The Civil Code adopts registration antagonism rules for the effectiveness of chattel mortgage. Article 403 of the Civil Code stipulates: "Where movable property is mortgaged, the mortgage right shall be established from the time the mortgage contract takes effect; without registration, it shall not be opposed to bona fide third parties." So, what are the scope of "third parties" that cannot be opposed in this provision? Does it include bankruptcy creditors or bankruptcy administrators? In other words, if the mortgagor goes bankrupt and the chattel mortgage has been established but not registered, can the mortgagee claim priority compensation from the bankruptcy administrator with the proceeds from the disposal of the mortgaged property? This article will reveal the answers to the above questions by analyzing a case and combining the provisions of the Civil Code and its associated judicial interpretations.

Referee gist

According to Article 54 of the Guarantee Interpretation of the Civil Code, "If mortgage registration is not handled after the conclusion of a chattel mortgage contract, the effectiveness of the chattel mortgage right shall be handled according to the following circumstances: (1)" "If the mortgagee requests the mortgagee to exercise the mortgage right after the mortgagee has transferred the mortgaged property and the transferee has taken possession of the mortgaged property, the people's court shall not support it, unless the mortgagee can provide evidence to prove that the transferee knows or should have known that the mortgage contract has been concluded;"; （2） "If the mortgagor leases the mortgaged property to another person and transfers possession, and the mortgagee exercises the mortgage right, the lease relationship will not be affected, except where the mortgagee can provide evidence that the lessee knows or should have known that a mortgage contract has been concluded;"; （3） "If any other creditor of the mortgagor applies to the people's court for preservation or enforcement of the mortgaged property, and the people's court has made a property preservation ruling or taken enforcement measures, and the mortgagee claims priority in repayment of the mortgaged property, the people's court shall not support it;"; （4） "If the mortgagor goes bankrupt and the mortgagee claims priority in repayment of the mortgaged property, the people's court shall not support it." It can be seen that the scope of "third party" in Article 403 of the Civil Code, which stipulates that "no confrontation against bona fide third parties", includes bankruptcy administrators and bankruptcy creditors. Therefore, when the mortgagor goes bankrupt and the chattel mortgage has been established but not registered, the mortgagee cannot apply to the bankruptcy administrator for priority repayment of the proceeds obtained from the disposal of the mortgaged property.

Case: Anyang Chemical Industry Group Co., Ltd. and Shenzhen Haige Jingu Industrial Technology Co., Ltd. Civil Judgment of the Second Instance on Sales Contract Dispute [Hebei Higher People's Court (2021) Yuminzhong No. 1437 Judgment Date: March 18, 2022]

Summary of the case

1、 On February 29, 2016, the supplier, Hager, and the buyer, Anhua Group, entered into a "Purchase and Service Contract" for Hager's acquisition of the operation rights of the existing air separation plant from Anhua Group and the provision of subsequent management services. It was agreed that Hager would purchase the 10-year operation rights of the original oxygen generation station from Anhua Group for 18 million yuan. Based on the production demand data proposed by Anhua Group, Haige Company optimized and transformed the existing original oxygen generation station and compressed air system to form new equipment, and formed a new oxygen generation station with the original oxygen generation station. It provided Anhua Group with operation, maintenance and management services for the 10-year new oxygen generation station. The oxygen, nitrogen, and compressed air produced by the new oxygen generation station are used by Anhua Group. Anhua Group pays gas service fees to Haige Company according to the agreement.

2、 In April, July, and November 2016, Haige Company paid a total of 18 million yuan for the acquisition of Anhua Group in three installments according to the agreement.

3、 On November 17, 2016, Haige Company and Anhua Group signed the "Equipment Mortgage Contract" regarding Anhua Group's willingness to set Haige Company as the first priority mortgagee for the air separation equipment property it has the right to dispose of in the "Acquisition and Service Contract". However, after the signing of the equipment mortgage contract, the two parties did not handle the mortgage registration.

4、 On December 28, 2021, the Intermediate People's Court of Anyang City, Henan Province ruled to accept the bankruptcy reorganization application of Anhua Group.

5、 During the performance of the Acquisition and Service Contract, the contract signed by both parties could not be continued due to the policies issued by relevant government departments to phase out outdated production capacity. Hager filed a lawsuit to the court, requesting Anhua Group to pay gas service fees, liquidated damages, and return the corresponding equipment operation rights costs to it, and claiming that the total amount of the aforementioned lawsuit should be paid in priority within the scope of the mortgaged property.

The court held that

The focus of this case is whether Hager has the right to claim a mortgage on the equipment involved, and its creditor's rights should be paid first within the scope of the equipment property involved.

