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The Supreme People’s Court issues interpretations on the Application of Laws in the trial of Private Lending cases

Han Kun Law Offices

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China August 31 2015

The Supreme People’s Court(SPC)issues the Provisions on Several Issues Concerning the Application of Laws in the trial of Private Lending cases (hereinafter referred to as the Provisions) on August 6, 2015. This judicial interpretation is regarded as a blockbuster by the media. The Provisions include clearer provisions and references to judicial judgments, such as definition of the loans between natural persons, between natural persons and legal persons, natural persons and other organizations, acceptance of and jurisdiction over private lending cases, ways to deal with crossed cases of civil law and criminal law, liabilities of internet lending platforms, judicial judging standards of fraud litigation, scope of protection for interest and so on. However, the most important thing is that the Provisions ensure that the lending between enterprises shall be valid in the level of judicial interpretation. With the Provisions coming into force, chaos existing for a long time in the trial of the lending between enterprises will be regulated, which leads to the stability of social economy and the unity of judicial judgments. Judicial Authorities’ Opinions on the Validity of the Lending Between Enterprises before the Provisions Came into Force Administrative authorities and judicial authorities have been denying all the legal effect of the lending between enterprises for a long period of time. The regulations denying the legal effect of the lending between enterprises include:  Reply of the People’s Bank of China on Issues concerning the Lending between Enterprises  General Rules for Loans  Reply of the General Office of the People’s Bank of China on Issues concerning Lending and Borrowing in convert form between Companies to be listed  Provisions of the Supreme People’s Court on Several Issues Concerning the Application of Laws in the trial of Disputes over a Joint Operation Contract  Reply of the Supreme People's Court about How to Solve the Problem of the Borrower Failing to Repay the Loan within the Time Limit HAN KUN LAW OFFICES  BEIJING  SHANGHAI  SHENZHEN  HONG KONG www.hankunlaw.com It wasn’t until 2013 that Xi Xiaoming, the former vice president of SPC, acknowledged the legal effect of lending between enterprises for the first time in the Several Problems in the trial of Business Cases (hereinafter referred to as the Statement). He stated that, when it comes to the lending between enterprises that don’t have aptitudes for financial business to meet the needs of production and operation, if the lender doesn’t take financial business as his regular business and the lending doesn’t fall into the circumstances violating the mandatory provisions of national regulation on finance, then the loan contract shall not be considered null and void. The Statement has largely changed the judicial authorities’ opinions on the validity of the lending between enterprises, so SPC acknowledges the legal effect of lending between enterprises meeting requirements in further judgments. Of course, this acknowledge doesn’t mean any lending between enterprises shall be valid. The Statement establishes determining standards to find the lending valid or not, which include: a) Meeting the needs of production and operation b) The lender doesn’t take financial business as his regular business c) Not falling into the circumstances violating the mandatory provisions of national regulation on finance Chaos in Judicial Judgments before the Provisions Came into Force Although lending between enterprises was always considered null and void before the Statement came out, no one can ignore that there is a need for high-level laws and regulations. Despite the fact that lending between enterprises saw the light, the statement fails to make a clearer definition of lending between enterprises fundamentally, but causes chaos in judicial judgments to some degree. a) The People’s Court’s Judgments Ruling that Lending between Enterprises is Null and Void Lacked a Legal Basis Although there are several provisions, rules and replies denying the legal effect of lending between enterprises,there aren’t any laws and administrative regulations before the Statement came out. The article 52 of Contract Law of the People’s Republic of China ((hereinafter referred to as the Contract Law) stipulates a contract that violating the compulsory provisions of laws and administrative regulations shall be null and void, which is the major provision used by SPC to invalidate lending between enterprises. However, there is a common belief that the article 52 should not be abused and the effectiveness of the contract should not be easily considered null and void. Especially, with Interpretation II of the Supreme People’s Court of Several Issues concerning the Application of the Contract Law of the People’s Republic of China coming into force, article 14 of the interpretation states: The term “mandatory provisions” as mentioned in subparagraph 5 of Article 52 of the Contract Law refers to the mandatory provisions on effectiveness. This provision limits the use of the article 52 of Contract law. HAN KUN LAW OFFICES  BEIJING  SHANGHAI  SHENZHEN  HONG KONG www.hankunlaw.com As a direct result,the courts have to consider lending between enterprises null and void on the basis of violating financial regulations. However, the courts can’t figure out which particular provision of financial regulations that the parties violates, can’t talk about the legal levels of these financial regulations, can’t decide whether these financial regulations are the mandatory provisions on effectiveness. These judgments absolutely can’t convince the parties. b) SPC’s Judgments about Lending between Enterprises Lack a clear Legal Basis, also Contradict the Valid Reply Made by SPC After the Statement came out, the SPC and some local people’s court turn the