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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. Case Background

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 Challenges

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 core defense, asserting that as the mortgage guarantee in question was an external guarantee, it had not undergone registration procedures in accordance with national foreign exchange management regulations at the time of its establishment. They argued this violated China’s mandatory provisions and should be rendered invalid. [1] This constituted the greatest obstacle to the bank’s realization of its mortgage rights.

Conflict of Laws Between Principal and Accessory Contracts

The principal contract and the accessory contract chose two different laws, those of Hong Kong and Mainland China, as the governing laws. There are no direct provisions in laws or judicial interpretations regarding the separate agreement of different applicable laws for principal and accessory contracts. How to define the scope of application for both laws, and whether the validity of the accessory contract would be affected by the choice of law for the principal contract, was a major issue in the trial of this case.

Ascertainment and Application of Foreign (Regional) Law

As the principal contract was governed by Hong Kong law, it was necessary to accurately ascertain and apply Hong Kong’s statutory and case law regarding lending, interest, and liability for breach of contract in a mainland court. This placed extremely high demands on the representing lawyers’ cross-jurisdictional legal knowledge and experience.

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, with their profound insight into complex legal issues and exquisite litigation strategies, successfully met all of the opponent’s challenges:

Precisely Defining the Nature of Legal Norms

Zhenghan Law Firm’s lawyers argued that the State Administration of Foreign Exchange’s regulations on the registration of external guarantees are primarily aimed at external guarantees that require approval. Since the external guarantee in this case did not require prior approval, the legislative intent of the Foreign Exchange Bureau lay in administrative supervision and balance of payments statistics, rather than being an “effectiveness-oriented mandatory provision” that determines the validity of civil contracts; instead, it should be classified as a “management-oriented mandatory provision.” Therefore, the failure to register should not affect the validity of the guarantee contract itself. More importantly, the bank subsequently completed the supplementary registration procedures, rectifying the legal flaw, making it even less appropriate to use the failure to register as a reason for the invalidity of the external guarantee.

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. They persuaded both courts to recognize the principle of party autonomy, clarified the respective scopes of legal application, and ensured the correct trial of substantive rights.

Skillful Application of Foreign Law: By submitting professional legal opinions issued by senior Hong Kong lawyers and combining them with thorough arguments during the court hearings, Zhenghan Law Firm’s lawyers assisted the court in accurately ascertaining Hong Kong law. This laid a solid foundation for the judgment to support all of the bank’s claims for principal, interest, and penalty interest.

IV. Key Points of the Judgment

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

Affirming that Principal and Accessory Contracts May Choose Different Governing Laws

The judgment clarified that the parties to a principal contract and an accessory contract may separately and independently agree on their respective governing laws, and both agreements are legal and valid.

Confirming the Validity of External Guarantee Contracts with Supplementary Registration

The Supreme People’s Court held that the provision of external guarantees by wholly foreign-owned enterprises does not require prior approval, and their external guarantee contracts do not take approval as a condition for taking effect. 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 determined to be legal and valid.

Full Support for the Creditor’s Claims

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

V. Case Insights

This case is a landmark case in the field of foreign-related financial guarantees tried by the Supreme People’s Court. Its judgment not only provides authoritative guidance on how to determine the validity of external guarantee contracts in judicial practice and clarifies the boundaries of the impact of approval and registration of external guarantees on contract validity under foreign exchange management regulations, but also reaffirms the importance of the principle of party autonomy in international commercial transactions. The case has a profound impact on promoting the stability of cross-border investment and financing transactions and ensuring the security of financial claims.

VI. Evaluation and Awards

The judgment of this case is a Gazette Case of the Supreme People’s Court and has been included in legal practice monographs such as “Guide to Difficult Issues and Winning Strategies in Guarantee Disputes.” This case is an important precedent in the field of foreign-related commercial trials, and its adjudication reasoning has a significant impact on subsequent cross-border financing guarantee businesses such as “domestic guarantees for foreign loans.”

 

*Special Note: This case occurred some time ago. Current regulations on external guarantees have been adjusted by the State Administration of Foreign Exchange. Practical operations should be based on the latest legal provisions and judicial practices.

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In a major international cargo sales dispute that underwent two levels of trial at a high people’s court and the Supreme People’s Court, Zhenghan Law Firm fought tenaciously for the client and successfully secured millions of US dollars in damages for the client even when the second-instance court adopted a different finding on the core legal issue.