The court of first instance held that:

"Where movable property is mortgaged, the mortgage right shall be established from the time the mortgage contract takes effect. Without registration, it may not be used against a bona fide third party.". "If the same property is mortgaged to two or more creditors, the proceeds from the auction or sale of the mortgaged property shall be paid off in accordance with the following provisions: (1) If the mortgage right has been registered, the order of payment shall be determined according to the time of registration;"; （2） The registered mortgage is repaid before the unregistered mortgage; （3） "If the mortgage right is not registered, it shall be repaid in proportion to the creditor's rights.". In this case, Anhua Group is willing to set Haige Company as the first ranking mortgagee with the total value of 45 million yuan of air separation equipment property it has the right to dispose of, and has signed an Equipment Mortgage Contract with Haige Company, which stipulates that the mortgage term is ten years, and the scope of mortgage guarantee is the main creditor's rights and interests agreed in the contract, The liquidated damages and damages payable by the mortgagor, as well as the expenses for realizing the creditor's rights and mortgage rights (including legal fees and legal fees). The "Equipment Mortgage Contract" takes effect after being signed and sealed by both parties, and the mortgage term has not expired. Although both parties have not handled mortgage registration, Hager Company has the mortgage right to the mortgaged equipment in accordance with the law in respect of its creditor's rights. Without antagonizing a bona fide third party and the mortgagee who has registered the mortgaged equipment, Hager Company has the right to receive priority compensation from the mortgaged property in accordance with the law. Therefore, Haige's claim is justified and supported by the court of first instance.

Hager Company filed a defense against the appeal grounds of Anhua Group, stating:

The provisions of Article 54 of the "Interpretation of the Supreme People's Court on the Application of the Guarantee System Related to the Civil Code of the People's Republic of China" (hereinafter referred to as the "Civil Code Guarantee Interpretation") are not applicable to this case. The implementation date of the "Civil Code Guarantee Interpretation" was January 1, 2021, while the "Equipment Mortgage Contract" between Haige Company and Anhua Group was established on November 17, 2016. When the "Equipment Mortgage Contract" was concluded, laws such as the "Guarantee Law" at the time did not provide for the confrontation between unregistered chattel mortgages and bankrupt creditors. Hager was unable to anticipate the provisions of the "Civil Code Guarantee Interpretation" when signing the contract, and the provisions of the "Civil Code Guarantee Interpretation" significantly impaired Hager's legitimate rights and interests. According to Article 3 of the "Several Provisions of the Supreme People's Court on the Application of the Time Effectiveness of the Civil Code of the People's Republic of China" (hereinafter referred to as the "Time Effectiveness Provisions"), the provisions of Article 54 of the Civil Code Guarantee Interpretation shall not apply to this case.

The court of second instance revised the judgment of the court of first instance and held that:

First of all, the Equipment Mortgage Contract involved in the case was established on November 17, 2016. According to Article 2 of the Time Effectiveness Regulations, "For civil dispute cases caused by legal facts before the implementation of the Civil Code, the laws and judicial interpretations at that time have provisions, and the applicable laws and judicial interpretations at that time shall apply." For civil dispute cases caused by the Equipment Mortgage Contract, the relevant provisions of the Property Law shall apply. Article 188 of the Property Law stipulates: "If the property specified in Items 4 and 6 of Paragraph 1 of Article 180 of this Law or the ship or aircraft under construction specified in Item 5 of this Law is mortgaged, the mortgage right shall be established from the time the mortgage contract takes effect; without registration, it shall not be against bona fide third parties." Among them, the provisions on the effectiveness of unregistered chattel mortgage rights are "not against bona fide third parties.", This part of the content continues to be stipulated in Article 403 of the Civil Code. Article 54 (4) of the Interpretation of the Supreme People's Court on the Application of the Security System Related to the Civil Code of the People's Republic of China refers to the provisions on the effectiveness of chattel mortgage rights when they are not registered in bankruptcy proceedings. It is an interpretation of the application of "not against bona fide third parties" stipulated in Article 188 of the Property Law and Article 403 of the Civil Code in bankruptcy proceedings, which does not deviate from the reasonable expectations of Haige Company, "It has not significantly impaired its legitimate rights and interests, and this case can be applied by reference.".

