Project Finance 2022

Last Updated September 23, 2022

China

Law and Practice

Author



Jingtian & Gongcheng is one of the first private partnership law firms in China. Since its establishment, Jingtian & Gongcheng has been dedicated to providing clients with high-quality and efficient legal services and has grown into one of the top full-service business law firms in China. The firm is active in a wide variety of practices and is recognised as an industry leader in capital markets, banking and finance, mergers and acquisitions, outbound investment, dispute resolution, and private equity (PE)/venture capital (VC) investments. It has always been deeply committed to serving its clients and maximising their interests, and can therefore boast a long list of many first-of-its-kind matters in various practices and sectors. Jingtian & Gongcheng has won numerous awards and recommendations from leading legal publications. The firm is headquartered in Beijing, with offices strategically located in Shanghai, Shenzhen, Chengdu, Tianjin, Nanjing, Hangzhou, Guangzhou, Sanya and Hong Kong.

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 enterprise to private enterprise, 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, while 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 legislations applicable to public-private partnership transactions include (but 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.

Firstly, the parties need to consider carefully on what basis 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.

It is expected that the industries/sectors relating to the so-called New Infrastructure, such as 5G, Data Centre, AI, Industrial Internet and IoT, etc, will 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 asset needs to be registered at the relevant asset-based registry for perfection purposes. The security perfection requirements for these types of asset 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;
  • for receivables – online registration at the Credit Reference Centre of the People’s Bank of China;
  • for shares in Chinese companies – depending on the types of company whose shares are pledged, registration at:

a)       the local State Administration for Market Supervision; or

b)       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, semi-manufactured products as well as its finished products, both those currently owned and 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 CNYB30 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 identify individually 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 in advance with the relevant security registry 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), which are Nei Bao Wai Dai (NBWD) and Wai Bao Nei Dai (WBND). 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 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 includes, among others, whether there are other liens or restrictions on the collateral. 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 de-registering 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.

Firstly, 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 off the collateral, 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 in the event that 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 same. The 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 (PRC laws or a foreign law) of that contract 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, the following contracts are considered to be foreign-related contracts:

  • 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;
  • the legal fact that leads to the establishment, change or termination of the contract relationship happens outside the territory of the PRC; and
  • any other contracts that may be determined as foreign-related contracts.

Based on the foregoing, for loan agreements entered into between a Chinese company and foreign lenders, PRC laws generally allow the parties to choose a foreign law (in particular, English law) as the governing 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, PRC courts shall, according to the international treaties concluded or acceded to by the PRC or based on the principle of reciprocity, 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 and 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, currently, China is still going through the ratification procedure. To date, there is no other international treaty in respect of recognition and enforcement of judgment between the PRC and England/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 provided that 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.

It is worth mentioning the following regulatory requirements when foreign lenders grant loans within the PRC.

Foreign Debt Quota

Pursuant to the regulations of the People’s Bank of China (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 * the cross-border financing leverage ratio * the macro-prudential regulation parameter.

Depending on the types 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; 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 for both financial institutions and enterprise borrowers.

NDRC 2044 Filing

For foreign loans with a tenor of not less than one year, the borrower is required to make a filing in advance with the National Development and Reform Commission of the PRC (NDRC). It is noteworthy that the NDRC 2044 filing is required not only where the borrower is a Chinese enterprise; technically, it is also required 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.

It is worth mentioning the following regulatory requirement when granting security or guarantees to foreign lenders: under PRC laws, there are two types of cross-border security that need to be registered with the SAFE, which are NBWD and WBND. 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 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 within China and take security over assets located in China, the security is not required to be registered with the SAFE.

In addition to the foregoing, security created over certain types of assets located in the PRC need 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. That means that foreign investors and Chinese investors are generally treated equally, provided that (i) a foreign investor does not invest in an industry or sector which is prohibited by the foreign investment negative list, and (ii) a foreign investor satisfies certain conditions when investing in an industry or sector which is restricted by the foreign investment negative list.

