EXCERPT:
Shanghai‑based professional contract‑dispute lawyers remind market participants to pay close attention to risks arising from ultra‑vires guarantees of target enterprises in corporate M&A, investment and financing activities. A guarantee may be held invalid where the creditor fails to perform its review obligations concerning an ultra‑vires guarantee.
Shanghai‑based professional contract‑dispute lawyers remind market participants to pay close attention to risks arising from ultra‑vires guarantees of target enterprises in corporate M&A, investment and financing activities. A guarantee may be held invalid where the creditor fails to perform its review obligations concerning an ultra‑vires guarantee.
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On July 7, 2021, the General Offices of the CPC Central Committee and the State Council issued the Opinions on Comprehensively and Strictly Cracking Down on Securities‑Related Illegal Activities. Article IV thereof stresses: strengthen sanctions against major securities‑related criminal cases and law‑enforcement efforts in key sectors; investigate and punish major cases in accordance with law… For conduct such as fund misappropriation and irregular guarantees that seriously harm the interests of listed companies, conduct thorough investigations, pursue recovery and mandate rectification within prescribed time‑limits.
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According to news reports, Xu Xiang, once dubbed “No.1 Private‑equity Investor” and the mastermind behind the “Death Squad” trading group, was released from prison.
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Ningbo Zhongbai Co., Ltd. (Stock Code: 600857), of which the Xu Xiang family held a 27.77% equity stake, saw its share price surge by 87.26% against market trends amid Gong Dongsheng’s ultra‑vires guarantee case. However, on the eve of Xu Xiang’s release from prison, its stock plunged by 13.68% within three trading days.
The Persistent Problem of Irregular Guarantees
Irregular guarantees have long been a stubborn ailment plaguing the A‑share market. Multiple documents have been issued by the Ministry of Finance, the China Securities Regulatory Commission and the Supreme People’s Court to curb such misconduct, yet outcomes remain limited. Incidents triggered by irregular guarantees continue to break out every year.
This persistent problem is largely attributable to ambiguous historical legal rules governing irregular guarantees, inconsistent judicial adjudication standards and insufficient criminal penalties. Controlling shareholders could therefore reap gains disproportionate to the liabilities they bore for issuing irregular guarantees. The newly‑revised Securities Law and Amendment (XI) to the Criminal Law have substantially raised fines and sentencing ranges for such violations. The Minutes of the National Courts’ Civil‑Commercial Trial Work Conference (“Jiu‑Min Minutes”), the Civil Code of the People’s Republic of China, and the Judicial Interpretation of the Supreme People’s Court on Application of the Security‑related Provisions of the Civil Code of the People’s Republic of China have clarified and unified adjudicative rules for irregular guarantees, furnishing guidance for corporate compliance, risk‑control, investment, financing and M&A transactions.
The reform of the registration‑based IPO system represents an indispensable step toward a healthy capital market, placing listing decisions back into market hands. Under the registration‑based system, market participants shall bear enhanced accountability, and violations such as irregular guarantees shall be severely punished without leniency.
Background of the Ningbo Zhongbai Ultra‑Vires Guarantee Case
Ningbo Zhongbai Co., Ltd. (600857.SH), formerly Harbin Institute of Technology Bada Group Co., Ltd. (“HIT Dachuang”), was listed on the Shanghai Stock Exchange in 1994. In the SOE restructuring of 2009, Shenzhen Jiuce, controlled by Gong Dongsheng, acquired a 70% equity interest in Bada Group via a delisting bidding process for RMB 380 million and became its actual controller.
On January 24, 2014, Bada Group entered into a share transfer agreement with Shanghai Zetian Investment & Development Co., Ltd. controlled by Xu Xiang, transferring 35,204,752 tradable shares (16.65% of total share capital). The company reverted to its former name Ningbo Zhongbai, and Shanghai Zetian became its controlling shareholder with Xu Xiang as the actual controller.
