Project Finance 2023 Comparisons

The project sponsors are almost always the shareholders of the project company. Depending on the industry, the institutions acting as sponsors will be different, ranging from state-owned enterprises to private enterprises, and from domestic corporates to international corporates.

Lenders involved in project finance transactions in China are mainly banks. Previously, foreign banks were quite active in the market, but in recent years Chinese banks have played a more and more important role in project finance transactions, which includes state-owned banks and joint stock banks. Export credit agencies, such as the China Export & Credit Insurance Corporation (Sinosure), also play a significant role in the market, by providing guarantees and insurances. Sinosure provides insurance support and issues guarantees to counterparties of Chinese export-oriented companies.

Public-private partnership transactions are commonly seen in public service industries, such as energy, transport, environmental protection, agriculture, forestry, technology, government-subsidised housing, healthcare, education and culture, etc.

The legislation applicable to public-private partnership transactions includes (without limitation) the Civil Code, the Budget Law, the Government Procurement Law and the Bidding Law.

There are several main issues that need to be considered when structuring project finance transactions in China.

First, the parties need to carefully consider the basis on which the deal should be structured: non-recourse, limited recourse or otherwise. Sponsors normally prefer a non-recourse or limited recourse deal. However, in many project finance transactions, the lenders will require a guarantee or other security from the sponsors even though they take security over all the project assets.

Secondly, the capital ratio is regulated and determined based on the nature of the investment project under PRC laws. Generally, the minimum capital ratio is 25% but it varies depending on the nature of the investment project. Project sponsors need to structure their financial model carefully so that the capital ratio requirement does not affect the return on invested capital.

Industries/sectors relating to the so-called New Infrastructure – 5G, Data Centre, AI, Industrial Internet and IoT, etc – are expected to be more active in the coming year.

Under PRC laws, the following types of assets are typically available as collateral to lenders:

• land use right and buildings;
• machinery, equipment, inventory and other movables;
• receivables;
• shares in Chinese companies;
• intellectual property;
• ships;
• aircrafts; and
• vehicles.

The forms that security typically takes in the market include guarantee, pledge and mortgage.

Under PRC laws, security created over certain types of assets needs to be registered at the relevant asset-based registry for perfection purposes. The security perfection requirements for these types of assets are as follows:

• for land use right and buildings – registration at the local real property registry;
• for machinery, equipment, inventory and other movables – online registration at the Credit Reference Centre of the People’s Bank of China (PBOC);
• for receivables – online registration at the Credit Reference Centre of the PBOC;
• for shares in Chinese companies – depending on the types of company whose shares are pledged, registration at:
1. the local State Administration for Market Supervision; or
2. the securities depository and clearing institution;
• for intellectual property – registration at the relevant IP registry;
• for ships – registration at the local maritime registry;
• for aircraft – registration at the Civil Aviation Administration of China; and
• for vehicles – registration at the local vehicle registry.

Security can be created in favour of a security agent in syndicated loan transactions, as the security agent concept is generally recognised in the PRC. A security agent can hold security, enforce the syndicate’s rights under the loan documents and apply any enforcement proceeds in accordance with the instructions of the lenders in the syndicate.

A Chinese company can create a floating mortgage over its machinery, equipment, raw materials and semi-manufactured products, as well as its finished products, both those currently owned and those to be owned in the future. However, under PRC laws, it is not generally possible to create a floating charge over all present and future assets of a company. Separate agreements are required to create a security over each type of asset.

Costs associated with registering collateral security interests in China are minimal, and the borrower usually pays these costs (if any) directly. For example, the registration fee for security over a land use right and buildings is CNY80 or CNY550 (depending on the types of land use right and buildings) for each registration; the registration fee for security over receivables is CNY30 per annum for each registration; and no registration fee is payable for security over shares.

To the extent practically possible, it is almost always necessary to identify each item of collateral in the security document individually in order to grant a valid security interest. It is noteworthy that it may not be possible to individually identify each item of collateral for certain types of security, such as a floating mortgage over machinery, equipment, raw materials and semi-manufactured products, as well as finished products (both currently owned and to be owned in the future). In this case, a general description of the collateral should be sufficient. It is also advisable to consult the relevant security registry in advance regarding whether the collateral needs to be individually identified for the purpose of security perfection.

