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Llinks Banking Law Bulletin
September 2009
“Constructive Notice” or “Actual Notice”
- A Brief Discussion on External Effect of the Articles of Association in CEB Case re
a Dispute over Loan Guarantee Contract
By Charles Qin and Tommy Xia
This article briefly discusses the determination of “constructive notice”
or “actual notice” by examining external effect of the articles of
association in China Everbright Bank Shenzhen Branch v. Powerise
Information Technology Co., Ltd., Shenzhen Zhixin Investment Co., Ltd.
and Hunan Powerise Group Co., Ltd. re a dispute over loan guarantee
contract (the “CEB Case”)1 ruled by the Supreme People's Court.
Case in Brief
On 30 September 2005, China Everbright Bank Shenzhen Branch
(“CEB Shenzhen”) and Shenzhen Zhixin Investment Co., Ltd. (“Zhixin”)
entered into a loan contract in which it was agreed that CEB Shenzhen
granted a loan of RMB185 million to Zhixin and that Powerise
Information Technology Co., Ltd. (“Powerise”), an affiliate of Zhixin,
and Hunan Powerise Group Co., Ltd. (“Powerise Group”) would be
jointly and severally liable for the default by Zhixin on repayment of the
loan. Pursuant to the loan contract, it would be considered as an event
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of default where the interest was not paid when due and payable or
where the business or financial conditions of either the borrower or
guarantors were deteriorated.
Consequently, CEB Shenzhen should
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have the right to (i) declare the loan immediately due and payable; (ii)
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and (iii) realize or enforce any rights under any security in respect of the
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demand the repayment of the principal, interest and other sums payable
loan.
On the same day, CEB Shenzhen entered into two guarantee contracts
respectively with Powerise and Powerise Group, pursuant to which the
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guarantors would be jointly and severally liable for the repayment of the
loan borrowed by Zhixin.
The Guarantee contract between CEB
Shenzhen and Powerise was affixed with a corporate seal of Powerise
This publication is for general guidance only and is not intended to provide legal advice in any specific case. We expressly
disclaim any liability for the consequences of action or non-action based on this publication. All rights reserved.
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“Constructive Notice” or “Actual Notice” A Brief Discussion on External Effect of the Articles of Association in
CEB Case re a Dispute over Loan Guarantee Contract
and signed by the legal representative of Powerise, chairman of the board. At a later stage, Zhixin failed to pay
the interest as required under the loan contract. Meanwhile, CEB Shenzhen believed that the security of the
loan in question was threatened as Powerise and Powerise Group as guarantors had incurred material foreign
debts and guarantee obligations and some creditors had filed their claims against them and some of their
properties had been frozen. As a result, CEB Shenzhen then brought a lawsuit to the Guangdong High People's
Court, requesting Zhixin to repay the principal, interest and penalty interest, and Powerise and Powerise Group
to assume joint and several liability to repay the loan borrowed by Zhixin. In addition, on 28 February 2006,
the Shenzhen Stock Exchange made public censure against Powerise and its personnel for failing to comply with
the required approval procedures and the duty to disclose interim report prior to provision of guarantee.
External Effect of Articles of Association
Whether the guarantee contract between CEB Shenzhen and Powerise is a valid contract is the key issue of the
CEB Case. Pursuant to the articles of association of Powerise, which was made available to the public, the
board may, within the scope of authority granted by the shareholders’ meeting, make decisions on risk
investment, property mortgage and other security matters. Meanwhile, the articles of association do not
provide that the chairman of the board or the legal representative has the right to decide the matters relating to
external security. However, there is in fact no evidence available to establish that the guarantee contract signed
by the legal representative, also chairman of the board of Powerise has been approved by the board resolution.
Therefore, the execution of the guarantee contract by the legal representative of Powerise is an act beyond his
scope of authority. In accordance with PRC law,2 if a legal representative of a company enters into a contract
without the authority as required while it is known or should have been known by the counterparty, the contract
signed by the parties will not be deemed valid. Therefore, whether CEB Shenzhen knew or should have known
that execution of the guarantee contract by the legal representative of Powerise in this case is beyond his scope
of authority would be the key to determine whether the guarantee contract is valid.
