Incoterms_® and Commercial Contracts

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1. Introduction

Throughout the 1990s, China’s increasing engagement in international commerce led its enterprises carrying on in international trade, including carriers, insurers and banks to adhere to international standards such as the International Chamber of Commerce Rules for Documentary Credits. But the Chinese financial markets remained stubbornly wanting in short-term instruments.

Chinese authorities undertook to spawn such a market with the adoption of the Law of Secured Transactions¹ and that of the Negotiable Instruments Law² that entered into effect respectively on October 1, 1995 and on January 1, 1996.

It was after a structure of norms dealing with various aspects of financing arrangements had been put in place that the National People’s Congress (NPC) finally adopted the Property Law that entered into effect on October 1, 2007.³ The new law does not significantly modify the existing trade financing framework.

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2. Loans of money⁴

Banks may make loans to enterprises that are legal entities registered with the State Administration of Industry and Commerce (SAIC) and that are authorized to carry on import and export business. They must abide by the laws and administrative regulations of the State and must use loans in compliance with the regulations of the lending bank. They must have an independent accounting unit, an integrated management organization and financial system, as well as a fixed operating establishment.

Loans provided by Chinese banks to enterprises typically fall into three categories of terms:

• short-term loans are defined as all loans with maturities of one year or less;
• medium-term loans are defined as all loans with maturities of more than one year and less than three years; and
• long-term loans are defined as all loans with maturities of three years to less than ten years.

The currency composition of loans provided by Chinese banks includes renminbi, United States dollars, British pounds, euros, Japanese yen and Hong Kong dollars. Borrowers make repayments and pay relevant commissions in the currency of the loan.

Short-term loans may be contracted with Chinese banks to finance working capital. So-called “packing loans” are made against valid credits issued by banks in importing countries for which commodities serve as collateral.

Medium-term loans are granted to support manufacturing of export commodities and they are used to finance the purchase of advanced technology or equipment.

To encourage exports of staple commodities, complete sets of equipment, aircraft and ships, etc., medium and long-term loans may be granted, though they do not usually exceed 85% of the contractual value. They are frequently granted at preferential interest rates and their maximum term is ten years. A foreign bank’s guarantee of the deferred payments is often a pre-requisite for their grant.

Chinese banks may grant loans to the qualified foreign banks of importers of China’s exports of staple commodities, complete sets of equipment, ships, labour, and services.

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3. Negotiable instruments

As China has not adhered to any of the three major international conventions relating to negotiable instruments, awareness of the applicable Chinese rules takes on additional significance for foreign operators. Admittedly, negotiable instruments are seldom used in the context of letter of credit operations initiated by Chinese banks and this situation has obviated the commercial banker’s need for a proper legal framework relating specifically to negotiable instruments.

The opening of China’s internal market to foreign-invested enterprises (FIEs), including wholesalers and franchisers, will inevitably create potential for the use of negotiable instruments for trade credit. Multinationals with substantial operations in China will be considering local treasury management instruments and their participation in a local commercial paper market would certainly foster its expansion.

There are three kinds of negotiable instruments under Chinese law: bills of exchange, promissory notes and cheques.

3.1. General principles

Certain general principles apply equally to all forms of negotiable instruments.

Under article 4 of the Negotiable Instruments Law, a holder has the right to obtain payment of the sum stated on the negotiable instrument and the obligor must pay the amount of the negotiable instrument to the holder.⁵ Liability attaches to those who sign the negotiable instrument as acceptor or guarantor. Signatures are affixed by manual inscription or by seal.⁶

The amount of the instrument must be written in both Chinese characters and numerical forms.⁷ The instrument’s amount, date and the payee’s name may not be altered lest the instrument be voided.⁸

The issue and negotiation of negotiable instruments must respect the principles of honesty and trustworthiness (cheng shi xin yong).⁹

Consideration must be given for a negotiable instrument, except in the context of tax settlements, bequests or gifts. When no consideration is given, the instrument remains valid but its holders do not have priority.¹⁰

Except in the case of the holder’s bad faith, an obligor may not raise personal defences, that is those based on claims against the drawer or parties behind the holder in the chain of negotiation.¹¹

A forged signature does not affect the validity of other authentic signatures.¹²

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By virtue of article 17, rights under negotiable instruments are subject to limitation periods:

• for rights of the holder in relation to the drawer and acceptor, two years from the date of maturity of the instrument (or from the date of issue for sight bills of exchange and promissory notes);
• for rights of the holder in relation to the drawer, six months from the date of issue of the instrument;
• for rights of recourse against prior parties, six months from the date acceptance was refused or the date of refusal of payment; and
• for the holder’s second right of recourse against prior parties, three months from the date of clearance or the date a lawsuit was instituted.

The loss of the rights of holder due to expiration or limitation periods or material inadequacies of the instrument do not compromise the rights of the holder in civil law to claim payment of the amount due from the drawer or acceptor.¹³

3.2. Bills of exchange

Article 19 of the Negotiable Instruments Law defines bills of exchange as negotiable instruments “signed by the drawer ordering the payer unconditionally to pay a specified amount, on sight or at a specified date, to the payee or to the holder of the bill.”

Validity of the bill of exchange is predicated upon the inclusion of the following items:

• the words “bill of exchange” clearly displayed;
• an unconditional order to pay;
• a sum certain;
• the name of the payer;
• the name of the payee; and
• the date the bill was drawn.¹⁴

If no date of payment is stipulated on the bill, it is presumed to be payable at sight.

