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The Case of XX v. XX On Dispute over the Liability of Guarantee
Jurisdiction: Arbitration; CIETAC Shenzhen
1.Case brief
On 23 November, 1985, the International Financial Department, subordinate of the claimant, signed (85) C No.087 loan agreement with the first respondent, on which the second respondent signed and sealed as the guarantor. The loan agreement stipulated that the International Financial Department subordinate to the claimant should offer a loan of HKD 5,500,000 to the first respondent used for the investment of the second project of the restaurant jointly operated by the first respondent and the second respondent; the loan term should be one year; the interest should be calculated at the rate of that of Hong Kong Interbank Offer Rate plus 1%, and fluctuated every 6 months; the date of calculating the interest should begin with every date of transferring the loan and should be paid every half a year; the second respondent should be the guarantor of the loan, who should repay the loan in case the first respondent failed to repay the principal and interest of the loan on time. When the term expired, the first respondent and the second respondent failed to repay the principal and the interest of the loan. Therefore the claimant applied to the CIETAC Shenzhen for arbitration.
The claimant claimed in the application as follows:
(1) The first respondent and the second respondent should immediately repay the principal of the HKD 5,500,000 loan and the interest calculated to 30 September, 1994 HKD 2,821,219.54, with total amount of HKD 8,321,219.54.
(2) The respondents should bare the arbitration fee of this case.
With regard to the claims aforesaid, the claimant considered that after signing the loan agreement, the claimant had lend HKD 5,500,000 under the loan agreement to the first respondent in three batches. But when the term expired, the first respondent did not repay the principal and the interest of the loan on time. The first respondent only paid HKD 19,585.68 on 23 March, 1993. The claimant requested the guarantor, the second respondent, to pay and the second respondent had paid HKD 2,669,265.85 from 13 March, 1989 to 26 November, 1993. After that time, the respondents had not paid to the claimant any more. The conducts of the respondents had constituted severe breach of contract and brought large economic loss to the claimant.
As regards the calculation of the interest, the claimant considered that they had added the interest due but unpaid to the principal to calculate the interest of the next term at the fluctuating rate as stipulated in the loan agreement and calculated like this time and time again. Until 30 September, 1994, the interest of the principal HKD 5,500,000 was totally HKD 2,821,219.54. Moreover the claimant explained that they adopted the compound interest account method because the loan of foreign exchange lent to the clients was borrowed from the banks or other financial institutions abroad and these banks or financial institutions usually adopted the compound interest account method when calculating the mature but unpaid interest of loans. Therefore, it was a practice to calculate in compound interest internationally or among the financial institutions. The claimant also presented relevant stipulations on the compound interest in the Interim Measures for Handling the Joint Venture Loan by the Bank of China promulgated on 13 March, 1981 by the Bank of China to prove that the professional banks in China also adopted and confirm this international practice of compound interest.
Against the claims and reasons of the claimant, the first respondent defended as follows:
(1) The reason for the first respondent's failing to repay the principal and interest on time was that the first respondent failed to obtain all the benefits deserved from the loan investment from the second respondent. Therefore, the first respondent was unable to repay the principal and the interest of the loan on time.
(2) After the first respondent failed to repay the principal and the interest, the claimant had request the second respondent to fulfill the obligation of guaranty by a letter. After that, the claimant and the first respondent jointly requested the second respondent in a letter to repay the principal and interest to the claimant directly. Afterwards, the second respondent had paid HKD 2,669,265.85 in installments to the claimant. The conducts between the claimant and the two respondents as mentioned above indicated that, the debtor of the loan agreement was changed to the second respondent from the first respondent and the debt had been transferred.
(3) Concerning the compound interest, the first respondent deemed that it should be calculated as stipulated in the loan agreement since the loan agreement did not stipulate the calculation method of compound interest.
The second respondent defended that:
(1) The loan agreement under dispute in this case was signed in the name of the International Financial Department subordinate to the claimant with the first respondent, on which the second respondent signed as the guarantor. While International Financial Department subordinate to the claimant was just a functional department inferior to the claimant and was not a qualified legal person. Although the signer of the claimant was the deputy general manager, he was still not the legal representative of the company. Furthermore, he signed the contract in the name of the International Financial Department of the claimant. Therefore, according to the relevant Chinese law, the loan agreement should be void and null. Since the loan agreement as the main contract was void and null, the guaranty agreement as a sub-contract should be void and null. As a result, the second respondent should not bear the obligation of guaranty.
