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Saturday, November 18, 2017

Is guarantee by third party in a loan contract to be revoked?

Updated: 11:37’ - 17/06/2014

Dang Van Vuong
YKVN Associate

It is reported that recently the court has revoked contracts for mortgage of land use rights on the only ground concerning the (mistaken) use of the term “mortgage”, instead of the term “guarantee”.[1] First-Instance Judgment No. 26/2011/KT-ST of the People’s Court of Quang Ngai province dated August 5, 2011, First-Instance Judgment No. 49/2012/KDTM-ST of the People’s Court of Cu Chi district dated September 24, 2012, and Appellate Judgment No. 105/2013/KDTM-PT of the People’s Court of Ho Chi Minh City dated January 18, 2013 (the “Judgment”) can be cited as examples.

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                     Transactions at Sacombank’s Hanoi branch__Photo: Tran Viet/VNA

To protect legitimate rights and interests of its credit institution members, the Vietnam Banks Association (the “VBA”) has issued Official Letter No. 17/CV-HHNH dated February 2, 2012, Official Letter No. 44/CV-HHNH dated March 7, 2012, and Official Letter No. 186/ HHNH-PLNV dated June 7, 2013, requesting the Supreme People’s Court to recognize such contracts for mortgage of land use rights on the ground that the guarantee with land use rights is construed as mortgage of land use rights (the “Official Letter”).

In this article I would like to present considerations of both the court and the VBA, to find out what the legal issue is, and what to do with this situation.

In the Judgment, among other reasons to revoke the contracts for mortgage of land use rights, the court opined that (i) such contracts (Contract for Mortgage No. 93 and Contract for Mortgage No. 94)[2] are in essence contracts for guarantee, not for mortgage, because Ms Nguyen Thi X, who was a third party, mortgaged Mr. Nguyen Van Y and Ms Nguyen Thi Z’s property in order to provide a guarantee for Company A in borrowing a loan from Bank B. As a result, Bank B’s consideration that such contracts were for mortgage of property was not in accordance with Article 361 of the Civil Code; and (ii) regarding the authorization, as Ms Nguyen Thi X was not authorized by Mr. Nguyen Van Y and Ms Nguyen Thi Z to take the property as a guarantee for the loan borrowed by Company A from Bank B, the contracts were regarded as invalid.

In the Official Letter, VBA stated that the revocation of such two contracts was contrary to regulations on secured transactions:

(i) The mortgage was a typical security through the use of property by the loan borrower or the third party, if the mortgagor was not required to be concurrently the loan borrower.  VBA quoted Article 342.1 of the Civil Code “Mortgage of property means the use by one party (hereinafter referred to as the mortgagor) of property under the ownership of the obligor as security for the performance of a civil obligation to the other party (hereinafter referred to as the mortgagee) without transferring such property to the mortgagee.

(ii) In a guarantee transaction, a guarantor undertakes to perform obligations on behalf of a guarantee. It is not provided that the guarantor must guarantee with property in order to secure the performance of obligations towards a beneficiary, VBA made considerations by referring to Article 361 of the Civil Code: “Guarantee means an undertaking made by a third person (hereinafter referred to as the guarantor) to an obligee (hereinafter referred to as the beneficiary) to perform an obligation on behalf of an obligor (hereinafter referred to as the principal) if the obligation falls due and the principal fails to perform or performs incorrectly the obligation. The parties may agree that the guarantor shall only be obliged to perform the obligation if the principal is incapable of performing it.”

(iii) Decree No. 84/2007/ND-CP dated May 25, 2007, additionally providing the issuance of land use right certificates; land recovery; exercise of land use rights; order and procedures for compensation, assistance for resettlement of people whose land is recovered by the State, and the settlement of complaints about land (“Decree No. 84/2007”), Article 31.1 provided “A guarantee using land use rights and assets attached to land pursuant to the Land Law means a mortgage using land use rights to a third party borrower in accordance with the Civil Code (hereinafter referred to as a land use right mortgage)”.

(iv) Decree No. 163/2006/ND-CP dated December 29, 2006, on secured transactions (“Decree 163/2006”), Article 72.4 stated “Guarantees using  land use rights and forest use rights, and ownership of planted forest land  for production pursuant to Decree No. 181/2004/ND-CP dated October 29, 2004, providing for implementation of the Land Law, and pursuant to Articles 32.5, 33.4, 34.4, 35.4 and 36.1 of Decree No. 23/2006/ND-CP dated March 3, 2006, on detailing and guiding the implementation of the Law on  Forest Protection and Development, shall be converted to mortgages of land use rights, of forest use rights or  of ownership of planted production  forests in order to secure performance of obligations of another person”.

Based on the above information, I understood that there were two possible issues, (i) the report was overstated and may make readers misunderstand that the revocation of the contracts for mortgage was only neither due to (mistaken) use the term “guarantee” instead of the term “mortgage” nor mistaken application of mortgage instead of guarantee, and (ii) if the report was not overstated, then a legal question should be made, which was whether a mortgage in which a party (a mortgagor) was entitled to mortgage its property to secure the performance of the obligation of another party (a third party, not of its own) towards a mortgagee.

