The Validity of Paying Debt by a House Contract

Abstract: 

With the increasing default rate of private lending, paying the debt by house (hereinafter included but not limited to house and apartment) becomes a general practice. We will discuss the validity of “paying by house” agreement in this article, which states that after negotiation, both parties of contract agree to terminate the loan contract, instead to establish a sale contract of commercial resident and convert the paid principal and interests to the purchase payment. 

In the scenario, A, B, C, D singed multiple loan contracts loaning 260 million Yuan to company X, therefore becoming the creditor of company X. In order to guarantee the performance, those four singed and registered multiple Commercial housing pre-sale contracts. When the debt is due, X Company is unable to repay. Both parties signed the commercial resident sale contract, agreed that X company sell the property to those four. The unpaid principal and interests convert unpaid purchase payment, and to be transferred to X Company after closing.

Generally, in contract law, the paying by house agreement is valid unless it is deemed to be void as in Contract Law of the People's Republic of China (hereinafter “contract law”) article 52. The article 52 rules that five circumstances a contract shall be deemed as void:  A contract shall be invalid under any of the following circumstances:(1) Where either party enters into the contract by means of fraud or coercion, undermining national interests; (2) Where the parties concerned maliciously collude with each other, damaging the interests of the State, the collective or a third party; (3) Where the contract is an attempt to conceal illegal objectives under the disguise of a legitimate form; (4) Where social and public interests are undermined; or (5) Where mandatory provisions of laws and administrative regulations are violated. Obviously, the new-signed “paying by house” contract, which is in legal essence a property sale contract, does not match the features to be invalid.

In property law, such a contract is valid except under special situations, such as before maturity of the debts, the mortgagee may not enter into an agreement with the mortgagor that the mortgaged property shall come under the ownership of the creditor when the debtor defaults, prescribed in Property Law of the People's Republic of China, Article 186 . The court rules that this scenario does not meet the factors of invalidation. The invalidation factors only applies to the mortgage contract, which the contract here is not. This “paying by house” contract is merely a transaction arrangement to reach the balance between rights and obligations among parties concerned. Moreover, the new commercial resident sale contract is an agreement reached by both parties. Therefore, the court should respect the intention of parties and admit the validness validity of the new contract.

Also, the contract doesn’t become invalid under private lending legal relationship. Company X moved the court to reject the lawsuit, in reason that the creditors should file the suit on loan contract but not the commercial resident sale contract. According to the Provisions of the Supreme People's Court on Certain Issues concerning Application of Law in Trial of Cases involving Private Lending (hereinafter Provision), In the event of the execution by the parties concerned of the sales contract as the guarantee for the contract for private lending, where the borrower is unable to repay the borrowing upon maturity thereof and the lender requests the performance of the sales contract, the people's court shall conduct trial based on the legal relationship of private lending and explain to the party concerned for changing the claims. In other words, if the house is a guarantee for the performance the loan contract, then the only legal relationship existing is the private lending legal relationship, which requires the parties to bring suit under this cause. Company X argued that the loan contract is formed first and the commercial resident sale contract is formed only to perform the first one, therefore both contracts are in the same private lending legal relationship thus the court should reject the current claim raised under commercial resident sale contract. The court is not convinced by that, instead the court believes that the loan contract and the commercial resident sale are in essence two different and separate legal relationships in this scenario. The parties formed the sales contract upon the termination of the previous loan contract. Here the legal relationship concerning private lending no longer exists. Therefore, the contract cannot be void under provision.

To sum up, A loan contract should satisfy the below factors to avoid being deemed invalid. First, the loan contract shall continue to exist and be valid, which means if the loan contract has been invalidated or rescinded, the following paying be house contract is invalid too. Second, the conversion to property purchase contract should be agree by all parties. The so call “conversion” consists by two acts, the first one is to terminate the loan contract, and the second one is to establish the new contract. Only in this way can the court recognize the property purchase as a separate legal relationship. Otherwise, in case the property purchase is deemed as a guarantee of the performance of the loan contract, it is not obligatory for the debtor to proceed the closing of the property since this is only optional for performing the contract. Third, the agreement on property purchase contract should not be flawed of the effectiveness.

In conclusion, a new- established property purchase contract, which formed upon terminating the precious loan contract, should be deemed as valid as long as the loan contract is valid and be terminated upon the agreement reached between both parties. 

Disclaimer

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