Creating collateral security packages

Types of collateral

What types of collateral and security interests are available?

There are three types of security interest under PRC law, namely, mortgage, pledge and lien rights.

Mortgage rights can be created over the following: (1) buildings and other attachment on the ground; (2) construction land use right; (3) contracted land operating right (such as barren land operating right) obtained through public tendering, auction or open negotiation; (4) production equipment, raw materials, semi-finished products and finished products; (5) buildings, vessels and aircraft under construction; (6) transportation vehicles; or (7) any other mortgageable property that is not prohibited by law. A floating mortgage may be created over after-acquired equipment, raw materials, and products. A mortgage over a building under construction will apply to the after-completed portion constructed over the same structure, but a mortgage over construction land use right does not apply to buildings that are newly erected after the mortgage.

Pledge rights may be created over movable property, or the following rights: (1) bank drafts, cheques, promissory notes; (2) bonds, certificates of deposit; (3) warehouse receipts, bills of lading; (4) transferable fund units and equity interest; (5) property rights in intellectual property right (trademarks, patents, and copyrights); (6) account receivables; or (7) any other property right that can be pledged as stipulated in laws and administrative regulations. Bank accounts are a recognised type of collateral that can be pledged; however, due to the lack of registration system for them, pure pledge over a bank account does not afford automatic protection against third-party legal actions seeking to seize the account. In practice, pledge over bank account is combined with the pledge of the account receivables under a fee collection right, such as toll right (for highway, bridge, tunnel or ferry), utility charge right (electricity, water, heating), and the bank will require that all receivables for such fee collection rights to be directed to a designated bank account, and seek registration of the account receivables with the Credit Reference Centre of the People’s Bank of China, in conjunction with the pledge of the bank account.

Lien rights can be exercised by a creditor over properties in its lawful possession.

Collateral perfecting

How is a security interest in each type of collateral perfected and how is its priority established? Are any fees, taxes or other charges payable to perfect a security interest and, if so, are there lawful techniques to minimise them? May a corporate entity, in the capacity of agent or trustee, hold collateral on behalf of the project lenders as the secured party? Is it necessary for the security agent and trustee to hold any licences to hold or enforce such security?

Perfection and cost

A mortgage over real property is created and perfected by signing a mortgage contract and registering the mortgage at the Real Property Registration Centre of where the property is located. Items (1), (2), (3) and buildings under construction under item (5) as listed in paragraph two of question 1 are considered as real property. The registration fee for mortgage over real property is 80 yuan each time for residential property, and 500 yuan each time for non-residential property.

A mortgage over movable property is created and perfected by signing the mortgage contract. Items (4), (6) and vessels and aircraft under construction under item (5) as listed in paragraph two of question 1 are considered as mortgageable movable property. Registration is permitted but not required; if not registered, the mortgage cannot be used as defence against a bona fide third-party right holder. Mortgage over equipment, material and products can be registered with the applicable Administration for Market Regulation, and mortgage over transportation vehicles (ie, vessels, aircraft and automobiles) is registered with the government agency responsible for registering title over such vehicles respectively. The cost of registration for a mortgage over movable property is as follows: free for mortgage over equipment, material and products, 0.05 per cent of value each time for vessel, free for aircraft and 70 yuan each time for automobile.

A pledge over movable property is created and perfected by signing the pledge contract and handing over the collateral to the pledgee. Pledge over those rights listed under paragraph three of question 1 is created and perfected by signing the pledge contract and registering with the applicable government agency or handing over the instrument, as applicable. Registration fee for publicly traded securities is as follows: shares: 0.1 per cent of face value for shares at or below 5 million yuan, and then 0.05 per cent for shares above 5 million yuan; bonds: 0.05 per cent of face value for bond notes at or below 5 million yuan, and then 0.005 per cent for bond notes above 5 million yuan; and (3) exchange-traded funds: 0.05 per cent of face value for fund units at or below 5 million yuan, and then 0.005 per cent for fund units above 5 million yuan. Registration of pledge over account receivables is 50 yuan per year for each application. Registration of other types of pledges over property rights are generally free of charge.

Lien rights normally arise by operation of law, for the benefit of a creditor who is in lawful possession of the debtor’s property.

There is no tax for creating and perfection of mortgage, pledge or lien rights, because title of the property will not transfer.

Priority

Where multiple security interests are created over the same collateral, lien rights will have priority over mortgage rights, and legally registered mortgage rights will have priority over pledge rights. If the mortgage right is not registered or the mortgage right is created after an existing pledge right, then the pledge right should have priority.

A registered mortgage right has priority over an unregistered mortgage right. The priority among registered mortgage rights held by different creditors is determined by the time of registration, namely, the mortgage right registered earlier will have priority over mortgage registered later. Unregistered mortgage rights have the same priority and rank pari passu based on the underlying creditor’s rights.

