China real estateAt the recently completed San Francisco seminar on Chinese real estate, co-blogger and fellow China attorney, Steve Dickinson, highlighted the provisions in China’s New Property Law relevant to foreign investors in China real estate.  Rather than seek to recreate that talk with my inadequate notes, we will instead, put forth the below paper on China’s New Property Law Steve wrote for the seminar.

This paper seeks to provide a summary overview of the new law, beyond just those provisions directly relevant to foreign investors in China real estate. However, because this new law is so sweeping and so important, it would be difficult to argue any of it is irrelevant to someone planning to invest in China real property.

Because the material is so dense and legalistic, I will be presenting it in parts. Today’s post is simply an introduction to the new Property Law and a short explanation of its purpose and overall scope. Tomorrow, we will get into some of its specifics.

I.  INTRODUCTION

On March 16, 2007, the National People’s Congress of the PRC adopted the New Property Law (wuquan fa , literally: “Law of the Rights in Things”). For the first time in the legal history of the PRC, this law provides for basic ownership rights in immovables (real property) and movables (personal property). Since individual property rights are the foundation of any market economy, the promulgation of a full Property Law is significant. For businesses and persons engaged in real property investment in China, the law is of fundamental importance. In providing for absolute ownership rights for private individuals and businesses, the Property Law marks a major change in the rights of both Chinese citizens and foreign investors.  This law is set to go into effect on October 1, 2007.

The Property Law is quite difficult to understand. There are three reasons for this.

The first and most significant reason is that the Property Law is based on civil law models, primarily Chapter 3 of the German Civil Code. The Law also draws heavily on the Swiss and Japanese Civil Codes. Its fundamental principles differ significantly from the U.S. and British common law based real property system. In addition, the civil method of exposition is quite unfamiliar to most civil law practitioners. The structure and method tends only to make sense to those familiar with the German and Japanese codes.

Second, understanding of the Property Law is further complicated because it incorporates many provisions intended to deal with unique Chinese characteristics that would never be mentioned in a pure, German civil law type code, including those provisions meant to address the Chinese government’s monopoly on land ownership and those dealing with prohibitions on illegal land transfers and theft of government property.

Third, the Property Law was a hotly debated law, opposed by many elements of Chinese society. It is therefore intentionally vague on many important issues. This vagueness was the price paid to allow any form of Property Law to be adopted. The drafters frankly admit that if all the critical issues concerning property rights in China had been resolved in the Property Law, the law would never have been adopted. These issues are explicitly left for later resolution.

The Law is divided into Five Parts, 19 Divisions and 247 Sections. I will introduce the law division by division and explain the most significant features. The Property Law covers both immovables (real property) and movables (personal property), but I will limit my discussion only to the Divisions of the Law concerning real property.

 

II.  GENERAL PRINCIPLES

Part I of China’s Property Law contains three Divisions.

A.  Division 1:  Fundamental Principles

A major focus of debate over adopting the Property Law centered on two concerns. First, many opponents of the Law argued that providing for private property would violate the fundamental principles of China’s socialist system. Second, many opponents argued that allowing for private property would protect prior illegal acquisitions of state property by local officials and would prevent the state from taking back such property. The eight sections of this division center on responses to these concerns.
The relative protection afforded to state owned property versus privately owned property is the most important issue addressed in this division. Many opponents of the Property Law argued for giving state property rights priority over individual property rights. The Property Law rejects this position by according equal protection to the property rights of the state, the collectives and private individuals. Section 4.The drafters provide two reasons for why this equal protection is necessary. First, the purpose of the Property Law is to provide for property rights as the basis for a market economy. Since the state and collectives are heavily involved in ownership rights in the economy, it is necessary for the smooth functioning of the economy to treat them on the same basis as private persons. Second, the drafters refer to the most recent revision to the Constitution which provides that the party (CCP) and the state must represent the vast majority of the people. The drafters quite openly pointed out that the vast majority of the people in China insist on individual property rights being on an equal footing with the state. The drafters essentially indicate they had no real alternative on this issue.

