China: Considerations when Executing a Guarantee Involving Chinese Elements

In Emeraldian Limited Partnership v (1) Wellmix Shipping Limited and (2) Guangzhou Iron & Steel Corporation Limited, the English High Court made a determination on the liability of a Chinese guarantor under a guarantee not approved by China's State Administration of Foreign Exchange ("SAFE"). This illustrates the relevant considerations involved when executing a contract of guarantee involving cross-border elements, in particular, Chinese ones.

Facts

The first defendant charterer (C) entered into a voyage charter with the claimant ship owner (O) for the carriage of iron ore from Itaguai, Brazil to China, and the charterparty was governed by English law and subject to English jurisdiction. O sought to claim demurrage in the sum of US$5mil from C who in turn claimed against the second defendant (G), a Chinese company, who was the alleged guarantor of C's obligations under the charterparty.

The significance of the case is O's claim against G. The guarantee issued by G did not contain a governing law clause and was signed by S, an employee of G, who informed O that he had authority to do so on G's behalf. G's defence was based on two grounds:

  1. S had no authority to sign the guarantee;
  2. The guarantee was void for illegality because it was entered into in breach of SAFE regulations, which mandated that a guarantee issued in favour of an overseas party had to be approved by SAFE, failing which, under Chinese law, the guarantee would be null and void.

Decision

The Court held that:

  1. S had actual authority to sign the guarantee;
  2. English law should be the governing law of the guarantee, and accordingly, G was liable as guarantor under the guarantee;
  3. Enforcing the guarantee was not contrary to English public policy.

Authority to contract

It was accepted that Chinese law governed the relationship between S and G, in particular, whether S had the requisite authority to contract on behalf of G.

Based on the evidence adduced, the Court drew a number of adverse inferences and found that S had actual authority.

It was therefore not necessary for the Court to deal with the issue of whether S had ostensible authority to sign the guarantee.

However, the Court observed that S's confirmation that he had authority did not amount to a holding out by G under English law. Whereas under Chinese law, ostensible authority was determined by whether O "had reason to trust" that S had the required authority. O did not try to argue that mere confirmation by S to O that the former had authority was sufficient to establish the required "trust" under Chinese law.

English law as the governing law of the guarantee

The Court's basis for deciding that English law is the governing law of the guarantee was due to the guarantee purporting to guarantee the obligations of C under the charterparty. The charterparty was expressly governed by English law and subject to English jurisdiction; G and O had therefore impliedly chosen English law as the applicable law of the guarantee.

Art. 3.3 of the Rome Convention and English public policy

Notwithstanding that the Court held that English law was the governing law of the guarantee, G argued that SAFE regulations should be applied pursuant to Art. 3.3 of the Rome Convention as "mandatory rules" of Chinese law. The Court held that this was not a case where all other elements were connected to China since O was a Liberian company and English law governed the charterparty.

G's alternative argument in persuading the Court that SAFE regulations were nonetheless relevant was on the basis that it would be contrary to English public policy to enforce an obligation which was unlawful in a friendly foreign state. The evidence on Chinese law was that an overseas guarantee which is not approved by SAFE would be null and void, and a penalty of 30% of the amount of money unlawfully involved could be imposed. However, despite the invalidity of an overseas guarantee issued without SAFE's approval, civil liability under the guarantee is still enforceable where the guarantor is at fault. The Court held that since Chinese law does not regard the civil liability otherwise arising from the guarantee as unenforceable, there is no reason why English law should do so. It would therefore not be contrary to English public policy, in this case, to refuse enforcement of the guarantee. In so doing, under English law (being held to be the governing law of the guarantee), G was held to be 100% liable for the guaranteed amount.

Possibility of reduction of liability to 50%

It should be noted that under Chinese law, if the creditor and guarantor are both at fault, the guarantor's liability shall not exceed 50% of the guaranteed sum. In paving the way for a possible partial appeal that G's liability should be reduced due to public policy considerations, the Judge set out the relevant facts as to whether O was also at fault and acknowledged that under Chinese law, G's civil liability would only be 50% as O was also to blame.

Significance

This case illustrates that in the absence of a governing law clause in a guarantee, the Court would be heavily persuaded by the choice of governing law in the main contract, the performance of which is the subject of the guarantee. It is therefore of paramount importance that parties to a guarantee expressly stipulate the governing law in the guarantee if they do not intend the guarantee to be governed by the same law governing the main or underlying contract.

It is also important to rigorously verify the actual authority of the signatory to the guarantee (or contracts in general), ensuring that the other party is held to its obligations. The signatory's confirmation of actual authority appears to be insufficient; as is reliance on the signatory's purported position or use of the company's stamp.

Last but not least, the need to obtain SAFE approval for any overseas guarantee issued by a Chinese guarantor cannot be emphasised enough. Without SAFE approval, the value of the overseas guarantee is significantly reduced with parties having to potentially engage in litigation over the civil liability of the Chinese guarantor and a potential exposure to a reduced guaranteed amount.

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.

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