Under PRC laws, there are two types of cross-border security that need to be registered with the State Administration of Foreign Exchange of the PRC (SAFE):

• Nei Bao Wai Dai (NBWD) refers to a financing transaction where both the borrower and the lender(s) are located outside China, while the guarantor/security provider is located in China; and
• Wai Bao Nei Dai (WBND) refers to a financing transaction where both the borrower and the lender(s) are located in China, while the guarantor/security provider is located outside China.

Other types of cross-border security are generally not required to be registered with the SAFE. For example, if foreign lenders lend into China and take security over assets located in China, the security is not required to be registered with the SAFE. In practice, cross-border security registration may need to have been completed prior to the application of security registration with the relevant asset-based registry, so it is advisable to check with the relevant authorities on a case-by-case basis.

Lenders usually conduct due diligence against the collateral over which they will take security. This due diligence normally assesses whether there are other liens or restrictions on the collateral, among other matters. Generally, liens are recorded with the relevant security registry and therefore are searchable following the prescribed procedures (eg, the authorisation of the collateral owner may be required).

Generally, the parties may choose the form of security release, as there is no restriction in this regard under PRC laws. It should be noted that, if a security release form is required to be submitted to the security registry for the purpose of deregistering the security, it is advisable to confirm with the security registry whether the release form is acceptable.

Under PRC laws, a secured lender can enforce its collateral if the debt secured by that collateral is not paid when due and payable, or if another event of default provided in the finance documents occurs. Generally, there are three methods by which to enforce collateral in China.

• First, a secured lender can reach an agreement with the security provider to receive payment by converting the collateral into value or by obtaining proceeds from the auction or sale of the collateral. When converting the collateral into value or selling it off, the price should be determined by reference to the market price.
• Secondly, a secured lender can initiate a lawsuit at the competent PRC court if no agreement could be reached by the parties regarding the collateral enforcement. PRC laws provide a special court procedure to enforce collateral, through which a secured lender can apply directly with the competent PRC court for auction or sale of the collateral. After examination, if there is no substantial dispute between the parties regarding enforcement of the collateral and the conditions to enforce the collateral are satisfied, the PRC court shall rule to auction or sell off the collateral; if a substantial dispute exists between the parties, the PRC court shall rule to reject the application, and the secured lender may initiate an ordinary court procedure.
• Thirdly, a secured lender can initiate an ordinary court procedure at the competent PRC court if the PRC court rules to reject the application for a special court procedure. Of course, the secured lender can also directly initiate an ordinary court procedure (without going for a special court procedure first). Once they have obtained a court judgment (or an arbitration award if arbitration is the agreed dispute resolution in the security documents), the secured lender can present it to the court for enforcement.

It is noteworthy that, under PRC laws, the parties can have a debt instrument notarised by a notary office and obtain a notarial certificate when signing the instrument. Debt instruments that can be notarised include but are not limited to loan agreements, security documents, etc. Once notarised, the debt instruments will be granted enforceability by notarisation under PRC laws. In the event of default, the secured lender can request the notary office to issue an enforcement certificate regarding the notarised debt instrument (eg, a security document) and apply directly to the competent PRC court for enforcement of the collateral.

It is generally possible for security enforcement to be taken directly by a security agent, unless the security document provides otherwise. As mentioned, a security agent can hold security, enforce the syndicate’s rights under the loan documents and apply any enforcement proceeds in accordance with the instructions of the lenders in the syndicate.

For a foreign-related contract, PRC laws generally allow the parties to choose the governing law of that contract (PRC laws or a foreign law), except where the choice of foreign law violates mandatory PRC legal provisions or where any provision of the foreign law violates a public policy of the PRC in the determination of a particular issue, in which case PRC laws would be the applicable laws. Under PRC laws, contracts are considered to be foreign-related contracts when:

• either party or both parties to the contract are foreign persons or foreign entities;
• the habitual residence of either party or both parties to the contract is located outside the territory of the PRC;
• the subject matter of the contract is outside the territory of the PRC; and
• the legal fact that leads to the establishment, change or termination of the contract relationship happens outside the territory of the PRC.