In addition, China is a member of the World Trade Organization. China 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 repatriation of capital by foreign investors. A foreign investor may, according to PRC laws, freely remit into or out of China its capital contributions, profits, capital gains, proceeds from disposition of assets, and proceeds from liquidation, whether in RMB or in a foreign currency.

Typically, a project company will maintain its RMB 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 an approval from the SAFE in advance.

It is worth mentioning the following registration/filing requirements that are applicable to financing agreements.

NDRC 2044 Filing

For foreign loans with a tenor of not less than one year, the borrower is required to make a filing in advance with the NDRC. It is noteworthy that the NDRC 2044 filing is required not only where the borrower is a Chinese enterprise; technically, it is also required where the borrower is an offshore subsidiary or an offshore branch controlled by a Chinese enterprise.

Foreign Debt Registration

After signing 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, which are NBWD and WBND. 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 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 in 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 need 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 with 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 that the project company be a company incorporated under the laws of China.

As a matter of fact, it is extremely rare that a project company is 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, which are 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 (a debtor will be considered insolvent if 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 with 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 by 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 accept 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 to the court a distribution report, 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. Similarly 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, during the reorganisation proceedings a secured lender shall suspend the enforcement of security. 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, while secured creditors may recover their outstanding loans from the enforcement proceeds of the collaterals, secured creditors may also recover their outstanding loans 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 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).

Firstly, 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. Similarly 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, during the reorganisation proceedings a secured lender shall suspend the enforcement of security. 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;
  • payment of undue debts in advance within one year before the court accepts the bankruptcy application;
  • waive of claim by the debtor within one year before the court accepts the bankruptcy application; or
  • payment 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 for the creditor an advantage 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.

There are no entities that are excluded from bankruptcy proceedings in China.

Insurance can be provided only 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 (i) the foreign lender has no establishment in China but receives payment of interest sourced from China, or (ii) 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. The aforementioned EIT payable by foreign lenders 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 payment of interest.

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

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

It is noteworthy that, 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 by a bank). 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 (PRC laws or a foreign law) of that contract 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, the following contracts are considered to be a foreign-related contract:

  • 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;
  • the legal fact that leads to the establishment, change or termination of the contract relationship happens outside the territory of the PRC; and
  • other contracts that may be determined as foreign-related contracts.

Based on the foregoing, 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 (in particular, English law) as the governing 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 previously mentioned, 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.

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Trends and Developments


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Zhonglun W&D Law Firm originated in Beijing in 1992 and is one of the earliest-established Chinese law firms approved by the Ministry of Justice. Today, it has become a large comprehensive law firm rooted in China with international perspectives, as well as the first law firm in China to set up branches in London and Saudi Arabia. The firm is headquartered in Beijing and has 24 offices in Shanghai, Chengdu, Shijiazhuang, Tianjin, Taiyuan, Wuhan, Guangzhou, Jinan, Shenzhen, Qianhai, Changzhou, Chongqing and other mainland cities. In addition, it has an established service branch in Hong Kong, and provides legal services in major cities in Europe and the Middle East, such as London, Riyadh, Paris and Lyon. The firm has more than 2,500 practising lawyers and professionals, who are equipped with solid theoretical knowledge and intensive practical experience, providing comprehensive, quality and efficient legal services for Chinese and overseas clients alike.