The law affords construction contractors a priority over mortgage or pledge rights on the property they build with respect to their claim for compensation under the construction contract. Such priority right can be exercised within six months after the payment is due pursuant to the contract, and may not be waived if it is to the detriment of construction worker’s interest.

Collateral trustee

There is no express legal basis for creditors to appoint collateral trustee or agent to hold the security interest on their behalf. Pursuant to a guidance rule on syndicated loan practices issued by the China Banking Regulatory Commission in 2011, an agency bank may be appointed to handle the security interest on behalf of all members to the syndicate; however, it is not clear whether the agency bank is permitted to be registered as the security interest holder in its own name on behalf of all lenders, or whether it is only permitted to handle the procedures, while it must procure registration of all banks as holders of the security interest. Both types have occurred in syndicated loan practice.

Assuring absence of liens

How can a creditor assure itself as to the absence of liens with priority to the creditor’s lien?

There is no unified system to host the registration information of all types of security interests. Therefore, it would be necessary to search the applicable register depending on the nature of the collateral as follows: a mortgage over real property can be searched at the Real Property Registration Centre of where the property is located; a mortgage over equipment, material and products, and pledge over a company’s equity interest, can be searched at the online database maintained by the State Administration for Market Regulation; a mortgage over transportation vehicles (ie, vessels, aircraft and automobiles) can be searched at the applicable government agency responsible for such registration; a pledge of account receivables can be searched at the Credit Reference Centre of the People’s Bank of China; a pledge of publicly traded securities can be searched at the relevant securities exchange; and a pledge of IP rights can be searched at the relevant trademark, patent or copyright registration agency.

After conducting the search, the creditor should seek and obtain proper registration of its security interest at the relevant government agencies, to perfect the rights and achieve priority.

Enforcing collateral rights

Outside the context of a bankruptcy proceeding, what steps should a project lender take to enforce its rights as a secured party over the collateral?

When the loan becomes due and the debtor fails to repay the loan, the lender should first seek to reach agreement with those who provided the collateral (ie, the mortgagor or pledgor) on a way to satisfy the outstanding debt, including selling the property to the lender at an agreed price, a private sale of the property to a third party, or auction, and then apply the proceeds to the debt. The price in the sale to the lender or to a third party in a private sale should be generally based on market price, and if such private agreement adversely affects the interests of the other creditors (eg, the sale price being too low as compared with market price), the other creditors may, within a year from the date they are aware or should have been aware of the matter, apply to the court to revoke the agreement.

If the lender and the mortgagor or pledgor fail to agree on how to realise the security interest, the lender may apply to the court to sell or auction the collateral.

In the case of a pledge over account receivables and the applicable bank account, the bank may directly take over the funds that are available in the account to satisfy the due and unpaid loan.

Sale or auction of the collateral shall be priced in renminbi, the official currency of China, but foreign parties are generally not prohibited from buying or participating in the auction of the property, and they may pay the price in a recognised foreign currency.

Enforcing collateral rights following bankruptcy

How does a bankruptcy proceeding in respect of the project company affect the ability of a project lender to enforce its rights as a secured party over the collateral? Are there any preference periods, clawback rights or other preferential creditors’ rights with respect to the collateral? What entities are excluded from bankruptcy proceedings and what legislation applies to them? What processes other than court proceedings are available to seize the assets of the project company in an enforcement?

Once the bankruptcy application in respect of the project company is accepted by a court, the attachment over its assets, enforcement actions and the seizure right of security interest holder should be stalled, and an administrator will be appointed to manage the assets and deal with claims in respect of the debtor. All creditors will be allowed to file their claims with the administrator, including the amount owed and any security interest. Secured creditors enjoy priority over other creditors in respect of the proceeds from the sale of collateral; such priority also ranks higher than salaries and social fund contribution owed to employees and taxes incurred prior to bankruptcy. However, the administrator’s cost, employee salary and social benefits and other costs incurred during the bankruptcy proceeding are paid out when incurred, effectively making these costs the highest ranking in the pay-out from the debtor’s assets.

The administrator may apply to the court to revoke the following transactions made within a period of one year prior to the bankruptcy application being accepted by the court:

  • free transfer of assets;
  • a transaction at an obviously unreasonable price;
  • a grant of security interest for unsecured debt;
  • a payment of undue debt; or
  • the giving up of a claim.

For payoffs to certain creditors made within six months prior to bankruptcy proceeding when the debtor has become insolvent, the administrator is also entitled to apply to the court to revoke such transaction. Concealment or transfer of assets for debt evasion, fabrication of debts that are imaginary or fictitious, or false admission of debts, are null and void, with no limitation on look-back time. If the administrator fails to file the application to the court while it should, the creditors may make a claim against the administrator or against the opposing parties in such transactions directly.

Foreign creditors are not treated differently from domestic creditors.

Foreign exchange and withholding tax issues

Restrictions, controls, fees and taxes

What are the restrictions, controls, fees, taxes or other charges on foreign currency exchange?

