Legal issues concerning security for overseas loans

By Wang Jihong and Xu Yibai, Zhong Lun Law Firm
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In 2017, the Export-Import Bank of China set up a RMB130 billion (US$18.5 billion) special loan to support implementation of the Belt and Road Initiative. As a continuation of the authors’ previous article, this article analyzes the conventional security measures for the loans extended by the Export-Import Bank for overseas investment in the hope of providing a reference for Chinese enterprises that are interested in participating in the Belt and Road Initiative.

Government letter of guarantee/letter of undertaking/letter of comfort

loans
Wang Jihong
Partner
Zhong Lun Law Firm

For large infrastructure projects that are priorities of the host country (where sources of income rely largely on the host country’s government agencies or state-owned enterprises), the lender generally will request the government of the host country to offer support for repayment, which may be in various forms under different names, and may vary greatly in legal nature.

For example, the letter of guarantee is by its nature the joint and several liability guarantee, or general liability guarantee. Since the credit of a national government is generally deemed reliable, as it is backed by the fiscal revenue of the country, Chinese banks and China Export & Credit Insurance Corporation attached much importance to the letter of guarantee issued (generally by the ministry of finance) by the government of the host country.

More and more governments, however, are unwilling or unable to issue this letter of guarantee because local laws prohibit or restrict them from doing so, and they are overburdened by financial liabilities, or other creditors (e.g., the World Bank or Asian Development Bank) request them not to. Therefore, the government of the host country gradually turns to support in the form of a letter of undertaking or letter of comfort.

These letters generally are not the “guarantee” provided by laws in the narrow sense. Their contents, however, will include a line of specific supporting obligations of the government. For example, the competent authority in charge of the project will undertake to provide support required by the project diligently, or urge local entities to perform contracts in good faith, etc.

Shareholders’ guarantee

loans
Xu Yibai
Associate
Zhong Lun Law Firm

Project investors generally will be requested to provide guarantees for full and timely repayment of the amounts due and payable by the project company. This guarantee may be close to the joint and several liability guarantee, or the general liability guarantee, or somewhere in between, with specific nature and realization path subject to the legal provisions of the host country.

Generally speaking, the Export-Import Bank inclines to the option that investors and the project company assume joint and several liabilities, while the investors naturally incline to the option of general liability guarantee. The final choice of guarantee is subject to the risk level of the project, completeness of other security measures, and the bargaining power of investors. The term of guarantee is changeable. Most commonly, banks will request that the term of guarantee is equal to or longer than the project construction period. If there is more than one investor, it is also one of the key points of the negotiation on guarantee whether the investors will assume joint and several liabilities, or several liabilities among themselves.

Security on the equity in the project company

It is one of the most common security measures for project financing that shareholders of the project company pledge their equity in the project company to the lending bank. It is almost a standard procedure of the security scheme for overseas investment loans. The authors notice that, in case of any default on repayment, the Export-Import Bank generally inclines to enforce and realize the security on assets, rather than the security on the equity in the project company.

The reason is that the project company’s default on repayment of loan generally indicates that it has been in a very difficult situation, perhaps even insolvent. Under this circumstance, the equity in the project company will no longer be valuable. In addition, it will not benefit the reorganization of the project company that the bank realizes the pledge of equity and becomes a shareholder of the project company, in comparison to preserving its original shareholders.

Security on the assets of the project company

The assets of the project company may be classified into different categories subject to the law of the host country, and different legal institutions may apply. Generally speaking, immoveable properties and moveable properties will be treated separately. Some special assets such as concession rights, land (ownership, right to use), material contracts, accounts receivables, bank accounts/deposits, etc., will be treated under special regimes.

As to material contracts, the Export-Import Bank may request pledge or assignment of the rights under the following three types of contracts: (1) for revenue contracts, the right to earnings under power purchase contracts of power generation projects, product sales contracts of mining projects, etc.; (2) for construction contracts, the rights of the project company under engineering, procurement and construction (EPC) contracts, bonds submitted by contractors, etc.; and (3) for insurance contracts, the right of the beneficiaries to the compensation under insurance policies, etc.

Other arrangements

In addition to the above-mentioned pledge of account, the Export-Import Bank may also request the bank of deposit to supervise the accounts of the project company, including its capital flow and progress of expenditures in the accounts, so as to ensure that the earmarked fund is used for its special purpose only, and the Export-Import Bank will be timely updated of the financial status of the project company.

If the project company borrows from creditors other than the Export-Import Bank (e.g., shareholders), the Export-Import Bank may request to execute subordination agreements or intercreditor agreements, so as to ensure the priority of its creditor’s right.

The Export-Import Bank generally will engage a Chinese law firm, which will take the lead and co-ordinate with local lawyers of the host country to render legal services, including analyzing a series of laws on security, drafting agreements, and accurately defining the terms (terms of pledge, mortgage, or lien under the Chinese law may not have equivalents in local language or English under the law of the host country).

The authors suggest that enterprises should take the preparation of a security scheme and the negotiation and revision of security documents seriously, and pay attention to the professional opinions of Chinese lawyers and local lawyers of the host country.

Wang Jihong is a partner and Xu Yibai is an associate at Zhong Lun Law Firm.

private funds

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