Banking litigation is defined in a broad sense in this chapter, referring to litigation where one of the parties is a banking or financial institution, such as a bank, a securities company or a fund management company. This chapter focuses on the recent developments in banking litigation in China (in this chapter, China refers to mainland China). It is known that the laws of China belong to the civil law system, in which statutes form the sources of law.
II RECENT LEGISLATIVE DEVELOPMENTS
After years of development, China has established its financial legal framework, which encompasses key laws, such as the Law on the People's Bank of China, the Law on Commercial Banks, the Banking Supervision Law, the Securities Law, the Securities Investment Fund Law and the Insurance Law, supplemented with administrative regulations, and other regulatory documents as essential rules. Along with the prosperity of banking business in China, the National People's Congress and its Standing Committee (the legislature) has enacted and amended numerous statutes, and the Supreme People's Court (SPC) has released judicial interpretations, both of which have had long-lasting effects on banking litigation.
i General Provisions of the Civil Law
China has adopted a ‘unified manner' for its civil and business legislation. As the opening and guiding part of the coming Civil Code, the General Provisions of the Civil Law (GPCL) will come into force on 1 October 2017 and will facilitate the resolution of banking disputes.
Customs may apply to banking litigation
As provided under Article 10 of the GPCL, both laws and customs can be applied to resolve civil disputes. Therefore, customs have become one of the sources of law in China. When not provided for by law, courts may resolve disputes in accordance with customs that are not contrary to public policy or morality. With regard to banking litigation, customs in banking business will undoubtedly play an essential role in the resolution of related disputes in the absence of law, which consequently requires legal practitioners not only to possess a thorough understanding of banking transactions but also comprehensive experience of the ordinary course of business therein.
Extension of the statute of limitations
The statute of limitations is a rule that states that where an obligee fails to exercise his or her right within a certain period, he or she is no longer entitled to exercise the right and the obliger may no longer be obliged to fulfil his or her obligation. The GPCL extends the general statute of limitations from two years to three years. This extension is conducive to the protection of creditors' rights in banking disputes. Confusion, however, may arise in the transitional period of the statute of limitations. For instance, when the two-year period expires before the GPCL comes into force but the three-year period under the GPCL has not yet been met, the question of whether the two- or three-year time limit shall apply to protect the creditor's rights remains unclear and it is to be further interpreted by the legislature or the SPC.
It is worth noting that the GPCL is the product of civil and commercial judicial practice of the past 30 years in China. Hence, the differences between the old and new rules are rather small. Confusion or uncertainty in the transitional period resulting from revisions, such as the previous example regarding the statute of limitations, has rarely occurred.
Validity of juridical acts
The GPCL provides uniform rules regarding the validity of juridical acts:
a juridical acts resulting from fraud and coercion by the other party shall be revocable;
b fraud or coercion by a third party will affect the validity of a juridical act, which shall be revocable; and
c juridical acts are revocable if they are evidently and unfairly constituted as the direct consequence of one party taking advantage of the other party's distress or lack of judgement.
The GPCL provides that a juridical act violating the imperative provisions of any law or administrative regulation is not inevitably void, as it would depend on the nature of the imperative provision it has violated. This provision is also applicable to the validity of banking juridical acts.
ii Provisions of the Supreme People's Court on Several Issues concerning the Trial of Independent Guarantee Dispute Cases
As known to legal practitioners, independent guarantee disputes, as typical banking disputes, are quite complicated. To facilitate the adjudication of independent guarantee dispute cases, the Provisions of the Supreme People's Court on Several Issues concerning the Trial of Independent Guarantee Dispute Cases (POIGDC) was released by the SPC and came into
force on 1 December 2016. The primary legal rules under the POIGDC can be summarised as follows:
a the nature of the independent guarantee is clearly defined and its legal status has been recognised;
b the validity rules that apply to foreign-related independent guarantees shall also apply to domestic independent guarantees;
c an independent guarantee will not be affected by its underlying transaction or its application for issuance. Exceptions to its independence are limited and only for the purpose of ensuring the safety of transactions;
d the requirements of suspension of payment are provided under the POIGDC. The applicant for suspension of payment must prove that it is highly likely that an independent guarantee fraud has been committed and failure to suspend payment would result in irreparable harm to the applicant's right with evidence. Meanwhile, the applicant is required to provide a security sufficient to compensate any possible loss suffered by the counterparty; and
e the nature of the deposit for the issuance of the independent guarantee is specified as a pledge payment and the rules of enforcement regarding the deposit are provided.