Based on this, for loan agreements entered into between a Chinese company and foreign lenders, PRC laws generally allow the parties to choose a foreign law as the governing law (in particular, English law), and PRC courts will give effect to the choice of foreign law. For security documents, however, as a matter of the lex situs doctrine, the security is typically governed by PRC laws, since the security asset is located in China.

Generally, the submission to a foreign jurisdiction should be upheld under PRC laws, provided that it does not contradict the mandatory legal requirements in China, such as the legal requirement regarding exclusive jurisdiction.

Under PRC laws and according to the international treaties concluded or acceded to by the PRC or based on the principle of reciprocity, PRC courts shall review an application or a pleading for the recognition and enforcement of a judgment rendered by a foreign court. If, upon review, the foreign judgment neither contradicts the fundamental principles of PRC laws nor violates state sovereignty, security or public interest, PRC courts shall rule to recognise and enforce the foreign judgment. China officially signed the Hague Convention on Choice of Court Agreements in September 2017, and is still going through the ratification procedure. To date, there is no other international treaty in respect of the recognition and enforcement of judgments between the PRC and the UK or USA.

China is a member of the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (ie, the New York Arbitration Convention). Therefore, a foreign arbitral award against a Chinese company should be enforceable in China if the legal provisions of the Arbitration Law of the PRC are complied with.

Generally, there are no substantive restrictions on a foreign lender’s ability to enforce its rights under a loan or security agreement. However, as the official language in PRC courts is Chinese, a foreign lender would have to prepare and present a Chinese translation of documents filed with PRC courts. Moreover, PRC courts generally require a foreign lender to notarise and legalise its constitutional documents, as well as the power of attorney granted to its legal counsel in a judicial proceeding.

The following regulatory requirements when foreign lenders grant loans within the PRC are worth mentioning.

Foreign Debt Quota

Pursuant to the regulations of the PBOC, a foreign debt quota is required for a Chinese borrower to take out loans from foreign lenders. The risk-weighted outstanding amount of all foreign loans borrowed by the Chinese borrower shall not exceed its foreign debt quota. The foreign debt quota is calculated as follows: the borrower’s capital or net assets multiplied by the cross-border financing leverage ratio multiplied by the macro-prudential regulation parameter.

Depending on the type of borrower, the calculation of foreign debt quota is different:

• for an enterprise borrower, the quota is calculated based on its net assets, and the cross-border financing leverage ratio is 2;
• for a bank borrower, the quota is calculated based on its Tier 1 capital, and the leverage ratio is 0.8; and
• for a non-bank financial institution (eg, insurance companies), the quota is calculated based on its capital, and the leverage ratio is 1.

Currently, the macro-prudential regulation parameter is 1.5 for both financial institutions and enterprise borrowers.

NDRC 56 Registration

For foreign loans with a tenor of more than one year, the borrower is required to apply for registration in advance with the National Development and Reform Commission of the PRC (NDRC). It is noteworthy that the NDRC 56 registration is required not only where the borrower is a Chinese enterprise but also, technically, where the borrower is an offshore subsidiary or an offshore branch controlled by a Chinese enterprise.

Foreign Debt Registration

After the signing of the loan agreement, the borrower is required to register the loan agreement with the SAFE.

Under PRC laws, there are two types of cross-border security that need to be registered with the SAFE: NBWD and WBND (see 2.5 Restrictions on the Grant of Security or Guarantees). Other types of cross-border security are generally not required to be registered with the SAFE. For example, if foreign lenders lend within China and take security over assets located in China, the security is not required to be registered with the SAFE.

In addition, security created over certain types of assets located in the PRC needs to be registered at the relevant asset-based registry for perfection purposes; see 2.1 Assets Available as Collateral to Lenders for details.

According to the Foreign Investment Law of the PRC, which was promulgated on 15 March 2019 and came into force on 1 January 2020, China applies the National Treatment Principle plus a negative list to foreign investment. This means that foreign investors and Chinese investors are generally treated equally, provided that:

• a foreign investor does not invest in an industry or sector that is prohibited by the foreign investment negative list; and
• a foreign investor satisfies certain conditions when investing in an industry or sector that is restricted by the foreign investment negative list.