A drawer accepts responsibility for ensuring that the bill is accepted and paid.

Holders may negotiate their rights under a bill by endorsement (signature on its reverse side) and delivery of the bill.¹⁵

Each new endorser bears responsibility for the authenticity of its immediately prior endorser.¹⁶ Endorsements may not be conditional and stated conditions are without effect as regards other stipulations of the bill. Endorsements may render a bill nonnegotiable. The endorser remains liable for acceptance and payment by subsequent parties.¹⁷

Acceptance of a bill refers to the process whereby the payer of the bill undertakes to pay the amount of the bill on its date of maturity.¹⁸

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A sight bill need not be presented for acceptance.¹⁹

A payer accepts a bill by recording the word “accepted” on its face and by dating and signing it.²⁰

If a payer seeks to attach conditions to the bill, the bill is deemed to be refused.²¹

Guarantees may be given for bills by clearly displaying the word “guarantee” on the bill together with the name, address, signature and seal of the guarantor, the name of the guaranteed person and the date of the guarantee. Conditions written with respect to guarantees are of no effect. Payment may be demanded of the guarantor once the due date of the bill has passed and no payment has been forthcoming.

Timeliness of presentation of bills of exchange means:

• for sight bills, presentation for payment within one month of the date of drawing of the bill; and
• for bills payable at a fixed date, within 10 days of such date.

The obligation to pay a bill of exchange survives the due date for payment.

In making payments, payers must check the continuity of bills’ endorsements and examine the identity documents or valid certificates of those presenting them for payment. Payers are liable for payments made with “dishonest intent” or through “serious error”.²²

Bills of exchange made out in foreign currency are payable in renminbi in amounts calculated at the market rate on the date of payment.²³

The drawer, endorser, acceptor and guarantor of a bill of exchange are jointly liable to the holder, who may pursue any or all of the obligors on the bill without necessarily following any priority.

A holder exercising a right of recourse against obligors after refusal of payment may obtain, in addition to the principal of the bill, interest calculated at the rate stipulated by the PBOC from maturity or presentation for payment until discharge of the obligation.²⁴

3.3. Promissory notes

Promissory notes are negotiable instruments signed by the drawer under which the drawer undertakes unconditionally to pay a determined amount to the payee or holder.²⁵ Article 79 of the Negotiable Instruments Law sets down a maximum term of two months.

Promissory notes may only be issued by banks.²⁶ Drawers of promissory notes must possess reliable financial resources commensurate with the amount of the obligation.²⁷ The qualifications of candidates for the issue of promissory notes are reviewed by the PBOC.²⁸

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Promissory notes must include the following items:

• the words “promissory note” clearly displayed;
• an unconditional undertaking to pay;
• a sum certain;
• the name of the payee;
• the date of drawing; and
• the signature and seal of the drawer.

The provisions with respect to the endorsement, guarantee and payment of bills of exchange and related rights of recourse also apply to promissory notes.²⁹

3.4. Cheques

Cheques are negotiable instruments signed and issued by a drawer entrusting a bank or other financial institution to unconditionally pay the cheque amount on sight to the payee or holder.

The following information must be recorded on a cheque:

• the word “cheque” clearly displayed;
• an unconditional order to pay;
• a sum certain;
• the name of the payer;
• the date of drawing; and
• the signature of the drawer.

The absence of any of these elements entails the nullity of the cheque.³⁰

Cheques may not be drawn in amounts in excess of the amounts in the debited accounts at the time of issuing of the cheque.³¹

Cheques are payable at sight and the inscription of any subsequent date on the face of the cheque is of no effect.³²

Cheques must be presented within ten days of the date of their issue.³³ Beyond such time limit, the payer may refuse to make payment, though the drawer remains liable to the holder.³⁴

3.5. Foreign-related negotiable instruments

Foreign-related negotiable instruments refer to those for which some of the activities of drawing, endorsement, acceptance, guarantee or payment have occurred outside the territory of the People’s Republic of China (PRC).³⁵

Treaty commitments binding upon China prevail over conflicting provisions of the Negotiable Instruments Law.³⁶ In the absence of a relevant provision of a treaty or of the Negotiable Instruments Law, international practice is applicable.³⁷

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An obligor’s civil capacity is determined on the basis of its national law, except where the obligor has no or limited capacity under such law and its capacity would be complete under the law of the place where the act is to be carried out, in which case, the latter law is applied.³⁸

The information recorded on a bill of exchange, promissory note or cheque when such bill or note is drawn, is governed by the laws of the place of drawing, though, in the case of cheques, and by express agreement of the parties, the applicable law may be that of the place of payment.³⁹

The laws of the place where the act was performed govern endorsement, acceptance, payment and guarantee of a negotiable instrument.⁴⁰

The laws of the place of drawing govern time limits for the exercise of rights of recourse related to negotiable instruments.⁴¹

The laws of the place of payment govern the limits for presentation.⁴²

Where a negotiable instrument is lost and the person who lost it requests that the order of rights be maintained, the laws of the place of payment are applicable.⁴³

3.6. Infractions and sanctions

According to article 103 of the Negotiable Instruments Law, any of the following acts may constitute a violation subject to sanction:

• to falsify or alter a negotiate instrument;
• to knowingly make use of a falsified or altered negotiable instrument;
• to sign and issue a bad cheque or deliberately sign or seal a cheque in a manner inconsistent with the sample signature or seal in order to obtain property fraudulently;
• to sign and issue a bill of exchange or promissory note without having sound financial resources in order to obtain funds fraudulently;
• to record false information on a bill of exchange or promissory note in order to fraudulently obtain funds;
• to use the negotiable instrument of another person under false pretences or to deliberately use a matured or invalid negotiable instrument to fraudulently obtain property; and
• for the payer and drawer or holder to collude with dishonest intentions to engage in any of the above practices.