iii Provisions of the Supreme People's Court on Several Issues concerning the Application of Law in the Trial of Private Lending Cases
To facilitate the adjudication of cases on private lending disputes, the Provisions of the Supreme People's Court on Several Issues concerning the Application of Law in the Trial of Private Lending Cases (POTPLC) came into force on 1 September 2015. It provides the requirements for a private lending contract to be valid as well as those circumstances in which a private lending contract may be ruled as void.
On one hand, the grounds to rule in favour of the validity of a private lending contract have been added and the POTPLC has specifically listed the requirements for a private lending contract to take effect. Five circumstances are recognised as ‘providing loans' to examine the validity of private lending contracts in the context of the Contract Law of the People's Republic of China (the Contract Law) and the POTPLC. Where the act of lending or borrowing is suspected to be a crime or has been ruled as a crime based on a valid judgment, the private lending contract is not naturally null and void as the court shall determine the validity of the private lending contract in accordance with Article 52 of the Contract Law and Article 14 of the POTPLC. Moreover, a private lending contract is valid where it is signed as required for production or business operation among legal persons and other organisations, or signed for raising funds from their employees in its entity for their production or business operation.
On the other hand, the POTPLC also stipulates the following circumstances in which a private lending contract will be ruled as void:
a the borrower knew in advance or should have known that the lender relends the funds obtained from a financial institution at a high interest rate, or funds borrowed from other enterprises or collected from employees of its entity for the purpose of making profit;
b the lender provided the loan despite the fact that he or she knew in advance or should have known that the borrower borrowed the money for illegal or criminal activities;
c the contract violates public order or good customs;
d the agreed interest has exceeded the annual interest rate of 36 per cent; and
e any other violation of compulsory provisions on the validity of any law, such as Article 52 of the Contract Law, or any administrative regulation.
III REGULATORY IMPACT ON CIVIL LIABILITIES
China's financial sectors are supervised and administered respectively by the People's Bank of China, the China Banking Regulatory Commission, the China Securities Regulatory Commission and the China Insurance Regulatory Commission (the PBOC and the Commissions). In recent years, in order to facilitate the new trend of China's financial development, the PBOC and the Commissions have released numerous regulations, such as the Deposit Insurance Regulation, the Measures for the Administration of Issuance and Transaction of Corporate Bonds, and the Measures for the Administration of the Suitability of Securities and Futures Investors. The publication of these regulations has had a profound impact on the supervision of China's finance industry in the current economic situation.
Despite the administrative nature of these regulatory documents, such documents inevitably affect civil liabilities that financial institutions may assume. For instance, precedents reveal that financial institutions shall be responsible for violating the ‘suitability obligation'.
The suitability obligation refers to the obligation that financial institutions are under to recommend financial products to suitable investors in an appropriate manner. If a financial institution violates this obligation and causes loss to an investor, it shall be held liable for damages suffered by the investor. In China, such obligation mainly exists in the administrative regulations and the supervisory documents released by the PBOC and the Commissions, such as the Regulation on the Supervision and Administration of Securities Companies, the Provisional Rules for the Administration of Commercial Banks' Personal Financial Management Services and the Provisions on Strengthening the Management of the Securities Brokerage Business. But so far, no law enacted by the legislature has provided that financial institutions shall bear civil liabilities for breach of the suitability obligation. Despite the absence of direct legal basis, the courts have held that a financial institution shall be responsible for breaching this obligation as the courts view it as compulsory in nature, and the aforementioned regulatory documents stipulate that the obligation reflects the fundamental principles of civil law. In Hu Xiangbin et al v. Bank of China, the court cited the provisions in the Provisional Rules for the Administration of Commercial Banks' Personal Financial Management Services, and held that these provisions reflect the principles of equality and good faith of civil law. Before the enactment of new laws and regulations, these provisions can be used as the basis to hold the defendant (the banking institution) liable for breaching the suitability obligation. In Lin Juan et al v. Industrial and Commercial Bank of China, the court of the second instance held that regulatory documents released by the PBOC and the Commissions can be used as the basis to hold the defendant to assume civil liabilities regarding breaching the suitability obligation. Therefore, the defendant is liable for damages suffered by the plaintiff.