Renminbi is the official currency of China and must be used in domestic trade. For cross-border trade and investment activities, the conversion between renminbi and foreign currency, as well as the remittance of foreign currency, needs to be supported by an underlying transaction, such as import and export of goods, payment for services, capital investment, lending or payment of dividends and interests, and relevant registration and record filing with the State Administration of Foreign Exchange (SAFE) are required. Currency conversion and remittance are subject to commercial charges by banks, but are generally not subject to any tax, while the proof of tax payment for the underlying transaction is a necessary document to apply for the conversion and remittance.

Investment returns

What are the restrictions, controls, fees and taxes on remittances of investment returns (dividends and capital) or payments of principal, interest or premiums on loans or bonds to parties in other jurisdictions?

Remittance of investment returns and payment of principal and interest on loans to foreign investors are generally permitted, as long as relevant corporate actions are taken, applicable taxes are paid and registration with SAFE has been made. There is a 10 per cent withholding tax on the payment of dividends or interest on a loan to foreign parties, unless a reduced rate is applicable pursuant to a tax treaty.

Foreign earnings

Must project companies repatriate foreign earnings? If so, must they be converted to local currency and what further restrictions exist over their use?

Foreign earnings by a project company registered in China are generally required to be paid to the onshore foreign exchange account of the project company. The project company is permitted to retain the foreign earnings in foreign currency; and if there is the need to use the funds domestically, then the project company is permitted to convert the foreign currency into local currency.

May project companies establish and maintain foreign currency accounts in other jurisdictions and locally?

A project company is generally permitted to open and maintain foreign currency accounts onshore in China to receive capital investment and lending from offshore, and to receive payment from an export business. Opening a bank account outside of China by a project company requires approval by SAFE, and is permitted only if there is a legitimate reason, such as needing to receive sporadic income from offshore, to make sporadic payment offshore, to contract for projects overseas, to issue securities overseas, and other special needs that are deemed legitimate.

Foreign investment issues

Investment restrictions

What restrictions, fees and taxes exist on foreign investment in or ownership of a project and related companies? Do the restrictions also apply to foreign investors or creditors in the event of foreclosure on the project and related companies? Are there any bilateral investment treaties with key nation states or other international treaties that may afford relief from such restrictions? Would such activities require registration with any government authority?

Foreign investment in real property and projects in China needs to follow the ‘business presence principle’ (ie, an onshore project company needs to be set up to hold the assets). China adopts the ‘negative list’ control on foreign investment, while foreign investment in areas outside of the negative list are allowed.

According to the negative list for foreign investment published in 2018, foreign investment in the following project areas is restricted: (1) the exploration and development of oil and natural gas (excluding coalbed methane, oil shale, oil sands, shale gas, etc) are limited to Sino-foreign joint ventures and cooperation; (2) it is prohibited to invest in exploration and mining of tungsten, molybdenum, tin, antimony, and fluorite; (3) it is prohibited to invest in rare earth exploration, mining and beneficiation; (4) it is prohibited to invest in the exploration, mining and beneficiation of radioactive minerals; (5) it is prohibited to invest in the smelting and processing of radioactive minerals, or production of nuclear fuel; (6) the ground receiving facilities and key parts production for satellite TV broadcasting are restricted; (7) the construction and operation of nuclear power plants must be controlled by the Chinese party; (8) the construction and operation of the gas, heat and water supply and drainage pipe network for a city with population of more than 500,000 must be controlled by the Chinese party; (9) the construction and operation of civil airports must be controlled by the Chinese party, and it is prohibited to invest in air traffic control; (10) foreign ownership in value-added telecommunications service companies must not exceed 50 per cent (excluding e-commerce); and (11) companies engaged in basic telecommunications services (infrastructure) must be controlled by the Chinese party.

Provision of debt financing by foreign investors to project companies in China is generally not deemed as investment, and therefore the foregoing restrictions do not apply, as long as the financing terms do not contain a mechanism for the foreign investor to own the project under some conditions. If the project assets as collateral for the loan must be foreclosed then the assets are usually sold to others, and the proceeds will be applied toward the debt owed.

China has entered into bilateral investment treaties, free trade agreements, or both, with more than 100 foreign countries, and these treaties and agreements all contain provisions on protection to foreign investors. Foreign investment in China generally requires incorporation of an onshore entity, which requires registration with the applicable Administration for Market Regulation, and record filing with the applicable branch of the Ministry of Commerce; approval is required only in certain restricted areas that are listed under the negative list.

The negative list has been updated very recently on 30 June 2019 with further reductions, including, among others, removal of items (1), (2) (except for tungsten) and (8) (except for water supply and drainage pipe network), and adding the following to the exclusion list under item (10): domestic multi-party communications services, store and forward services and call centre services (ie, these areas would now be allowed for foreign investment with no ownership restriction).