First, as stated in the Judgment, the initial court ruling that the contracts for mortgage were those for guarantee was to conclude these contracts for mortgage were not in accordance with the provisions of Article 361 of the Civil Code; subsequently, the court referred to the unauthorization of the representative to take the property of the owners for guarantee, then concluded that the contracts were invalid. So, I found that the main reason, for which the court revoked the contracts, was such unauthorization.

Second, while the Judgment just considered such contracts were for guarantee, in the past the People’s Court of Quang Ngai province revoked contracts for property mortgage in order to secure the obligatory repayment by the other party to Vietcombank and Military Bank on a ground that by law such revoked contracts must be contracts for guarantee.[3] Hence, to determine whether such type of contract, with three parties involved, can be regarded as contracts for mortgage is crucial to the validity of those contracts.

According to Article 342.1 of the Civil Code quoted above, that mortgage of property means the use of property by one party under its ownership as security for the performance of a civil obligation to the other party. Because of the use of “the other party”, it does not mean that the mortgage contract would be between only two parties, there may be a related party (a third party) here. This provides a ground on which some hold that there are two and only two parties in a mortgage, while other argue that there may be three or more parties with the mortgagor using its property as mortgaged assets towards a mortgagee to secure the obligation performance by a third party to such mortgagee. So, which opinion is correct?

Dang Van Hung from the Civil Tribunal of the Supreme People’s Court opined that there are only two subjects: mortgagor and mortgagee [] the property mortgage is a case where enterprise A uses its own property to secure its own obligation under a loan contract with a bank[4]. It means that there is no third party in a mortgage transaction. However, Dang Van Hung’s opinion was not backed by any legal ground.

Article 369.1 of the Civil Code of Japan[5] clearly provides “a mortgagee shall have the right to receive the performance of his/her claim prior to other obligees out of the immovable properties that the obligor or a third party provided to secure the obligation without the transferring possession”. It means that an obligor/a third party may mortgage its property to a mortgagee to secure an obligation, or in other words there may be three parties in a mortgage transaction.

In my view, because the wording of Article 342.1 of the Civil Code does not state whether such secured civil obligation belongs to the mortgagor or belongs to a third party to the other party, then there are two options: (i) the mortgagor mortgages its property to secure the performance of its own obligation to the mortgagee, (ii) the mortgagor mortgages its property to secure the performance of an obligation of a third party to the mortgagee. This understanding is also compatible with the Civil Code of Japan, in a civil law system like ours. Furthermore, if the mortgage falls into option (ii), the mortgage is still different from a guarantee, because the mortgage is valid without transfer of the mortgaged property to the mortgagee while the guarantee can be valid with or without transfer of the mortgaged property to the beneficiary depending on security measures, such as pledge, mortgage, security deposit, or escrow deposit.[6]

Through this case, I realize that there are shortcomings relating to mortgage and guarantee as per the law, for example, (i) the definition of guarantee does not exactly express the nature of term and only requires the guarantor “to undertake to perform an obligation” instead of “must perform an obligation”. In practice, therefore, it is risky to use the term “guarantee” because the guarantee does not enforce the obligation performance; (ii) the definition of mortgage may lead to an incorrect understanding that a mortgage would not have a third party, then the mortgagee can only be the loan borrower (in a loan contract) or make the court think that the mortgage is in essence guarantee; and (iii) confusion of definitions, which might cause, in some guiding documents, alteration or reinterpretation of terms to make them compatible with their practical nature.

To avoid the risk of aforesaid contracts being revoked, an easy solution would be to establish both mortgage contract and guarantee contract, though they could face high possibility of challenge.-



[1] http://thoibaonganhang.vn/index.php/tin-tuc/5-khuyen-khich-gian-lan--boi-uoc-9580.html, by lawyer Truong Thanh Duc.

[2] According to the Judgment, these are two contracts for mortgage of land use rights and of residential houses.

[3] Item 3.5, “Comments on Institution of the Loan Security in Bank Credit Sector”, Lawyer Truong Thanh Duc, on http://www.basico.com.vn/vi-VN/News/2013/11/766/164-Binh-luan-Che-dinh-bao-dam-tien-vay-doi-voi-hoat-dong-tin-dung-ngan-hang-BTP.aspx.

[4] Pages 21 and 23 in the article “Applying law in carrying out transactions on representation, property mortgage and guarantee” published on People’s Court Magazine of February 2012, Volume No. 04.

[5] http://www.moj.go.jp/content/000056024.pdf.

[6] Page 157, Scientific Comments on the 2005 Civil Code (Volume II), Institute of Legal Sciene - Ministry of Justice, Associate Professor Dr Hoang The Lien as the leading author, published by National Politics Publishing House, 2010.

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