B.  Division 2:  Creation, Change, Transfer and Termination of    Property Rights

This division focuses on the technical issues relating to Property Rights. For immovables, the key provisions are as follows:

1.  The Property Law requires creating a unified registry for all interests in land. Under the Property Law, there are three fundamental interests in land: ownership of land, ownership of buildings and fixtures on the land and mortgages affecting the land and/or the buildings and fixtures. All such interests must be recorded in the official government register. Under China’s current system, it is not uncommon to register the three interests mentioned above in three different registries. As can be imagined, this creates uncertainty and confusion.  Some of the major cities such as Beijing, Shanghai and Guangzhou have already adopted a unified registry but it is expected that the second tier and smaller cities may need some time to do so.

2.  The Law provides that ownership or any change in ownership of land or buildings and fixtures is effective only upon registration in the official land register. The land register is also conclusive evidence of ownership. This means that in the case of multiple sales of the same property, the first party to register the sale will prevail over any other claimants to the property, no matter who was first with the contract of sale. This follows the German approach to this issue, and rejects the French and Japanese approach which provides that the contract of sale is effective to transfer ownership and registration simply provides notice to innocent third parties.

3.  Since registration in the land registry is such a critical matter, the Law provides for two important protections:

a.  An interested party has the right to petition for a correction of mistakes in the land registry. If the registrar declines to make the correction, the interested party has the right to file suit. If a mistake in the registry causes damage to an interested party, that party has the right to claim for damages against the registry. Section 19.

b.  An interested party has the right to sue for damages against any person who submits falsified documents for an entry in the land registry and to receive from the registry that accepted the falsified documents. Section 21.

4.  Multiple sales of a single property are a major issue in China. The Property Law addresses this by providing for a system of notice filing. Notice of the pendency of any transaction that would affect land or buildings may be filed with the land registry. During the pendency of such filings, no competing transactions will be processed.  Section 20.

C.   Division 3: Protection of Property Rights

Division 3 provides for the standard civil set of legal measures for protection of property rights.  These are:

1.  Claim for recognition of right.

2.  Claim for return of the original property.

3.  Claim to eliminate or mitigate danger/damage to property.

4.  Claim to repair, rebuild, exchange or restore property to its original condition.

5.  Claim for damages due to injury to property.

These claims are all made through arbitration or through the people’s courts. The claim for the right to return of the original property can be used by the state itself to require the return of property illegally taken for private purposes by local government officials. Since this is a major concern of the Property Law, such claims should be anticipated. It is not clear how this will affect transactions in land and buildings entered into by innocent third parties such as foreign investors. Since the government itself estimates 50% to 70% of transfers of land use rights are illegal, this provision has the potential to cause significant uncertainty.

For the first time in the PRC, the Property Law provides for ownership by private persons. Private persons have the right to own all property except land. Private ownership includes buildings and fixtures located on land. This Part also includes the rules for real property concepts of neighboring rights, common ownership and condominium ownership,

D.  Division 4: General Principles 1.

The Property Law provides for the following general principles:

a.  An owner of property has the right to occupy, utilize, enjoy the fruits of and dispose of property.

n.  An owner of property has the right to subject the property to use rights and security interests.

The Property Law provides for certain special measures limiting ownership rights in land and buildings. Ownership of land and buildings is subject to state seizure by through eminent domain. The state has the right to take land owned by collectives and buildings and personal property owned by private persons for a public purpose. The state is required to provide compensation for such takings. The state taking farmland for commercial buildings and taking urban residences for urban redevelopment is a major social issue in China. Abuses in this area are common, well documented, and a cause of unrest.

Two major issues arise. First, what is a public purpose? Many Chinese argue urban redevelopment and commercial development for manufacturing and leisure activities are not public purposes. However, the vast majority of land and building seizures are for just such primarily commercial purposes. Second, what is the standard for determining compensation when land and buildings are taken by the state? Many Chinese believe the standard should be fair market value, not the tiny amounts of compensation currently paid.

