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Gazette Case of the Supreme People’s Court | Zhenghan Law Firm Assists Foreign Bank in Successfully Defending 100 Million Yuan Debt Claim, Final Appeal Victory Selected for Supreme Court Gazette

Zhenghan Law Firm represented an international bank and successfully litigated a complex cross-border financial loan and guarantee dispute at the Supreme People’s Court. Through a precise grasp of core issues such as the cross-jurisdictional application of law for principal and accessory contracts, the validity of mandatory provisions, and the ascertainment of foreign law, the firm ultimately resolved the cross-jurisdictional dispute over the principal and accessory contracts, overcame the key defense that the external guarantee was invalid due to lack of foreign exchange approval, and fully recovered hundreds of millions in loans for the client. The judgment of this case holds landmark significance for the determination of the validity of external guarantees.

I. Basic Facts of the Case

The mainland branch of an international bank provided a loan totaling hundreds of millions of Hong Kong dollars to an overseas company. This loan was secured by a mortgage guarantee provided by the domestic affiliate of the overseas company—a well-known wholly foreign-owned hotel—using its core property assets. The principal loan agreement was governed by the laws of the Hong Kong Special Administrative Region, while the domestic mortgage guarantee contract was governed by the laws of Mainland China. After the borrower defaulted, the bank filed a lawsuit demanding repayment of principal and interest from the borrower and claiming priority compensation rights over the mortgaged property.

II. Key Points and Difficulties

This case is a typical “domestic guarantee for foreign loan” dispute, involving complex legal relationships spanning two major jurisdictions. The core points of contention and case difficulties were highly concentrated:

Crisis Over the Validity of the External Guarantee

The guarantor raised a key defense, arguing that the mortgage guarantee in question, as an external guarantee, was not registered in accordance with national foreign exchange regulations at the time of its establishment, violating China’s mandatory provisions and should therefore be invalid.[1] This constituted the primary obstacle for the bank to realize its mortgage rights.

Conflict of Laws Applicable to Principal and Accessory Contracts

The principal contract and the accessory contract chose the laws of Hong Kong and Mainland China, respectively, as their governing laws. As laws and judicial interpretations provide no direct stipulations for situations where principal and accessory contracts choose different governing laws, defining the scope of application of these two legal systems and whether the validity of the accessory contract would be affected by the governing law of the principal contract were significant issues in the trial of this case.

Ascertainment and Application of Foreign (Interregional) Law

The principal contract was governed by Hong Kong law, necessitating the accurate ascertainment and application of Hong Kong’s statutory and case law concerning loans, interest, and liability for breach of contract in a Mainland court. This placed extremely high demands on the cross-jurisdictional legal knowledge and experience of the representing lawyers.

III. Highlights of Representation

During the process of representing the bank in the first instance and the second instance at the Supreme People’s Court, Zhenghan Law Firm’s lawyers successfully addressed all challenges from the opposing party through profound insight into complex legal issues and sophisticated litigation strategies:

Precise Definition of the Nature of Legal Norms

Zhenghan Law Firm’s lawyers argued that the State Administration of Foreign Exchange’s regulations concerning the registration of external guarantees primarily targeted guarantees requiring prior approval. Since the external guarantee in this case did not require prior approval, the legislative purpose of SAFE’s regulations was administrative supervision and balance-of-payments statistics, not establishing “mandatory provisions concerning validity” that determine the validity of civil contracts, but rather “administrative mandatory provisions.” Therefore, the failure to complete registration should not affect the validity of the guarantee contract itself. More importantly, the bank subsequently completed the supplementary registration procedure, remedying the legal defect, which further eliminated the grounds for invalidating the external guarantee due to lack of registration.

Navigating Complex Choice of Law

Zhenghan Law Firm’s lawyers clearly demonstrated the independence and legality of the principal and accessory contracts choosing their respective governing laws, persuading both the trial and appeal courts to recognize the principle of party autonomy, clarifying the scope of application of each governing law, and ensuring the correct adjudication of substantive rights.

Proficient Application of Extraterritorial Law: By submitting a professional legal opinion from a senior Hong Kong lawyer and combining it with thorough argumentation during the trial, Zhenghan Law Firm’s lawyers assisted the court in accurately ascertaining Hong Kong law, laying a solid foundation for the judgment to support all the bank’s claims for principal, interest, and penalty interest.

