Mortgage law in China: comparing theory and practice.

AuthorStein, Gregory M.
PositionSymposium: A Festschrift in Honor of Dale A. Whitman
  1. INTRODUCTION

    China is in the puzzling position of developing free markets while still nominally subscribing to Communist ideology. (1) Nowhere is this tension more evident than in its real estate sector. (2) Developers are building award-winning office towers, modern shopping malls, and five-star hotels, and tens of millions of urban families are scraping together the money to buy their own apartments. (3) At the same time, Communist doctrine prohibits private ownership of property, and all land in China still is owned by the state or by agricultural collectives. (4) This doctrinal confusion does not seem to be holding back the real estate market, particularly in China's major cities, which have been booming for most of the last two decades.

    China has adopted numerous written laws and regulations since the 1980s, but property law has lagged behind other areas of civil law. The first Chinese law focusing specifically on property rights became effective on October 1, 2007, (5) which means that China's breakneck real estate development during the preceding two decades occurred in a nation with no published law of real estate. (6) China has only haltingly begun to adhere to international role-of-law standards, and there still is heavy reliance in China on guanxi, or personal relationships and connections. (7) Chinese property rights also are limited by communitarian considerations in ways that are unfamiliar to Americans. (8) These factors ensure that property law as it is actually practiced in China diverges from the published legal rules. Thus, those who have been buying, selling, and lending against Chinese real estate have been operating in a world of significant legal uncertainty. (9) Moreover, while a newcomer to American law can learn much by reading statutes, cases, treatises, and academic articles, there are few similar sources in China.

    This Article examines Chinese mortgage law as it actually operates in the field, focusing on both legal and business issues. (10) During the summer of 2005, I interviewed dozens of Chinese and Western lawyers, bankers, real estate developers, government officials, judges, economists, real estate consultants, law professors, business professors, real estate agents, law students, and recent homebuyers. (11) Their comments offer reliable insights into how China's real estate markets truly function. The discussion that follows draws on these conversations to examine China's budding mortgage law practices, including how they developed, how they comport with or differ from written laws, and what questions they leave unanswered. (12)

    I first visited China as a Fulbright Lecturer at Shanghai Jiaotong University Law School during the spring of 2003. Amazed by the staggering scale of the real estate development in Shanghai, I became curious as to how China was succeeding in building new structures and rebuilding crumbling infrastructure so quickly in a partial legal vacuum. I returned two years later and conducted this field research into the legal and business grounding for the current Chinese real estate boom, interviewing a wide variety of experts in various segments of the Chinese real estate industry. These professionals come from a broad range of fields and backgrounds, with their only shared attribute being a willingness to meet with an inquisitive foreigner. (13)

    Several features of the blossoming Chinese real estate sector quickly became apparent. These characteristics remind American lawyers interested in China that their assumptions about the American real estate industry will not necessarily apply in a nation with a strikingly different history and legal culture. First, the legal and business communities have fashioned their business approach largely from scratch. There is little received wisdom, today's leaders have few mentors on whom they can rely, and many so-called experts still operate by trial and error. Second, while China's market is more open today than it has been in at least a half-century, it is far from a free market. The government intervenes in all aspects of the economy to a degree that is surprising to the Western observer. Third, the legal system is not transparent, laws are not always applied and enforced as written, and there is much corruption. "Rule of law" is viewed by many Chinese as a Western construct designed to preserve Westerners' current advantage; it has not yet won its battle against "rule by man."

    Fourth, China's legal system is a responsive one. Rather than adopting laws and regulations prospectively--an enormous task for a huge country that has been reforming its legal and economic systems rapidly and dramatically-the Chinese government often drafts them to address the crisis du jour. Meanwhile, China's creative business community continuously formulates new ways to approach new problems without waiting for formal government action. Market participants devise novel economic arrangements that subsequent legal developments expressly permit, or at least tacitly tolerate. The business community often seems to be prodding the government to act, and China's legal system must struggle mightily to keep up. (14) In short, formal law lags behind actual practice.

    Part II of this Article offers some historical and legal background. Part III examines the types of loans that are available to Chinese borrowers and the types of lenders that are making these loans. These lenders expect to be repaid, and Part IV raises the question of what assets a borrower has available to offer to a lender as security for that repayment. Part V continues by addressing the lending standards these lenders apply before they agree to extend credit. This analysis raises the more general question of where the lenders' funds actually come from, and Part VI discusses the ultimate sources of these funds. Part VII questions how stable the Chinese banking sector actually is, and Part VIII offers some concluding thoughts.

  2. THE HISTORICAL AND LEGAL BACKGROUND

    Mao Zedong led the Chinese Communist Party to power in 1949, but China arguably did not complete the nationalization of its land until 1982, six years after Mao's death. (15) Ironically, market-based systems began to reappear at about this time, hastened by Deng Xiaoping's rise to power during the late 1970s. Deng ignited China's "reform and opening" policy in 1992, causing the Chinese economy to begin growing rapidly from a nearly dead stop. The Chinese economic system, including its real estate sector, has developed quickly since then, with spectacular acceleration since the mid-1990s. Nonetheless, private ownership of land remained prohibited during this era of transition and still is forbidden today. (16)

    China amended its Constitution in 1988 to read, "The right to the use of land may be transferred in accordance with the law." (17) This provision does not permit private land ownership (18) but does allow the government to grant land use rights for a specified term. (19) The government thereby created opportunities for private development (20) while it also "avoided abandoning the Marxist principle of state ownership." (21) The maximum permissible term for a land use right is seventy years for residential property, forty years for commercial property, and fifty years for industrial and other types of property. (22)

    The party that acquires a granted land use right technically is required to develop the land within two years, (23) but the government often fails to enforce this deadline. Rights holders may pay an additional fee to extend the term, may initiate the barely acceptable minimum amount of construction before the two-year period expires, or may otherwise seek to extend the initial term. The initial and subsequent holders of land use rights may transfer these rights to others, within certain limits. (24) For example, in an apparent effort to head off speculation in undeveloped land, the law prevents the initial holder of a residential land use right from transferring the right to a third party until it has constructed at least 25% of the proposed structure. (25)

    Despite some superficial similarities, the Chinese land use right differs considerably from the common law ground lease. (26) A party acquiring a land use right must pay the entire cost for that right in advance; (27) the holder of a land use right may not register that right until it has paid the fee in full; (28) at least in some parts of China, the purchaser apparently may not use borrowed funds for the acquisition of a land use fight; the land to which use fights are granted must be developed within a fixed amount of time or the right is forfeited, as just noted; there are official limits on the transferability of land use rights, also as just noted; the holder of the land use right must own the building constructed on that land; (29) and land use rights are not subject to landlord-tenant law. (30) The Chinese land use right thus is not a ground lease. (31)

    One obvious question about China's current system of land use rights is what happens to the land use right and the structures on the land when the term of the right expires. (32) Since the system of land use rights is only about two decades old while most land use rights are granted for periods of forty years or more, China's legal system and real estate market have had little occasion to address this question so far. It is reasonable to assume, however, that even if Chinese government entities are not required to renew land use rights that are nearing their expiration date, they will be willing to negotiate extensions of these rights in exchange for the payment of a periodic or onetime fee. Pressure to implement such a policy is likely to increase as the first wave of land use rights begins to approach its expiration date and the holders of those rights discover that lenders have become unwilling to finance construction or renovation on the land. (33)

    The amount of this...

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