Insurance restrictions

What restrictions, fees and taxes exist on insurance policies over project assets provided or guaranteed by foreign insurance companies? May such policies be payable to foreign secured creditors?

The provision of insurance policies in China is a regulated business, so that only insurance companies (including foreign invested insurance companies in China) with a proper licence may provide such services. Reinsurance to foreign reinsurance companies is generally permitted. Insurance policies procured by the project company are usually for the benefit of the project company; there will be difficulties in naming a foreign creditor to be co-insured and have the proceeds from the domestic insurance policy to be paid to the foreign creditor without going through the project company. Foreign creditors may also procure insurance offshore to cover its exposure and risk to the project; the proceeds from such offshore policies will not be subject to any restriction or tax in China.

Worker restrictions

What restrictions exist on bringing in foreign workers, technicians or executives to work on a project?

Foreigners are classified into three categories for the purpose of obtaining a work permit in China. Class A foreigners are considered as highly skilled people, including achieved scientists, entrepreneurs, artists, athletes, doctors and senior executives; class B foreigners are considered as professionals, with at least a bachelor’s degree and two years working experience; other foreigners and those who wish to work in China for a short period (less than 90 days) are put under class C. Class A foreigners are encouraged to work in China and there is no quota limit or age limit; class B foreigners are generally accepted based on market needs, and should not be older than 60; and class C foreigners are subject to quota limitation as may be set by relevant government authority from time to time.

Equipment restrictions

What restrictions exist on the importation of project equipment?

Generally, there are no restrictions on the importation of project equipment, provided that customs clearance is obtained and applicable customs duties and taxes are paid. Equipment meeting certain requirements may enjoy exemption from or reduced rate of customs duties and taxes, provided that they should be subject to supervision by the customs office for a number of years, and cannot be sold or transferred during the supervision period.

It is also possible to import certain equipment for a temporary period (six months, up to two renewals) subject to customs supervision, without incurring customs duties or taxes, by paying a refundable bond to the customs office.

Nationalisation laws

What laws exist regarding the nationalisation or expropriation of project companies and assets? Are any forms of investment specially protected (from nationalisation or expropriation)?

The new PRC Foreign Investment Law, which will come into force on 1 January 2020, reiterates the provisions in existing laws on foreign investment that that state will not expropriate investment made by foreign investors, while under special circumstances, the state may, for the need of the public interest, expropriate or requisition the investment of foreign investors according to law; in the case of expropriation or requisition, it is specified that statutory procedures shall be followed, and fair and reasonable compensation shall be made in a timely manner.

In addition, in the bilateral investment treaties and free trade agreements signed between China and foreign countries, typically there are provisions to protect foreign investment against nationalisation or expropriation, and to require that nationalisation or expropriation must meet the following conditions: for public interest; done in accordance with legal process; without discrimination; and with compensation.

Fiscal treatment of foreign investment

Incentives

What tax incentives or other incentives are provided preferentially to foreign investors or creditors? What taxes apply to foreign investments, loans, mortgages or other security documents, either for the purposes of effectiveness or registration?

Foreign invested enterprises are generally subject to the same tax rules as domestic enterprises. Project companies are subject to 25 per cent enterprise income tax on profit; and sales revenue is subject to VAT at 13 per cent for sale of goods, 9 per cent for real property transfer, lease and construction work and 6 per cent for services. Dividends and interest over loans paid to foreign investors are subject to 10 per cent withholding tax unless a reduced rate is applicable pursuant to a bilateral tax treaty. There are no taxes for the creation and registration of security interest. There is stamp duty at 0.05 per cent for each party for a loan agreement, and associated security documents are not subject to stamp duty.

Companies engaged in investment in certain types of infrastructures, such as port, airport, railroad, highway, urban transportation, power and hydraulic projects meeting certain standards, will enjoy a tax holiday, including three years with no enterprise income tax and three years with enterprise income tax at half rate, from the first year when revenue is generated.

Government authorities

Relevant authorities

What are the relevant government agencies or departments with authority over projects in the typical project sectors? What is the nature and extent of their authority? What is the history of state ownership in these sectors?

Macroeconomic supervision and project approval

The National Development and Reform Commission (NDRC) is responsible for monitoring macroeconomic and social development trends, and formulating and implementing strategies of national economic and social development, annual plans, and medium and long-term development plans for the country. The NDRC is also responsible for the planning of key construction and infrastructure projects and has the authority to approve all fixed-asset investment projects.

Environment, health and safety

The Ministry of Ecology and Environment (MEE) is responsible for ensuring compliance with environment protection laws and policies, reviewing and approving environment impact assessment report of projects, and supervising the installation and acceptance of necessary waste prevention and treatment facilities within construction projects.

The National Health Commission and the Ministry of Emergency Management are the authorities of health and safety supervision respectively.

Industry sector supervision and state ownershipOil and gas

The National Energy Administration under the NDRC is responsible for the supervision of the energy market (including oil, gas and electricity power) and the formulation of national plans for the development of energy infrastructure. The Ministry of Natural Resources is authorised to grant licences for exploration and extraction of oil and gas resources.