In addition, China is a member of the World Trade Organization, and has entered into more than 130 bilateral investment treaties and more than 100 double tax treaties with other countries.

Generally, there are no restrictions on payments abroad or the repatriation of capital by foreign investors. According to PRC laws, a foreign investor may freely remit into or out of China its capital contributions, profits, capital gains, proceeds from the disposition of assets and proceeds from liquidation, whether in CNY or in a foreign currency.

Typically, a project company will maintain its CNY account(s) and/or foreign currency account(s) onshore with Chinese banks. In several circumstances (such as for the purpose of collecting offshore revenue proceeds, or making payment of expenditures outside China), PRC laws allow a project company to maintain offshore foreign currency accounts, provided that the project company applies for and obtains approval from the SAFE in advance.

The following registration/filing requirements apply to financing agreements.

NDRC 56 Registration

For foreign loans with a tenor of more than one year, the borrower is required to apply for registration in advance with the NDRC. It is noteworthy that the NDRC 56 registration is required not only where the borrower is a Chinese enterprise but also, technically, where the borrower is an offshore subsidiary or an offshore branch controlled by a Chinese enterprise.

Foreign Debt Registration

After the signing of the loan agreement, the borrower is required to register the loan agreement with the SAFE.

Cross-Border Security Registration

Under PRC laws, there are two types of cross-border security that need to be registered with the SAFE: NBWD and WBND (see 2.5 Restrictions on the Grant of Security or Guarantees).

In addition, security created over certain types of assets located in the PRC needs to be registered in the relevant asset-based registry for perfection purposes; see 2.1 Assets Available as Collateral to Lenders for details.

In China, land and natural resources are generally owned by the state. Individuals or enterprises can be granted the usufruct in order to use or operate such assets; a licence or a certificate (such as a land-use certificate) will be required in this respect. However, foreign entities are restricted from holding the usufruct of land or natural resources directly. As required by the principle of commercial presence, foreign entities need to establish a foreign investment enterprise in China in order to undertake relevant business or operate such assets.

The security agent concept is generally recognised in the PRC and a security agent can hold security, enforce the syndicate’s rights under the loan documents and apply any enforcement proceeds in accordance with the instructions of the lenders in the syndicate.

Where security interests compete with each other, priority will be determined based on the time when the security interest is perfected: the security interest that is perfected earlier will have priority over that which is perfected later.

Where a sponsor injects equity by way of subordinated debt, the project finance lenders usually procure a subordination undertaking from that sponsor. This kind of contractual subordination provision should generally be upheld by the PRC court, even in the case of the insolvency of the borrower, provided that the contractual subordination provisions do not violate the rules governing the priority of competing security interests under PRC laws.

PRC laws do not generally require a project company to be organised under the laws of China. However, in practice, the competent governmental authority usually requires the project company to be a company incorporated under the laws of China.

As a matter of fact, it is extremely rare for a project company to be a foreign company incorporated outside China, and the typical legal form of a project company is a limited liability company.

The Enterprise Bankruptcy Law of the PRC provides for three types of insolvency proceedings: reorganisation, conciliation and bankruptcy liquidation. An insolvency proceeding is commenced by filing an application with the competent PRC court.

A debtor can file an application for reorganisation, conciliation or bankruptcy liquidation with the competent PRC court if the debtor is insolvent (ie, it is unable to pay off its due debt and/or its assets are not sufficient to pay off all its debts). A creditor can also apply for the reorganisation or bankruptcy liquidation of a debtor from the competent PRC court if the debtor is unable to pay off its due debt. If the court accepts the application, it shall appoint an administrator. Once appointed, the administrator will take over all the debtor’s assets, as well as the management of the debtor. The administrator shall report to the court and be supervised by the creditors’ meeting and the creditors’ committee.

