Mortgage contract disputes: When the bank lacks the necessary care

The plaintiff argued that the bank had arbitrarily revalued the assets and extended the security obligation beyond the original agreement, while the bank invoked the provision on security for future obligations to affirm the validity of the mortgage contract. The appellate civil case No. 109/2024/DS-PT between Mr. Ha Anh D, Ms. Pham Thi Thanh T and K3 Commercial Joint Stock Bank related to the dispute over the mortgage contract for a third-party loan raises many important legal issues[1].  In this article, we will clarify the role of the principles of transparency, voluntariness, and equality in contracting, especially clarifying the legality and limitation of the scope of the mortgage contract when performing the contract.

The plaintiff argued that the bank had arbitrarily revalued the assets and extended the security obligation beyond the original agreement, while the bank invoked the provision on security for future obligations to affirm the validity of the mortgage contract.

Background of the dispute between the parties

Mr. D and Ms. T mortgaged the land use right of 90 m² (plot 42, map sheet 21, Vung Tau City, Land Use Right Certificate No. M 393656 issued in 1998 in the names of the two grandparents) to secure part of the loan obligation of T5 Co., Ltd. under the Credit Limit Agreement No. VTU20154331/HDCTD dated 23/3/2015 (limit of VND 35 billion). The bank valued the land at about VND 2,484 billion, committing assets to only secure a maximum of about VND 1.8 billion (equivalent to 75-80% of the valuation value). Immediately afterwards, the bank disbursed VND 1,995 billion to T5 Company (contract dated September 1, 2017), in accordance with the original commitment.

However, the mortgage contract (No. VTU20170227/HDTC and VTU20170228/HDTC) has a clause extending the scope of security at Point a, Clause 3, Article 3: the collateral for all obligations of T5 Company to the bank, including the 2015 credit contract, this mortgage contract, any contracts arising before/after the date of signing,  and any appendices and amendments. This clause covers future obligations, without limitation on specific amounts or durations.

After signing, at the end of 2017, T5 Company repaid the debt and settled the first loan. By 21/5/2019, all obligations secured by the assets of Mr. D and Ms. T have been completed (old loans are settled). However, the Bank arbitrarily continued to use this asset to secure new loans of T5 Company through many appendices to the credit contract without signing additional mortgage addendums or notifying the plaintiff. The bank arbitrarily revalued the land many times to raise the new loan limit without signing a new mortgage contract or notarizing it.

By May 2022, when the bad debt occurred, the bank informed the plaintiff that the asset was collateralizing the outstanding debt of VND 5,454 billion. Mr. D and Ms. T were surprised, affirmed that they did not agree to be responsible for exceeding the initial VND 1.8 billion, and said that the bank seriously violated the regulations related to the mortgage contract.

Accordingly, the plaintiff initiated a lawsuit to request the Court to declare the mortgage contract invalid in its entirety due to violation of the agreement, lack of transparency, and illegality on secured transactions; at the same time, request the bank to release the mortgage and return the Land Use Right Certificate.

The bank's argument on the scope of security and future obligations

K3 Commercial Joint Stock Bank believes that the mortgage contract in 2017 has been implemented in accordance with the law. The mortgage contract dated 31/8/2017 was notarized and fully registered. At the same time, in the contract, the mortgagor has agreed that its assets will guarantee both the current and future obligations of T5 Company to the bank. In other words, the scope of the guaranteed obligation is that there is no specific limit on the amount or duration, including loans incurred later (as long as it is between the bank and T5 Company).

To reinforce the above view, K3 Bank cited Clause 1, Article 294 of the Civil Code which allows the parties "to have the right to specifically agree on the scope of the secured obligation and the duration of the performance of the secured obligation" when securing the obligation formed in the future. Clause 2, Article 294 of the Civil Code stipulates that "when a future obligation is formed, the parties are not required to re-establish security measures for that obligation". According to the bank, this means that a mortgage contract can secure multiple loans in the future without having to re-sign a new mortgage contract each time a loan arises. In this case, the 2017 mortgage contract agreed on the scope of security including future obligations, so every time T5 Company borrowed more (according to the credit appendices), the bank did not have to re-sign the mortgage contract with Mr. D, Ms. T. The bank argued that the law did not force them to notify or ask for the opinion of the the mortgagor when a new obligation arises, because the mortgage contract and the law do not have any provisions on this notification obligation. At the same time, Clause 2, Article 294 of the Civil Code implies that the security for future obligations takes place automatically according to the original agreement, without the need to re-establish or modify the security measure.

The defendant also pointed out that legally, the mortgage contract does not contain a limit number, but also clearly lists the assets that will be secured for both "contracts signed before, during and after the date of signing this contract" and the attached appendices. Therefore, according to the bank, Mr. D and Ms. T have agreed to be responsible indefinitely and without limiting the specific amount right from the time of signing the contract. All risks arising from T5 Company's additional borrowing are within the scope that the mortgagor must accept.