Three state-owned enterprises (SOEs) have dominant ownership of oil and gas fields and properties, namely, PetroChina, Sinopec and CNOOC; CNOOC has the exclusive rights to explore and extract oil and gas from offshore reserves within China’s sea territory, and is the designated Chinese party in joint ventures or cooperatives with foreign companies to jointly explore certain offshore fields.

Minerals extraction

The Ministry of Natural Resources grants permits and licences for the exploration and extraction of mineral resources.

Chemical refining

Chemical refining projects do not require special permits other than those required for a construction project. Compliance with environmental laws and safety regulations is considered very important for chemical refining projects, and therefore, such projects often receive heightened scrutiny from the MEE and the Ministry of Emergency Management. In addition, large-scale chemical refining projects are carefully reviewed by the NDRC before a project approval is granted.

Water treatment

The MEE is responsible for granting permits to water treatment facilities; and permits on water supply and discharge from local Administration of Water would also be required.

Power generation and transmission

As mentioned above, the National Energy Administration under the NDRC is the authority over power generation and transmission. The State Grid Corporation manages the national grid and provides connection services to power generation facilities.

Transportation and ports

The Ministry of Transport oversees the transportation market, including public roads, waterways, railway, civil aviation and ports. Railways used to be under the supervision of Ministry of Railway, which has been reorganised into the National Railway Administration under the Ministry of Transport; and the China Railway Corporation, an SOE incorporated to own railway assets. Certain newly built railways started to invite private investment. Highways, ports and airports are also predominantly owned by SOEs, while private investment in such areas are not as uncommon as in railway.

Telecommunications

The Ministry of Industry and Information Technology oversees the telecommunications area, and grants licences to telecom operators. In the basic telecom sector, China Mobile, China Telecom and China Unicom, all SOEs, are major operators.

Regulation of natural resources

Titles

Who has title to natural resources? What rights may private parties acquire to these resources and what obligations does the holder have? May foreign parties acquire such rights?

All natural resources, including mineral resources, water and sea territories, belong to the state. Land is either owned by the state or local collectives (of farmers), with construction land use right for a fixed period either allotted (free of charge) or granted (through competitive bidding) to users, depending on the nature of use. For mineral resources, private parties may apply for exploration and extraction licences; for land and water areas, private parties may apply for use rights for a specified period of years. Foreign parties are generally not prohibited from owning such rights, but would be required to incorporate a project company in China to hold such rights. If the exploration or extraction of underground mineral resources would impact on the land and properties and things on the land, in particular, collectively owned land, then prior approval from government authorities needs to be obtained and proper compensation should be paid to the owner or use right holder.

Royalties and taxes

What royalties and taxes are payable on the extraction of natural resources, and are they revenue- or profit-based?

In addition to the price payable to the government in obtaining the mining license (exploration or extraction), the right holder is required to pay a use fee of 100-500 yuan per square kilometre per year for an exploration licence, and 1,000 yuan per square kilometre per year for an extraction licence.

A resources tax is applicable to the extraction of natural resources, at 5-10 per cent of sales revenue for oil and gas, and 0.3-60 yuan per metric ton for other types of minerals (such as coal, metal or non-metal minerals, and salt). Exemptions or reduced rates may be applicable if meeting certain requirements, such as the extraction of deepwater oil and gas, shale gas, heavy oil, high condensate oil and sulphur-bearing natural gas. The same tax rates apply to both domestic companies and foreign invested companies engaged in extraction of natural resources.

In addition, each mining company is required to establish a fund within its books and accounts, for the purpose of environment protection and restoration; contribution to the fund is based on a certain percentage of its revenue.

Export restrictions

What restrictions, fees or taxes exist on the export of natural resources?

The export of the following types of natural resources require an export licence: natural sand (including standard sand), alumina, phosphate ore, magnesia, talcum lump (powder), fluorite (fluorspar), rare earth, tin and tin products, tungsten and tungsten products, molybdenum and molybdenum products, antimony and antimony products, coke, refined oil (lubricating oil, lubricating grease and lubricating base oil), paraffin, some metals and products, disodium sulphate, silicon carbide, ozone depleting substances, citric acid, vitamin C, penicillin industrial salt, silver, platinum (exported in the form of processing trade), indium and indium products.

The export of the following types of natural resources require first obtaining an export quota and then an export licence: coal, crude oil, refined oil (excluding lubricating oil, lubricating grease or lubricating base oil), sawn timber and cotton.

China imposes export duties on limited types of goods, which include the following mineral resources: lead, zinc, tin, tungsten, tantalum and niobium, antimony, phosphorus and benzene.

Legal issues of general application

Government permission

What government approvals are required for typical project finance transactions? What fees and other charges apply?