(2) The period of the loan was one year as stipulated in the loan agreement while the claimant altered it to 6 months, which was a unilateral modification to the loan agreement. The claimant should lend money according to the drawing procedures as stipulated in Section 5 of the loan agreement; however, the claimant did this only on the strength of the spending plan submitted by the first respondent and the second respondent, which violated the necessary drawing procedures stipulated by the loan agreement. While the necessary drawing procedures was a precondition to the second respondent to perform the obligation of guarantee. The claimant's conducts as mentioned above altered the second respondent's scope of guaranty. The obligation of guaranty of the second respondent should be exempted.
(3) The first respondent and the second respondent had repaid HKD 5,329,500.67, instead of the claimant stated HKD 2,669,265.85, in 16 installments since 23 March, 1987. The claimant deducted HKD 2,660,000 from the aforesaid repayment as the repayment of another loan without the two respondents' approval. The second respondent opposed to this conduct. In addition, the second respondent demurred at the conduct that the claimant made the two respondents to bear the bank fees due to the money transfer among the banks.
(4) The second respondent considered that the loan agreement did not stipulate the account of compound interest. The conduct of the claimant to account the compound interest unilaterally was forbidden by the Chinese law. It was stipulated in Section 7 of the Several Opinions on the People's Court Hearing the Loan Cases promulgated by the Supreme Court that the lender should not add the interest into the principal to gain high interest. In case the lender added the interest to the principal to calculate compound interest, the borrower may repay the principal only. The Interim Measures for Handling the Joint Venture Loan of the Bank of China the claimant presented was aiming at the loan given to the joint venture companies, which should not be applied to this case.
2.Award
(1)
The first respondent and the second respondent shall repay HKD 8,282,047.81 to the claimant within 30 days as of this award being made and the two respondents shall bear the joint liability of the repayment. If failed to repay on time, the interest shall be calculated at an annual rate of 10%.
(2)
The arbitration fee and handling fee of this case shall be separately assumed by the first respondent and the second respondent on a 50-50 basis.
This award shall be final.
3.Comment
Legal issues in relation to this case are mainly as follows:
(1)
The application of the law
Neither of the parties in this case chose the appropriate law applied to the disputed issues. Because the lender (the claimant) was registered in China, and the conduct of lending happened in China also, the loan agreement of this case had close relation to China. This case should be governed by China law.
(2)
The validity of the loan agreement
The arbitral tribunal held that although according to the fact 1, the claimant concluded the loan agreement with the first respondent and second respondent in the name of the International Financial Department. As indicated in facts 5, 6 and 7, the claimant had once sent a letter to the second respondent singly on 25 October, 1988 and then sent a letter to the second respondent together with the first respondent on 31 October, 1988 requesting the second respondent to pay the claimant directly the investment benefit as deserved by the first respondent. The second respondent transferred money to the claimant directly in 15 installments after receiving the two aforesaid letters. And each remittance receipt indicated the claimant as the recipient. These conducts of the claimant and the two respondents made the arbitral tribunal to conclude that the claimant had regarded the conduct of signing the loan agreement by its subordinate International Financial Department as its own conduct, moreover, the claimant was a legal person institution entitled to concluding foreign exchange loan. The second respondent transferred to the claimant directly also indicated that the second respondent had recognized the confirmation of the claimant. Meanwhile, the arbitral tribunal noticed that after claiming the loan agreement void and null, the second respondent emphasized the reason he should not bear the obligation of guarantor was that the claimant failed to act according to the scope of guaranty as stipulated in the loan agreement. This statement of the second respondent was contrary to the reason it provided that the guaranty agreement was void resulting from the void loan agreement. Therefore, the arbitral tribunal held that although the claimant's subordinate financial department did not possess the qualification of legal person, the claimant's conducts made up the agreement and the first respondent and the second respondent had recognized this. In this condition, the arbitral tribunal could not accept the statement the second respondent presented that the guarantee agreement should be void because of the void loan agreement.