spirit of the Statement into the reasons in the court’s reasoning part of the verdict, to indirectly use the spirit of the statement to consider lending between enterprises valid. This way is a little awkward,though it conforms with Contract Law and SPC’s interpretations. But the reasoning part of the verdict contradicts the spirit of Reply of the Supreme People's Court about How to Solve the Problem of the Borrower Failing to Repay the Loan within the Time Limit, that lending between enterprises should be considered null and void because of violating financial regulations. c) There is a Difference in Judging the Effectiveness of Lending between Enterprises in the Court System After the Statement came out, the SPC’s opinion on the effectiveness of lending between enterprises have changed, but local courts may not agree with SPC because of the reason that the Statement, a kind of guidance, lacks the effectiveness of judicial interpretations. Some local courts including Beijing court’s opinions on the effectiveness of lending between enterprises are consistent with SPC’s, while the other local courts including Shanghai court hold a different view by insisting on applying Reply of the Supreme People's Court about How to Solve the Problem of the Borrower Failing to Repay the Loan within the Time Limit as the legal basis of their judgments. Resulting from the chaos, the parties have to consider whether the court will use the Statement as the legal basis as a key factor in judging whether the court will acknowledge the effectiveness of lending between enterprises or not, which leads to people’s negative judgments about judicial authority’s credibility. There is Chaos in Business Because Enterprises use Several Legal Ways to Cover up the Lending between Enterprises to Avoid Legal Risk There is an increasingly intensified contradiction between the judicial authority’s judgments about that lending between enterprises should be null and void in a long term and the growing demands for lending between enterprises in the market with the development of economy. In order to avoid legal risk and realize financing at the same time, there begins to appear many “freaks” in business, including: HAN KUN LAW OFFICES  BEIJING  SHANGHAI  SHENZHEN  HONG KONG www.hankunlaw.com a) Nominally as Joint Operation, Actually as Lending This pattern generated during the transition between planned economy period and market economy period. To stop this practice,Provisions of the Supreme People’s Court on Several Issues Concerning the Application of Laws in the trial of Disputes over a Joint Operation Contract made by SPC came out in 1990, which directly considers it null and void. b) Nominally as Contribution, Actually as Lending This pattern is same with the former pattern mentioned above, which means cooperating between enterprises by agreeing on fixed income, but by means of equity trading. The lender bails out of the company which lender has made capital contribution to, after the deal closes. c) Nominally as Bargain, Actually as Lending In practice, the lender usually pretends to be buyer, while the borrower pretends to be seller. The lender makes a one-time payment for goods to the borrower, and the borrower won’t supply the goods when it’s due, then the borrower pay a certain sum of liquidated damages in accordance with the terms of the sales contract and return all the payment for goods in the end. The lender can collect the repayment of principal by collecting the payment for goods, and collect the interest by collecting the payment of liquidated damages. This pattern develops into a more high-end pattern. The fact that many enterprises participate in serial transactions makes this pattern more hidden. There are more hidden patterns other than those listed above play an important role in covering up lending between enterprises. These business patterns which enterprises are forced to adopt can’t effectively protect the parties’ legitimate rights. In the meantime, these patterns make it harder for the courts to unify the definition and judgment of the deal. The Provisions can Exercise a Large Degree of Control over Chaos in Business and Judicial Practices With the Provisions coming into force, whether lending between enterprises is valid can be judged on the legal basis of judicial interpretations. So the people’s courts can directly quote the Provisions,avoiding the embarrassment that there is only spirit, with no law can be resorted to. On the other hand, the Provisions are different from the Statement, because the latter is just a guidance spirit while the former is a legal basis with which the courts should comply in its adjudications. There is no need to consider whether the court dealing with the lawsuit agrees with the Statement, so we can achieve the unity of judicial judgments. The Provisions, in principle, acknowledge the effectiveness of lending between enterprises, but take opposite views under exceptional circumstances. There is no need for enterprises to find ways to cover up this behavior so the “freaks” can be stopped on account of lacking in market demands. HAN KUN LAW OFFICES  BEIJING  SHANGHAI  SHENZHEN  HONG KONG www.hankunlaw.com In consequence,the Provisions’ coming out is of positive significance, both from a judicial practice prospective and from a business practice prospective. The Provisions Never Mean to Indulge Lending between Enterprises without Limits Although the Provisions deregulate lending between enterprises, it doesn't mean that enterprises can finance without limits. Lending between enterprises should still be regulated by Contract Law, and it should be null and void if violating the article 52 of Contract Law. Besides, the article 14 of the Provisions lists the circumstances under which lending between enterprises shall be null and void, including: a) The lender illegally obtains credit funds from a financial institution and relends them to other people at a high interest rate and the borrower knew or should have known; b) The lender obtains funds from other enterprises or raises funds from staffs and relends them