Overview of the seminar on clarifying the current status of disputes arising from credit contracts, jointly organized by the Vietnam Banks Association, the Supreme People’s Procuracy, and the State Bank of Vietnam.

Judgments of courts at all levels on the limitation of security, contractual validity and handling of collateral

The Court of First Instance (People's Court of Vung Tau City) in Judgment No. 143A/2023/DS-ST declared Mortgage Contracts No. 227 and 228 invalid and forced the bank to return the Land Ownership Certificate to Mr. D, Ms. T. The first-instance judgment found that the scope of the security obligation imposed by the bank on the plaintiff's property exceeded the agreed limit and not in accordance with the law, especially after the initial obligation has been completed. Due to the invalidity of the mortgage contract, the court of first instance did not accept the bank's request for the sale of the 90m² land plot of Mr. D, Ms. T; instead, the bank is only entitled to sell other collateral (a 357m² land plot in Thai Nguyen owned by Mr. T2 – another guarantor) to recover the debt for the loan of T5 Company. This result shows that the court of first instance has protected the interests of the mortgagor (Mr. D, Ms. T), limited their liability to VND 1.8 billion as originally guaranteed, and did not allow the bank to handle their assets for the additional debt.

K3 Bank appealed this part of the decision, arguing that the first-instance court "had not fully and objectively assessed the case" and proposed to cancel the decision to declare the mortgage contract invalid, recognize the contract as valid and sell the mortgaged assets of Mr. D and Ms. T.

The Court of Appeal (People's Court of Ba Ria – Vung Tau province) reviewed the case. The Court of Appeal first determined the scope of the security agreement in the mortgage contract as presented by the bank: the collateral for the past, present and future obligations of T5 Company, is unlimited. However, the court pointed out that this clause is a "general, confusing concept", does not specify the scope of the guaranteed amount and does not have a specific timeline. That is "not in accordance with the provisions" in Clause 1, Article 294 of the Civil Code, which requires a specific agreement on the scope and duration. In other words, the mortgage contract lacked transparency and specificity in the very most important part. The bank interpreted itself in a way that was unfavorable to the mortgagor – assuming that the property would secure "one loan after another in the future" without notifying the owner. The court said that the bank's interpretation and implementation "is not in accordance with nature, with Clause 1, Article 294 of the Civil Code and may cause unjustifiable damage to the party with the collateral". Thus, even if the law allows the security of future obligations, the vague agreement, favoring the interests of the bank as in this contract is considered a violation of the spirit of the law. Especially, the mortgagor is not concurrently the borrower in the credit contract.

The Court analyzed that the plaintiff's will when mortgaging was only to secure a loan equivalent to VND 1.8 billion of T5 Company – this was reflected in the testimony of the representative of T5 Company that Mr. D, Ms. T "only guaranteed the company a loan of VND 1,800,000,000", in accordance with the asset valuation value of VND 2,484 billion and the fact that the bank only disbursed the maximum the original was about 1,995 billion VND. In contrast, the clause "all future obligations" is included by the bank in the contract form, which is clearly detrimental to the mortgagor. Therefore, according to the principle of interpretation of the contract, this mortgage contract must be understood in a way that is beneficial to Mr. D and Ms. T – that is, limited to a loan of about 1.8 – 2 billion VND as their will. The Court came to the conclusion that the plaintiff did not voluntarily accept an indefinite and unlimited guarantee to T5 Company, and therefore could not use the general contractual clause to bind them beyond the actual agreement.

A key point that the appellate court clarified was the time of termination of the security obligation of the collateral. According to the content of the judgment, the loan according to the Appendix to the credit contract No. 04 (loan of 1.8 billion) was fully paid by T5 Company on May 21, 2019. The Trial Panel affirmed that this is the only future obligation that Mr. D and Ms. T agreed to guarantee and this obligation was completed and terminated on May 21, 2019. According to the law, when the secured obligation is terminated, the mortgage must also be terminated, the bank is responsible for returning the documents and papers on the mortgaged property and deleting the mortgage registration. However, K3 Bank did not fulfill this obligation, nor did it notify the plaintiff that it had exhausted its security liability. Instead, the bank continued to revalue the assets, and lent more money to T5 Company based on the "added value" of the assets. Especially not notifying the property owner. The Court of Appeal affirmed that the defendant had abused the right to revaluation, misinterpreting the purpose of the contractual clause, because "it is clear that there is no regulation or agreement that allows the bank to unilaterally value the collateral in order to raise the loan limit". The act of agreeing with Company T5 to continue using Mr. D's and Ms. T's assets to secure loans after May 21, 2019 without the consent of the property owner is considered a serious violation of the agreement and the law. Therefore, the bank does not have the right to handle this collateral to recover debts arising later.