Prior to the above‑mentioned equity transfer, on April 16, 2013, Gong Dongsheng and Tianjin Jiuce High‑Tech Industrial Park Co., Ltd. (“Tianjin Jiuce”), another entity under his control, executed a Repayment Agreement for Project Debts with China Construction Fourth Engineering Bureau Co., Ltd. (“CCFEB No.4 Bureau”). The agreement governed repayment of RMB 947 million in outstanding construction fees owed by Tianjin Jiuce for Phase‑I works of the Tianjin Jiuce High‑Tech Industrial Park Base. HIT Dachuang was named as one of the sureties to provide suretyship for Tianjin Jiuce. The guaranteed amount (excluding interest) amounted to 179.87% of HIT Dachuang’s audited net assets for FY 2012.
This guarantee was approved by neither the board of directors nor the shareholders’ meeting of HIT Dachuang. According to disclosures by Ningbo Zhongbai and Ying Ying (Xu Xiang’s spouse), the company only learned of this huge hidden liability on April 12, 2016 upon receiving a Letter Urging Performance of Guarantee Liability from CCFEB No.4 Bureau. On April 18, 2016, Ningbo Zhongbai issued its first public announcement regarding this demand letter. On June 27, 2016, CCFEB No.4 Bureau filed an arbitration application with the Guangzhou Arbitration Commission over the surety‑contract dispute against Ningbo Zhongbai, which accepted the case.
On September 20, 2017, the Guangzhou Arbitration Commission rendered Arbitral Award No. (2016) Sui Zhong An Zi No. 5753. The arbitral tribunal ruled that Ningbo Zhongbai shall bear joint and several liability for full debts of RMB 527 million owed by Tianjin Jiuce to CCFEB No.4 Bureau, and shall bear arbitration fees of RMB 3.5513 million. Ningbo Zhongbai received and disclosed the award on September 22, 2017.
Ningbo Zhongbai applied to the Guangzhou Intermediate People’s Court to set aside the arbitral award; its application was rejected on June 12, 2020. CCFEB No.4 Bureau subsequently applied for enforcement before the Beijing No.1 Intermediate People’s Court, which froze 95,110,000 shares of Xi’an Bank held by Ningbo Zhongbai with a market value of approximately RMB 530 million.
Adjudicative Approaches to Ultra‑Vires Guarantees under the Company Law Era
Article 16 of the Company Law of the People’s Republic of China provides:
Where a company makes investment in other enterprises or provides guarantee for others, resolutions shall be adopted by the board of directors or the shareholders’ meeting in accordance with its articles of association. If the articles of association set caps on total investment/guarantee amount or individual investment/guarantee amount, such limits shall not be exceeded.
Where a company provides guarantee for its shareholders or actual controllers, the matter must be resolved by the shareholders’ meeting.
Pursuant to this provision, corporate guarantee is not a matter for the legal representative to decide unilaterally; it must be premised on resolutions of corporate organs such as the board of directors or shareholders’ meeting. Where a legal representative provides guarantee in the company’s name without due authorization, this constitutes an ultra‑vires guarantee.
Article 16 defines ultra‑vires guarantees yet does not specify remedies. Disputes over ultra‑vires guarantees essentially reflect a conflict of values: preservation of corporate assets versus security of transactions.
For a long time, wide divergences existed among judges and arbitrators in interpreting Article 16 of the Company Law, resulting in diametrically opposed rulings by courts and arbitration tribunals across different jurisdictions and court tiers. One mainstream view treated Article 16 as a mandatory validity‑affecting norm, directly holding guarantee contracts void. Proponents argued that violating mandatory provisions under laws or administrative regulations renders contracts void pursuant to Article 52 of the former Contract Law. Article 14 of the former Judicial Interpretation II on the Contract Law further stipulated that violation of validity‑affecting mandatory provisions invalidates contracts. Statistics show that among 114 guarantee‑related judgments rendered in 2010‑2011, 80 found the guarantee void (a 66.7% invalidity rate). Among 144 identifiable corporate‑guarantee‑related cases after 2016, merely 23 held guarantees void on grounds of breach of Article 16 (representing only a 16% invalidity rate). Judicial practice has therefore undergone a marked shift in deciding disputes arising out of ultra‑vires guarantees by legal representatives.
