I. Function and Significance of Payment Agreements

When establishing trust schemes, trust companies, together with the financing party and its actual controller, usually nail down the issuing of a Notarial Certificate for Compulsory Enforcement ("Compulsory Certificate") for future debt payments. Compulsory Certificates are very beneficial for trust companies. If the counterparty defaults or is reluctant to perform, trust companies can skip judicial proceedings and apply directly for an enforcement certificate with a notary public office, and then apply to the People's Court for compulsory enforcement. This swift procedure incentivizes counterparties to timely and proper fulfillment of their obligations, and enhances the agreed performance of contracts.It has proved to be an efficient way for creditors to realize their rights.

The Circular of the Supreme People's Court and the Ministry of Justice concerning Issues on the Enforcement of Credit Documents Granted Enforceability by Notary Public Offices (the "Joint Circular") (1)constitutes the foundation for compulsory enforcement of notarial documents in judicial practice. In order to satisfy Joint Circular qualification requirements as "repayment/refund agreements", trust companies will usually sign extra documents in addition to trust instruments. This additional"Payment" or "Repayment" Agreement (hereinafter called "Payment Agreement") signed with a financier may vary in title but will have similar content and function. Parties to Payment Agreements usually specify that the financing party must perform its payment obligations when certain conditions are met and the financing party undertakes to accept compulsory enforcement if it fails to perform or only partially performs its payment obligations.

The existence of a Payment Agreement is a prerequisite for a notary public office to issue a Compulsory Certificate. However, in a trust package, the agreements on claims and liabilities between trust companies and counterparties are usually complicated and interwoven with multiple legal relations, such as security. Mistakes and omissions in a Payment Agreement may impede possible compulsory enforcement when disputes arise in a trust deal. Therefore it is vitally important to employ certain principles and tricks when drafting a Payment Agreement in a trust scheme.

II. Principles and Tricks for Drafting Payment Agreements

A credit document granted a Compulsory Certificate by a notary public office should be comprehensive, accurate, lawful, and unambiguous if it is to qualify as a Payment Agreement under the Joint Circular. Furthermore, the feasibility of certain features should be thoroughly investigated. We canvas specific drafting principles below.

  1. Complying with Article 1 of the Joint Circular
  • Article 1 of the Joint Circular provides that to be granted a Compulsory Certificate by a notary public office, a credit document must meet the following requirements:
  1. The credit document must contain payment of currency, goods and/or negotiable securities;
  2. The creditor-debtor relationship must be clear, and neither the creditor nor debtor have any doubt about the payment obligations in the credit document; and
  3. The credit document must clearly contain the debtor's promise that if the debtor fails to perform or to completely perform its obligations, the debtor agrees to accept compulsory enforcement.

We can infer from the above that:

  1. The payment obligations in a Payment Agreement should be purely about delivery of currency, goods or negotiable securities. In practice, this principle is met by most Payment Agreements, and is seldom the cause of disputes. What needs to be noted is that, in a Payment Agreement, only the obligors will pay, while trust companies as obligees do not have any payment obligation.
  2. The Payment Agreement must be clear, unambiguous and coherent with the content of other trust documents.Specifically, the parties must remove potential conflicts between different documents, such as the amount of trust fund principal, calculation of interest or other expenses and the definition of the security.

For example, take a real estate investment trust (REIT) scheme generating returns through loans, having expected returns pegged to its fund-raising performance, and with an estimated Loan Contract interest rate set at 15%. Perhaps after the trust scheme is established, this interest rate is adjusted to 14.5% based on the actual financing performance. In practice, it is highly recommended that the potential for a change in the quoted interest rate should be set out in the Payment Agreement. Otherwise, the project company (real estate developer) may have a defence against compulsory enforcement because the Payment Agreement is wrong or unclear.

  1. The payment details in Payment Agreements must be accurate. A trust scheme may contain complicated debtor-creditor relationships, perhaps installment payments of principal and interest, segmented calculation of interest, penalty or even compound interest. Clear and practical rules must be set out to define the amounts of payments to be made.