(3)
The exemption of the liability of guaranty
With regard to the statement that the claimant failed to act according to the withdrawal procedure stipulated in the loan agreement and provided the loan just depending on the spending plan as presented by the first respondent and the second respondent, which altered the scope of guaranty and resulted the exemption of the guarantee obligation of the second respondent, the arbitral tribunal held that, according to fact 2, 3 and 4, the first respondent and the second respondent jointly submitted the withdrawal plan to the claimant indicating that they hoped the claimant to lend money as the time and amount in the plan, in fact, the claimant lent the money as the withdrawal plan required and the first respondent had received HKD 5,500,000 lent by the claimant, all of which indicated that the claimant and the two respondents had a joint will, namely, the three parties of the loan agreement did not require to handle the loan strictly according to the withdrawal procedures in the loan agreement. In fact, they had handled the issues of loan in accordance with the withdrawal plan. With regard to this, both the claimant and the two respondents should assume the liability. The second respondent imputed the liability to the claimant, which could not be accepted by the arbitral tribunal.
When a contract was legally established, the modification of the contract should be approved by each party to the contract. One party could not modify the contract without the approval of the other party. In case one party failed to perform the obligation as stipulated in the contract, it would constitute a breach of contract other than modification of contract. Furthermore, the notice of lending of the claimant just indicated to the first respondent that he had lent the money as the two respondents' withdrawal plan. As for the marked word "loan period of 6 months" in the lending notice, the claimant explained that it was the period to balance the interest of the loan and the claimant deemed the period of the loan as one year not 6 months all the time. Seeing the conduct of the claimant, the claimant did not request to regard the loan period as 6 months. The first respondent as the main debtor did not regard the period as 6 months either. There was no evidence indicating that the first respondent once misunderstood the period of the loan agreement for this reason. There was no evidence either indicating that the two respondents had once claimed the claimant's breach of contract and refused to receive the money for this reason. Under the condition that the claimant and the two respondents did not understand the period of the loan agreement differently, the first respondent had accepted the loan and devoted it to the project jointly ventured by the first respondent and the second respondent. Therefore, it could not be established that the second respondent regarded the lending notice as the modification of the period of the loan agreement. As mentioned above, the arbitral tribunal should not support the allegation that the second respondent requested to exempt his obligation of guaranty for the reason of the claimant's altering the loan agreement.
(4)
The transfer of the loan and the scope of guaranty
The first respondent insisted that the debt of the loan agreement had been transferred to the second respondent on the basis of the fact 5 and fact 6 as confirmed by the arbitral tribunal. The fact 5 and fact 6 indicated that whether the claimant separately or jointly with the first respondent sent letters to the second respondent to request to repay the loan to the claimant directly, it should be seemed to be the principal and the interest that the first respondent should have repaid to the claimant, namely, the second respondent paid the benefit that the first respondent should have gained from the investment to the restaurant to the claimant directly instead of the first respondent, other than repaid the debt for the first respondent to the claimant. Even though the second respondent repaid the debt for the first respondent, it would prove that the second respondent was performing the obligation of guarantee other than transferring the debt. It could not be established that the debt had been transferred.
Since the second respondent confirmed by signing and sealing on the loan agreement including guarantee terms as a guarantor, it should be regarded as the establishment of the guaranty contract. Section 9 of the loan agreement stipulated that the second respondent should be the guarantor of the loan and should sign and seal on the loan agreement to confirm. In case the Party A (namely the first respondent) failed to repay the principal and interest on time, the second respondent should bear the obligation to repay the whole principal and interest and the first respondent had the obligation to repay the whole principal and interest at the same time. Therefore, the obligation of repaying to the claimant the whole principal and interest should be joint obligation to the first respondent and second respondent. The claimant as the creditor was entitled to choose one or both of the respondents as joint debtors to repay part or the entire loan at the same time or one after another. Under the condition that the contract did not conclude the period of guarantee, the second respondent should bear the obligation of guarantee within the period that the first respondent should bear the obligation. Each time the claimant required the first respondent or the second respondent to repay the principal and the interest of the loan and requested the first respondent and/ or the second respondent to pay part of the principal and the interest means the interruption of the time bar. Based on the reasons aforesaid, the arbitral tribunal held that it was reasonable for the claimant to require the first respondent and the second respondent to repay the outstanding principal and the interest and the claimant's request should be supported.