Adjudicative Rules on Ultra‑Vires Guarantees under the Jiu‑Min Minutes and the Civil Code
Paragraph 17 of the Jiu‑Min Minutes stipulates that a legal representative acting without authorization to provide corporate guarantee commits ultra‑vires representation, while Article 16 of the Company Law does not directly invalidate the guarantee contract. Courts shall apply Article 50 of the former Contract Law governing ultra‑vires representation by legal representatives, and assess contract validity by determining whether the creditor acted in good faith at contract formation: the contract is valid if the creditor is in good faith; otherwise, it is void.
Article 504 of the Contract Book of the Civil Code and Article 7 of the Judicial Interpretation on the Security‑related Provisions of the Civil Code further clarify adjudicative rules for ultra‑vires guarantees by legal representatives. Analysis shall first focus on the validity of the representative act, i.e., whether the guarantee contract binds the company, rather than directly judging contract validity. Where the guarantee contract does not bind the company, the company bears no liability regardless of contract validity; the legal representative or responsible person shall perform contractual obligations or pay damages instead.
Creditors are generally only required to conduct formal review of corporate‑organ resolutions, satisfying a standard of reasonable care rather than overly stringent scrutiny. Courts shall generally reject a company’s defence alleging bad faith on the creditor’s part based on forgery or falsification of resolutions, procedural defects in resolution‑making, forged signatures/seals or excess guarantee amounts, unless the company proves that the creditor had actual knowledge of the forgery or falsification.
Where the guarantor is a public company, the creditor shall pro‑actively examine relevant public disclosures issued by the listed entity. If the creditor accepts a guarantee without corresponding public announcements from the listed company, the creditor is deemed a counterparty acting in bad faith and the listed company shall incur no guarantee liability.
Risk‑Control for Corporate External Guarantees
Corporate external guarantees represent one of the most destructive risk factors in corporate compliance management and M&A. Such guarantees often lack registration and are hard to trace, creating highly concealed risks. For acquirers or minority shareholders, they amount to hidden landmines waiting to detonate. For creditors accepting guarantees, failure to complete due review may render guarantees unenforceable and leave claims unsecured.
Another noteworthy risk stems from arbitration clauses commonly inserted into commercial contracts to protect trade secrets, given that arbitral awards are not publicly accessible. Arbitration prioritizes party autonomy. For example, courts may adjust excessively high liquidated damages under litigation to no more than 30% of actual loss; yet arbitral tribunals may uphold substantial liquidated‑damage awards, which parties must abide by. Arbitration awards are final and binding with no right of appeal. Under the Arbitration Law, courts only review procedural regularity of arbitral awards; errors in substantive law application fall outside the scope of judicial review of arbitral awards.
For instance, in the Ningbo Zhongbai guarantee case, its application to set aside the arbitral award before the Guangzhou Intermediate People’s Court in 2018 was dismissed for failure to satisfy the statutory grounds under Article 58 of the Arbitration Law, which include:
(1) absence of an arbitration agreement;
(2) the subject‑matter exceeds the scope of the arbitration agreement or falls outside the arbitral tribunal’s jurisdiction;
(3) arbitral‑tribunal constitution or arbitral proceedings violate statutory procedures;
(4) evidence relied on by the award is forged;
(5) the opposing party has concealed material evidence sufficient to affect a fair award;
(6) arbitrators have engaged in bribery, corruption or perversion of law in rendering the award.
This serves as a reminder for enterprises contracting with large counterparties: exercise prudence in evaluating legal risks where contracts contain arbitration clauses, especially given high default exposure and heavy liquidated‑damage stipulations.
Disclaimer: This article does not constitute investment advice.Author: Lawyer Li Haiquan