During the reorganisation proceedings, the debtor or the administrator shall prepare and submit a draft reorganisation plan to the court and the creditors’ meeting within six months (unless otherwise extended) after the court accepts the reorganisation application. The creditors will discuss the draft reorganisation plan in the creditors’ meeting, and will be divided into groups based on the categories of debts for voting on the draft reorganisation plan. If all groups of creditors pass the draft reorganisation plan, it will be submitted to the court for approval. The reorganisation proceedings shall be terminated upon approval of the reorganisation plan by the court. If the reorganisation plan is not passed by the creditors’ meeting or in other circumstances prescribed by the Enterprise Bankruptcy Law, the court will terminate the reorganisation proceedings and declare the bankruptcy of the debtor.

A debtor can apply for conciliation with the court directly; it can also apply for conciliation after the court accepts a bankruptcy application made by a creditor, but before the declaration of bankruptcy of the debtor. In applying for conciliation, the debtor shall submit a draft conciliation agreement. The creditors’ meeting will discuss and vote on the draft conciliation agreement. If it is passed by the creditors’ meeting, the court shall rule to acknowledge the draft conciliation agreement and terminate the conciliation proceedings. If the draft conciliation agreement is not passed by the creditors’ meeting or in other circumstances prescribed by the Enterprise Bankruptcy Law, the court will terminate the conciliation proceedings and declare the bankruptcy of the debtor.

Once the court declares the bankruptcy of the debtor, it shall notify the debtor, the administrator and the creditors, and make a public announcement. The administrator shall prepare a conversion plan and a distribution plan for the bankruptcy estate, and submit that plan to the creditors’ meeting for discussion. Once the plan has been passed by the creditors’ meeting and approved by the court, the administrator shall be responsible for selling off the bankruptcy estate (usually through auction) and carrying out the distribution plan. Following the final distribution of the bankruptcy estate, the administrator will submit a distribution report to the court, based on which the court will decide whether to conclude the bankruptcy proceedings.

As a matter of principle, upon the debtor’s insolvency a secured lender shall still enjoy priority over the security assets and can enforce the security in accordance with the provisions of PRC laws.

The Enterprise Bankruptcy Law of the PRC provides that, after the court accepts the insolvency application, the preservation measures concerning the debtor’s property shall be released and the execution procedures shall be suspended. Similar to unsecured creditors, a secured lender shall file its claim (specifying the claim amount as well as whether the claim is secured) with the administrator and participate in the insolvency proceedings. In particular, a secured lender shall suspend the enforcement of security during the reorganisation proceedings. However, if there is a possibility that the collateral may be damaged or the collateral value may decrease dramatically so that it will prejudice the rights of the secured lender, the lender may apply to the court for resumption of the enforcement of security.

In the case of bankruptcy liquidation proceedings, secured creditors may recover their outstanding loans from the enforcement proceeds of the collateral, and also from the debtor’s general assets to the extent that those secured creditors cannot fully recover their loans from the enforcement proceeds of the collaterals. Subject to the credits mandatorily preferred by PRC laws (such as wages, social insurance premiums and taxes), proceeds from the disposition of the debtor’s general assets are distributed to creditors on a pro rata basis.

In the case of a reorganisation proceeding, all the creditors, including secured creditors, will recover their outstanding loans in accordance with the approved reorganisation plan.

Lenders should be aware of the following risks associated with a borrower, security provider or guarantor becoming insolvent (this is not an exhaustive list).

First, PRC laws provide that, after the court accepts the insolvency application, the preservation measures concerning the debtor’s property shall be released and the execution procedures shall be suspended. Similar to unsecured creditors, a secured lender shall file its claim (specifying the claim amount as well as whether the claim is secured) with the administrator and participate in the insolvency proceedings. In particular, a secured lender shall suspend the enforcement of security during the reorganisation proceedings. However, if there is a possibility that the collateral may be damaged or the collateral value may decrease dramatically so that it will prejudice the rights of the secured lender, the lender may apply to the court for resumption of the enforcement of security.

Secondly, the following transactions are voidable upon insolvency:

• the transfer of the debtor’s assets for free within one year before the court accepts the bankruptcy application;
• transactions entered into with other parties at an undervalue within one year before the court accepts the bankruptcy application;
• security provided for existing debts within one year before the court accepts the bankruptcy application;
• the payment of undue debts in advance within one year before the court accepts the bankruptcy application;
• a waiver of claim by the debtor within one year before the court accepts the bankruptcy application; or
• payments made to specific creditors (while the debtor is already insolvent) within six months before the court accepts the bankruptcy application.