All fixed-asset investment projects must obtain project approval by the NDRC or its local branch. A number of permits and licences will be required for a construction project, including approval of an environmental impact assessment report, planning approval, a land certificate and a construction permit. Foreign investors need to incorporate a project company in China to hold the assets and licences. The incorporation of a project company usually does not require approval other than corporate registration, unless it is in an area under the negative list for foreign investment and a special approval is required. Domestic lending does not require government approval, while under cross-border lending to a project company in China, a foreign debt quota needs to be obtained based on the project company’s net asset value. The permits and licences for operating a project depend on the nature of the project; for public utility and infrastructure projects, a concession agreement with the government is required. Remittance of a dividend and loan interest to foreign investors is permitted as long as the applicable withholding tax is paid.

Registration of financing

Must any of the financing or project documents be registered or filed with any government authority or otherwise comply with legal formalities to be valid or enforceable?

Freedom of contract is recognised under Chinese law, so that the parties are free to write and negotiate civil and commercial contracts between them. There is no requirement for contracts to be written in Chinese, but Chinese translation should be provided if the contract is presented to a Chinese court for enforcement. Notarisation is not required when signing contracts; however, when incorporating a project company in China, or when pursuing legal actions in China, a foreign investor should have its incorporation documents and the relevant power of attorney notarised in its home country and legalised by the Chinese embassy or consulate in that country.

Cross-border loan documents and guarantee documents are required to be registered with SAFE, which monitors China’s foreign debt exposure, and the registration is necessary to ensure that proceeds in renminbi can be converted into foreign currency and remitted to foreign investors, which is subject to the supervision of SAFE.

Arbitration awards

How are international arbitration contractual provisions and awards recognised by local courts? Is the jurisdiction a member of the ICSID Convention or other prominent dispute resolution conventions? Are any types of disputes not arbitrable? Are any types of disputes subject to automatic domestic arbitration?

China is a member of the New York Convention and the ICSID Convention. China made the following reservation in its accession to the New York Convention:

  • China only applies the New York Convention on the recognition and enforcement of arbitral awards made within the territory of another contracting state to this convention on a reciprocity basis; and
  • China only applies the New York Convention on the disputes arising from contractual and non-contractual commercial legal relationship identified by the law of China.

Pursuant to the PRC Arbitration Law, the following disputes are not arbitrable:

  • disputes concerning marriage, adoption, guardianship, alimony and inheritance; and
  • administrative disputes that shall, in accordance with the law, be dealt with by administrative bodies.

Foreign arbitration is permitted only in contracts or commercial relationship with a foreign element. The following are considered foreign elements: one of the parties being a non-China citizen, resident or legal entity; the subject matter of the dispute being located outside of China; or the facts that causes the civil relationship to occur, change or extinguish occur outside of China (such as performance under a contract).

A foreign arbitration award against a Chinese party, while meeting the above requirements, can be brought to the local court of where the Chinese obligor is located for recognition and enforcement, in accordance with the New York Convention.

If the dispute is between a foreign investor against the Chinese government as the hosting country for the investment, it should be brought to ICSID in Washington, DC without using the dispute resolution clause agreed in the applicable contract.

Law governing agreements

Which jurisdiction’s law typically governs project agreements? Which jurisdiction’s law typically governs financing agreements? Which matters are governed by domestic law?

The choice of foreign law as governing law to a contract also requires a foreign element (see question 22). As a result, if all parties to a project agreement or a financing agreement are registered within China and it does not involve performance outside of China (which would usually be the case for development of a project in China), it must be governed by Chinese law. For cross-border financing agreements, such as a cross-border loan provided by a foreign party to the project company in China, as well as a cross-border guarantee, the choice of foreign governing law is permitted, because of the existence of foreign element or elements.

Notwithstanding the above, contracts for Sino-foreign joint venture, and contracts for Sino-foreign joint exploration and extraction of natural resources must be governed by Chinese law. Contracts involving real property located in China, such as transfer of ownership and mortgage over real property, are also required to be governed by Chinese law.

The following matters are considered involving public interest, and, therefore, the applicable mandatory requirements under Chinese law must be applied and complied with, regardless of the choice of governing law under the contract:

  • labour protection;
  • food or public health safety;
  • environmental safety;
  • foreign exchange control and other financial security matters;
  • anti-monopoly or anti-dumping matters; or
  • other circumstances that should be determined as mandatory provisions under law.
Submission to foreign jurisdiction

Is a submission to a foreign jurisdiction and a waiver of immunity effective and enforceable?

Submission to foreign court jurisdiction is not common in contracts of projects in China, because China’s recognition and enforcement of foreign court judgment is based on the principle of reciprocity, which has not been fully established by Chinese courts in respect of major western countries, except if there is a bilateral civil and commercial law judicial assistance treaty between China and that foreign country. China has signed such bilateral treaties with about 35 countries, including Italy, Spain, France, Singapore and South Korea, but not including the United States, the United Kingdom, Germany and Japan.