Secondly, bankruptcy proceedings are summary liquidation procedures, with creditors being equally compensated. After the mortgagor enters the bankruptcy proceedings, if it is determined that the unregistered chattel mortgage has the effect of priority repayment without registration and publicity, it is inconsistent with the concept of pursuing fair repayment for creditors in the bankruptcy proceedings, and on the other hand, it is in conflict with the legal provisions of registration antagonism for chattel mortgage, which impairs the equality of creditors' rights, And prone to moral hazard of malicious collusion between the mortgagor and a creditor to reverse sign the chattel mortgage contract. Therefore, Article 54 (4) of the Interpretation of the Supreme People's Court on the Application of the Guarantee System Related to the Civil Code of the People's Republic of China stipulates: "After the conclusion of the chattel mortgage contract, the mortgage registration has not been handled, the mortgagor has gone bankrupt, and the mortgagee claims priority in repayment of the mortgaged property, the people's court does not support it." In this case, Haige Company did not handle the mortgage registration after signing the Equipment Mortgage Contract with Anhua Group, Anhua Group entered bankruptcy proceedings, and there is no legal basis for Haige Company to claim the priority right to repayment of the involved mortgage price funds. The defense reasons of Hager Company shall not be adopted. The appeal reason of Anhua Group is established and supported.

Analysis of key points of adjudication

The focus of this case is: After the signing of the chattel mortgage contract, the chattel mortgage has not been registered, so when the mortgagor enters bankruptcy proceedings, can the mortgagee have priority in receiving compensation for the proceeds from the disposal of the mortgaged property?

The court of first instance and the court of second instance in this case have given different answers to this focus issue.

The court of first instance held that the chattel mortgage contract involved in the case has been signed, and although it has not been registered, Haige Company has the right to obtain priority compensation for the mortgaged property in accordance with the law without antagonizing bona fide third parties and the mortgagee who has registered the mortgaged equipment.

The judgment of the court of second instance denied the determination of the court of first instance. The court of second instance held that in the event of the bankruptcy of the mortgagor, due to the consideration of pursuing fair compensation for creditors in the bankruptcy proceedings, unregistered chattel mortgages should not be recognized as having the effect of priority compensation.

The author notes that the legal facts at issue in this case occurred before the implementation of the Civil Code and the Civil Code Guarantee Interpretation. The appellant, Anhua Group, claimed that the relevant provisions of the Civil Code and the "Civil Code Guarantee Interpretation" should be applied to determine that the mortgagee involved in the case does not enjoy the priority right to compensation. However, the appellee believes that according to the relevant provisions of the "Time Effectiveness Regulations", the provisions of the Civil Code and the "Civil Code Guarantee Interpretation" should not apply to this case. In response, the Hebei High Court of Second Instance held that it should be applied. The author believes that the judgment conclusion of the court of second instance on this issue is correct, and the author basically agrees with the reasoning of the court of second instance. Since this issue is not the core issue that this article intends to discuss, it will not be discussed here.

From the perspective of the Civil Code alone, if the mortgagor goes bankrupt and the chattel mortgage contract has been signed but the mortgage right has not been registered, can the mortgagee have priority in receiving compensation based on this?

To answer this question, first of all, we need to analyze Article 403 of the Civil Code. Article 403 of the Civil Code stipulates: "Where movable property is mortgaged, the mortgage right shall be established from the time the mortgage contract takes effect; without registration, it shall not be against a bona fide third party." Therefore, the key to answering this question is actually to clarify the scope of the "third party" in the legal provisions of this article. In other words, what "third parties" cannot be opposed without registration? Does the "third party" here include bankruptcy creditors?

There are different theoretical views on the scope of third parties:

According to one theory, a third party should refer to the person who has a real right in the same subject matter, excluding the unsecured creditor of the debtor. "If a chattel mortgage has been established, whether registered or not, it is a real right, and its effectiveness should take precedence over the debtor's unsecured creditors.".

According to the second theory, a third party refers to all persons, that is, any third person who has a claim on the same subject matter, [2] or persons who have an interest in the collateral, such as the assignee, lessee, other secured parties, and unsecured creditors of the mortgagor. An unregistered mortgage right has only the effect of a creditor's right and may not act against all third parties. [3]

According to the third theory, a third party is only limited to those who form a competitive relationship with the mortgagee regarding the same subject matter, regardless of whether they are the property owner or the creditor, as long as they "obtain a dominant relationship with a certain object," unregistered mortgage rights cannot be opposed. Such as sealing up or detaining creditors, participating in the distribution of creditors, bankrupt creditors, or bankruptcy administrators.