Earlier drafts of the Property Law included various provisions that would have defined “public purpose” and would have required payment of fair market value or some market based compensation for land and buildings. However, all of these protective provisions were eliminated from the law as adopted. In the commentary issued by the NPC, the drafting committee admits the statute is purposely vague in not addressing these issues. The controversy over these issues was too great and an attempt to resolve them in the Property Law would have indefinitely delayed adoption. The NPC candidly admits these major issues await resolution in some other forum.

c.  Protection of agricultural land. Land owned by collectives is reserved exclusively for agricultural purposes. To be used for housing, manufacturing or other commercial purposes, such land must first be transferred to state ownership. Much unrest in the rural areas of China arises from such transfers.  Section 42 of the Property Law attempts to address the issue of improper transfers of agricultural land: “The state engages in special protection of agricultural land, severely limits the conversion of agricultural land for construction purposes and controls the quantity of land used for construction purposes. It is not permissible to seize collectively owned land in violation of the limits and procedures provided by law.” It is difficult to know what to make of this provision. It seems to forbid transferring agricultural land to the state for construction purposes, but it does not absolutely prohibit such transfers and, in fact, it says nothing more than that parties must obey the law when such transfers occur. Since this section has no mandatory effect, its purpose is not clear.

E.  Division 5: Ownership Rights of the State and Collectives and Ownership Rights of Private Persons.

1.  Ownership rights of the state.  This Division provides that the state owns all land not owned by collectives.  The state also owns natural resources, radio wave spectrums, cultural relics, mineral resources, military installations and basic infrastructure.  The rights of the state with respect to ownership are exercised by the State Council.

2.  Ownership rights of collectives.  Collectives own agricultural land and land for residential purposes located in rural villages and townships. Collectives also own businesses founded by collectives using their own capital.  A major issue in China is that the term “collective” is quite vague.  It is often extremely difficult precisely to identify the collective or to determine who is authorized to make decisions on behalf of the collective. The Property Law makes no decisive pronouncements in this area and leaves the decision to the “relevant laws and regulations” even though such “laws and regulations” often do not exist.  All of this increases the uncertainty in dealing with land ownership issues in the rural areas.

3.  Ownership rights of private persons.  Private persons have the right to ownership in their income and basic property such as homes, items of daily use, tools, and materials of trade.  The ownership right extends to their savings and capital investment in businesses.  The right to inheritance is guaranteed.  In addition to natural persons, the right of ownership of legal persons is also protected.  Where the state, collectives and natural persons all invest in a single legal person, the rights of all three are protected on an equal basis depending on the amount of the investment.

C.  Division 6: Condominium Ownership Rights The vast majority of urban Chinese live in multi-family structures.  The property law provides for the first legal regime governing condominium ownership.  When these units were owned and operated by the state, there was no need for any special legal regime.  The explosion in private ownership of condominium units over the last ten years began with conversions of state owned units to private ownership, but has now expanded to purely commercial residential housing sales.  The condominium rules are based on the condominium law of Japan.  Most civil law countries provide for condominium laws in a separate statute. China has included condominium law rules in the Property Law because they are so important and to make the Property Law as complete as possible. An owner of a condominium has three distinct sets of rights:

1.  Individual ownership right in the specific dwelling unit and the parking space assigned to that unit.

2.  Common ownership right in the common areas of the residential complex.  Under Chinese law, common ownership is either common ownership or common ownership by shares.  The Property Law does not specify which type applies in the case of condominium ownership, but common ownership is the most probable.  The Law does not delineate between what constitutes individual portions and what constitutes common portions, leaving this to the formation documents for each condominium project.  Many condominiums already exist that have not clearly addressed this issue.  Newer condominiums are also often very vague on these issues. Division of private and common areas is therefore likely to be the source of some dispute in the future.