Pursuant to the “Notice of the China Securities Regulatory Commission Concerning Provision of Guarantee
for other Parties by Listed Companies” (2000) (the “CSRC Notice”) and the “Notice of the China Securities
Regulatory Commission and the State-owned Assets Supervision and Administration Commission of the State
Council Concerning Regulating the Funds between Listed Companies and Affiliates and Listed Companies’
Provision of Guarantee for other Parties” (2003) (the “CSRC & SASAC Notice”), a listed company is not
allowed to provide security for its affiliates by using the assets of the company and provision of security for
other parties requires the approval of the board or the shareholders’ meeting.3
It was thus held by the court of first instance that CEB Shenzhen, as a financial institution, should have known
the aforesaid departmental rules and that when signing the guarantee contract, CEB Shenzhen should double
check whether Powerise had acted within the scope of authority. Accordingly, CEB Shenzhen should have
known that the execution of the guarantee contract by the legal representative was beyond his scope of authority
and the guarantee contract should be deemed invalid. In addition, the guarantee contract was also invalid as a
result of the provision of guarantee by Powerise, as a listed company for its affiliate, Zhixin, being in breach of
the aforesaid departmental rules.
This publication is for general guidance only and is not intended to provide legal advice in any specific case. We expressly
disclaim any liability for the consequences of action or non-action based on this publication. All rights reserved.
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“Constructive Notice” or “Actual Notice” A Brief Discussion on External Effect of the Articles of Association in
CEB Case re a Dispute over Loan Guarantee Contract
It was held by the Supreme People’s Court, the court of second instance that the departmental rules of the CSRC
and SASAC are statutory instruments which have public effect so that financial institutions such as banks should
have more duty of care than ordinary creditors and should have known the special restrictions on listed
companies in relation to provision of external security as prescribed in the departmental rules. Generally, the
articles of association of a company should have internal effect only. Even though the articles of association
need to be filed with company registration authority, the counterparty of a transaction would not be deemed to
know the content of the articles of association. However, listed companies are different from ordinary
companies since the articles of association of listed companies are not only required to be filed with company
registration authority, but also are available for the public inspection. Therefore, the court of second instance
ultimately held that financial institutions should have known that such conduct was beyond the scope of
authority and that the guarantee contract was invalid on the ground that CEB Shenzhen had failed to perform the
duty of inspection.
From the judgment of the court of second instance, it is believed that the approach the court has taken is the
principle of “constructive notice”. Given that the articles of association of a listed company is available to the
public, it is presumed by PRC courts that financial institutions should know the content of the articles of
association.4
Compared with this case, in the case of Fuzhou Jinan Branch of the Industrial and Commercial Bank of China v.
Fuzhou Yibeisi Beverages Co., Ltd. and Fuzhou Yibeisi Pharmaceutical Co., Ltd. re mortgage contract, which
was concluded by the Supreme People's Court in 2000,5 it was held that pursuant to Articles 28 and 29 of the
Detailed Rules on the Implementation of the PRC Cooperative Joint Venture Law in 1995, the board meeting of a
cooperative joint venture must form a quorum of at least two-thirds of the directors and that the resolution on an
property mortgage of the cooperative joint venture must be passed unanimously by the directors attending the
meeting. However, such provisions could be only regarded as an internal separation of powers and
responsibilities, and the validity of the mortgage created by the board of a company should not be challenged or
against a bona fide third party6 on the ground of lack of authority for whatever reason relating to the company’s
articles of association.
Although the parties in both cases were in breach of the statutory provisions, the court held that the party in the
former case was not acting in good faith whereas the party in the latter case was. The underlying reasons for
the judgments are that the party in the former case is a listed company and its articles of association are available
to the public while the latter is a non-listed company whose resolutions are not available to the public.
It can be seen that with respect to the articles of association and relevant resolutions of non-listed companies,
PRC courts apply the principle of “actual notice” rather than “constructive notice” and assume that financial
institutions do not know the content of the articles of association. It is understood that the basis for the
distinction between “constructive notice” and “actual notice” is to determine as to whether a party “acts in good
faith”. In other words, it is an application of principle concerning “bona fide third party” under PRC civil law.
In this Case, the main reason for the PRC court’s application of the principle of “constructive notice” lies on the
fact that the articles of association of the listed company are available for the public inspection.
This publication is for general guidance only and is not intended to provide legal advice in any specific case. We expressly
disclaim any liability for the consequences of action or non-action based on this publication. All rights reserved.
3
“Constructive Notice” or “Actual Notice” A Brief Discussion on External Effect of the Articles of Association in
CEB Case re a Dispute over Loan Guarantee Contract
Pursuant to judicial practice, the courts tend to apply the principle of “actual notice” with respect to the articles
of association or resolutions of non-listed companies.