The complexity of banking disputes gives rise to the difficulty of adjudication, which requires judges to have business awareness as well as sound professional judgement. Regulatory documents of the PBOC and the Commissions have become pertinent references for adjudication in spite of their administrative and supervisory nature, and hence play a key role in determining civil liabilities. Accordingly, it is crucial for legal practitioners to keep a close eye on the relevant regulatory documents when dealing with banking litigation. Only with a thorough understanding of the basis of civil liabilities that might be assumed by financial institutions can disputes be resolved efficiently, smoothly and effectively.
IV CHANGES TO COURT PROCEDURE
The recent changes to court procedure outlined below have had a significant impact on banking litigation. The reform of the registration system for case filing has reduced the threshold of case registration, the reform of the judge quota system has promoted the professionalisation of judges and the establishment of special procedures is conducive to the realisation of security interests.
i Registration system for case filing
Under the registration system for case filing, where a party initiates a lawsuit, the court must register the case as long as the case materials submitted by the party are in accordance with the requirements under the law. In the past, the court would conduct a substantive review of the case materials before determining whether to register the case or not. A large amount of cases could not be accepted or registered because of a shortage of judges. Fortunately, after the implementation of the registration system for case filing, the threshold for case registration has been greatly lowered.
However, the registration system for case filing has certain negative aspects in spite of its convenience. The number of cases has increased dramatically, which means that the previous imbalance between the number of cases and the shortage of judges has been reinstated, and work stress has been heavily imposed on judges and their assistants, resulting in concerns regarding the quality of adjudication. At the same time, the occurrences of malicious litigation, including but not limited to false lawsuits and repeated lawsuits, have increased and have consequently wasted judicial resources. In this regard, the SPC implemented reforms of case diversion, established the mechanism for linking litigation with mediation, and introduced new regulations to punish malicious litigation and other acts in order to defend the authority of law.
In this regard, for a lawsuit concerning financial dispute to be initiated before a court in China, it is necessary to prepare for all the required materials to pass the prima facie examination for case registration. Moreover, the lawsuit and claims shall be ‘legally appropriate' in order to be free from any punishment of abusing the right to sue.
ii The judge quota system
The judge quota system refers to a system in which the judiciary is divided into judges, judicial assistants and administrative staff, among which the proportion is fixed. Only judges are empowered to handle cases and hold trials.
The implementation of the judge quota system can be viewed as successful thus far; it has been helpful in accomplishing the objective of de-administration of the judicial system. Judges are separated from other civil servants to be able to adjudicate cases independently and justifiably. The system has also raised the threshold regarding qualification to serve as judges and will eventually improve the professionalism of the practitioners within the judicial system.
This reform is significant to banking litigation. Owing to the socialisation of the financial market, the legal relationships involved in finance cases are often complicated because of the involvement of different parties and the widespread location of the assets for the purpose of property preservation. The rapid development of the financial market also leads to the diversity and complexity of financial activities and transaction structures thereof, and thus results in difficulty in resolving banking disputes. The improvement of professionalism among judges enables them to understand the nature, facts and applicable law thoroughly and accurately when resolving banking disputes. Consequently, the possibility of misjudgement would be minimised, and the procedural rights and substantive interests of the parties in banking disputes could then be better protected.
iii Establishment of special court procedures for realisation of security interests
The revised Civil Procedure Law of the People's Republic of China (the Civil Procedure Law) has established special court procedures for realisation of security interests. By such procedures, a creditor may realise its security interests over the collateral without going through the normal court proceedings (i.e., the first instance, followed by the second instance until the issuance of a binding and final judgment over the creditor's right and security interests). Under the special procedures, the time limit for judges to review an application is shortened to one month. Most importantly, the ruling from the judge is final and the counterparty shall have no right to appeal. Besides, the fees may be lower than the standard fees with the same disputed amount in the normal court proceedings.
