Under the Chinese legal framework, non-financial companies are banned from directly carrying out lending and borrowing activities, under the general rules on loans issued by the People’s Bank of China in June 1996 and the Supreme People's Court (“SPC”) reply of September 23, 1996.
However, in practice, companies have sidestepped this legal prohibition by using entrusted loans (i.e., by entrusting a commercial bank to grant the loan to the borrower on behalf of the lender, acting merely as a bridge, without bearing any material liabilities or risks).
The SPC’s provisions on private lending of August 6, 2015 (“the Provisions”), explicitly acknowledge, for the first time, the validity of loan agreements directly entered into between nonfinancial companies to cover production or operational business needs, establishing the following:
- Intercompany loan agreements will be valid when entered into to cover production or business operation, unless they fall under the following circumstances:
- Fraudulently obtaining credit funds from a financial institution and relending them to the borrower, when the borrower knew or should have known in advance;
- Relending funds borrowed from another enterprise or from its employees to the borrower with the purpose of making a profit, when the borrower knew or should have known in advance;
- Lending funds to the borrower while the lender knows or should have known in advance that the borrower will use the borrowed funds for illegal or criminal activities;
- Violating public order and good morals; and
- Other violations of legal and administrative provisions on validity.
- Interest claims will be supported by the People’s Court hearing the case, unless the parties failed to agree on the interest, based on the following thresholds:
- Where the agreed yearly interest rate is under 24%, the lender is entitled to the full interest;
- Where the agreed yearly interest rate is above 24% but under 36%, the interest exceeding 24% is void. However, if the borrower has already paid the interest to the lender, the borrower is not entitled to claim it back;
- Where the agreed yearly interest rate is above 36%, the interest exceeding 36% is void. The borrower is entitled to request that the lender returns the excess interest paid.
Date of issue: August 6, 2015. Effective date: September 1, 2015.