For example, the Payment Agreement of a trust company may state, "if payment of current trust returns are overdue, the obligor shall pay a default interest rate of 0.05% per day, with all outstanding payments being added to the principal." At first glance, this provision seems clear and unambiguous. However, at the compulsory enforcement stage, this provision will interfere with a claim based on subsequent rights. This is because the trust scheme has not ended yet and the trust returns keep accumulating, so it is not possible to compute the exact amount of default fines for the principal is yet to be fixed. As a result, the parties should instead adopt a simplified method to calculate liquidated damages.

  1. It should be clearly stated in a Payment Agreement that the obligor is willing to accept compulsory enforcement when certain conditions are achieved, and is not entitled later on to produce evidence and deny liability to the notary public office.

We set out below some additional considerations in drafting Payment Agreements.

  1. Payment Agreement should be comprehensive.

First, the parties should include trust companies, financiers, other obligors (such as the actual controller of the financing party) and sureties (if any); Second, the categories and items of property that qualify for compulsory enforcement should be enumerated in the Payment Agreement as comprehensively as possible; More importantly,the payments of obligors should include but not be limited to: trust fund principal, interest (returns), liquidated damages, damages, trust remuneration, custodial fees, and the expenses incurred in realizing the obligee's rights.

Take the case of a payment dispute in a trust scheme as an example:

In the Payment Agreement, the trust company agreed that the obligor need only pay the trust fund principal and corresponding interest. This creates a dilemma. If the trust company waives its claims for penalty interest, trust remuneration and the expenses of realizing the obligee's rights, the whole trust scheme would likely fail to reach its expected return. If it insists on the above claims, the notary public office will probably refuse to provide an Enforcement Certificate. Or, if it files a lawsuit or tries to realize its security right through special procedure, then the project company may claim in defence that the trust company has already given up any returns aside from principal and interest under the Payment Agreement.

  1. Provisions relating to liquidated damages and damages should be lawful and reasonable. An apparently excessive rate or double counting may probably lead to enforcement failure.

For instance, in a trust scheme, the parties agreed on the following six kinds of liquidated damages: (1) Liquidated damages for "overdue payment of investment returns"; (2)Liquidated damages for "non-satisfaction of the prerequisites for establishment of the trust scheme"; (3) Liquidated damages relating to the "grace period", where losses will be collected within five days of noncompliance; (4) Liquidated damages specified as "all outstanding payments shall be accumulated as principal, with an overdue interest rate of 0.05% per day"; (5) Liquidated damages for "delayed acquisition ofconstruction certificates"; and (6) Liquidated damages for "violation of use of company stamp".

Obviously, for the above items (1), (3) and (4), the various liquidated damages overlap with each other. Despite the Enforcement Certificate, a court may still reduce the amount of liquidated damages at its discretion. A 2010 case(2)demonstrates that where the agreed liquidated damages were too high, the court denied the implementation of the Enforcement Certificate. This issue calls for more attention from trust companies.

  1. Complying with Article 1 of the Joint Circular

Financing parties in trust schemes usually provide securities to trust companies. A provision should be drafted to cover an obligors' security liability, stating that if the obligors fail to fulfill their obligations, then they will accept compulsory enforcement on their secured property. At the same time, the relevant Security Agreement should be included in the Compulsory Certificate.

Whether security agreements could be subject to Compulsory Certificates or not still remains controversial among academics. However, some courts, including the Supreme People's Court, the High People's Court of Shandong and the Beijing High People's Court, have ruled that a Compulsory Certificate relating to security over an obligor's own property is enforceable. Therefore, it is preferable to include the relevant security provisions in a Payment Agreement, and then the Enforcement Certificate based upon it will better safeguard the rights and interests of an obligee.

It is often worthwhile writing into Payment Agreements, securities offered by third parties other than obligors, such as mortgages and equity pledges provided by the actual controllers of the obligors. It is controversial in practice and the decision should be made on a case by case basis. Communication in advance with notary public offices is strongly recommended before drafting Payment Agreements. Trust companies can decide according to circumstances and taking into account the various major court decisions.