V INTERIM MEASURES and PROPERTY PRESERVATION IN BANKING LITIGATION
Under the Civil Procedure Law, interim measures include property preservation, conduct preservation and evidence preservation. In banking litigation, the realisation of creditors' rights requires efficient and effective property preservation measures.
i Provisions on property preservation
Chapter 9 of the Civil Procedure Law provides general conditions and procedures for property preservation. Pursuant to Article 100 of the Civil Procedure Law, property preservation measures may be granted upon the application of a party or ex officio by the court when the opposing party's actions or other reasons may result in the impossibility or difficulty in enforcing a judgment. Besides, a competent court may issue a ruling on property preservation measures upon the request of an interested party before its initiation of a legal action, where the lawful rights and interests of an interested party will be irreparably damaged if property preservation measures will not granted immediately under urgent circumstances.
The Provisions of the Supreme People's Court on Several Issues concerning the Handling of Property Preservation Cases by the People's Courts (the Property Preservation Provisions) came into force on 1 December 2016 to supplement general provisions in the Civil Procedure Law. They specify conditions for granting property preservation measures, security for property preservation, discovery of property clues and implementation of property preservation measures.
ii Key issues on property preservation
Applying for property preservation
Under the Civil Procedure Law and the Property Preservation Provisions, an interested party may apply for property preservation before initiating an action, during the litigation proceedings, or before application for enforcement of an effective judgment.
Discovery of property clues
Pursuant to the Property Preservation Provisions, the party applying for property preservation shall provide specific information or clues in connection with the property to be preserved. Article 11 of the Property Preservation Provisions provides that where the court renders a ruling to take a property preservation measure during the litigation proceeding, the applicant may, during the process of the ruling being enforced, file a written application with the enforcement court to check the established online enforcement control system for the counterparty's assets.
Security for property preservation
Pursuant to Articles 100 and 101 of the Civil Procedure Law, the court may require the party requesting property preservation measures during the litigation proceedings to provide appropriate security and shall require the party requesting property preservation measures before initiating an action to provide appropriate security. Article 8 of the Property Preservation Provisions provides that a financial institution obtaining the necessary licence from the relevant supervision authority may provide an independent letter of guarantee as security for property preservation. Following this, Article 9 of the Property Preservation Provisions provides that the aforesaid financial institutions or their branch offices capable of independent debt repayment may be exempt from providing security for property preservation measures that are applied to other entities.
Wrongful property preservation
According to Article 105 of the Civil Procedure Law, the applicant shall be liable for any damages caused by the property preservation measures where the court subsequently determines that an application for property preservation measures was wrongfully filed.
Relationship between the first seizure, impoundment or freezing measure and the disposal of the preserved property
Article 21 of the Property Preservation Provisions provides that where the preservation court has not disposed of the preserved property for more than one year after taking the seizure, impoundment or freezing measure, the court awaiting seizure, impoundment or freezing of the property may consult with the preservation court on transfer of the preserved property for enforcement, unless the preserved property is the subject matter of the dispute, except as otherwise specified by any judicial interpretation.
VI SOURCES OF BANKING LITIGATION
i Common sources of banking litigation
In China, common banking disputes mainly relate to, among other things, lending and loans, guarantees, bankcards, financial leasing, securities, futures business, commercial instruments, trust and letter of credit. These disputes not only happen between financial institutions and financiers, but also among financial institutions or between financial institutions and investors.
ii Sources of banking litigation after the recent development of China's economy under the ‘new normal'
Under the new normal, new types of banking disputes have arisen as a result of continuing economic slowdown, structural economy problems, supply-side structural reform, innovation of the internet and other factors.
Bond default disputes
The bond market in China has witnessed a large amount of bond defaults in recent years, including but not limited to defaults of corporate bonds, enterprise bonds, medium-term notes, short-term financing bonds, small and medium enterprises' collection notes, and other types of bonds that are traded in the inter-bank market and the exchange market.
