SPC Gives Effect to All Terms in Contractual Interpretation

By Patrick Zheng | Charles Qin

Background

This case concerned the construction of a Financing Agreement between the L/C applicant, Lanyue Energy, the buyer of an underlying contract for sale of coal, and the issuing bank, Construction Bank, for a L/C in favor of the seller. In order to obtain the L/C, Lanyue Energy also signed an annex to the Financing Agreement on the provision of security interest to Construction Bank (“Annex”). Article 9 of the Annex provided that in case of default by Lanyue Energy to reimburse the L/C amount, Construction Bank was entitled to:
“…
(4) exercise security interests (担保权利); and
(5) request that Lanyue Energy increase the deposit or offer other collaterals (其他担保).” (emphasis added)

After the issuance of the L/C, Lanyue Energy imported coal from the seller and handed over the B/L to Construction Bank. Later, Lanyue Energy failed to reimburse the payment made by Construction Bank under the L/C.

Disputes arose on whether Construction Bank could assert security interest(s) (specifically, pledge) created over the B/L.

Under Chinese law, there are two types of pledges, i.e. pledge over movables and pledge over rights. The latter is pledge over bill of exchange, cheque, promissory note, bond, certificate of deposit, warehouse receipt, bill of lading or share. The creation of such pledge requires a written contract to this effect and physical delivery of the above document of title, or registration of the share pledge.

So in order to create a pledge over a B/L, in addition to the physical delivery of the document to the pledgee, the pledgor and the pledgee shall also enter into an agreement to that effect.

This case is about whether the parties have reached an agreement on the pledge to render the pledge effective.
 
Rulings
The trial court, the Guangzhou Intermediate Court, considered that the pledge at issue was pledge over movables and no physical delivery of the coal to the pledgee, Construction Bank, was made, so there was no effective creation of the pledge. On appeal, the Guangdong High Court upheld the decision by further invoking Article 212 of the PRC Property Law, which provides that a pledge is created upon physical delivery of the collateral by the pledgor. However, the pledgor, Lanyue Energy, was not in direct possession of the collateral, the coal under the B/L, so no way to make physical delivery. Nor did it notify the person in possession of the coal, namely the consignor in this case, to make that delivery,[2]  like an attornment under English law by a third party who has physical possession of the asset. Thus, the pledge was not created over the coal under the B/L.

In the retrial proceedings, under which a final judgment could be reheard de novo, the Supreme Court opined that the pledge at issue was pledge over the B/L per se (提单权利质押) rather than pledge over movables. Pursuant to Article 224 of the PRC Property Law, two requirements must be met for the creation of a pledge over a B/L, namely a written contract to that effect and physical delivery of the B/L to the pledgee. [3]

There are two contractual provisions relevant here, i.e. Article 9(4) (Construction Bank to) “exercise security interests (担保权利)”, and Article 9(5) (Lanyue Energy to) “offer other collaterals (其他担保)”. The issue before the court was to decide whether “security interests” was the same as “other collaterals”. If not, according to the Supreme Court’s view, the pledge over the B/L could be one of the “security interests” agreed upon by the parties in Article 9(4).

In construing the meaning of “security interests”, the Supreme Court took the whole contract or holistic approach by giving effect to both contract terms. It reasoned that, in light of the facts presented, “other collaterals” referred to the guarantee liability borne by the parties concerned and a pledge of shares.[4]  The Supreme Court observed that “security interests” should have a different meaning to that of “other collaterals”. When a contract term is capable of being understood differently, such term should not be treated as surplusage; instead, an interpretation which makes each contract term effective is to be preferred. On the basis of the above reasoning, the Supreme Court concluded that “security interests” under Article 9(4) did mean the pledge over the B/L, so there was an agreement over the creation of the pledge over the B/L. Together with physical delivery of the document of title by Lanyue Energy, Construction Bank effectively created the pledge over the B/L.

Comment

The UNIDROIT Principles of International Commercial Contracts (1994 version) envisages the rule of giving effect to all contract terms,[5]  and the principle of the whole contract approach is well established under English law. This case sheds light on the application of such rule by Chinese courts, although Article 125 of the PRC Contract Law does not explicitly so provide. On the other hand, it should be noted that even employing the Supreme Court’s approach of contractual interpretation, it is still questionable to reach the conclusion that without express wording on pledge, “security interests” provided in Article 9(4) of the Annex means or refers to a pledge over a document of title. Having said that, it is still noteworthy that the Supreme Court’s approach of giving effect to all terms (subject to exceptions) provides helpful guidance in the construction of contract under Chinese law.

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