Where any of the provisions of the Law are violated with consequent losses, in addition to the liabilities under the Negotiable Instruments Law, civil liability may also be imposed.

Serious violations may merit criminal pursuits and administrative penalties may be imposed.⁴⁴

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4. Secured transactions

The Law of Secured Transactions is intended to be used in the context of sales, loans, transportation and work for hire as a safeguard for creditors. The types of security created by the Law are guarantees, mortgages, pledges, liens and deposits.⁴⁵ These contracts are accessory and, unless otherwise agreed in the security contract, the invalidity of the master contract entails that of the accessory contract.⁴⁶ In such operations, the principles of equality, free will, fairness and good faith are applicable.⁴⁷ Where a guarantee contract is affirmed to be invalid, and the debtor, guarantor or creditor is at fault, each is liable in proportion to its respective faults.⁴⁸

4.1. Guarantees

Guarantors and creditors agree that, where debtors fail to perform their obligations, the guarantor will perform the obligations or bear the liabilities defined in the agreement.⁴⁹

Any legal person, organization or citizen capable of assuming debts may act as guarantor.⁵⁰

Except for securing loans for onward lending from a foreign government or an international economic organization and as approved by the State Council, no State organ may act as guarantor.⁵¹

Public organizations and institutions established for purposes of public welfare such as schools and hospitals may not act as guarantor.⁵²

Branches of legal persons may not act as guarantor.⁵³

Where there are two or more guarantors for any obligation, creditors may call upon any of them to bear the entire liability. Inter se, guarantors bear liability in proportions agreed in the guarantee contract. In the absence of an agreement to this effect, guarantors are jointly and severally liable. Guarantors enjoy a right of recourse against the debtor.⁵⁴

Guarantors and creditors must conclude written contracts.⁵⁵

Article 14 of the Law of Secured Transactions provides that guarantors and creditors may specify maximum amounts of claims for successive draws on loan contracts or commodities contracts over a defined term.⁵⁶

4.1.1. Guarantee contracts

Guarantee contracts must contain the following information:

• the kind and amount of the principal claim to be secured;
• the time limit for the debtor to perform the obligation;
• the modes of security;
• the scope of the guarantees; and
• the guarantee’s term.

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Omitted particulars may be added by amendment.⁵⁷

Guarantees may be general or joint and several.⁵⁸ In the absence of agreement otherwise, the guarantors bear liability on a joint and several basis.⁵⁹

General guarantees refer to contracts whereby the guarantor agrees to assume the debtor’s liability toward the creditor in the event of the former’s default. In such cases, the guarantor may refuse to assume liability towards the creditor until the dispute over the principal contract has been tried or arbitrated and the obligations remain due even after the debtor’s assets have been seized. However, guarantors may not exercise this right in any of the following circumstances:

• the change of the debtor’s domicile makes it extremely difficult for the creditor to enforce the debtor’s obligation;
• a people’s court suspends the enforcement proceedings due to the debtor’s bankruptcy case; or
• the guarantor has waived its right in writing.

The guarantor and the debtor may accept joint and several liability. Where the debtor on a joint and several guarantee defaults, the creditor may demand that the debtor perform its obligation, or demand that the guarantor assume its liabilities under the guarantee agreement.⁶⁰

The guarantors may invoke the debtor’s rights of defence despite the latter’s waiver of its own rights.⁶¹

4.1.2. Guarantee liability

Unless the guarantee contract provides otherwise, the guarantor is liable for the principal claim and the interest thereon, plus any default fines, damages and expenses for enforcing the claim.⁶²

If a creditor transfers, in accordance with the law, the principal claim to a third party during the period of the guarantee, the guarantor remains bound by the guarantee contract within the scope of the original contract unless agreed otherwise.⁶³

For the duration of the guarantee, where the creditor consents to the debtor’s assignment of its obligations, that of the guarantor must also be obtained in writing lest the guarantor be relieved of its obligations.⁶⁴

Unless the guarantee agreement otherwise provides, amendments to the commercial contract must be approved by the guarantor.⁶⁵

In general guarantees, unless the guarantor and the creditor agree otherwise, their term is six months from the date of maturity of the principal debts. Where the creditor neither files a lawsuit against the debtor nor applies for arbitration during the term of guarantee, the guarantor is relieved of its liability.⁶⁶

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In the absence of agreement of the parties otherwise, in connection with joint and several guarantees, creditors have six months from the date of maturity of the principal debt to invoke the guarantor’s liability.⁶⁷

Where there are both guarantees and property security for the same claim, the guarantor is liable for the creditor’s claim unsecured by the property security.⁶⁸

After honouring their guarantee commitments, guarantors are entitled to recourse against their debtors.⁶⁹

4.2. Mortgages

The Property Law of 2007 reiterates for the most part the provisions with respect to mortgages already set down in the Law with respect to Secured Transactions.

In this chapter, the material on security in movables is presented. Rules with respect to security in real estate are presented in the chapter on that subject.

Under the Law of Secured Transactions, mortgages are created when a debtor or a third party grants to a creditor rights with respect to property without transfer of possession thereof, provided, in event of default of the debtor, that the property may be converted into money or the proceeds of its auction or sale⁷⁰ may be used to offset the debt.

