Earth Research | A Brief Discussion on the Company Guarantee System

Authors: Chen Xia, Wang Yueyu

In business activities, companies providing guarantees is a common practice. However, this action must follow strict procedures and decision-making requirements to ensure that the legal rights and interests of the company and shareholders are not violated.

To prevent legal representatives or major shareholders of a company from using their positions to harm the interests of minority shareholders, Article 15 of the Company Law of the People's Republic of China stipulates the following regarding a company providing external guarantees: 1. A company providing guarantees for others shall, in accordance with the provisions of its articles of association, make a resolution through the board of directors or the shareholders' meeting (or general meeting of shareholders); 2. If the articles of association stipulate a limit on the total amount or the amount of guarantees, the limit shall not be exceeded; 3. If the company provides a guarantee for a company shareholder or actual controller, it must be resolved by the shareholders' meeting (or general meeting of shareholders); 4. Shareholders requesting the company to provide a guarantee, or shareholders controlled by the actual controller requesting the company to provide a guarantee, shall not participate in the voting on the guarantee matter. The resolution shall be passed by more than half of the voting rights held by the other shareholders attending the meeting.

In other words, a company providing external guarantees must go through the necessary procedural resolutions. For non-related party guarantees, the company can make a resolution through the board of directors or the shareholders' meeting (or general meeting of shareholders) as stipulated in the articles of association; for related party guarantees, only the shareholders' meeting (or general meeting of shareholders) can make the resolution, and shareholders with vested interests shall not participate in the voting.

When a company acts as a guarantor, in addition to establishing a guarantee agreement, it must also follow the internal voting procedures as stipulated by law. What are the main due diligence obligations for the counterparty?

Article 15 of the Company Law 五 stipulates the internal voting procedures for corporate guarantees. The counterparty should pay attention to the corresponding due diligence obligations. However, these obligations should not be overly burdensome, otherwise it will increase the burden on the counterparty, and the counterparty may not be able to fulfill strict due diligence obligations. Therefore, the counterparty only needs to fulfill the formal review obligations, i.e., if a company provides external guarantees, the counterparty needs to request the company to provide a resolution on the guarantee matter that has been passed by the board of directors or the shareholders' meeting/general meeting of shareholders when entering into a guarantee contract with the company; if the company provides a guarantee for its shareholder or actual controller, the counterparty needs to have a resolution passed by the shareholders' meeting or general meeting of shareholders; as for whether the above resolutions are forged or altered, the counterparty does not need to fulfill comprehensive due diligence obligations. However, according to Article 7 of the Interpretation of the Guarantee System, this is unless there is evidence that the counterparty knew or should have known that the resolution was forged or altered. 据证明相对人知道或应当知道决议系伪造、变造的除外。

    (1) The effectiveness of unauthorized guarantees by the legal representative on the company is premised on the good faith of the counterparty

Generally, contracts are signed on behalf of a company by its legal representative. In reality, many company legal representatives are also their major shareholders, and the company seal is often under the control of the legal representative. If the legal representative violates the Company Law's provisions on the external resolution procedures of the company and signs a guarantee contract with the counterparty on behalf of the company without authorization, how is the legal liability of the company determined? In this regard, Article 7, paragraph 1, of the Interpretation of the Guarantee System, which was implemented simultaneously with the Civil Code, uses "whether the counterparty acted in good faith" as the judgment standard to distinguish the legal consequences: 1. If the counterparty acted in good faith, the guarantee contract is effective against the company; if the counterparty requests the company to assume guarantee liability, the people's court shall support it. 2. If the counterparty did not act in good faith, the guarantee contract is not effective against the company; if the counterparty requests the company to assume compensation liability, the relevant provisions of Article 17 of the Interpretation of the Guarantee System shall be applied by analogy.

Of course, the company can request the legal representative to assume compensation liability for losses caused to the company due to the legal representative providing guarantees beyond their authority.

    (2) The scope of "reasonable review" by the counterparty should include reviewing the articles of association

In practice, there are disagreements on whether the counterparty has the obligation to review the articles of association to ascertain the internal guarantee decision-making bodies and the corresponding voting rules, and then review the company's internal resolution approving the guarantee based on this content. We believe that under Article 504 of the Civil Code, if the legal representative exceeds their authority and signs a guarantee contract with the counterparty, and the counterparty acted in good faith, the guarantee contract is still legally effective, and the company's defense based on the legal representative exceeding their authority cannot be supported. The good faith mentioned here refers to the counterparty not knowing or not being expected to know that the legal representative signed the guarantee contract beyond their authority. The "knowing or should have known" in Article 504 of the Civil Code plays a "conducive function," introducing Article 15 of the new Company Law into Article 504 of the Civil Code. When accepting a guarantee from a company, the counterparty should pay attention to the representative authority of the legal representative based on the provisions of Article 504 of the Civil Code, and review the company's articles of association, company guarantee resolutions, and other internal documents. This is not a manifestation of the external effectiveness of the articles of association, but a due diligence obligation based on legal provisions. Therefore, when accepting a guarantee from a company, the counterparty has a due diligence obligation to review the company's articles of association, company guarantee resolutions, and other internal documents. Article 7 of the Interpretation of the Civil Code Guarantee System stipulates that to determine whether the counterparty acted in good faith, the counterparty should provide evidence to prove that they conducted a reasonable review of the company's resolution. This is the natural interpretation of the limitation of the representative's authority in Article 15 of the new Company Law.