IV. Key Rulings

Both the Shanghai High People’s Court in the first instance and the Supreme People’s Court in the final instance ruled in favor of the bank’s claims. In its judgment (2010) Min Si Zhong Zi No. 12, the Supreme People’s Court clarified the following core adjudication rules:

Affirmation That Principal and Accessory Contracts May Choose Different Governing Laws

The judgment clarified that parties to principal and accessory contracts may separately and independently agree on their respective applicable governing laws, and both types of agreements are legally valid.

Confirmation of the Validity of External Guarantee Contracts with Supplementary Registration

The Supreme People’s Court held that a wholly foreign-owned enterprise providing an external guarantee does not require pre-approval, and the effectiveness of its external guarantee contract is not contingent upon approval. Although external guarantees should be registered, given that the guarantee in this case had undergone supplementary registration procedures, the mortgage guarantee contract in question was deemed legally valid.

Comprehensive Support for the Creditor’s Claims

The judgment required the borrower to repay the bank the full loan principal, interest, and penalty interest, and confirmed the bank’s priority compensation rights over the mortgaged property of the domestic hotel.

V. Case Implications

This case is a landmark in the Supreme People’s Court’s adjudication of cross-border financial guarantee disputes. Its judgment not only provides authoritative guidance for judicial practice on how to determine the validity of external guarantee contracts, clarifying the boundaries of the impact that approval and registration requirements under foreign exchange regulations have on contract validity, but also reaffirms the importance of the principle of party autonomy in international commercial transactions. This case has a profound impact on promoting the stability of cross-border investment and financing transactions and safeguarding the security of financial claims.

VI. Recognition and Awards

The judgment in this case is included as a Supreme People’s Court Gazette Case and has been compiled into legal practice books such as the “Guide to Complex Issues and Successful Litigation Strategies in Guarantee Disputes.” This case is an important precedent in the field of foreign-related commercial adjudication, and its adjudication logic significantly influences subsequent cross-border financing guarantee businesses such as “domestic guarantees for foreign loans.”

 

*Special Note: This case occurred relatively early. Current regulations on external guarantees have been adjusted by the State Administration of Foreign Exchange. Practical operations should adhere to the latest legal provisions and judicial practice.

Second-instance reversal: Zhenghan Law Firm, litigating away from home, recovers hundreds of millions in investments from a local government investment platform.

This case involves a complex real estate cooperative development dispute concerning a local government resettlement housing project, with the core controversy focusing on the calculation of losses after the contract was deemed invalid. The case was under the jurisdiction of the court located in the place where the local government is situated. Zhenghan Law Firm represented the project investor and the engineering construction and management agent, while the opposing party, the project owner, was a local government platform company. The first-instance court only upheld the party’s claim for the return of the investment principal and determined that the local government platform company had suffered losses amounting to over 100 million yuan. Through rigorous and meticulous courtroom argumentation and detailed post-trial communications with the judges, Zhenghan Law Firm successfully persuaded the second-instance court to re-determine the losses, not only revoking the unfavorable first-instance judgment but also helping the client fully withdraw from the project led by the local government platform, recovering hundreds of millions of yuan in investment principal, interest and damages, thus achieving a complete reversal.

I. Basic Facts of the Case

The Appellant (Original Plaintiff), Company A (the project’s construction and management agent), entered into a real estate cooperative development agreement with the Appellee (Original Defendant), Company B (a local government platform company and the project owner), stipulating that Company A would invest in and construct a local resettlement housing project. During the project’s construction, a dispute arose between the two parties, and the agreement in question was ultimately characterized by the court as a construction project contract and deemed invalid in a separate effective judgment due to the project’s violation of the mandatory provisions of the Tendering and Bidding Law.

As the project could not proceed further, Company A had already incurred substantial upfront costs and faced huge losses. Accordingly, Company A filed a lawsuit with the court, demanding that Company B return Company A’s investment funds and compensate for losses arising from the occupancy of funds, as well as reimburse Company A for upfront investment cost losses. Company B, through a counterclaim, asserted that it had also suffered losses and demanded that Company A bear liability.

The first-instance court upheld Company A’s claim for the return of the investment principal but completely dismissed Company A’s request for losses arising from the occupancy of funds. Meanwhile, it included all expenses incurred by Company B using the investment funds provided by Company A as part of Company B’s losses, resulting in a final determination of Company B’s losses of up to over 100 million yuan, even though Company B’s counterclaim only sought more than 20 million yuan. Since the court’s judgment allocated and offset the losses of Company A and Company B in proportion to their respective faults, Company A was required to make additional payments to Company B for losses beyond the investment funds, placing Company A in an extremely unfavorable position.