4.2.1. Mortgage property

Other than real estate, property that may be mortgaged includes machines, means of transport and other property including that under State ownership.⁷¹

The amount of a claim secured by a mortgagor may not exceed the value of the mortgaged property.⁷²

Where factories and other buildings of township or village enterprises are mortgaged, the land-use rights to the land occupied by such buildings are deemed to be covered by the mortgage.⁷³

Enterprises, small industrial and commercial businesses and rural contractors may mortgage their existing and future production goods.⁷⁴

Where enterprises, small businesses and rural contractors mortgage movable property, the contracts must be registered. They enter into effect upon registration. If a party does not register the mortgaged property, it may not resist claims of third parties in good faith. Even if the mortgage is registered, this does not protect against the claims of third parties that have paid consideration and obtained the mortgaged property in the ordinary course of business.⁷⁵

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4.2.2. Mortgage contracts

Mortgages must be in writing.⁷⁶

The mortgagor and the mortgagee may not stipulate that ownership of the mortgaged property will be transferred to the creditor in case the mortgagee’s claim is not satisfied after maturity of the debt.⁷⁷

Mortgages to certain types of property only enter into effect upon their registration with the competent authorities.⁷⁸ The registration departments for means of transport are responsible for aircraft, ship and vehicle mortgages. Equipment mortgages and mortgages of other movables⁷⁹ of enterprises are registered with the administrative departments of industry and commerce where the property is located.⁸⁰

Applications to register property mortgages are accompanied by the principal contract and the mortgage contract and certificates evidencing the ownership of or right to use the mortgaged property. These documents are accessible by the public which may also copy them.⁸¹

4.2.3. Effects of mortgages

Unless otherwise provided in the mortgage contract, the mortgage includes the principal debt and the interest thereon, plus default fines, damages and expenses for its enforcement.⁸²

Leased property may be mortgaged and the lease continues in effect.⁸³

When a mortgagor transfers property subject to a duly registered mortgage, the transferee must be informed of the mortgage and the mortgagee must receive notice of the transfer, lest it be void. If the proceeds expected from the transfer of the mortgaged property are manifestly less than its value, the mortgagee may demand additional guaranties and, if the mortgagor fails to provide them, the mortgaged property may not be transferred. The proceeds are used to liquidate the claim secured by the mortgage, or they may be deposited with a third party agreed upon by the mortgagor and the mortgagee. If the proceeds exceed the claim, the balance belongs to the mortgagor and the debtor remains liable for shortfalls of the proceeds.⁸⁴

Rights under mortgages may not be separated from the creditor’s rights or transferred separately, and they may not be used to secure other creditor’s rights.⁸⁵

Where a mortgagor’s acts are likely to cause the value of the mortgaged property to decline, the mortgagee may demand cessation of the conduct and, if the property’s value does decline, it may demand that the mortgagor restore the original value or provide security corresponding to the amount of the lost value.⁸⁶

A mortgage is co-existent with the creditor’s right and if the latter’s right lapses, so does the mortgage.⁸⁷

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If the mortgaged property is seized by a people’s court due to the debtor’s failure to perform its obligation prior to the maturity of the debt, the property rights are separated among natural and legal fruits to which the mortgagee and the mortgagor are respectively entitled.⁸⁸

4.2.4. Enforcement of mortgages

Mortgagees may bring suit before the people’s courts to enforce their rights to the proceeds of conversion of mortgaged property from its auction or sale. The debtor remains liable to the mortgagee for shortfalls of the proceeds.⁸⁹

According to article 54 of the Law of Secured Transactions, where the same property is mortgaged to two or more creditors, the proceeds from its auction or sale are used according to the following priorities. Where a mortgage contract takes effect with its registration, priority is determined according to the time of registration of the mortgaged property and, if the registrations are simultaneous, the proceeds are distributed in proportion to the amounts of the claims.⁹⁰

Third parties that guarantee mortgages have recourse against the debtors after enforcement of the rights of the mortgagees.⁹¹

Rights under mortgages lapse upon loss or destruction of the mortgaged property and compensation obtained on such account is treated as if it were mortgaged property.⁹²

4.2.5. Mortgages of maximum amount

A mortgage of maximum amount means that the mortgaged property is used to secure creditors’ claims that occur successively during a given period of time and to the extent of the total amount of the claims, as agreed upon between a mortgagor and a mortgagee.⁹³

Contracts executed by creditors and debtors for continuous transactions of specific commodities in a definite period may give rise to mortgages of maximum amounts,⁹⁴ and creditors’ rights under the principal contracts secured by mortgages of maximum amounts may not be transferred.⁹⁵

Before the determination of a claim secured by a mortgage of maximum amount, a mortgagor and mortgagee may change the term, scope and maximum amount of the claim through agreement, provided that the change does not cause any detriment to other mortgagees.⁹⁶

4.3. Pledges

The Law of Secured Transactions admits pledges of movable property and of intangible rights such as those to patents, trademarks and copyrights.

