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Factual Summary: On or about 25 January 2011, Bank of China Wudi Sub-branch and Eco-Technology entered a Line of Credit Agreement covenanting that Eco-Technology may apply for domestic LC from Wudi Sub-Branch and it shall indemnify Wudi Sub-Branch if the latter occurred payment on account because of the insufficient provision provided by Eco-Technology.

On the same day, Wudi Sub-Branch and Eco-Technology entered a Maximum Amount of Mortgage Contract (hereinafter “Mortgage Contract”), the purpose of which was to serve as a guaranty of the Line of Credit Agreement and all special agreements made before or after the Agreement.

On the same day, Kangfa and Wudi Sub-Branch signed a Maximum Amount of Mortgage Contract (hereinafter, “Guarantee Contract”), the purpose of which was to serve as a guaranty of the Line of Credit Agreement and all special agreements made before or after the Agreement. The form of guarantee was joint and several guarantee.

On or about 11 October 2011, Eco-Technology applied for a domestic LC from Wudi Sub-Branch, the application of which was deemed as the master contract as prescribed in the Guarantee Contract (i.e., Kangfa would provide joint and several guarantee for the domestic LC). Because Eco-Technology failed to pay the LC amount until the expiry date, on or about 10 April 2012, Bank of China Binzhou Branch paid the LC amount of RMB 19.6 million.

On or about 4 May 2012, Wudi Sub-Branch entered an Assignment of Rights Contract (hereinafter, “Assignment Contract”) with the plaintiff Fangzheng Investment and Yuyue Home Textile in which Wudi Sub-Branch assigned all its right, including those in the Guarantee Contract, to Fangzheng Investment. Fangzheng Investment then informed Eco-Technology to pay the LC amount and Kangfa to perform its guarantee obligation.

Kangfa claimed that firstly, Yuyue Home Textile already paid the LC amount on behalf of Eco-Technology and therefore Wudi Sub-Branch’s rights under the LC had extinguished. Secondly, the Assignment Contract was void for violating mandatory laws and regulations of China.

The trial court ruled that Kangfa cannot provide evidence to show that Yuyue Home Textile paid Binzhou Branch for the specific purpose of payment on behalf of Eco-Technology under the LC. Therefore the trial court ruled that Wudi Sub-Branch’s right under the LC still existed. Also, Kangfa cannot provide evidence demonstrating the Assignment Contract violated any laws or regulations of China. Accordingly, the Assignment Contract was valid and Kangfa should perform its obligation of guarantee.

Kangfa appealed against the plaintiff, arguing that WUdi Sub-Branch’s right had extinguished whatever Yuyue Home Textile paid, on behalf of Eco-Technology, the amount in the name of guarantor or as third party. The original guarantor (i.e. Kangfa) did not bear the obligation of guarantee unless there was new agreement. Furthermore, the Guarantee Contract had specific arrangement in terms of assignment of rights, namely, “If Wudi Sub-Branch needed to authorize other branches of Bank of China to conduct business, guarantor (i.e. Kangfa) would acknowledge it. The authorized branch of Bank of China shall have all rights under the Guarantee Contract.” Therefore, Wudi Sub-Branch could only assign its right to specific third party (i.e. other branches of Bank of China). Accordingly, the Assignment Contract between Wudi Sub-Branch, Fangzheng Investment and Yuyue Home Textile was void. Meanwhile, because Eco-Technology provided mortgage under the Mortgage Contract, Wudi Sub-Branch should first claim its mortgage right, or it would in fact cause the creditor gave up its mortgage right, rendering great loss to grantors.

Shandong High People’s Court ruled against the appellant/defendant and upheld the judgment of the trial court. The appellate court ruled that the Assignment Contract was entered with true intent of both parties without violating any laws or regulations of China. Fangzheng Investment, as the assignee, received the right Wudi Sub-Branch had against Eco-Technology and kangfa. The arrangement in the Guarantee Contract only demonstrated that Wudi Sub-Branch may authorize other branches of Bank of China to act on behalf of Wudi Sub-Branch rather than limiting the assignment of its right. Also, the appellate court ruled that according to article 176 of the Property Law of China, “In the event of a secured obligee’s rights involving both collateral and guarantor, where the obligor fails to pay a due debt or any circumstance for realizing collateral rights as agreed by the parties concerned occurs, the obligee shall realize obligee’s rights as agreed.” Therefore, the arrangement in article 5 of the Guarantee Contract between Wudi Sub-Branch and Kangfa that “the main obligation has pledge or guarantee other than such in this contract shall not have any influence on the performance of rights or obligations of credit thereof” did not violate any laws or regulations of China. The fact that Fangzheng Investment, as assignee, claimed against Kangfa would not render it to give up the mortgage right.

Kangfa petitioned for review of case to the Supreme People’s Court, which was rejected because it cannot prove that RMB 19.6 million paid by Yuyue Home Textile to Binzhou Branch was the payment made by Yuyue Home Textile on behalf of Eco-Technology under the LC.

Kangfa petitioned for supervision of case to the Supreme People’s Procuratorate, which was rejected because the LC fraud would not necessarily render the underlying contract (i.e. the application and the Guarantee Contract ) null and void when it did not damage the nation’s interest.

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