There have been reported cases in recent years that the courts in the US and China have both recognised and enforced judgments rendered by courts in the other country, which show that there is a tendency that reciprocity may now exist between the two countries, although it is not fully established.

China signed the Hague Convention on the Choice of Court Agreements on 12 September 2017, which is yet to be ratified by the PRC National People’s Congress in order for it to become effective and binding on China.

China adopts the doctrine of ‘absolute immunity’ and does not allow a waiver of immunity enjoyed by the state. There is no domestic law on sovereign immunity and its waiver. SOEs are typically considered as separate from the state, particularly when they are engaged in commercial activities. A waiver of immunity clause in a commercial contract with an SOE is usually effective, by providing express confirmation that the SOE is not acting in a sovereign capacity, and unequivocal waiver of immunity covering all of its assets.

Environmental, health and safety laws

Applicable regulations

What laws or regulations apply to typical project sectors? What regulatory bodies administer those laws?

The MEE administers the laws and regulations in respect of environmental protection, which include: the Environment Protection Law, the Marine Environment Protection Law, the Environmental Impact Assessment Law, the Law on Atmospheric Pollution Prevention and Control, the Law on Soil Pollution Prevention and Control, the Law on Water Pollution Prevention and Control, the Law on Environmental Noise Pollution Prevention and Control, and the Wild Life Protection Law.

The National Health Commission and the Ministry of Human Resources and Social Security are responsible for ensuring health to workers, and they administer relevant laws, such as, the Law on the Prevention and Control of Occupational Diseases.

The Ministry of Emergency Management is responsible for ensuring work safety in construction and production activities, and it administers relevant laws such as the Work Safety Law, the Fire Control Law, the Law on Mine Safety and the Regulation on Emergency Responses to Work Safety Accidents.

Project companies

Principal business structures

What are the principal business structures of project companies? What are the principal sources of financing available to project companies?

Project companies usually take the form of a limited liability company, whose shareholders all enjoy limited liability up to the amount of registered capital committed by each of them to the company, and the equity interest in the company is determined based on the amount of registered capital committed and paid by each shareholder. A joint stock company limited by shares is another form of company under Chinese law, whose equity interest is determined by the number of shares issued to and owned by each shareholder; the use of this form of entity is not common in the development of projects. A limited partnership (with at least one general partner and one limited partner) is also a recognised type of incorporated entity, but cannot be used in areas listed under the negative list for foreign investment.

In the past, Sino-foreign joint ventures may also adopt the cooperative joint venture structure (Cooperative JV), where the Chinese and foreign parties may make in kind contributions in addition to monetary contribution and things of value, and may agree on disproportionate distribution of profits and accelerated return of capital to foreign investors. The Cooperative JV may take the form of an incorporated or unincorporated entity. However, the newly introduced PRC Foreign Investment Law in 2019 (coming into force on 1 January 2020) will be replacing the existing laws on foreign investment; as a result, the Cooperative JV form will no longer be available; and existing Sino-foreign JVs are given a five year period to change their form of entity to be consistent with the Foreign Investment Law, and the PRC Company Law or the PRC Partnership Law, as applicable.

Financing for a project company can come from various sources, including equity contribution by the shareholders, loans provided by banks or investment funds, as well as proceeds from issuance of securities on the capital market (such as corporate bonds on the inter-bank market, national or regional stock exchanges).

Public-private partnership legislation

Applicable legislation

Has PPP-enabling legislation been enacted and, if so, at what level of government and is the legislation industry-specific?

The PPP model was propelled and started to boom due to a number of ministry-level administrative rules issued by the NDRC and the Ministry of Finance since 2014. The Ministry of Finance has become the key government authority in formulating the rules and administering the projects; and it maintains a website as the database of PPP projects, which is openly accessible to the public. The State Council (the Central Government of China) published a draft regulation on PPP in July 2017 solicitating public comments (titled as Regulation on Cooperation between Government and Social Capital in Infrastructure and Public Service Areas), but the draft has not been formally adopted by the State Council.

The choice of social capital partner (private investors) is also required to be conducted by the applicable government in accordance with the procedures required by the PRC Government Procurement Law, namely, through public tendering, competitive negotiation or other permitted means.

In some industry sectors, the government has issued rules to require the use of PPP model in all such projects, such as water treatment and waste processing.

PPP - limitations

Legal limitations

What, if any, are the practical and legal limitations on PPP transactions?

The local government is required to conduct and pass two tests before it may promote a PPP project and invite private parties to bid for it, namely, the value for money test and fiscal pressure test, to ensure that it is a fair and reasonable deal from the government’s perspective and that the government will have the fiscal capacity to honour its obligations under the PPP contract.

