Under the General Provisions on Lending issued by the People’s Bank of China (“PBOC”) on 28 June 1996, intercompany loans between two PRC non-financial entities are not permitted. In the past, any lending between companies had to be structured as so-called “entrustment loan” arrangement. I.e. a bank was entrusted to act as agent to assist in granting and recovering the loan. The entrusted bank only received a commission fee but did not bear the loan risk. The Reply on Late Return of the Principal of Intercompany Loans (Fa Fu 1996 [No.15]) (“1996 Reply”) of the PRC Supreme People's Court ("SPC") of 23 September 1996 also confirmed that intercompany loan contracts are invalid.
On 6 August 2015, the SPC now promulgated the Provisions on Several Issues concerning the Application of Law in the Trial of Private Lending Cases (the "2015 Provisions"). The 2015 Provisions entered into effect on 1 September 2015 and brought a breakthrough for intercompany loans. The most significant changes are as follows:
- The 2015 Provisions for the first time allow direct intercompany loans. Article 11 of the 2015 Provisions stipulates that for contracts concluded between companies for the purpose of production and business operation (which includes working capital and fixed assets investment), where the parties concerned claim that the loan contract is effective, such claim shall be upheld by the People's Court provided that the loan contract does not violate the PRC Contract Law and neither of the following circumstances exists:
- credit funds are fraudulently obtained from financial institutions and then lent to a borrower with high interest, and the borrower knew in advance or should have known this situation;
- the funds are obtained from loans taken out from other companies or are raised from employees of a company and then lent to a borrower to make profit from such arrangement, and the borrower knew in advance or should have known this situation;
- the lender knew in advance or should have known that the borrower will use the loan for illegal or criminal activities but still provided the loan; or
- the loan is in violation of public order or mandatory laws and administrative regulations.
- Previously, according to the 1996 Reply and the Interpretations on Trial of Joint Operation Contracts (Fa Fa 1990[No.27]) dated 12 November 1990, in case of direct intercompany loans, the principal of the loan could be returned to the lender. However, the lender had no right to claim interest. The interest agreed by the parties or the interest already obtained by the lender could be confiscated.
According to the 2015 Provisions, interest claims agreed between the parties for intercompany loans shall be supported by the People’s Court unless the parties failed to agree on the interest. If the borrower and the lender have no clear agreement on the loan interest, and the lender claims interest payment, the court shall determine the interest in combination with the content of the lending contract and based on the trading modes or practice, market interest rate, or other factors in the locality or of the party concerned.
In addition, interest rates for intercompany loans are subject to the following thresholds:
- if the agreed interest rate is not above 24% per year, the lender is entitled to the interest in its entirety.
- if the agreed interest rate is above 24% per year but lower than 36% per year, the interest exceeding 24% is void. However, if the borrower has already paid such interest to the lender, the borrower is not entitled to claim return.
- if the agreed interest rate is above 36% per year, the interest exceeding 36% is void. A borrower has the right to demand lenders to return the part of interest accrued over the 36% threshold if it has already been paid.
The above interest rates are surprisingly high and a multiple of the interest rates charged by banks. We assume that these high interest rates are based on the actual practices which seem to be common in private lending practice.
Intercompany loans are very common in China, both between foreign invested enterprises and domestic enterprises. Many privately owned domestic enterprises face difficulties in getting loans from banks. The 2015 Provisions aim to facilitate the companies’ financing by widening their financing channels. For the same purpose, the PRC National Development and Reform Commission has issued on 14 September 2015 a circular which simplifies the procedures and cancels the quota for domestic companies to take out loans overseas.
On the other hand the 2015 Provisions are another example that legislation in China is fragmented and the legislation activities of different government bodies are not coordinated. The General Provisions on Lending of the PBOC are still in place. It can be expected that they will also be amended in the near future. In the meantime, since the 2015 Provisions clearly acknowledge intercompany loans, companies in the future no longer have to rely on the entrustment loan mechanism.