Baker & McKenzie and FenXun Partners are pleased to share our joint legal update on this question by answering five frequently asked questions below. In particular, we have taken into account the Provisions of the PRC Supreme People's Court on Several Questions Relating to the Application of Law in Cases of Borrowing and Lending in the Society (最高人民法院关于审理民间借贷案件适用法律若干问题的规定) promulgated in August 2015 (2015 SPC Rules on Loans)

Q1. Would a late payment interest of 0.1% per day (or 36.5% per annum) be too high and therefore legally unenforceable?

It would be partially unenforceable. A late payment interest of 0.1% per day in a share transfer agreement has been held by the Supreme Court in 2013 as excessive and therefore partially unenforceable. We believe that the court would have rendered the same judgement had the subject matter been a real estate lease, purchase or service agreement. This judgement is generally in line with the legal benchmark set in the 2015 SPC Rules on Loans. Sources: Liu Case, Supreme Court Civil Verdict No. 84 of 2013.

Q2. The 2015 SPC Rules on Loans have stipulated that the portion of loan interest exceeding 24% per annum is legally unenforceable. Does this "24% cap" apply to late payment interest under real estate agreements, share transfer agreement and other non-loan agreements?  

The practical and prudent answer is yes. Simply put, when a party under a non-loan agreement defaults in payment, effectively the other party is being forced to provide a loan to the defaulting party. Our detailed legal analysis is set out in the Reference Note below.

Q3. The 2015 SPC Rules on Loans have also stipulated that the portion of loan interest exceeding 36% per annum is legally void. Does this "36% cap" apply to late payment interest under real estate agreements, share transfer agreements or other non-loan agreements? What is the difference between the "24% cap" and the "36% cap"?  

Likewise, the practical and prudent answer is yes. The difference between the “24% cap” and the “36% cap” lies in the legal right of the paying party to recover the relevant portion of loan interest (or late payment interest).

Under the "24% cap", the portion of loan interest (or late payment interest) not exceeding 24% per annum is enforceable by the receiving party through a court action.

For the portion exceeding 24% per annum but less than 36% per annum, the receiving party cannot enforce payment through court action, and the paying party cannot commence a court action to recover such portion if it has already been paid to the receiving party.

Under the "36% cap", the portion of loan interest exceeding 36% per annum similarly cannot be enforced by the receiving party through a court action. Furthermore, the party who has already paid the portion of loan interest in excess of 36% per annum can commence a court action to recover such portion from the receiving party.

Q4. What happens if your real estate agreement or share transfer agreement is silent on late payment interest?

The court will still grant late payment interest even if an agreement is silent on this issue. There are several rules on this which all point to the same outcome. In short, the court will award late payment interest at 1.3 to 1.5 times of the applicable benchmark loan interest rate set by the People's Bank of China (PBOC). For illustration, if the agreement is silent and the payment is late for two years, the court will grant late payment interest ranging from 6.5% to 7.5% per annum (i.e. 1.3 to 1.5 times of 5% per annum, being PBOC benchmark interest rate as of 25 August 2015 for a two-year term loan).

Sources: Supreme Court Explanation on Property Sale Contract (No. 7 of 2003), Art. 17; PBOC Notice on Loan Interest Rates (No. 251 of 2003), Art. 3; Supreme Court Interpretation on Sale and Purchase Contracts (No. 8 of 2012), Art. 24; Contract Law (1999), Arts. 174 and 207.

Q5. Say the court has ordered the defaulting party to pay late payment interest in accordance with the terms of the agreement or the relevant court rules (where the agreement is silent), but the defaulting party still refuses to pay. Will there be additional legal penalties?

Yes. The court will impose an additional daily penalty of 0.0175% (equivalent to 6.3% per annum) on the overdue principal amount stated in the court judgment from the date of non-compliance with the judgment. The late payment interest already awarded under the court judgment will continue to accrue on the overdue principal amount from the due date under the agreement until payment.

Sources: Supreme Court Interpretation on Default Interest in Execution Procedures (No. 8 of 2014), Arts 1 and 2.

Reference Note: Strictly speaking, the 2015 SPC Rules on Loans and the "24% cap" and "36% cap" only apply to loan interest. Prior to that, the Supreme Court had previously set the legal cap on loan interest at four times the benchmark loan interest rate of the PBOC. Although the Supreme Court has never issued any interpretation to formally extend this rule of "4 x PBOC rate" to non-loan agreements, in practice the Supreme Court and some lower courts had applied this rule by analogy to non-loan agreements. Specifically, the Beijing High Court has issued a judicial notice to apply the rule of "4 x PBOC rate" to late payment interest under real estate leases.

Late payment interest is the most typical form of liquidated damages pre-agreed by the parties in agreements. The overall legal policy is that the court does not support claims for liquidated damages which significantly exceeds the actual loss of the non-defaulting party. To this end, the Supreme Court has issued an interpretation stating that if the liquidated damages pre-agreed by the parties are more than 1.3 times of the non-defaulting party’s actual loss, then the portion in excess will not be enforced by the court. As noted above, if one party defaults in payment, effectively the other party is being forced to provide a loan to the defaulting party. Hence, in practice the court tends to simply apply the specific rules and caps relating to loan interest by analogy to non-loan agreements if the agreement is silent on late payment interest, rather than try to ascertain the amount of "actual loan" and then apply the general rule of "no more than 1.3 times of actual loss".

Note that if the agreement provides for late payment interest as well as additional liquidated damages, the court will allow both of these claims by the plaintiff, but subject to a total cap of 24% per annum as mentioned above.

Sources: Supreme Court Interpretation II on Contracts (No.5 of 2009), Art. 29; Beijing High Court Interpretation on Real Estate Lease Disputes (No. 462 of 2013), Question 25; Liu Case, Supreme Court Civil Verdict No. 84 of 2013.