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Official Gazette

Wednesday, May 22, 2019

Third-party security in the Civil Code

Updated: 17:59’ - 30/08/2017
Nguyen Hong Hai
Deputy General-Director
Department of Civil-Economic Laws, Ministry of Justice

The 2015 Civil Code (the Code) provides nine measures to secure the performance of civil obligations according to two approaches, namely law-prescribed security[1] and agreement-based security[2], and security without property[3] and security with property[4]. Under either approach, the issue that attracts special attention from the parties to civil transactions is whether third-party security is recognized and what legal contents of this issue are. This article touches upon the issue in light of the Code.

Definition and necessity of third-party security

Third-party security means that a third party[5] agrees with the obligee (creditor) or with both the creditor and obligor (debtor) on the third party’s commitment to take a trust-based security measure (guaranty or pledge of trust[6]) or a property-based security measure (mortgage or pledge[7]) to secure the performance of the debtor’s civil obligation. This security involves three parties: the security-accepting party (creditor), securing party (third party), and secured party (debtor).

In this security, the relation between the security-accepting party and securing party is central and decisive. The agreement between the creditor and third party is a prerequisite for a security relation to arise, and the agreement with the debtor is required only when it is so agreed upon by the parties or when the consent of the debtor is required by law. The third party’s security for the performance of the debtor’s obligation may be the outcome of the agreement between them, under which the third party provides a service to help the debtor get a loan from the creditor, and, in return, the debtor must pay a service charge or remuneration or reimburse the value of the property or the obligation already performed by the third party to secure the debtor’s obligation.

Acknowledging the third-party security is simply the extension of one of the fundamental principles of civil law that individuals or legal persons may establish, perform and terminate their civil rights and obligations on the basis of free and voluntary commitment and agreement, thus offering them more opportunities for participation in civil relations in general and in securing the performance of civil obligations in particular.

On the debtor’s part, once its debt payment obligation is secured by a third party, it will be able to access and get more funds for investment, production, business or consumption purposes, especially when it has no or insufficient financial sources to gain the trust of the creditor or when its available funds are not enough to meet investment, production and business or consumption requirements[8].

For the creditor, the third-party security for the debtor’s obligation will help the creditor become more financially capable and legally secure to grant loans to the debtor and decide on loan amounts. The creditor can bear no or fewer legal risks in case the debtor defaults, thus being able to expand investment channels and increase investment efficiency through “pumping” its funds into the market and society.

The third party’s security for performance of the debtor’s civil obligation will not only help the debtor get more loans but it is also a form of investment to exploit material benefits from the property used as security or from the performance of the debtor’s obligation.

For the society at large, the third-party security contributes to increasing investment sources for the society and enhancing the linkage between the capital market, goods and service market, real estate market, science and technology market, and labor market, thus promoting the sustainable and stable socio-economic development.

Signing ceremony of a strategic cooperation contract between VietinBank and Saigon Co.op__Photo: Thanh Vu/VNA

Guaranty[9]

Guaranty is defined by the Code as a trust-based security measure thereby a third party (guarantor) commits with the obligee (creditor) to perform an obligation on behalf of the obligor (principal) if, when the obligation becomes due but the principal fails to perform or improperly performs the obligation.

To suit the nature of a trust-based security measure, the Code does not allow the creditor to realize the guarantor’s property to pay for the principal’s obligation in case the principal breaches the obligation. In this case, the creditor may only request the guarantor to pay for the value of the obligation breached by the principal, including interest on the principal loan, fine, damages, and late-payment interest, unless otherwise agreed upon. Should the guarantor fail to voluntarily perform its obligation, the creditor may request the court or arbitration (if so agreed upon) to compel the guarantor to perform the obligation on behalf of the principal.

However, to build the confidence among the parties, raise the responsibility of the principal and guarantor in performing their obligations and prevent legal risks, the Code acknowledges three legal regimes below:

(i) The parties may agree that the guarantor has to perform the obligation on behalf of the principal only when the latter is incapable of performing the guaranteed obligation;[10]

(ii) The parties may agree to use the property as security (e.g., pledge or mortgage) to perform the guaranteed obligation; and,

(iii) The guaranteed obligation may be a future obligation. In this case, the guaranty does not cover the obligation arising after the guarantor being an individual dies or the guarantor being a legal person ceases its existence.