   （ (3) In the trial of cases, will the people's court actively review whether the counterparty acted in good faith?

In the book "Understanding and Application of the Civil Code Guarantee System," the Supreme People's Court's Civil Division II offered a suggestive opinion: Regardless of whether the company providing the guarantee was present in court or not, and regardless of whether the company providing the guarantee raised any objections to its legal representative exceeding their authority, the people's court should actively ascertain the basic facts of the case, including whether the legal representative of the company providing the guarantee exceeded their authority and whether the creditor acted in good faith.

Considering the stability of company transaction order, Article 8 of the "Interpretation of the Civil Code Guarantee System" stipulates three exceptional circumstances in which a company does not require an organ resolution to provide external guarantees: First, financial institutions issuing letters of guarantee or guarantee companies providing guarantees; second, a company providing guarantees for the business operations of its wholly-owned subsidiaries (excluding listed companies providing external guarantees); third, the guarantee contract is signed and agreed upon by shareholders who individually or jointly hold more than two-thirds of the voting rights on the guarantee matter (excluding listed companies providing external guarantees). In these cases, the guarantee contract signed by the legal representative on behalf of the company and the counterparty will not be affected by the lack of a company organ resolution. It is important to note that the exceptional circumstances for company resolutions must be strictly controlled. In the field of companies providing guarantees for others, apart from the three exceptional circumstances for company resolutions stipulated in Article 8 of the "Interpretation of the Civil Code Guarantee System," there are no other exceptional circumstances for company resolutions.

According to the provisions of Article 80, Paragraph 1, and Paragraph 2, Item 3 of the "Securities Law" and Article 22, Paragraph 1, and Paragraph 2, Item 1 of the "Measures for the Management of Information Disclosure of Listed Companies," and in conjunction with the relevant provisions of the "Rules for Stock Listing on the Shanghai Stock Exchange (Revised in August 2023)" and the "Rules for Stock Listing on the Shenzhen Stock Exchange (Revised in August 2023)", listed companies should make public announcements for any compliant guarantees. According to Article 9, Paragraph 1 of the "Interpretation of the Civil Code Guarantee System" and Article 22 of the "No. 9 Civil Judgment," guarantee contracts entered into by counterparties with listed companies based on publicly disclosed information regarding guarantee matters that have been approved by the board of directors or shareholders' meeting are effective against the listed company, and the listed company bears the guarantee liability. This provision forms a rule, that is, to ensure that the guarantee contract entered into by the counterparty and the listed company is effective against the listed company, the counterparty only needs to review the publicly disclosed guarantee information of the listed company. If the listed company publicly discloses the main content of the guarantee contract to be entered into with the counterparty, such as who is being guaranteed and the amount of the guarantee, then the guarantee contract will be effective against the listed company.

Article 15 of the new "Company Law" stipulates that a company providing related guarantees must obtain a resolution from the shareholders' meeting, and shareholders with interests involved should recuse themselves from the voting procedure. However, the pre-resolution regulation for related guarantees in Article 15 of the new "Company Law" is premised on the existence of a shareholders' meeting. For a single-member company with only one internal shareholder and no shareholders' meeting, the application of Article 15 of the new "Company Law" will lead to different interpretations. Specifically, when a single-member company provides a guarantee for a shareholder's debt, it should be decided by the shareholder. If the provisions of Article 15 of the new "Company Law" are applied, the guaranteed shareholder needs to recuse themselves, but this would lead to the inability to form a shareholder decision, thus concluding that a single-member company cannot provide a guarantee for a shareholder. However, the legislative intent of Article 15 of the new "Company Law" is to protect the interests of the company and minority shareholders, but in a single-member company, there is no distinction between majority and minority shareholders, nor is there a distinction between shareholders with interests and shareholders without interests. There is no such thing as the provision of a guarantee by a company for a shareholder harming the interests of other shareholders, therefore, the shareholder of a single-member company can independently make the decision for the company to provide a guarantee for themselves. From the above, it can be seen that Article 15 of the new "Company Law" does not apply to a single-member company providing a guarantee for its shareholder.

Although the "Civil Code" stipulates that a company's branch can engage in civil activities in its own name, a branch is a non-legal entity in nature and is a designated representative agency of the company. Its representation power comes from the authorization of the company, and the scope of the branch's representation of the company in civil activities must be determined according to the written authorization of the company. At the same time, a company's external guarantee behavior is an unusual transaction and is subject to special regulations under company law. According to Article 15 of the new "Company Law," the legal representative of a company does not have the right to represent the company in providing external guarantees, nor does it have the right to authorize the company's branch to provide external guarantees on behalf of the company. Since the legal representative of a company needs the company's authorization in the form of a resolution to provide external guarantees on behalf of the company, the company's branch providing external guarantees even more requires authorization from the company in the form of a resolution from the shareholders' meeting or board of directors. Without a resolution from the company's shareholders' meeting or board of directors, the company's branch representing the company in providing external guarantees will constitute unauthorized representation. Only under the circumstances of ostensible representation can the counterparty claim that the company or the company's branch bears the guarantee liability.

In summary, the law has made stricter regulations on companies providing external guarantees. Creditors who accept company guarantees have a heavier review obligation (such as reviewing company resolutions and articles of association for general company guarantees, and reviewing publicly disclosed information for listed company guarantees), which should be given sufficient attention.