The decision of the Court of Appeal clearly stated that it did not accept the appeal of K3 Bank, upholding the first-instance judgment. Accordingly, the mortgage contract dated 31/8/2017 was declared invalid, the bank was not allowed to handle the 90m² land plot of Mr. D, Mrs. T to collect debts. The bank only has the right to handle another land plot (Mr. T2's property in Thai Nguyen, according to the mortgage contract in 2022) as determined by the first-instance court. This judgment of the court has ensured that the limit of the security obligations of Mr. D and Ms. T is exactly the same as the scope they voluntarily agreed on (about 1.8 – 2 billion VND), and at the same time condemned the bank's lack of transparency in expanding the security obligation against the agreement and the law.

Legal basis for mortgage contracts and security of obligations

The Civil Code 2015 has specific provisions that govern the case of a collateral for multiple obligations and security of future obligations. Specifically, Article 294 of the Civil Code 2015 stipulates the security for the performance of obligations in the future. This law recognizes the legality of the agreement on advance security for the obligation that will arise, but at the same time sets a requirement: the parties have the right to specifically agree on the scope of the secured obligation and the duration of the performance of the secured obligation. This means that the law allows security for future obligations, but requires specificity and clarity in scope and duration. The purpose is for the guarantor of the parties, especially the underdog in the transaction, to know what obligations they are covering, how much and for what period of time. If the contract does not clarify those factors, it is very likely that it does not meet the effective conditions required by law. In addition, Article 294(2) of the Civil Code exempts the "re-establishment of security" for each future obligation when it arises, but it does not mean that the guarantor loses the right to know or agree on each new loan. In addition, Article 296 of the Civil Code 2015 mentions the case of an asset that secures many obligations. According to Clause 1 of this Article, an asset may be used to secure multiple obligations if, at the time of establishment of the secured transaction, the value of such property is greater than the total value of the secured obligations, unless otherwise agreed upon or otherwise provided for by law. More importantly, Clause 2, Article 296 of the Civil Code requires that when an asset is secured for multiple obligations, the securing party must notify the secured party that the property is being used to secure other obligations; and each guarantee must be made in writing. This regulation shows that the general spirit of the law is towards transparency and consensus for each time the security obligation arises with the same property. In this case, the bank did not make additional mortgage documents nor notified Mr. D and Ms. T when continuing to use the assets to secure new loans. The bank relies on the infinite range of guarantee clause in the contract to assume that there is an "other agreement", but this clause lacks the necessary specificity under Article 294(1) of the Civil Code.

Source: The People’s Court of Ba Ria – Vung Tau Province (former)

Decree No. 163/2006/ND-CP on secured transactions and Decree No. 83/2010/ND-CP on registration of secured transactions also provide relevant rules. Article 10 of Decree No. 163/2006/ND-CP stipulates the validity of secured transactions, which clearly states that secured transactions take effect from the time they are lawfully concluded or from the time of registration if registration is required by law. For the mortgage of land use rights, Point a, Clause 1, Article 12 of Decree 163/2006/ND-CP (amended by Decree 11/2012/ND-CP) determines that this is a case of compulsory registration of secured transactions. K3 Bank registered the mortgage in 2017, however when the original obligation ended (2019) it should have been deregistered. If you want to continue using the assets for other loans, the bank should have registered a new security transaction or adjusted the registration contents. Article 3 of Decree 83/2010/ND-CP lists subjects subject to registration, including mortgage of land use rights. The fact that the bank maintains the status of registering the old mortgage and relending without additional registration may be considered as not complying with the procedures for registration of secured transactions. The Court of Appeal found that the bank's behavior was "not in accordance with regulations... Decree 163/2006/ND-CP and Decree 83/2010/ND-CP", when using the trick of appendix to the credit contract to avoid having to make a mortgage contract and register a new secured transaction. The provisions of Articles 10 and 12 of Decree No. 163/2006/ND-CP and Article 3 of Decree No. 83/2010/ND-CP are referred to to affirm the requirement of transparency in secured transactions: banks cannot "quietly" expand the scope of mortgages without official recognition from mortgagors.

Conclusion

From the above analysis, it can be concluded that the two-level Court has correctly and reasonably applied the legal provisions and basic principles to resolve mortgage contract disputes. The case also sets a precedent and a lesson for credit activity: the security clause for future obligations is not a "universal reserve" for the bank if it is drafted in a non-transparent manner and abused to lend beyond reasonable limits. Basic principles such as transparency, voluntariness, and equality will be applied by the court to correct inadequacies in the conclusion and performance of contracts, in order to achieve fair results. Therefore, in order to prevent legal risks, banks should review their security contract templates, ensure that the terms of the guarantee scope, notify the guarantor in a clear, transparent and easily provable manner. The above case will be a valuable practical "case law", warning banks to be cautious in implementing the principles of transparency, voluntariness and equality in all secured transactions – the fundamental principles to protect the legitimate rights and interests of parties in today's complex credit relationships.