Pledges of rights are governed by the provisions applicable to pledges of movable property and are also subject to certain specific rules.⁹⁷

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4.3.1. Pledges of movables

To pledge movables, debtors or third parties transfer their possession to creditors as a security for their debts. If the debtor defaults, the creditor is entitled to convert the property into money as payment of the debt or enjoy priority on the proceeds of auction or sale of the pledged property.⁹⁸

Pledge contracts must be concluded in writing. They enter into effect upon transfer of possession over the pledged property to the pledgee.⁹⁹

If transfers of a certain movable are forbidden by laws or administrative regulations, then the movable must not be used as security for debt.¹⁰⁰

Pledge contracts may not stipulate that ownership of the pledged property is transferred to the pledgee if the obligation is not discharged at its maturity.¹⁰¹

Unless otherwise provided in the pledge agreement, liability on pledges covers the principal claim and the interest thereon, default fines, damages, storage charges and the cost of the pledge’s enforcement.¹⁰²

Unless otherwise provided in the pledge agreement, the pledgee is entitled to the fruits derived from the pledged property once the expenses for their collection is covered.¹⁰³

The pledgee must maintain the pledged property in good condition and is liable for losses or destruction due to its negligence.¹⁰⁴

Where a risk arises that the pledged property may perish or that its value will decline such as to impair the rights of the pledgee, the latter may demand that the pledgor provide additional security. If the pledgor refuses to provide the additional security, the pledgee may auction or sell the pledged property and the proceeds may be used to pay the debt secured in advance or they may be deposited with a third party acceptable to the pledgor.¹⁰⁵

After the debtor or the pledgor pays the debt, the pledgee must return the pledged property. If the pledgee is not paid at maturity of the obligation, it may conclude an agreement with the pledgor that the pledged property be converted into money in order to pay the debt, or it may auction or sell the said property according to law. Proceeds from the pledged property in excess of the debt secured are paid to the pledgor and shortfalls remain due by the debtor.¹⁰⁶

Pledges lapse if the pledged property is lost or destroyed and any compensation obtained is treated as pledged property.¹⁰⁷

Rights in pledges co-exist with the secured creditors’ rights and their lapse entails the lapse of the pledge.¹⁰⁸

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4.3.2. Pledges of rights

According to article 75 of the Law of Secured Transactions, the following rights may be pledged:

• bills of exchange, cheques, promissory notes, bonds, certificates of deposit, warehouse receipts, bills of lading;
• shares of stocks or certificates of stocks that are transferable;
• the rights to patents, trademarks and copyrights;
• the rights to collect fees for the use of roads and power grid infrastructures; and
• other rights which may be pledged according to law.¹⁰⁹

Where a bill of exchange, cheque, promissory note, bond, certificate of deposit, warehouse receipt or bill of lading is pledged, a written pledge contract must be set down and the document of title becomes effective upon its delivery to the pledgee.¹¹⁰

Where such instruments bear a date of payment or of delivery of goods, as the case may be, if they are pledged and the date of payment or delivery of goods is prior to the time limit for the performance of the obligation, the pledgee may be paid or accept delivery of the goods, and conclude an agreement with the pledgor that the payment or the goods accepted will be used to pay in advance the debt secured or be deposited with a third party as agreed upon with the pledgor.¹¹¹

Where receivables are pledged, a contract is concluded in writing and the pledge becomes effective upon its registration with the competent authority. Unless otherwise agreed by the pledgee and the pledgor, pledges of receivables may not be transferred. Proceeds from transfers are used to pay the pledgee’s claims in advance or are deposited with a third party.¹¹²

Pledges of participations in a fund or pledges of shares must be concluded in writing. Where they have been registered with the security registration and settlement authorities, the rights of pledge become effective upon registration with the securities registration authorities. Where shares of any other kind are pledged, the rights on the pledge become effective upon registration with the administrative department in charge of commerce. When participations in funds or shares are pledged, they may only be transferred if the pledgor and pledgee so agree. The proceeds may be used to pre-pay the pledgee’s claims, or held on deposit with a third party.¹¹³

Where certificates of stock are pledged, the pledgor and the pledgee must conclude a contract in writing and register the pledge contract with the securities registration authorities. The pledge contract may not enter effect without registration. Unless otherwise agreed between the pledgor and the pledgee, pledged stock certificates may not be transferred. Proceeds obtained from the transfer of the certificates of stocks are used to pay the pledgee’s claims in advance or they are deposited with a third party with the consent of the pledgor. Where shares of stocks of a limited liability company are pledged, the contract enters into effect on the date on which the pledge is recorded in the shareholder register.¹¹⁴

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Where rights to patents, trademarks and copyrights are pledged, the pledgor and the pledgee must conclude a written contract and register it with the administrative department in charge before it can enter into effect.¹¹⁵ The pledgor may not transfer or permit the rights to be used by others without the consent of the pledgee. Proceeds from transfers or uses by the pledgee serve to pay in advance the pledgee’s claims secured by the pledgee or they may be deposited with a third party as agreed by the parties.¹¹⁶

4.4. Liens

Where a party has possession of the other party’s property under a contract and the latter violates the contract by failing to pay a required sum of money within the specified time limit, the possessor may invoke a lien on the property and may keep the retained property to offset the debt or may claim priority on the proceeds from its sale.¹¹⁷

Liens arise when creditors take possession of the debtor’s movables in accordance with a contract. If the debtor defaults, the creditor may retain the property, and it enjoys priority to the proceeds from its conversion, sale or auction.¹¹⁸

Liens cover the principal claim and interest, default penalties, damages, costs of preservation of the retained property and expenses for enforcing the lien.¹¹⁹

Liens on certain properties may be prohibited by law. The parties may agree that liens may not be practised.¹²⁰

Lien holders must keep the retained property in good condition and they are liable for loss or destruction of, or damage to, the retained property due to their negligence.¹²¹

Lien holders are entitled to the fruits derived from the retained property.¹²² The lien holder and the debtor agree on the time for the debtor’s performance of its obligations after the property is retained. In the absence of agreement, the debtor must be given a minimum of two months from the creditor’s possession of the debtor’s property within which to perform its obligations. If the debtor defaults, the creditor may, with the debtor’s consent, convert the retained property into money, or it may auction or sell the retained property. Proceeds in excess of the debt secured are paid to the debtor and shortfalls remain due by the debtor.¹²³

According to article 239 of the Property Law, where movable property that has already been mortgaged or pledged is retained at a later time, the lien holder enjoys priority proceeds from its sale or auction.

