Minutes redefine notes financing business of financial institutions

The Minutes of the National Working Conference on the Trial of Civil and Commercial Cases by Courts was issued by the Supreme People’s Court (SPC) and became operative on 8 November 2019. The minutes stress that people’s courts should distinguish the types and functions of notes and correctly understand the legislative intent of abstraction of acts involving negotiable instruments during the trial of cases of disputes over negotiable instruments.

Especially, the minutes define the ruling principles for controversial issues in the notes financing business, such as determining the nature of habitual practices, and ascertaining the validity of agreements regarding discount of negotiable instruments, inter-bank discounts, and reverse repurchases. It is provided in the minutes that inter-bank discounts of negotiable instruments, and notes inventory transactions and packet transactions, are not acts involving negotiable instruments. Therefore, the parties concerned will not directly obtain the right on negotiable instruments.

This dispute handling principle is significant to the stock notes financing business of commercial banks, trust companies and other financial institutions, including but not limited to conventional notes financing business such as discount of negotiable instruments and inter-bank discounting, and electronic notes financing business that has emerged in recent years with the development of acceptance of bills of exchange via e-banking. The authors suggest that attention should be paid to the following:

Inter-bank discount and validity of agreement. Inter-bank discount does not directly give rise to the right on negotiable instruments. If the financial institution handling inter-bank discount, pursuant to the agreement on inter-bank discount, requests the applicant for inter-bank discount who does not endorse the negotiable instruments to return the amount of inter-bank discount and compensate for losses as per the legal relationship of contract when such institution receives the notice of dishonour, the cause of the case should be decided as a dispute over contract.

Validity of notes inventory transaction and packet transaction and liabilities of participating entities. If idle notes financing or reverse operation is found in these transactions, the parties will have no right on negotiable instruments. If evidence proves non-compliance with a regular transaction sequence of inter-bank discount, such as reverse payment, transfer without endorsement, and no actual honouring of the negotiable instruments, the lending bank is not entitled to claim any right on the negotiable instruments. In trial of these cases, the court, in the principle of one-time dispute resolution, should rule the actual fund user to repay the principal and interests, and other parties concerned to assume the liability for damages to the extent of their faults, provided that all financial institutions involved in the transaction take part in the proceedings.

Responsibility of discount house for conspiracy to forge materials for discount application. In discount business, if the head of the discount house, or the staff who have the right to handle the discount business, conspire with the discount applicant and forge the materials for discount application – such as the contract and VAT invoice that prove the real transaction relationship between the discount applicant and previous holder of the negotiable instruments – the discount house will claim no right on such negotiable instruments, and only the legal relationship of contract is created between the discount house and the applicant.

Validity of discount handled by shadow banks. If a legitimate holder, out of its need for financing, applies for discount to an entity that is not legitimately qualified for discount business, such discount can be recognized as a shadow loan. The holder will claim no right on the negotiable instruments, but the real loan-raising act is valid. For example, a legitimate holder applies for a discount to an entity not qualified for discount handling. This entity, after payment of a discount, directly delivers the negotiable instruments to another holder, who pays the consideration and records itself as the endorsee. Then the latter holder negotiates the instruments with endorsement based on a real transaction relationship or creditor-debtor relationship. Under this circumstance, in the principle of abstraction of acts involving negotiable instruments, it can be decided that the last holder will be the legitimate holder. In other words, if the parties to the legal relationship of negotiable instruments are direct parties to the underlying legal relationship of negotiable instruments, the parties may defend themselves on the ground of the underlying relationship.

In most cases, the notes financing business of commercial banks, trust companies and other financial institutions involve discounts of negotiable instruments, inter-bank discounts, reverse repurchases, and pledges of negotiable instruments. Based on the above-mentioned contents in the minutes, the authors suggest that commercial banks, trust companies and other financial institutions pay attention to the following points when they take the inventory of stock notes financing projects and commence news notes financing business:

(1) Financial institutions should conduct notes financing business – including but not limited to discounts of negotiable instruments, inter-bank discounts, and purchases of resale – in strict compliance with applicable transaction procedures;

(2) Financial institutions should thoroughly check the credit risks of original counterparties to the notes financing business and the business itself. Especially, in inter-bank discounts involving multiple financial institutions, they should thoroughly check the substantial risks based on the nature of the business, instead of excessive trust of the credit standing of other financial institutions;

(3) Financial institutions should strictly follow the elementary requirements of the right on negotiable instruments. Before the financial institutions commence each business, they should strictly check the original negotiable instruments and follow the delivery procedures. They should make payments as per related agreements, provided that they strictly follow the check and delivery procedures. When financial institutions receive negotiable instruments, they should carefully check the instruments to ensure their authenticity. They should strictly examine the particulars of the instruments for completeness and continuity, they should verify the authenticity of the instruments, and they should check the underlying transaction relationship involving the negotiable instruments in as much detail as possible in accordance with the specifications of the financial institutions on check procedures. Real transaction relationships and creditor-debtor relationships should be created for issuance and acquisition of negotiable instruments, and their negotiation among participating entities; and

(4) For notes financing business involving “inventory transactions” in process, the financial institutions should timely supplement and complete the delivery and endorsement procedures of the negotiable instruments. If the delivery and endorsement procedures are not possible, they should collect and sort related evidence, and learn about the details of the entire negotiation and fund transfer process, and grasp the trend in each link of negotiation.

Yang Guang is a partner and Zhang Xiaoke is an associate at Lantai Partners.

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