Security with a third party’s property

Legal bases

The Code has no specific provisions on securing the performance of civil obligations with a third party’s property, sparking worries that lawmakers have no clear views on this issue and legal risks may occur to the parties, especially the security-accepting party.[11] The Code neither imposes any limitation on the right of the parties to choose security with a third party’s property nor requires the secured obligation be of the secured (Article 293), the collateral belong to the party whose obligation is secured (Article 295) and the subjects of security measures be the creditor and debtor.

However, the Code provides sufficient legal mechanisms for the settlement of civil relations in case of absence of applicable law within the limits of the rights of the subjects of civil relations, specifically as follows:

- The court may not refuse to settle a civil case or matter for the reason that there is no applicable law. In this case, it must base itself on the parties’ agreement; customary practices or analogous law; or court precedents, fundamental principles of civil law and justice to settle the case or matter;[12]

- Civil rights may only be limited by a law in cases of necessity for the reasons of national defense, security, social order and safety, social morality, or community well-being;[13]

- Individuals or legal persons may establish, perform and terminate their civil rights and obligations on the basis of free and voluntary commitment and agreement. All commitments and agreements that are neither prohibited by law nor contrary to social morality will be binding on the parties and must be respected by other subjects;[14]

- Individuals or legal persons may perform their civil rights of their own free will provided such does not contravene fundamental principles of civil law, and they may not abuse these rights to cause damage to others, breach their obligations or realize an illegal purpose;[15]

- No one may be illegally restricted in or deprived of his ownership rights or other rights over property; in case of extreme necessity for the reasons of national defense and security, national interests, state of emergency or disaster prevention and control, the State may effect a compulsory purchase or requisition of property of organizations or individuals with compensation at the market price.[16]

So, it can be affirmed that if the parties agree to secure the performance of a civil obligation with the property of a third party and such agreement is neither prohibited by law nor contrary to social morality, it will be binding on the parties and must be respected by other subjects. The court and competent authorities must respect and protect this right.[17],[18]

Applicable forms of security for performance of civil obligations with a third party’s property

This security may take two forms. The first involves the use of a third party’s property to secure the performance of the debtor’s obligation. With this form (normally mortgage or pledge[19]), the creditor is the security-accepting party, the third party is the securing party, and the secured obligation is part or the whole of the debtor’s obligation (as agreed upon or prescribed by law). If the debtor breaches the secured obligation[20], the creditor may realize the collateral put up by the third party.

Example: X borrows a sum of money from Y; M agrees with Y on the mortgage of M’s property to secure the performance of X’s repayment obligation. In this case, three relations arise, namely X-Y relation (under regulations on the obligation relation), M-Y (under regulations on mortgage), and X-M (relation involving or not involving compensation). When X breaches its repayment obligation toward Y, then Y may realize the property used by M to secure the repayment of X’s debt. When agreed upon or prescribed by law, X must return the value of M’s property already realized to pay X’s debt, which may include a service charge or remuneration.

With the second form, the guarantor uses its property to secure its guaranty obligation. This form is basically similar to the first one. The key difference is that the secured obligation is not the debtor’s obligation but part or the whole of the guaranty obligation of the guarantor. So, unlike in the first form, if the debtor breaches the guaranteed obligation,[21] the creditor must, first of all, request the guarantor to perform the obligation on the debtor’s behalf; if the guarantor breaches its obligation, then the creditor may realize the property used by the third party to secure the obligation.

Example: A provides B with guaranty to borrow a sum of money from C. As agreed with C, A mortgages its property to secure the performance of its guaranty obligation. In this case, three relations arise, namely B-C-A relation (under regulations on guaranty), A-C relation (under regulations on mortgage), and A-B relation (relation involving or not involving compensation). If B breaches the repayment obligation toward C, then C may not realize the mortgaged property yet, but must first request A to perform the repayment obligation on B’s behalf; if A breaches its guaranty obligation, then C has the right to realize the mortgaged property as agreed upon or prescribed by law. When agreed upon or prescribed by law, B must reimburse the value of A’s property already realized to pay B’s debt, which may include a service charge or remuneration.

Security for the guarantor’s guaranty obligation may also be provided with others’ property. For instance, M provides N with guaranty to borrow a sum of money from P. As agreed with P, Y mortgages its property to secure M’s guaranty obligation toward N. In this case, four relations arise, namely N-P-M relation (under regulations on guaranty), P-Y relation (under regulations on mortgage), N-M relation (relation involving or not involving compensation), and Y-M (relation involving or not involving compensation). If N breaches the repayment obligation toward P, then P may not realize the mortgaged property yet, but must first request M to perform the repayment obligation on N’s behalf; if M breaches its obligation, then P has the right to realize the mortgaged property used by Y to secure P’s guaranty obligation. When agreed upon or prescribed by law, N and M must reimburse the value of the property of the securing parties (i.e., M and Y) which has been realized to pay for the obligations of N and M, which may include a service charge or remuneration.