Thirdly, mutual debts can be set off in insolvency proceedings, but with limitations. The debts to be set off must arise before the court accepts the bankruptcy application. If the creditor knows that the debtor is insolvent when it acquires the debt to be set off, set off is not permitted, because this will procure an advantage for the creditor to the prejudice of the debtor’s assets. In addition, a debt of unpaid capital contributions to the debtor is generally not permitted to be set off.

No entities are excluded from bankruptcy proceedings in China.

Insurance can only be provided by licensed Chinese insurance companies, which are heavily regulated.

Insurance policies over project assets should be payable to foreign creditors, provided that the creditor in question is named as a beneficiary under the relevant insurance policies.

Domestic lenders must pay enterprise income tax (EIT) in respect of interest originating both within and outside China.

PRC EIT will also arise in respect of interest payable to foreign lenders if:

• the foreign lender has no establishment in China but receives payment of interest sourced from China; or
• the foreign lender has an establishment in China and receives payment of interest sourced from China, but the payment of interest is not actually connected with that establishment.

Such EIT shall be subject to withholding at source. The payer (eg, the borrower) will be the withholding agent, and the EIT will be withheld from the interest amount paid to the foreign lenders.

China has signed double taxation treaties with many countries. Tax relief and exemption may be available from the payment of interest according to provisions of the double taxation treaty between China and the country of the foreign lender.

There is no specific tax provision under PRC laws regarding the proceeds of enforcing security or claiming under a guarantee. However, it is generally believed that similar tax treatment should apply to the extent the proceeds of enforcing security or claiming under a guarantee (or part of them) constitute the payment of interest.

Other taxes may also be applicable (eg, value-added tax). Domestic lenders shall pay value-added tax in respect of the payment of interest. For foreign lenders receiving the payment of interest from China but having no establishment in China, value-added tax will be deducted from the payment by the payer (eg, the borrower).

As a result of the market-oriented interest rate reform, there are currently no usury laws or regulations generally limiting the amount of interest charged by lenders.

According to the Supreme People’s Court’s latest judicial interpretation, the interest rate for private lending shall not exceed four times the Loan Prime Rate (which is the benchmark rate published on a monthly basis by the National Interbank Funding Centre authorised by the PBOC) for a one-year loan when the loan agreement is concluded. Generally, private lending refers to lending transactions between natural persons, companies or other organisations, but excludes loans provided by regulated financial institutions (such as banks). The Supreme People’s Court’s latest judicial interpretation clearly provides that it shall not apply to loans provided by regulated financial institutions. However, in practice, the PRC courts may apply the above interest rate limit to loans provided by other lenders (including by foreign lenders).

For a foreign-related contract, PRC laws generally allow the parties to choose the governing law of that contract (PRC laws or a foreign law), except where the choice of foreign law violates mandatory PRC legal provisions or any provision of the foreign law violates a public policy of the PRC in the determination of a particular issue, in which case PRC laws would be the applicable laws. Under PRC laws, contracts are considered to be foreign-related contracts when:

• either party or both parties to the contract are foreign persons or foreign entities;
• the habitual residence of either party or both parties to the contract is located outside the territory of the PRC;
• the subject matter of the contract is outside the territory of the PRC; or
• the legal fact that leads to the establishment, change or termination of the contract relationship happens outside the territory of the PRC.

Based on this, if all parties to a project agreement are Chinese companies and no other foreign factors are involved, the project agreement shall be governed by PRC laws. However, if one of the parties to a project agreement is a foreign company, then, in most cases, that project agreement could be governed by a foreign law, provided that this does not violate the mandatory provisions under PRC laws.

For loan agreements entered into between a Chinese company and foreign lenders, PRC laws generally allow the parties to choose a foreign law as the governing law (in particular, English law), and PRC courts will give effect to the choice of foreign law.

For security documents, however, as a matter of the lex situs doctrine, the security is typically governed by PRC laws, since the security asset is located in China.

As a matter of the lex situs doctrine, a security document is typically governed by PRC laws, since the security asset is located in China.