Where the lien holder loses possession of the property or accepts other security provided by the debtor, the right of retention lapses.¹²⁴

The right of retention lapses when the creditor’s right lapses.¹²⁵

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4.5. Deposits

Parties may agree upon the payment of a deposit as security for a debt. After debtors perform their obligations, the deposits are either retained as partial payment or returned. If the party paying the deposit defaults, it loses the right to demand its return; if the party accepting the deposit defaults, it must return twice the amount of the deposit.¹²⁶

Deposit contracts must be executed in writing. They enter into effect on the date of the actual delivery of the deposit.¹²⁷ Deposits may not exceed 20% of the amount of the principal contract.

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5. Leasing

Pending the adoption of the long-awaited law with respect to leasing, the Contract Law has provided a general framework for financial leasing.

In 2005, the MOFCOM adopted further measures dealing with foreign investment in financial leasing activities in China.

On January 23, 2007, the China Banking Regulatory Commission (CBRC) issued the Administrative Measures on Financial Leasing Companies that have been in effect since March 1, 2007. The Measures set out the qualifications, business scope and operating rules for financial leasing companies.

5.1. Financial leasing under the Contract Law

Financial leasing contracts are those whereby the lessor provides the leased item to the lessee for its use, and the lessee pays rent. Financial leasing contracts must be set down in writing.¹²⁸

The leased good is delivered to the lessee in accordance with the sales contract.¹²⁹ Lessees may exercise the remedies of buyers against sellers for their failures of performance.¹³⁰

But title to the leased property remains vested in the lessor and were the lessee to enter into bankruptcy, the leased property would not be included in the bankruptcy assets.¹³¹

Unless otherwise agreed by the parties, the rent under a financial leasing contract is determined based on the major portion of, or the full costs of, purchasing the leased property, plus a reasonable profit for the lessor.¹³²

Except where the lessee has relied on the skills of the lessor in selecting the leased property or the lessor has interfered in the selection, if the lease item does not comply with the contract or is not fit for the intended purpose, the lessor is not liable to the lessee.¹³³

The lessor warrants that the lessee will enjoy possession and use of the leased property.¹³⁴

If, while in the possession of the lessee, the leased property causes personal injury or damage to property, the lessor is not liable.¹³⁵

The lessee must maintain the leased property and use it with due care.¹³⁶

Where the lessee fails to pay the rent within a reasonable period after receiving demand for payment from the lessor, the lessor may require payment of the full rent or it may terminate the contract and repossess the leased property.¹³⁷

The lessor and the lessee may agree on the ownership of the leased property at the end of the lease term and, in the absence of such determination, title to the leased property remains vested in the lessor.¹³⁸

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5.2. Administrative measures with respect to leasing activities139

The CBRC’s Financial Leasing Company (FLC) Measures on January 23, 2007 have been in effect since March 1, 2007.

The minimum registered capital of FLCs is RMB 80,000,000. They must have a management team with professional knowledge of financial leasing as well as adequate premises and equipment and they must implement internal management and risk management systems.

Financial leasing companies must respect certain ratios:

• risk assets, including contingent liabilities, may not exceed ten times the total assets;
• investments in industries other than the financial leasing industry may not exceed 30% of the total assets; and
• their assets under financial lease and other financial leases cannot be less than 60% of the total assets.

In a sale-and-lease-back transaction, the acquisition cost for the leased property may not exceed 20% of the actual value or the book value of the leased property.

5.3. Administrative measures with respect to foreign investment in leasing activities

On February 3, 2005, the MOFCOM promulgated Measures for Administration of Foreign Investment in Leasing that entered into effect as of March 5, 2005 (the Foreign Investment in Leasing Measures).¹⁴⁰

Foreign enterprises may invest in leasing activities in China through joint ventures (equity – EJVs, and cooperative – CJVs) or wholly foreign-owned enterprises (WFOEs).¹⁴¹

Foreign investors in the leasing and financial leasing businesses in China must be engaged in such activities in their countries of origin.¹⁴²

The MOFCOM is the administrative department in charge of foreign-capital leasing activities.¹⁴³

Foreign-invested financial leasing companies (FFLCs) may undertake direct leases, subleases, leasebacks, leveraged leases, trust leases and joint leases.¹⁴⁴

The types of property that that may be leased include:

• movable property such as equipment, communication facilities, medical devices, scientific research equipment, inspection and testing apparatus, engineering machinery and office equipment;
• means of transport such as planes, automobiles and vessels; and
• intangible assets integrated with movable property such as software and technology, but the value of such intangible assets may not exceed 50% of that of a leased property.¹⁴⁵

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The total foreign-invested assets of FLCs and FFLCs may not be less than USD 5 million.¹⁴⁶

In general, the operating period for FLCs may not exceed 30 years.¹⁴⁷

FLCs must have registered capital in compliance with the general requirements such as are contained in the Company Law with respect to limited liability companies.¹⁴⁸

FFLCs must have registered capital of at least USD 10 million.¹⁴⁹ Their senior management must have the corresponding professional qualifications and at least three years’ experience.¹⁵⁰

Materials to be submitted for the establishment of FLCs or FFLCs include:

• a feasibility study signed by all the investors;
• bank references for the legal representative of each investor;
• each investor’s audit report concerning the previous year;
• a list of the members of their board of directors and proof of their appointment;
  and
• proof of the certifications of their senior management.¹⁵¹

FLCs and FFLCs may be established as limited liability companies (LLCs) or as companies limited by shares (CLSs).