According to Article 54 of the Guarantee Interpretation of the Civil Code, "If mortgage registration is not handled after the conclusion of a chattel mortgage contract, the effectiveness of the chattel mortgage right shall be handled according to the following circumstances: (1)" "If the mortgagee requests the mortgagee to exercise the mortgage right after the mortgagee has transferred the mortgaged property and the transferee has taken possession of the mortgaged property, the people's court shall not support it, unless the mortgagee can provide evidence to prove that the transferee knows or should have known that the mortgage contract has been concluded;"; （2） "If the mortgagor leases the mortgaged property to another person and transfers possession, and the mortgagee exercises the mortgage right, the lease relationship will not be affected, except where the mortgagee can provide evidence that the lessee knows or should have known that a mortgage contract has been concluded;"; （3） "If any other creditor of the mortgagor applies to the people's court for preservation or enforcement of the mortgaged property, and the people's court has made a property preservation ruling or taken enforcement measures, and the mortgagee claims priority in repayment of the mortgaged property, the people's court shall not support it;"; （4） "If the mortgagor goes bankrupt and the mortgagee claims priority in repayment of the mortgaged property, the people's court shall not support it." It can be seen that the viewpoint of the Supreme Court is a combination of the first viewpoint and the third viewpoint. Regarding the scope of the third party, the author summarizes the views of the Supreme Court as follows: first, the buyer and lessee who have obtained possession; 2、 Excluding the person with a security interest, as including the person with a security interest would conflict with the general provisions of Article 414 of the Civil Code on the order of settlement between security interests; 3、 Based on the general principle that property rights have priority over claims, it tends to exclude general creditors; 4、 For unregistered chattel mortgage rights, due to the consideration of eliminating implicit guarantees, such mortgage rights should not be given excessive adversarial effect. Therefore, in litigation or enforcement proceedings, if a third party applies for attachment or sealing up of the mortgaged property, the unregistered mortgage of movable property may not oppose the court's attachment or sealing up. Moreover, in bankruptcy proceedings, unregistered chattel mortgages should be paid equally to general claims.
In connection with this case, Article 54 (4) of the Supreme Court's "Civil Code Guarantee Interpretation" has made it very clear that unregistered chattel mortgage rights cannot be used against bankruptcy creditors and bankruptcy administrators. This is because, after the mortgagor enters bankruptcy proceedings, as other creditors of the mortgagor may be either bona fide or malicious, if it is determined that unregistered chattel mortgages have the effect of priority repayment, it may bring unfair results to some creditors, which conflicts with the idea of pursuing fair repayment for creditors in bankruptcy proceedings. Due to the emphasis placed on fair repayment by creditors in bankruptcy proceedings, in the absence of registration and publicity of chattel mortgage rights, for other creditors, chattel mortgage rights should have priority in repayment, lacking legitimacy, and prone to the moral hazard of malicious collusion between the mortgagor and a creditor to reverse sign the chattel mortgage contract. Therefore, in the case of bankruptcy of the mortgagor, the people's court should not support the claim of the mortgagee who has not gone through the mortgage registration for priority in repayment of the mortgaged property. [4] It can be seen that the court of second instance is correct in its judgment that Haige Company has no right to claim the priority right to compensation for the price obtained from the mortgaged property involved in the case.

Practical Summary and Suggestions

From the provisions of the Civil Code and its related judicial interpretations, it can be seen that the Civil Code adopts registration antagonism rules for the effectiveness of chattel mortgages. Although the chattel mortgage becomes effective upon the establishment of the contract, if the chattel mortgage is not registered, it may not oppose a bona fide third party. "The scope of the" third party "that cannot be contested here does not refer to all persons, but mainly refers to the buyer and lessee who have obtained possession, as well as creditors who have applied to the court for attachment and sealing up and the court has made a decision on attachment and sealing up, bankruptcy creditors and administrators in bankruptcy proceedings, and of course, does not include general creditors and security interests holders.". Therefore, for chattel mortgage, completing the signing of the mortgage contract is not a panacea. To make it effective, it is necessary to complete registration on the Zhongdeng website, namely, the unified registration system for chattel financing of the People's Bank of China's Credit Reference Center, to prevent the legal risk that the chattel mortgage right cannot achieve priority repayment of the proceeds from the collateral due to non registration.

References and Notes:
[1] See Wang Zejian, "Civil Law Theories and Case Studies: Rearrangement and Binding," Peking University Press, 2015 edition, page 1481.
[2] See Liang Huixing, editor in chief, "Proposed Draft of China's Property Law", Social Science Literature Press, 2000 edition, page 615.
[3] See Li Guoguang et al., "Interpretation and Application of the Supreme People's Court on Several Issues Concerning the Application of the Guarantee Law of the People's Republic of China", Jilin People's Publishing House, 2000 edition, below page 226.
[4] See Supreme People's Court: Understanding and Application of Judicial Interpretation of the Guarantee System of the Civil Code of the Supreme People's Court, People's Court Press, May 2021 edition, page 473.