II. Key Points and Difficulties

1. The opposing party had a government background, making litigation away from home extremely challenging

The opposing party, Company B, was a platform company backed by the local government, and the project involved a major local livelihood project (resettlement housing construction). Litigation was conducted in the local court, and an unfavorable judgment had already been issued in the first instance. Overturning the original findings on appeal faced enormous pressure from the opposing party’s “home-court advantage.”

2. The complexity of proving losses

As the investor, Company A had invested a large amount of upfront costs in the project, whereas Company B, as the owner, had actually invested very little in the project. The first-instance court mechanically applied the law, excluding a significant portion of Company A’s actually incurred expenses on the grounds of insufficient relevance of evidence, and instead recognized expenses that Company B had not even raised in its counterclaim as losses. Another major difficulty was how to construct a complete chain of evidence and logic in the second instance to reduce the opposing party’s loss amount and increase our client’s loss amount.

3. The fault game after the contract was deemed invalid

It was an established fact that the contract in question was deemed invalid due to a violation of the Tendering and Bidding Law. The difficulty lay in how to argue that Company A, as the investor and construction/management agent, was less at fault than Company B, as the owner, thereby reducing the proportion of fault liability borne by Company A.

III. Highlights of Representation

1. Detailed communication and professional argumentation reshaped the judges’ inner conviction

Faced with the opposing party with a government background, the acting lawyers persuaded the judges through multiple rounds of professional, detailed and well-organized communications both in court and after the trial to recognize that the court should not adjudicate beyond the claims or recognize losses exceeding the amount claimed in Company B’s counterclaim.

2. Visual charts clearly presenting the specific composition of losses

The legal team produced detailed visual charts that corresponded the complex project costs with thousands of pages of evidence, clearly presenting the name, amount, payment date, etc., of each expense, and strongly proved that Company A’s expenditures were directly related to the project and should be recognized as losses.

3. Precisely identifying the liable subject and reducing the proportion of fault liability

The legal team conducted in-depth legal research on the issue of liability for invalidity of a contract due to failure to tender when required, and provided a legal research report for the judges’ reference. During the trial, through rigorous logical deduction, the team clarified to the judges that Company B, as the employer and the government-backed party, held an absolutely dominant position in the project, and its “failure to tender when required” was the fundamental cause of the contract’s invalidity; Company A, as the bidder, had no right to decide on the tendering and bidding procedures and should not bear primary liability.

4. Arguing vigorously and persuading the court to uphold claims for losses arising from fund occupancy

Regarding the fund occupancy fees dismissed in the first instance, the acting lawyers cited the latest judicial interpretations to argue that even if the contract was invalid, losses arising from fund occupancy should still be compensated. Ultimately, the second-instance court upheld the fund occupancy interest calculated based on the Loan Prime Rate (LPR).

IV. Key Adjudication Points

1. Fault determination for an invalid contract

In a case involving the invalidity of a real estate development contract subject to mandatory tendering, the employer (tenderer) is obligated to organize the tendering and bidding process. Its failure to tender in accordance with the law leading to the contract’s invalidity shall bear primary fault liability.

2. Scope of compensation for losses

Compensation for reliance interest losses shall cover the necessary expenses incurred by the parties in performing the contract, including upfront start-up fees, management fees and project investments, and shall not be limited to the actual project construction cost. Meanwhile, the court’s determination of losses shall not exceed the scope of the claims raised in the plaintiff’s complaint or the defendant’s counterclaim.

3. Nature of fund occupancy fees

After a contract is deemed invalid, the compensated losses shall include interest losses during the period of fund occupancy.

V. Case Implications

This case is a typical example of disputes arising from social capital’s participation in local government infrastructure projects. For investors, it is essential to attach great importance to the compliance of tendering and bidding procedures in the early stages of a project; otherwise, once the contract is deemed invalid due to procedural violations, they will face huge risks in claiming compensation. At the same time, the second-instance reversal in this case also demonstrates that through the precise analysis of legal issues by professional lawyers, even when facing a powerful local government platform company, one can still protect their legitimate rights and interests through judicial channels. This case provides important reference significance for the liability settlement after the invalidity of contracts in similar “government-enterprise cooperation” projects.