Private equity investment disputes
As stated in the 2017 Work Report of the SPC, along with the fast development of private equity (PE) investment in China, new types of PE disputes have arisen, such as private-equity partnership disputes, valuation adjustment mechanism disputes, equity repurchase disputes and corporate control disputes.
Internet financing disputes
Despite the combined positive effects on the economy, the existence of mobile internet, e-business and internet finance, such as peer-to-peer lending and mass and accumulative fundraising, and third-party payment platforms have caused complex and diverse disputes. Generally, the inapplicability of the traditional principle to determine jurisdiction, the normalisation of class actions with small disputed amounts, and the wide usage of electronic evidence in resolving a dispute are the common features in internet financing lawsuits.
Other banking disputes
In addition, the number of disputes relating to derivatives and trade financing has increased dramatically in China in recent years.
VII SIGNIFICANT RECENT CASES
China adopted the guiding cases system on 26 November 2010. The SPC is in charge of selecting and releasing guiding cases. In addition to guiding cases, the SPC regularly releases typical and influential cases in its gazette (the SPC Gazette). Outlined below are some significant recent cases released by the SPC or represented by Zhong Lun relating to complicated issues such as pledge of rights, pledge of funds, guarantee obligation and entrusted loans.
In Fuzhou Wuyi Sub-branch of Fujian Haixia Bank Co, Ltd v. Changle Yaxin Sewage Treatment Co, Ltd and Fuzhou Municipal Engineering Co, Ltd (guiding case No. 53 concerning a dispute over a loan contract), the court ruled that the right to receive proceeds from franchises may be pledged and registered as a pledge of account receivable. Where the pledgee claims for priority right for compensation therein but it is inappropriate to liquidate, auction or sell off the aforesaid pledged right, the court may order the pledger to make a priority payment to the pledgee from the proceeds of the account receivable.
In Anhui Branch of Agricultural Development Bank of China v. Zhang Dabiao and Anhui Changjiang Financing Guarantee Group Co, Ltd (guiding case No. 54 concerning a dispute over an objection to enforcement), the court ruled that the fact that the account balance in the special bank account occasionally floats shall not affect the validity of the pledgee's right over the pledged funds deposited in the special bank account as long as three requirements have been met. First, the pledger has opened the bank account and deposited such funds for the purpose of providing collateral to the pledgee. Secondly, the pledgee lawfully possesses and controls the bank account. Thirdly, the pledged property has been specified and the possession has been transferred from the pledger to the pledgee.
In Ningbo Branch of Wenzhou Bank Co, Ltd v. Zhejiang Chuangling Electric Appliance Co, Ltd (guiding case No. 57 concerning a dispute over a financial loan contract), the court held that when a creditor has entered into several maximum guarantee contracts with guarantors but failed to specify some of those guarantee contracts under the master loan contract, those guarantors, though not expressly stated under the master loan contract, shall still be liable for the indebtedness, so long as the debts have been incurred during the time limit of the guaranty liability provided under the maximum guarantee contracts and the creditor does not expressly waive its right against the guarantors.
In Beijing Changfu Investment Fund v. Wuhan Zhongsenhua Century Real Estate Development Co, Ltd et al (a case of a dispute over an entrusted loan contract), the court held that when the entrusted bank lent the loan to the borrower under the instruction of the lender without assuming any legal risks or liabilities under the loan contract entered into between the lender, the entrusted bank and the borrower, such loan shall be deemed as ‘private lending' rather than lending by a financial institution. Laws, regulations and judicial interpretations concerning ‘private lending' are applicable to the validity of the entrusted loan contract as well as its main provisions (i.e., interests, default interests and damages).
In Dalian Donggang Sub-Branch of China Merchants Bank Co, Ltd v. Dalian Zebon Fluorocarbon Paint Stock Co, Ltd and Dalian Zebon Group Co, Ltd (a case of a dispute over a loan contract), the defendant, as the guarantor, argued that its legal representative acted beyond his authority to enter into the guarantee contract and the shareholders' meeting resolution to provide a guarantee to its shareholder was falsified. The court ruled that pursuant to Article 16 of the Company Law, if a company intends to provide a guarantee to its shareholder or its actual controller, the shareholders' meeting or the shareholders' assembly shall pass a resolution for such decision. However, this provision was designed for the company's internal management and should not be used to determine the validity of the guarantee contract. If the company, as the guarantor, later argues that its legal representative acted beyond his or her authority to enter into the guarantee contract, the court shall rule in favour of the creditor's claim as long as the creditor proves that the relevant shareholders' meeting resolution meets the formality requirements and the act of the legal representative constitutes an ‘apparent' representation of the company.
