The Provisions on Several Issues Concerning Application of Law in Hearing Private Lending Cases (“Provisions”) lately released by the PRC Supreme People’s Court (“SPC”) has become effective as of September 1, 2015. One of the highlights addressed by the Provisions is the potential liberalization of direct intercompany lending between non-financial entities, thereby loosening the statutory restriction of such lending currently being handled via “entrusted bank loans”. However, as of today, it cannot yet be reliably concluded that entrusted bank loans between companies has become obsolete after Sept. 1, 2015 despite the mentioned positive development in this direction.

Validity of lending between non-financial companies generally supported by SPC

Having released the Provisions, the SPC has shown a liberalizing attitude and will explicitly support the validity of private lending between non-financial companies. Thereby, it has clearly abandoned its traditional and slightly vague interpretation that “loan contracts between (non-financial) enterprises that are in violation with relevant financial laws and regulations shall be invalid”, according to the SPC Reply on How to Deal with Failure in Repaying Loans by Borrowers of Loan Contracts between Enterprises (issued on September 23, 1996). The wording of such interpretation implied that the SPC was rather referring to financial laws and regulations while deciding on the validity of lending between companies. Such financial laws and regulations could be the “General Rules on Loans” (promulgated by the People’s Bank of China on June 28, 1996), which imply that the competency to grant loans is reserved exclusively to financial institutions and thus intercompany lending is not permitted and shall be punished by the PBoC. In fact, for a long time, the General Rules on Loans (Article 61 and 73) have practically been applied and referred to as the legal basis for prohibiting intercompany lending.

If the following conditions are met consistently, the People’s case shall support the validity of private/intercompany lending:

  1. loan contracts are concluded for needs of production and operation;
  2. cases of invalid contracts according to Article 52 Contract Law do not exist, i.e.
    1. either party enters into the contract by means of fraud or coercion and impairs the State’s interest;
    2. there is a malicious conspiracy causing damages to the interest of the State, the collective of a 3rd party;
    3. there is an attempt to conceal illegal intentions under the disguise of legitimate forms;
    4. the public order and good customs are disobeyed;
    5. mandatory provisions of laws and administrative regulations are violated.
  3. cases of Item 14 of the Provisions do not exist where the court shall deem private loan contracts invalid, i.e.
    1. fraudulently obtaining credit funds of financial institutions and lending such funds at high interest to the borrower, and the borrower knows or shall have known this in advance;
    2. lending the loans from other enterprises or funds raised from the employees of the entity to the borrower for making profits, and the borrower knows or shall have known this in advance;
    3. the lender knows or shall have known in advance that the borrower will use the loan for illegal and criminal activities and still provides the loan;
    4. violating the public order and good customs; or m) violating effective and mandatory provisions of laws and administrative regulations.

With a strictly literal interpretation of the above, especially the reference 2/e) to the Contract Law and 3/m), the conclusion may be drawn that SPC would no longer bind the validity of private loan contracts to any “relevant financial laws and regulations”, but rather to mandatory provisions of laws (i.e. promulgated by the National People’s Congress or its Standing Committee) and administrative regulations (i.e. promulgated by the State Council). Consequently, the Chinese courts should then not follow, for instance the General Rules on Loans in deciding upon the validity of private loan contracts. This is because the General Rules on Loans are departmental rules (部门规章) which have lower legal effects than laws and administrative regulations in PRC law hierarchy.

Caution is still recommended for private lending; resort to “entrustment loans” in case of doubt

The immediate next question is whether the above enumeration is exhaustive and whether there exists any “law” or “administrative regulation” still prohibiting intercompany loans if none of the other invalidity reasons is applicable. For instance, the Measures for Clampdown of Illegal Financial Institutions and Illegal Financial Businesses (“Measures”, promulgated by the State Council on July 13, 1998), which are “administrative regulations”, prohibit “illegal lending of loans” between non-financial companies, however, without defining what “illegal lending” means or requiring any purpose which legitimates intercompany lending. The context of these Measures suggests that illegal lending must be subject to a comparable severity as “illegal absorption of public deposits”, “illegal fund raising”, e.g.. Such activities will be deemed by the People’s Bank of China as illegal financial businesses and will likely also trigger criminal liabilities. It is not clear yet or at least cannot fully be excluded whether intercompany lending for joint production or operation could be deemed as “illegal financial business” in violation of the Measures, and thus constituting an invalidity case under the SPC Provision.

Due to the different functions of PRC courts and administrative organs, the SPC and State Council may represent different interests and therefore apply different criteria when judging on the legal consistency of intercompany lending. This may very likely lead to contradictory results and legal uncertainty. To be on the safe side when implementing intercompany lending one – at least for the time being – may still need to consider the arrangement of “entrustment loans” by involving the banks. In this regard, it is noteworthy that the PBoC, jointly with the China Banking Regulatory Commission (“CBRC”), has been soliciting public opinions on amendment of the General Rules on Loans since 2004 but yet without any effective promulgation. In the draft rules the arrangement of “entrustment loans” can interestingly NOTbe found. Instead, entrustment loans were to be explicitly regulated by the Measures on Administration of Entrustment Loans by Commercial Banks, published by the CBRC on January 16, 2015, which are also under public soliciting process. Whether such changes would mean a fundamental opening for intercompany lending at the ministerial level, or just further strengthening of the governmental control of the same via entrustment loans, so far no relevant development in this regard has been identified.

On the one hand, the Provisions show a clearer and positive attitude of the SPC to encourage private lending on one hand. On the other hand, the actual implementation and practice applied by the people’s courts remains to be awaited as of September 1, 2015. Caution is still advisable against over-optimism on liberalization of intercompany lending. A clearer picture may only become evident after some cases are rolled out and the court or banking practice is established.