Basic Facts of the Case

Zhenghan Law Firm represented a large Singaporean trading company (the “Buyer”) in purchasing petroleum coke worth nearly eight million US dollars from a renowned German industrial group (the “Seller”). The contract stipulated a “typical value” range for the Hardgrove Grindability Index (HGI), a key quality indicator of petroleum coke. However, inspection of the goods delivered by the Seller revealed that the HGI was far below the minimum value agreed in the contract, making it difficult for the Buyer to sell the goods normally in the Chinese market and suffering huge losses. The Buyer filed a lawsuit with a high people’s court, claiming that the Seller constituted a fundamental breach of contract, requesting the rescission of the contract, the return of the purchase price, and compensation for all losses.

Key Points and Difficulties

Finding of Fundamental Breach of Contract

The core controversy in this case was whether the non-conformity of the goods delivered by the Seller constituted a “fundamental breach” as defined in Article 25 of the United Nations Convention on Contracts for the International Sale of Goods (CISG). The first-instance court upheld the claim of fundamental breach, but the Supreme People’s Court held a different view. How to respond to this change in the core legal opinion in the second instance was the greatest difficulty in the case.

Application of International Conventions

The parties to this case were from Singapore and Germany respectively, and the contract stipulated the application of the law of the State of New York, the United States, but all parties agreed to the application of the CISG in the first instance. How to accurately apply the CISG at the level of the Supreme People’s Court to maximize the client’s interests imposed extremely high requirements on the professional capabilities of the acting lawyers.

Calculation of Complex Losses

On the basis that the breach of contract was established, how to clearly define and calculate the losses of price difference, storage fees and corresponding interest caused by the quality problems of the goods was directly related to the client’s vital interests.

Highlights of Representation

Complete Victory in the First Instance

In the first-instance stage, Zhenghan Law Firm, relying on solid evidence and sufficient legal arguments, successfully persuaded the high people’s court to find that the Seller’s conduct constituted a fundamental breach of contract, declared the contract invalid and upheld all the client’s main claims, laying a solid foundation for the success of the case.

Adjustment of Strategy in the Second Instance

During the second-instance trial at the Supreme People’s Court, faced with the situation that the collegial panel might adopt a stricter standard for finding “fundamental breach”, Zhenghan Law Firm responded calmly and adjusted its representation strategy in a timely manner. While insisting on the nature of the Seller’s breach of contract, it focused the argument on the actual losses suffered by the client due to the breach, ensuring that even in the case of a change in legal characterization, the client’s substantive rights and interests could be protected to the maximum extent.

Securing Core Interests

Although the Supreme People’s Court ultimately did not find that the Seller’s conduct constituted a fundamental breach of contract, it fully recognized the fact of the breach. Through strong representation work, Zhenghan Law Firm successfully proved the key losses suffered by the client, such as the price difference of the goods and storage fees, and finally helped the client obtain compensation of millions of US dollars, realizing the core commercial demands.

Key Adjudication Points

The High People’s Court (First Instance) Held:

The HGI of the goods delivered by the Seller was far below the contractual stipulation, making the goods difficult to sell in the Chinese market and frustrating the Buyer’s expected purpose of concluding the contract, thus constituting a fundamental breach of contract.

The Supreme People’s Court (Final Instance) Held:

The core standard for finding a “fundamental breach” is whether the breach “in fact deprives the party of what he is entitled to expect under the contract”. In this case, although the goods had quality defects, they still had use value, and the Buyer had successfully resold them without completely losing the expected benefits under the contract, so it did not constitute a fundamental breach. However, the Seller’s conduct undoubtedly constituted a breach of contract and shall be liable for compensation for the Buyer’s losses of price difference, storage fees and interest caused thereby.

Case Implications

The final judgment of this case was rendered by the Supreme People’s Court, which clearly stated that where goods have quality defects but can still be used or resold in a reasonable manner, it is generally not appropriate to easily find a fundamental breach of contract. This is of great significance for the application of the CISG in China’s judicial practice, especially for the definition of “fundamental breach”. This case was selected as a “Typical Case of People’s Courts Providing Judicial Services and Guarantees for the Construction of the ‘Belt and Road Initiative’” issued by the Supreme People’s Court and included as “Guiding Case No. 107”, which has guiding significance nationwide.