Checking and sealing mortgaged property__Photo: Internet
 

Security for obligations of represented persons with property of representatives

Under the Code, each individual or legal person may represent different individuals or legal persons but may not, in the name of the represented person, establish and perform a civil transaction with himself/herself/itself or with a third party which he/she/it also represents, unless otherwise prescribed by law.[22] Concerning this issue, some hold that the representative’s use of his property to secure the obligation of the represented person is incompliant with the Code. However, with the exception “unless otherwise prescribed by law”, the Code does not deny all civil transactions established and performed by the representative with himself or with a third party which he also represents. This is explicitly expressed in Clause 1, Article 6, Clause 1, Article 86, and Clause 1, Article 162, of the 2014 Law on Enterprises. Accordingly, unless otherwise provided by the charter, the representative  of an enterprise may secure the performance of the obligation of this enterprise if such is approved by the Members’ Council, Shareholders’ General Meeting or Board of Directors.[23],[24]

For other cases, security for the performance of the obligation of the representative with his property must be provided under a contract in the interest of a third party. That means, the represented person only acts as the beneficiary from such security, and the relation between the securing party and secured party must involve no compensation, thereby the secured party is not required to perform any obligation toward the securing party. That the secured party has to perform an obligation toward the securing party also means that the representative’s performance of transactions with the represented person runs counter to the Code’s provision on the scope of representation. To avoid complexities and unnecessary legal risks, the author holds that the parties’ relation should be clarified as in the first form of security analyzed above, and the security contract should only bear the signatures of, or be accepted in another written form by, the security-accepting party (creditor) and securing party (representative).-


[1] Lien.
[2] Pledge, mortgage, deposit, security collateral, escrow account, retention of title, guaranty, and pledge of trust.
[3] Guaranty, and pledge of trust.
[4] Pledge, mortgage, deposit, security collateral, escrow account, retention of title, and lien.
[5] One or more than one individual or legal person.
[6] This article does not deal with legal contents of the measure of pledge of trust.
[7] In addition to mortgage and pledge, measures of security with property under the Code also include deposit, security collateral, escrow account, and lien (law-prescribed security measures).
[8] Reality shows that the mechanism on security for others’ obligations is actually helpful for people, startups and small- and medium-sized enterprises in accessing appropriate funding sources to meet their housing, scientific research, investment, production and business needs, etc.
[9] Articles 335 thru 343.
[10]  This provision is taken over from the 2005 Civil Code.
[11]  These worries are understandable because in fact some court already pronounced a contract on mortgage of the right to use the security for others’ obligations null and void for the reason that there is no applicable law.
[12] Articles 5 and 6, and Clause 2, Article 14.
[13]  Clause 2, Article 2.
[14]  Clause 2, Article 3.
[15]  Clause 1, Article 9 and Clause 1, Article 10.
[16]  Article 163.
[17] Clause 2, Article 3, and Clause 1, Article 14.
[18]  It is suggested that to ensure consensus on and consistency in the application and enforcement of laws, the Government should issue specific guidelines on this issue. Also, the Supreme People’s Court should guide or issue court precedents for consistent application in the settlement of cases and matters related to third-party security. At the same time, relevant laws, especially those on land, housing, real estate business, credit, and securities, should set out more specific provisions on security for the performance of civil obligations with the property of a third party.
[19]  Theoretically, the parties may agree to apply other measures of security with property.
[20]  The debtor fails to perform its obligation timely, fully or properly.
[21]  The debtor fails to perform its obligation timely, fully or properly.
[22]  Clause 3, Article 141.
[23]  In addition, for a single-member limited liability company, the security in this case will also be accepted if the company president or director or director general so decides (Article 86 of the Law on Enterprises).
[24]  Furthermore, if other cases are specified by law, the representative may provide security with his property for the performance of the obligation of the represented person. For instance, under Article 59 of the Code, the guardian may perform civil transactions related to the ward’s property in the ward’s interest; civil transactions between the guardian and ward which are related to the ward’s property will become null and void, unless they are performed in the ward’s interest.

 

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