3.  Right to participate in managing condominium affairs, either through voting in the general meeting of owners or through voting for or participating in the condominium owners association.  The rules for operation and voting for the general meeting and owners association are general and unspecific. The stated reason for this is that the tremendous variety of condominium type arrangements in China makes one set of rules virtually impossible to impose.  This lack of detailed rules is likely to be a source of dispute, especially for existing condominium projects that have never had a formal owner management structure. Because of the newness and uncertainty of China’s condominium system, the local government is charged with supervising and assisting in forming condominium management for condominium owners.  Since many existing condominium projects have never implemented any form of owner management, a primary task of the local government is to ensure owners associations are formed.  Local governments are to act in a consulting capacity, providing examples of form agreements and advising on formal procedures.  Local governments do not have the right to interfere with or direct the affairs of the owners once a proper owner’s management system has been implemented.

F. Division 7: Neighboring Rights.

As in all civil law jurisdictions, rights in real property are not absolute.  All rights in real property are burdened with basic obligations owed to neighboring property.  These obligations to neighboring property are the following:

1.  The obligation to allow access to water and to allow discharge of water.

2.  The obligation to allow access to roads other means of transportation.

3.  The obligation to allow access for construction, laying of cables, laying of pipe, etc.

4.  It is not permissible to allow construction that will interfere with access to sunlight, view or airflow of the neighboring property in violation of government regulation. In densely populated areas like Chinese cities, access to sunlight, view and airflow are important and frequently disputed rights. This is particularly true as traditional neighborhoods are converted to high-rise projects and as large buildings are constructed within residential neighborhoods. Chinese building regulations have extensive rules related to these rights. However, these rules are frequently violated. Though this provision limits claims to circumstances where government regulations are violated, the fact such violations are common means this provision could be the source of substantial litigation.

5.  It is not permissible for the interested party on one parcel of land to expel onto neighboring land solid waste, polluted air, polluted water, noise, light or electromagnetic radiation in amounts exceeding government regulations. This provision basically allows an interested party to sue to enforce government environmental regulations. Given the weak enforcement of such regulations in China, this provision could be the source of substantial litigation.

6. During excavation, construction of buildings, laying of cables and the like, it is not permissible to endanger neighboring property. Reckless excavation is very common in China.  This provision too could be the source of substantial litigation.

G.  Division 8: Common Ownership.

There are two forms of common ownership: ownership by shares and undivided common ownership.  Absent a specific agreement, common ownership is assumed to be ownership by shares except in the case of a family relationship, where the opposite assumption is made.

1.  The basic attributes of ownership by shares is:

  • Each common owner has a percentage ownership in the undivided property.  The amount of each share is based on the amount contributed by the party to purchase the property.   If this amount cannot be determined and there is no express agreement, the common owners will all have equal shares.
  • The common owners share in income and expenses in proportion to their share interest.  However, with respect to third parties, common owners have joint liability.
  • Each common owner has the right to sell his share in the property, subject to the right of first refusal of the other common owners to purchase that share.
  • Each common owner has the right to petition for partition of the commonly owned property.

Many of these features of common ownership by shares are disadvantageous in a commercial setting.  Any of the provisions can be modified by agreement except for joint liability to third parties.

2.  The basic attributes of undivided common ownership is:

  • Each common owner has an undivided ownership interest in the entire property.
  • Each common owner has a right to the income of the property and also the obligation for the expenses of the property.  The common owners have joint liability with respect to third parties.
  • No common owner has a right to sell any portion of the property absent the consent of all of the other common owners.
  • As a general rule, a common owner does not have the right to petition for partition of the property.  However, partition is permissible if a) there is a compelling reason or b) the underlying relationship is terminated.  A compelling reason is not defined in the statute, but the commentaries suggest a major medical expense would be such a reason. Termination of the relationship most commonly would be divorce.
  • As with ownership by shares, the default rules for undivided common ownership can be modified by agreement.

The Law does not provide whether ownership by a partnership is ownership by shares or undivided ownership. The majority of scholars believe the answer should be ownership by shares. Partnerships that do not desire such a result should clearly set out the terms of their relationship in a partnership agreement.