. In both replies, the Supreme People's Court held that the violation of mandatory provisions of Chinese law does not necessarily constitute a violation of Chinese public policy and, therefore, the foreign awards should be enforced in China.
China is not a common law jurisdiction and judicial precedent is not binding. Although replies of the Supreme People's Court carry a lot of weight, they are (strictly speaking) not judicial interpretations of the law by the Supreme People's Court. These replies are prompted by the lower courts and based on fact-specific cases. The Supreme People's Court may change its views in the future, if asked to consider a different set of facts surrounding the same issue.
Conclusion
Acceptance of a Chinese guarantee may entail a degree of risk for the beneficiary. One should always check whether the guarantee needs approval by SAFE and whether the guarantor has obtained corporate authorisation for the issuance of the guarantee. Where possible, local counsel in China should be asked to check and advise on these matters, as they will be governed by Chinese law (although ostensible (apparent) authority is a separate issue to be determined by English law). If a dispute arises and the guarantee comes to be considered by an English court or arbitral tribunal, full and frank disclosure of documents relating to the issues in dispute will be important, as always.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