In A Fund Company v. A Real Estate Development Company (a case of a dispute over an entrusted loan contract), the lender entrusted a bank (the entrusted bank) to lend money to the borrower. The borrower provided its land-use right as collateral and registered such security interest under the name of the entrusted bank. In precedent cases, courts held that the lender was not entitled to sue the borrower directly because of the doctrine of the privity of contract. However, in this case, the court made an important breakthrough and ruled that the lender could initiate the lawsuit directly against the borrower and seek enforcement of its security interests as the actual creditor.
In T Securities Company v. A Bank (a case of a dispute over transferring property that had been frozen by the court), the debtor has pledged a listed company's stocks as collateral to the creditor, a securities company (the T Securities Company). After obtaining an arbitral award confirming its creditor's right against the debtor, T Securities Company applied for enforcement before court A. However, the debtor's other creditor, a bank, initiated a lawsuit against the debtor before court B, claiming that the debtor is not the lawful owner of the stocks pledged to T Securities Company. Court B then froze the stocks upon the bank's application for property preservation. T Securities Company's attorney, a member of Zhong Lun, applied with court A to realise T Securities Company's creditor's security interest. In the meantime, Zhong Lun applied to court B, the court that had frozen the property, to transfer the pledged stocks to court A for enforcement as court B has failed to enter into any auction or sales procedures in respect of the frozen property after 60 days of the start of the property preservation procedures. Eventually, the courts sustained Zhong Lun's applications and requests.
VIII LOOKING AHEAD
In China, the slowdown of the economy has profoundly influenced banking and financing investments and the resolution of relevant disputes. As a result, banking disputes have revealed four new trends, namely complexity, expansion, quantification and crowded disputes. Complexity refers to the fact that professional, complicated and innovative banking and financing investments have given rise to sophisticated disputes. Notably, the range of banking disputes has expanded dramatically along with the recent development of new methods of financing, in which the parties involved are becoming increasingly diverse, which has imposed unprecedented challenges on the regulatory framework. In addition, the number of banking disputes, as well as the amounts involved in such disputes, has grown. Newly emerged economic problems under the new normal have resulted in a lot of defaults and the disputed amounts often exceed hundreds of millions. Numerous individual investors are also involved in banking disputes, which means that financial institutions are being dragged into class actions initiated by those who failed to profit and even lost their principal investment.
The above-mentioned trends in banking disputes call for creative resolution under the new normal, which requires the foresight of the regulatory authorities, precautionary measures adopted by financial institutions, support from the judicial system and the arbitration institutions, as well as intelligence, courage, and professionalism of legal practitioners.
1 Wilson Wei Huo is a partner at Zhong Lun. The author would like to thank Yuanjin Wei, Rui Yang, Xinping Chen and Shaowen Huang for their valuable assistance in preparing this chapter.
2 Article 19, GPCL.
3 Articles 148-149, GPCL.
4 Ibid, Article 150.
5 Ibid, Article 151.
6 Ibid, Article 153.
7 Articles 1-2, POIGDC.
8 Ibid, Articles 22-23.
9 Article 3, POIGDC.
10 Ibid, Article 14.
11 Ibid, Article 24.
12 Article 9, POTPLC.
13 Ibid, Article 13.
14 Article 12, POTPLC.
15 Ibid, Articles 14 and 26.
16 (2015) Hu Yi Zhong Min Liu (Shang) Zhong Zi No. 198.
17 (2016) Su 01 Min Zhong No. 1563.
18 Article 101, Civil Procedure Law.
19 Article 11, Property Preservation Provision.
20 Issue No. 11, 2016, the SPC Gazette.
21 Issue No. 2, 2015, the SPC Gazette.