To establish a FLC, an application is filed with the commerce administrative department of the province or equivalent¹⁵² level where the enterprise is to be located, which must decide and reply within 45 working days. Approvals give rise to the issue of Foreign-capital Enterprise Approval Certificates and they are notified to the MOFCOM. Refusals must be justified in writing. In the case of FFLCs, the provincial level communicates its position, but the decision to approve the application or not is made by the MOFCOM. Where the request is made to establish an FFLC, then the provincial-level administration communicates an opinion to the MOFCOM within 15 days, which renders a decision within 45 days. Enterprises already established in China may amend their corporate documents and registration and seek the required approvals.¹⁵³

Within 30 workings after receiving their Foreign-capital Enterprise Approval Certificates, FLCs and FFLCs must register with the competent SAIC office.¹⁵⁴

FLCs may carry on the following businesses:

• leasing;
• purchases of leased property;
• maintenance of leased property;
• disposal of scrap value of leased property; and
• other businesses approved by the competent department.¹⁵⁵

FFLCs may also carry on financial leasing activities, consulting and guarantee business relating to lease transactions as well as other businesses approved by the competent department.¹⁵⁶

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The “at risk” assets of FFLCs may not exceed ten times their net assets.¹⁵⁷

On or before March 31 of each year, FFLCs must submit to the MOFCOM their report for the previous year and their audited financial statements.

FLCs and FFLCs are encouraged to join the Lease Industry Commission of the China Foreign-investment Enterprises Association, a professional organization providing regulation and discipline enforcement in the industry.¹⁵⁸

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6. Trading-trust contracts

A trading-trust contract is one whereby the trustee-trader conducts trading activities in its own name for the trustor, and receives remuneration from the trustor.¹⁵⁹

Except otherwise agreed by the parties, the trustee-trader bears its own expenses.¹⁶⁰

Where property is consigned to the trustee-trader, it must exercise due care over it.¹⁶¹

If a consigned item of property is defective, perishable or subject to deterioration at the time it is delivered to the trustee-trader, the latter may, with the consent of the trustor, dispose of it; where the trustee-trader is unable to contact the trustor in time, it may dispose of the property in any reasonable manner.¹⁶²

If the trustor fixes a price below which not to sell an item, or above which not to buy it, its sale is binding on the trustor only if it consents or if the trustee-trader makes up any difference.¹⁶³

Where the trustee-trader has sold the trust item above, or purchased the trust item below, the price designated by the trustor, the remuneration may be increased in accordance with the contract. But if the contract does not contain such a provision, the benefit belongs to the trustor.¹⁶⁴

Where the trustor gives special pricing instructions, the trustee-trader may not make any other sale or purchase.¹⁶⁵

Where the trustee-trader is to sell or purchase a commodity, the price of which is fixed by the market, it may, unless the trustor has expressed a different intention, purchase or sell in its own name while retaining its right to remuneration.¹⁶⁶

Once the trustee-trader has purchased the trust property, the trustor must take delivery in a timely manner. Where the trustor refuses without cause to take delivery, the trustee-trader may place the trust property in escrow.¹⁶⁷

Where the trust item is not sold or the trustor withdraws it from sale, and if the trustor fails to retrieve or dispose of it after receiving a notice to that effect, the trustee-trader may place the trust item in escrow.¹⁶⁸

Where the trustee-trader enters into a contract with a third party, it directly enjoys its rights and assumes its obligations.

Except as otherwise agreed by the trustee-trader and the trustor, where a third party fails to perform its obligations and thereby causes damage to the trustor, the trustee-trader is liable for damages.¹⁶⁹

Where the trustee-trader has completed the entrusted matter or has partially completed the entrusted matter, the trustor must pay the appropriate remuneration. Where the trustor fails to do so within the prescribed period, the trustee-trader, except otherwise agreed, is entitled to a possessory lien on the trust property.¹⁷⁰

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7. Financing international trade

The Bank of China is the leading institution for the financing of international trade.¹⁷¹ China has also established an Export-Import Bank for the promotion of its international trade.¹⁷²

7.1. Documentary credits

Chinese banks generally dealing with letters of credit subjected the letters of credit to UCP 500 with respect to documentary credits. Indications are that the new UCP 600 will be widely accepted in the country as well.

In principle, customers requesting the issue of documentary credits are required to have an authorization to carry on an import and export business. Before acceptance of the application, Chinese banks routinely carry out qualification investigations, for example by checking the business licence and import-export licence presented by its customers.

The issuing bank has the option of choosing the advising bank, but in practice it accommodates its customers’ wishes within the limits of its correspondent policies and agreements. The issuing bank assumes an irrevocable definite undertaking to pay if the stipulated documents are presented and the terms and conditions of the credit are respected. Generally, Chinese banks will only issue transferable credits in favour of designated transferees.