to borrower for profit and the borrower knew or should have known; c) The lender knew or should have known that the borrower use loans for crimes; d) Violating the public order and good morals; e) Violating the mandatory provisions of laws and administrative regulations. Subparagraph 1 and 2 are similar to the judgment rule requested by SPC that “the lender’s lending with his own funds is valid” after the Statement came out. But the difference is that the provisions restrict the courts’ judgment rule, more specifically: In fact, subparagraph 1 of article 14 of the Provisions doesn’t deny the effectiveness of lending by use of credit funds obtained from a financial institution. If the lending satisfies both of the following two criteria: relending them to other people at a high interest rate and the borrower knew or should have known, the lending shall be null and void. Or lending by use of credit funds obtained from a financial institution shall be valid. In fact, subparagraph 2 of article 14 of the Provisions doesn’t deny the effectiveness of lending by use of funds obtained from other enterprises or raised from staffs. If the lending satisfies both of the following two criteria: relending them to borrower for profit and the borrower knew or should have known, the lending shall be null and void. Moreover, lending for illegal purposes or violating the public order and good morals shall be null and void. Deregulation of the Lending between Enterprises by the Provisions Remains to be Further Verified Admittedly,the Provisions have positive effect on the business practice as well as the judicial HAN KUN LAW OFFICES  BEIJING  SHANGHAI  SHENZHEN  HONG KONG www.hankunlaw.com practice. However, the implementation of the Provisions remains to be further verified. In the writer's opinion, we should focus on the following two major issues at least: a) Is it reasonable that the provisions don’t include the standard that “The lender doesn’t take financial business as his regular business” mentioned in the Statement? The provisions don’t include the standard that “The lender doesn’t take financial business as his regular business” mentioned in the Statement. Under this circumstances,if the lender takes financial business as his regular or major business, it is worth considering whether the lending should be considered valid or not. In other words, if the lender takes financial business as his regular business and finally grow into a “bank”, will the lending be considered valid? There is no legal basis in the Provisions to answer no. Otherwise,if we take yes as an answer, it remains to be further verified in practice whether normal economic order will be influenced if a larger number of these kind of banks appear. b) Is it reasonable that the Provisions consider lending by use of funds of others valid, with subjective and strict circumstances as the exceptions? Subparagraph 1 and 2 of article 14 of the Provisions have largely acknowledged the effectiveness of lending by use of “funds of others”, which leads to that the following four circumstances shall be valid:  Lending by use of credit funds obtained from a financial institution, and the borrower knew or should have known, but the lender didn’t make super-profit;  Lending by use of credit funds obtained from a financial institution and the lender made super-profit, but the borrower was not aware of that;  Lending by use of funds obtained from other enterprises or raised from staffs, and the borrower knew or should have known, but the lender didn’t make profit;  Lending by use of funds obtained from other enterprises or raised from staffs and the lender made profit, but the borrower was not aware of that. The Provisions mentioned above may result in that the enterprise lacking in corresponding credit can obtain funds from a financial institutions through another enterprise, may also result in that the enterprise with corresponding credit can make reasonable profit by relending funds obtained from a financial institutions to other enterprises. Besides, funds obtained from other enterprises or raised from staffs can be used for lending and making profit. It’s worth paying attention to the question whether the deregulation will cause a threat to the fund security of financial institutions, other enterprises, and staffs in this enterprise. Furthermore, the subjective element that “the borrower knew or should have known” mentioned in subparagraph 1 and 2 of article 14 of the Provisions is a necessary condition for denying the HAN KUN LAW OFFICES  BEIJING  SHANGHAI  SHENZHEN  HONG KONG www.hankunlaw.com effectiveness of lending between enterprises. If the borrower was never aware that the lender relends funds obtained from a financial institution or other third party to other people at a high interest rate and make profits, then the lending shall be valid. Under this circumstance, it remains to be further verified in practice that whether the subjective element can control the legal risk accompanying lending by use of funds of others. In a word, the promulgation of the Provisions, deregulating lending between enterprises, meets the reasonable requirements of enterprise funds collecting from multiple channels, and provides necessary legal support for judgments on effectiveness of lending between enterprises in the judicial interpretation. No one can deny this immeasurable positive effect. However, on the other hand, without any strict restrain on “operating financing as regular business” and “lending by use of funds of others”, the Provisions may result in potential risks on economic stability. Especially, the Provisions legitimize fraudulent obtaining on financial capital for lending in particular case, causing some potential problems, which need to be tested further in practice. It remains to be seen that whether the article 14 of the Provisions stipulating conditions in order to control non-equity capital lending may take effect as expected in the judicial practice. We will continue to focus on it.

Han Kun Law Offices - Yaxing ZHANG

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