Coming to terms with forms of receivables finance in China

Q : What are the common forms of receivables finance in China?

A: Receivables finance is usually based on either receivables purchase or receivables pledge.

Under receivables purchase, a creditor sells the receivables to which it is entitled to a financier and obtains funding. Receivables purchase is often called factoring and the financier is called a factor.

In China, factors are mainly banks, but there are also some licensed non-bank factors.

There are different types of factoring structures, including with recourse or without recourse, disclosed or non-disclosed to the debtors. In contrast, receivables pledge is much simpler.

It is a secured finance, where a borrower obtains loans from a lender and pledges its receivables in favour of the lender.

Q: What receivables can be financed?

A: According to the rules on registration of pledge over receivables issued by the People’s Bank of China, receivables means the right to request a payment arising out of provision of goods, services or facilities, including rights to claim present or future monetary payment and interest, but not including those arising from negotiable instruments or other monetary securities.

Receivables include rights to the following:

1) claims arising from sales, including sales of goods, supply of water, electricity, gas, heating and license to use intellectual property;

2) claims arising from lease, including leasing of movable assets or real properties;

3) claims arising from provision of services;

4) toll right arising from real properties, including highways, bridges, tunnels and crossings; and

5) claims arising out of loans or other credit facilities.

The above scope is not applicable for receivables purchases. A factor can purchase any receivables that are not restricted by law for assignment. In practice, however, receivables purchased by a factor are mainly those listed above.

Q: What is the legal requirement and effect of receivables purchase?

A: Receivables purchase is subject to the credit assignment rules under the Contract Law. A written consent from the debtor is required if there are provisions in the underlying contract that restrict the assignment.

If there are no restrictions on assignment in the underlying contract, notification must be made to the debtor. Should no written consent be obtained from, or no notification be made to the debtor, the receivables purchase will not be enforceable against the debtor, which means that the debtor may refuse to make payment to the financier who has purchased the receivables.

By receivables purchase, the receivables will be truly transferred to the financier who steps into the shoes of the creditor and is entitled to claim against the debtor. Receivables cannot be assigned as security under PRC law.

Q: What is the legal requirement to create and perfect receivables pledge?

A: According to the Property Rights Law, receivables pledge should be registered at the online registration system maintained by the People’s Bank of China. The pledge is effective upon registration. There is no statutory requirement to notify the debtor, although in practice a financier often requires such a notification to be made to protect its interest. If there is any restriction on disposal of receivables in the underlying contract, the receivables pledge will be subject to written consent from the debtor.

Q: What defences may be raised by the debtor against the financier?

A: A debtor may raise a defence against a financier. A financier should be aware of the following defences:

1. Non-performance by the creditor under the underlying contract, which may entitle the debtor to refuse full or partial payment. A financier should be aware of the performance risk of the creditor;
2. Set-off against the creditor. According to the Contract Law, a debtor may, upon receipt of notice, set off its debt against the creditor if the debtor’s credit matures on or before the maturity of the creditor’s credit. The debt to be set off may be debt of the same type and nature, or of other type and nature as agreed between the creditor and debtor;
3. Other assignees or security if the creditor has assigned its receivables to any other party or created security in favour of another party. For receivables purchase, the priority will be determined by the sequence of notification made to the debtor. For receivables pledge, the priority will be determined by the sequence of registration at the People’s Bank of China.

Q: Is there any foreign exchange restriction under the PRC law for a foreign financier?

A: A foreign financier will be subject to certain foreign exchange restrictions when it provides funding, based on receivables payable by a PRC entity.

Where the funding is made available to a PRC borrower, it will constitute foreign debt and will only be allowed if the PRC borrower has sufficient borrowing gap should the borrower be a foreign invested enterprise (FIE), or have obtained approval or short-term foreign debt quota from the State Administration of Foreign Exchange (SAFE) should the borrower not be an FIE.

Where the funding is made available to a foreign entity that exports goods to a PRC importer, it will also be subject to some SAFE regulation. The SAFE’s administration is different depending on the rating of the PRC import, which is given by SAFE as Grade A, B or C. For a Grade C importer, its payment of foreign exchange to a foreign entity is subject to prior approval from SAFE.

If there is any problem in payment by the PRC importer, the financier’s interest may be affected. Therefore a foreign financier should be aware of these SAFE regulations.

Ren Gulong is a partner at AnJie Law Firm