(5)
The amount of the repayment
The second respondent insisted that he and the first respondent had repaid HKD 5,239,500.67 in total to the claimant under the (85) C No.087 loan agreement. It was wrong for the claimant to deduct HKD 2,660,000 as repayment for another loan of HKD 2,000,000. In accordance with fact 5 and fact 6, the claimant sent the two notices separately or jointly with the first respondent referring to the loan under No.C-84009 and (85) C No.087 contracts and the second respondent did not mark the money transferred for which contract while transferring. Therefore, the arbitral tribunal held that the money transferred from March 6, 1989 to November 10, 1993 should be for the loan under the two contracts mentioned above. As it was repaying two contracts and did not mark to repay which one, the claimant was entitled to identity the repayment according to the time of loan. Meanwhile, the arbitral tribunal also noticed that the first respondent as the main debtor did not demurred for the deduction of HKD 2,640,542.51 as the repayment for the No.C-84009 contract in light of for this partition. Concerning the fees as deducted by the bank, the claimant stated that when transferring in the bank, it would cost HKD 20 to HKD 50 as the procedure fee, which should be assumed by the claimant. The arbitral tribunal concluded that the loan agreement did not stipulate who should assume this fee. The respondents had paid the fee to the bank when transferring. The procedure fee happened when transferring among banks was unforeseen to the respondent while the claimant could foresee the fee as an institution operating foreign exchange loan. So the claimant should have told the respondent when presenting the text of the contract in the form of terms of contract or other forms while the claimant did not. Therefore, this fee should be assumed by the claimant. According to the facts 7, 8 and 9, the arbitral tribunal identified that the first respondent and the second respondent had transferred HKD 5,329,228.23 in total (in which USD 9,800 was converted to HKD 75,533.51 at the exchange rate of 1∶7.7075) as from March 23, 1987 to November 11, 1993. The money mentioned above deducting HKD 2,640,542.51, the left HKD 2,688,685.72 should be regarded as the repayment for the (85) C No.087 loan agreement to the claimant from the first respondent.
(6)
The calculation of interest
The claimant adopted compound interest when calculating interest, which was demurred by both respondents.
The claimant presented the Interim Measures for Handling the Joint Venture Loan of the Bank of China (hereinafter referred to as Measures), Article 2 of Section 8 of the Measures stipulated that in case the interest could not be paid on time, the bank should actively add the interest that should have been gained to the credit account of the loaned enterprise to calculate the compound interest. With regard to this question, the claimant attempted to persuade that the compound interest was an international practice and had been accepted by the Bank of China. The arbitral tribunal found out that the Measures the claimant presented had been abolished upon approval of the State Council on April 7, 1987 and by the Measures For Lending to the Foreign Invested Enterprises by the Bank of China, which did not include the stipulations concerning compound interest any more.
The second respondent presented the Some Opinions of the People's Court Hearing the Loan Cases promulgated by the Supreme Court, Section 7 of which stipulated that the lender should not add the interest to the principal to obtain high interest. Anyone who added the interest to the principal to calculate compound interest as found in hearing should be repaid the principal only.
According to the interpretation of the Supreme Court, when handling loan cases, if the lender adopted compound interest to calculate interest and it was beyond 4 times of the loan rate of the banks in the same catalogue, the beyond part was not protected. Then it could be inferred that if the compound interest was not more than the stipulated limit (which was 4 times at most), the interest that the lender ought to deserve should be protected. It could be seen that in the practice of judiciary in China, it was not prohibited to calculate in compound interest except for obtaining high interest by compound interest. It was an international usual method among banks to add the unpaid interest of overdue loan to the principal to calculate the interest. In general, this usual method was practiced through contract between the lender and the borrower so as to prevent the borrower from defaulting for long time and making loss to the bank or decrease loss for the bank. Under the condition that Chinese law did not forbid the compound interest, the arbitral tribunal respected and adopted this usual method among the international banks from the point of fairness and reasonableness.
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