Some PPP projects require a government subsidy for a certain period or continued support, so that the ability of the government party to honour its payment obligations and the enforceability thereof is important. There are different views on whether the PPP contract or the concession agreement signed in association with it should be viewed as the exercise of administrative function by the government, or as a commercial contract signed by the government. In general, Chinese courts have expressed the opinion that such contracts are of commercial nature and can be enforced against the government, unless it is with respect to certain element which requires the exercise of administrative power by the government.

How to secure land use rights is also a common challenge in PPP projects, because the allotment of land use right (free of charge) is limited to a narrow scope for public welfare, which may not cover the entire scope of industries where PPP is promoted; and projects built on allotted free land use right are often subject to price control by the government. The other means of obtaining land use right requires either paying the land grant fee through open competition under public auction or contribution of the land use right as equity to the project company by the government, which may make the investment return on the project less appealing to the private investors.

PPP - transactions

Significant transactions

What have been the most significant PPP transactions completed to date in your jurisdiction?

The Jing-Gang Subway PPP Project is the first PPP project for urban subway in China, and consists of Metro Line 3, 14 and 16 in Beijing, as a partnership between Beijing Municipal Government and the project company, which is a JV between Hong Kong’s Mass Transit Railway and two Beijing SOEs; the total investment amount is over 100 billion yuan. The Hangzhou-Shaoxing-Taizhou High Speed Railway PPP Project is another landmark project being the first railway project with majority control by privately owned companies, led by Fosun Group; the total investment is over 40 billion yuan. In the past three years, there have been about 40 PPP projects with total investment above 10 billion yuan, most of which are for toll ways, subways or light railways.

UPDATE & TRENDS

Recent developments

In addition to the above, are there any emerging trends or ‘hot topics’ in project finance in your jurisdiction?

Key developments of the past year30 In addition to the above, are there any emerging trends or ‘hot topics’ in project finance in your jurisdiction?Construction permitting reform

In the past two years, China has adopted a number of reform measures in the construction permitting area, to simplify the process and improve the efficiency of the construction permitting work, such as removal of the construction contract registration requirement, combing several procedures into one, including those related to design drawing review and planning review, quality and safety review and construction permit issuance, environment and energy saving review, utility supply, and completion acceptance. In addition, pilot reform programmes in the construction area have been implemented in Beijing and Shanghai, the two cities that accept research from World Bank in its Doing Business Report; the measures include setting up an official website as the unified platform to process all construction-related permits, allowing electronic filing, and reducing the time of review. In 2018, China made significant improvement in its ranking in the Doing Business Report by World Bank, rising to 32nd from 78th a year ago; the main areas of improvement include, Starting a Business, Getting Electricity, Registering Property, and Enforcing Contracts. The focus of reform in 2018 and 2019 have been on ‘Dealing with Construction Permits,’ and with the new rules being issued and new measures taken, it is expected that China will make further improvement in its ranking in this area in the World Bank Doing Business Report to be published in 2019.

The shortened time period, unified filing and permit issuing system, and reduced permitting steps for construction projects resulting from the reform will increase investor confidence and create value for investors and lenders.

Asset-backed securitisation as exit means for investors

The asset-backed securitisation market continues to boom in China. The issuance of asset backed notes (ABN) backed by the fee collection rights has been a popular way for investors and lenders in seeking exit from completed projects, particularly PPP projects where the private investors are usually required to hold interest in and operate the project company for years. The proceeds from the issuance of ABN (usually on the interbank bond market) provide early recovery of capital and loan provided by private investors and lenders, to allow the promoters and investors to pursue more projects.

Private and foreign participation in infrastructure projects

The government has traditionally been in predominant position in the infrastructure investment areas, such as railway, toll way, ports, power plant, water treatment and supply, and waste treatment. With real estate (residential and commercial) development becoming less attractive to private investors, due to expensive land prices and restrictive policies issued by the government, infrastructure projects with long term stable income have started to attract private and foreign capital. As such, projects often require large amount of capital and long-term investment and operation, cooperation and JVs between SOEs, private Chinese companies and foreign investors will be a normal phenomenon in the project development area.

The Belt and Road Initiative

China’s Belt and Road Initiative, since its introduction by Chinese President XI Jinpin, in 2013, has received wide responses, both within China (policy makers, construction contractors and banks) and in those countries covered by the Initiative. China has very strong construction capabilities, and has accumulated lots of experience and technologies in building its own infrastructure system; bringing such capabilities overseas is a natural trend. China has also amassed capital during its fast growth in the past 40 years, so that there are financial resources from China to support project development overseas. From a national policy perspective, China has shifted from making donations to developing countries to encouraging contractors and banks to seek reasonable return from overseas projects. In this process, Chinese contractors and banks are also actively working with engineering companies and financial institutions from developed countries and multinational development banks, and are open to use project finance models and contract forms that have been developed and used by their western counterparts. China took the lead to establish Asian Infrastructure Investment Bank (AIIB), a multinational development bank with US$100 billion registered capital, to provide financial support to infrastructure projects in the Belt and Road countries; AIIB currently has 93 member states.