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Factual Summary: On 19 January 1996, Applicant and Issuer entered into an Issuing LC Agreement, under which Issuer would issue several LCs based on the application of Applicant in the maximum amount of US$12,000,000. On 19 January 1996 and 1 March 1996 respectively, Issuer and Applicant entered into two Maximum Mortgage Agreements, under which Applicant provided a property over which it owned land use rights as a mortgage for its application of LC. On 23 October 1997, such mortgages were registered with the authority. After the execution of the Issuing LC Agreement, Issuer issued 9 LCs on 1 February 1996, 5 February 1996, 6 March 1996, 7 March 1996, 16 March 1997, 20 March 1997, 16 June 1997, 14 July 1997 and 17 October 1997 respectively in a total amount of US$17,922,480. When the payments under those LCs were due, from March 14, 1997 to 13 September 1997, Issuer prepaid the money under those LCs for Applicant in the total amount of US$18,448,216.14. During that period, Applicant repaid US$8,680,000 to Issuer with the remaining US$9,768,216.14 unpaid.

On 8 April 1996, Issuer and Applicant entered into an agreement, pursuant to which Issuer approved Applicant to use a special fund of RMB15,000,000 to in order to purchase Guarantor's equity, and Applicant warranted that it would collect such fund before 15 July 1996. On 8 April 1996, Guarantor and Issuer entered into a mortgage agreement, pursuant to which Guarantor provided its assets with a value of RMB17,990,000 as the guarantee for Jianyuele Company's obligations under the aforesaid agreement dated 8 April 1996. The right certificates of Guarantor's assets under such agreement were delivered to Issuer but the mortgage under such agreement was not registered with the authority. Later, Applicant remitted RMB15,000,000 to Guilin but failed to remit such in time.

On 30 April 1998, SAFE issued a Punishment Decision to Applicant. As reflected in this decision, from March to October 1997, Applicant had applied to Issuer for several LCs in a total amount of US$9,957,700. The underlying contracts for the issuances of those LCs were alleged to be several import agreements between China National Packaging Import & Export Corporation Guangxi Branch and Hong Kong Keninlok Development Co., Ltd. However, it was later proved that there was no actual import of goods under those LCs. Based on those findings, SAFE concluded that Applicant's application to Issuer was a kind of illegal arbitrage through issuing LC for the nonexistent imports in order to obtain foreign currency. Therefore, Applicant was imposed a forfeit of RMB100,000 by the SAFE.

Legal Analysis:

First Instance Decision of High People's Court of Guangxi Zhuang Nationality Autonomous Region

The High People's Court of Guangxi Zhuang Nationality Autonomous Region held that as the Issuing LC Agreement and the two Maximum Mortgage Agreements between Issuer and Applicant reflected the true intentions of both parties and did not violate mandatory rules of laws and regulations, those agreements should be deemed as valid. After the execution of Issuing LC Agreement, Issuer performed its obligations of issuing and paying for the LC, while Applicant failed to pay Issuer the money which had been prepaid by Investment. Therefore, Applicant was in breach of the Issuing LC Agreement. With respect to the mortgage agreement between Guarantor and Investment, although the mortgage under such agreement was not registered, because Guarantor had delivered the certificates under such agreement to Issuer and no third party had challenged such mortgage, the mortgage agreement should also be deemed as valid. Therefore, the court agreed with Issuer's claims alleging that Applicant should pay the money of US$9,768,216.14 that had been prepaid by Issuer as well as the corresponding interests to Issuer, and further held that Guarantor should bear its guarantee obligations for Applicant's obligations to the extent of RMB15,000,000.

Second Instance Decision of Supreme People's Court

Applicant appealed the first instance judgment to Supreme People's Court alleging that the court of first instance made several mistakes in its finding of facts: (1) the first instance court on the one hand confirmed that the total amount of the LC issued by Issuer was US$17,922,480, while on the other hand, held that the total amount prepaid by Investment was US$18,448,216.14; (2) Applicant had actually repaid US$15,880,000 to Issuer while the first instance court held that it had only repaid US$8,680,000; (3) Guarantor's guarantee for Applicant's use of special fund had no relationship with the settlement under LC. Therefore, Applicant requested Supreme People's Court to revoke the first instance judgment, and alleged that the principal amount that should be repaid to Issuer should be US$2,042,480, and Guarantor should not be responsible for its obligations under the settlement of LC.

During the second instance trial, Applicant acknowledged that Issuer's prepaid amount of US$18,448,216.14 decided by the first instance court was correct, as relevant issuance fees and interests were included. Although it had remitted US$15,880,000 in its account of Issuer, US$7,200,000 was used by itself later. Therefore, the Supreme People's Court agreed with the first instance court that the principal amount to be repaid by Applicant should be US$18,448,216.14.

With respect to Guarantor's guarantee obligations, the Supreme People's Court held that since Guarantor did not appeal the first instance judgment itself, it should be deemed that Guarantor was willing to bear the guarantee obligations for Applicant, and Applicant did not have the appeal rights over Guarantor's obligations. Therefore, the Supreme People's Court held that the first instance judgment had neither violated mandatory regulations nor harmed the public interests or third party's interests.

However, the Supreme People's Court held that, according to the findings of SAFE, the purpose of Applicant's application to Issuer for issuing the LC was not to import goods, but to finance for other projects. That is to say, Applicant's conduct was actually for the purpose of obtaining foreign currency through illegal arbitrage. According to relevant laws, where the parties under a contract intend to conceal an illegal purpose under the guise of a legitimate transaction, such contract is invalid. Accordingly, the Supreme People's Court held that the Issuing LC Agreement between Issuer and Applicant was invalid. Therefore, Applicant's obligations under this case were not based on the breach of contract. However, as provided by Article 61 of the PRC General Principles of Civil Law, after a civil act has been determined to be null and void or has been rescinded, the party who acquired property as a result of the act shall return it to the party who suffered a loss. Therefore, the Supreme People's Court still held that Applicant had the obligation to repay US$9,768,216.14 and corresponding interests to Issuer.

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The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.

* JIN Saibo is partner of Commerce & Finance Law Offices. He may be reached at: jinsaibo@tongshang.com. Assisted by LiANG Jiang.