In other words, the courts are more willing to find out
whether the relevant parties actually know the relevant information based upon the available facts and evidence.
For example, in the case ultimately held by the Supreme People's Court, in relation to a dispute over the
liquidation group of Wenzhou International Trust and Investment Corp. (the “Trust and Investment Company”),
Hubei Xingfu Industry Co., Ltd. (the “Industry Company”) and Xingfu Group (the “Group Company”) arising
from an agreement of transfer of claims and liabilities,7 it was held by the Supreme People’s Court that pursuant
to the PRC Company Law as amended in 2005, the guarantee provided by the Industry Company for its largest
shareholder, the Group Company, should be considered as invalid.
In addition, given that the transfer agreement specified that if the Group Company failed to pay off the debts
owed to the Trust and Investment Company, the corporate shares in the Industry Company held by the Trust and
Investment Company shall be used to pay the debts, the Trust and Investment Company as creditor would have
known that the Group Company was a shareholder of the Industry Company which had provided guarantee for
the Group Company and that both the Trust and Investment Company and the Industry Company had violated
the prohibitive provisions of law by entering into the guarantee contract and were liable for the invalid guarantee.
Therefore, the court applies the principle of “actual notice” with respect to the articles of association or
resolutions of non-listed companies pursuant to the available evidence in each case.
This publication is for general guidance only and is not intended to provide legal advice in any specific case. We expressly
disclaim any liability for the consequences of action or non-action based on this publication. All rights reserved.
4
“Constructive Notice” or “Actual Notice” A Brief Discussion on External Effect of the Articles of Association in
CEB Case re a Dispute over Loan Guarantee Contract
Contact Details
If you would like to know more information about the subjects covered in this publication, please feel free to
contact the following people or your usual Llinks contact.
Charles Qin
Tel: (86 21) 3135 8668
(86 10) 6655 5020
[email protected]
Michael Mei
Tel: (86 21) 3135 8669
[email protected]
© Llinks Law Offices 2009
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This case is cited from the Guidance on Civil and Commercial Trials, Volume 2 2008 (Volume 14 of total), edited by the
Supreme People's Court Civil Trial Second Court, People's Publishing House, 2008 Edition.
Please see Article 43 of the PRC General Principles of Civil Law (1986), Article 50 of the PRC Contract Law (1999)
and Article 11 of the Judicial Interpretation of the Supreme People's Court on Some Issues Regarding Application of the
PRC Security Law (2000).
Pleas refer to Articles 2 and 5 of the CSRC Notice and Article 2 of the CSRC & SASAC Notice.
In a case of guarantee of Fujian CFC Industries Co. Ltd. as appellant v. Fuzhou Mindu Branch of the Industrial and
Commercial Bank of China as appellee in 2000, the Supreme People's Court expressed the same point of view in its
judgment of second instance (2000 Jing Zhong zi No.186). Please refer to the Selected Case Judgments of Financial
Security, mainly edited by Song Xiaoming and Jin Saibo, Law Press, page 417. In addition, the Integration of Judicial
Points of View of the Supreme People's Court, a book edited by Liu Dequan and published by Law Press, expresses the
similar point of view by quoting the Study on Guarantee Contract, a book edited by Chen Xiao and published by Law
Press, that if a listed company provides guarantee for its shareholders, the creditor could be directly inferred that it knew
or should have known this because the information of a listed company such as shareholding structure, major
shareholders, nature of major shareholdings, number of shareholders, etc, is available to the public and the creditor
could easily find out such information when accepting the guarantee. Therefore, the court could infer that the creditor
knew or should have known the relevant matter of guarantee.
Please refer to the Financial Judgments and Protection of Claims of Bank, 2007 Edition, mainly edited by Cao Shibing
and Li Qi, Law Press, page 478.
The resolution of the board of directors provided by the cooperative joint venture company for the pledgee contained the
signatures of three foreign directors; however, the pledgee did not know the total number of the directors of the
cooperative joint venture and the number of the directors who attended the board meeting.
Please see for reference Gazette of PRC Supreme People’s Court, Volume 2 2004 (Volume 88 of total), page 28.
This publication is for general guidance only and is not intended to provide legal advice in any specific case. We expressly
disclaim any liability for the consequences of action or non-action based on this publication. All rights reserved.
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