  1. Complying with Article 1 of the Joint Circular
  1. Obligation Acceleration Clauses

Where the obligor agrees to perform by installments then acceleration provisions must be set out in the Payment Agreement; otherwise the trust company may have difficulty realizing its rights. If the obligor delays an installment or in the event of a default that makes further performance of the agreement impossible, all remaining principal and interest will be due and must be paid immediately.

Take an example, where a Payment Agreement provides that the obligor will repay principal and interest by installments on a schedule of 50 million Yuan by December 2010, 80 million Yuan by June 2011 and 100 million Yuan by December 2011, but no obligation acceleration clause is incorporated in the Payment Agreement.If the obligor honors the first installment but delays in the second installment, the trust company will fall into a predicament. As the third installment is not mature, the company cannot apply for an Enforcement Certificate covering both the second and the third installments.If the company applies for compulsory enforcement solely for the second installment, it will apply to the local Intermediate People's Court.However, if it needs to apply in the future for the third installment, then it must go to the local High People's Court. (regulations requiren which the court by which the application were to be enforced is located that where the value of claim exceeds 100 million Yuan and one party resides outside the jurisdiction of the province in which the court by which the application were to be enforced is located, the case shall be referred to the High Court; but where the value of the claim is less than 100 million Yuan, it shall be referred to a corresponding intermediate court). Therefore in these circumstances a trust company has to proceed with two cases and has to apply for enforcement before two courts of different levels of jurisdiction. This will significantly increase time and labor costs.

  1. Agreement on Preferential Application Conditions for Trust Companies

The conditions covering applications for Enforcement Certificates must be clear and concise to avoid potential disputes. However, in practice, some Payment Agreements permit obligors to produce evidence and to raise a defence. These can become unexpected barriers for trust companies applying for Enforcement Certificates. In addition, bearing in mind that trust companies enjoy many trustee rights under common trust frameworks, the application of Enforcement Certificates may not be conditional upon the termination or expiry of a trust entity.

  1. Obligation Acceleration Clause

When a security clause is incorporated into a Payment Agreement, trust companies should require concise and clear-cut conditions for the exercising of collateral rights. Otherwise, the obligor (the guarantor as well) may raise objections to the enforcement procedure.

III. Principles and Tricks for Drafting Payment Agreements

  1. Where substantial changes are made to a Payment Agreement by Supplemental Agreement then it should also receive Compulsory Certificate Notarization.

For various reasons, a Supplemental Agreement may be executed in order to modify or to amend a Payment Agreement. The legal effect of a notarized Payment Agreement does not necessarily extend to a related Supplemental Agreement. Thus, in general, notary public offices do not issue Enforcement Certificates for Supplemental Agreements which have not been notarized. If the Enforcement Certificate is solely issued based on the original Payment Agreement (if any) , the obligor can claim that there are mistakes in the Payment Agreement due to substantial changes agreed in the Supplemental Agreement and the Payment Agreement is therefore not enforceable. Hence, if a trust company signs an amended Payment Agreement or a Supplemental Agreement, then a Compulsory Certificate should be obtained for all the updated agreements to remove obstacles and to avoid potential future failure of compulsory enforcement.

  1. Choice of and Communication with Notary Public Offices

It is highly recommended, given the significance of Compulsory Certificate, that trust companies communicate in advance with notary public offices to perfect the drafting of trust documents. Simultaneously, trust companies can discuss with notary public offices the optimum notarial formats suitable for their applications so as to effect the issuance of the Enforcement Certificate in compliance with laws and regulations as soon as practical.

We have canvassed principles and tricks in drafting Payment Agreements we acquired in handling various trust payment disputes. Although trust schemes are common and well understood, legislation on trust laws and judicial practice are still developing in China. Considering the increasing pressures of payment in the recent future, trust companies are advised to engage experienced lawyers for drafting Payment Agreements and for making applications for enforcement. The requisite well drafted Payment Agreements and Enforcement Certificates must be submitted in order to ensure that Payment Agreementsare sustainable in court, and efficiently protect the parties' legitimate rights and interests.