Most of the credits issued by Chinese banks are sight negotiable credits subject to presentation of documents to the issuing bank. They may also issue credits with such clauses as “reimbursement claim through telex/swift accepted” or “designated reimbursing bank accepted”. In accordance with the UCP, Chinese banks are expected, when examining all documents presented by the beneficiary, to use reasonable care to determine whether on their face they are in compliance with the terms and conditions of the credit and whether they are consistent with one another. If the credit is available at the counters of a designated bank for negotiation, payment, acceptance or deferred payment, the documents should be presented to the designated bank. The issuing bank may request the confirmation of the designated bank.

Chinese banks will pay, incur a deferred payment undertaking or accept drafts and pay at the maturity date within seven banking days following the day of receipt of the documents. When there are discrepancies in the documents, a Chinese bank may reject the documents and it must then give notice to such effect to the presenting bank within seven banking days of receipt of the documents. These delays will of course be shortened to five days under UCP 600.

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7.2. Bill purchases

Bill purchases fall into two categories: bill purchases in the context of letters of credit and bill purchases for collection. Bill purchases in the context of letters of credit are commonly referred to as “negotiation”. A negotiating bank in China reviews the following matters:

• the political and economic situation of the country where the issuing bank is located;
• the credit status of the issuing bank;
• whether the terms and conditions of the credit comply with international practice;
• who is entitled to the goods; and
• the credit status of the exporter.

If the documents are presented on a collection basis, the exporter may make early payment of part or all of the amount of the bill. The main difference between bill purchase for collection and bill purchases in the context of letters of credit is that the former relies on commercial credit whereas the latter relies on banking credit.

Collecting banks in China will consider the following matters when evaluating such credit applications:

• the credit status of the exporter;
• the availability of export credit insurance;
• whether the documents will be released against payment or against acceptance;
• the terms of transportation insurance; and
• the options of the collecting bank.

The risk in bill purchases for collection is higher than that involved in bill purchases in the context of letters of credit. Accordingly, the former yield higher rates of interest. The term of the former is longer than that of the latter.

When the collecting bank cannot obtain reimbursement, it is entitled to recourse for the principal of, and interest on, the credit plus other commissions.

7.3. Bank guarantees

In international business, Chinese banks usually adopt the ICC Uniform Rules for Demand Guarantees (ICC Publication No. 458). The most commonly used bank guarantees are bid bonds, performance bonds, repayment guarantees, loan guarantees, overdraft guarantees, deferred payment guarantees and leasing guarantees.

In international practice, most bank guarantees are not accessory to the principal contract. The duty of the guarantor to make payment is not conditional on actual default by the principal in the underlying transaction. Such guarantees are called demand guarantees.

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The measures of control over the provision of guarantees to foreign creditors by organizations within the PRC (Guarantee Measures) promulgated by PBOC, which came into effect on 1 October 1996, govern all guarantees issued by Chinese residents to non-residents. According to the Guarantee Measures, foreign-invested financial institutions and the branches of foreign financial institutions are deemed to be non-residents.

The SAFE is responsible for the approval, administration and registration of guarantees given to foreign creditors by Chinese organizations. According to the Guarantee Measures prior to their issue, all guarantees must be approved by the SAFE. Guarantees issued without the approval of the SAFE are void. However, with regard to Chinese banks, only those guarantees involving financing from abroad, such as loan guarantees, overdrawn guarantees, finance leasing guarantees, etc., and deferred payment guarantees with a repayment tenor of more than one year are subject to pre-issuance approval of the SAFE. All other types of guarantees issued by Chinese banks need not be approved by the SAFE before issuance.

For financial institutions, the sum of their total outstanding balance of guarantees to foreign creditors and their total foreign exchange liabilities may not exceed 20 times their self-owned foreign exchange funds. For non-financial enterprise legal persons, the total outstanding balance of guarantees to foreign creditors may not exceed 50 per cent of their net assets, and may not exceed the amount of their foreign exchange income of the previous year.

7.4. Factoring

In export factoring, an exporter signs a factoring agreement with a factor whereby all trade receivables are assigned to the factor that assumes the responsibility of collecting payments.

On the domestic market, in 1992 the Bank of China (BOC) launched the market for international factoring operations. Chinese factors provide full service factoring and recourse factoring on both the export and the import sides. They also provide invoice discounting.

7.5. Forfeiting

Forfeiting involves a medium- to long-term loan to finance exports without recourse to the exporter. The importer signs the contract with the exporter and clearly states “using the facility of forfeiting”.

In practice, the draft drawn by the exporter must be guaranteed by the importer’s bank. The guarantor may put its signature on the bill to guarantee payment at maturity. This is called an “aval”. Or it may issue a letter of guarantee of the future payment. The exporter may discount the accepted bills or issued promissory notes of the importer, as guaranteed by its bank, at the counters of approved forfeiting institutions.

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7.6. Trust receipts

The issuing bank may release the documents to the applicant against a trust receipt signed by the importer. The applicant may take delivery of the goods for processing or sale and repay the principal of, and interest on, the credit to the issuing bank in a certain period of time.

The applicant acting as the trustee of the issuing bank –

• acts as bailee of the goods;
• provides for their storage;
• processes them and stores them; or
• makes arrangements to sell the goods and repay the credit from the proceeds of the sales.

If the applicant files for bankruptcy, the goods covered by the trust receipt belong to the bank and are excluded from the assets liquidated to pay creditors. The issuing bank may claim payments due from the buyer directly if goods sold were not completely paid.

The validity of trust receipts does not usually exceed six months.

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