Project Finance in China’s Real Estate Sector

Changes in regulatory policies on project finance in China’s real estate sector

Since 2016, the supervision and control policies of project financing in China’s real estate sector have been increasingly strict, mainly in the aspects of land financing, project development financing and pre-sale funds, etc. In December 2016, the Central Economic Working Conference proposed that “housing is for living in, not for speculation”, which started the deleveraging of the real estate industry. On 27 April 2018, the People’s Bank of China and three other departments issued new asset management regulations, the Guiding Opinions on Regulating the Asset Management Business of Financial Institutions, to restrict land financing. On 20 August 2020, in order to control the growth of interest-bearing debts of real estate enterprises, the Ministry of Housing and Urban-Rural Development and the People’s Bank of China convened a symposium of 12 key real estate enterprises in Beijing. The symposium formulated fund monitoring and financing management rules for key real estate enterprises, namely, the real estate enterprises will be supervised by dividing them into four categories by three regulatory indicators, ie, after deducting the advance receivables, the liability to asset ratio of less than 70%, the net gearing ratio of less than 100% and the cash-to-short-term borrowing ratio of at least 1, which can be referred to as the “Three Red Lines” regulations. As the first batch of pilot enterprises, the 12 real estate enterprises participating in the conference as required, shall achieve all the targets of the “Three Red Lines” regulations by the end of June 2023, and other real estate enterprises should achieve all the targets of the “Three Red Lines” regulations by the end of 2023. The “Three Red Lines” regulations mainly restrict development financing. In July 2021, the Ministry of Housing and Urban-Rural Development and other seven ministries jointly issued the Notice of the Ministry of Housing and Urban-Rural Development and Other Seven Departments on Continuing to Regulate the Order of the Real Estate Market to supervise the pre-sale funds of real estate enterprises.

According to the actual financing data of real estate projects, the real estate financing contracted by more than CNY800 billion in the second half of 2021. While net funding rose slightly in the first half of 2022, it was still lower than that of the same period last year. The financing of real estate enterprises was under great pressure. Although the financing scale of bank credit extension, overseas bonds and trust continued to shrink, the financing scale of new financing instruments such as trade acceptance, factoring and asset securitisation increased relatively. The following is a brief introduction to the current status and development trend of the seven major financing instruments in China’s real estate sector.

Main instruments and development trends of project finance in China’s real estate sector

Bank loans

Bank loans mainly include development loans, M&A loans, land reserve loans, working capital loans, commercial property loans, policy-based lending, etc. According to the statistics on the research report of TF Securities, compared with the end of 2021, the balance of real estate development loans in the first half of 2022 increased by CNY480 billion, a year-on-year growth of 1.54%, which is nearly 10 percentage points lower than the overall loan balance growth of financial institutions. The share of new credit extended by banks to real estate fell to 4.9% in the first half, down 14% from 2021. On the whole, the proportion of real estate credit resources has been significantly reduced, and it is more difficult for real estate projects to obtain funds through bank loans.

In recent years, there has been an upward trend in real estate loan lawsuits associated with Chinese banking institutions, and the credit risk in the real estate sector has flowed on to the banking institutions. When pursuing repayment by lawsuits, banking institutions have experienced difficulties in the enforcement and confirmation of their rights to the collaterals for the loans, which are also related to the flaws in mortgage procedures. Among them, the dispute with Chinese characteristics and most relevant to the people’s livelihood is the confrontation between the buyer’s right to claim transfer of the house and the mortgagee right. According to the relevant Chinese laws, if the house purchased is for residential use, the sale and purchase contract is signed before the property is seized by court, and the price paid exceeds 50% of the total price, the buyer’s right to claim transfer shall take precedence and the bank cannot enforce its mortgagee right. Such dispute resolution is an exception made for the protection of consumers in response to irregular pre-sale of commercial housing and other practices existing in China.

Debenture bonds

Debenture bonds refer to the bonds issued by entities other than the government, which stipulate certain cash flow from principal and interest payments. Real estate enterprises can issue enterprise bonds, corporate bonds, short-term financing bonds, medium-term notes and private placement notes and other debenture bonds for project construction.

Overall, the issuance scale of domestic bonds and overseas bonds of China’s real estate enterprises contracted in the first half of 2022. According to statistics on the research report from Huatai Securities, the issuance scale of domestic bonds in real estate sector amounted to CNY295.2 billion in the first half of 2022, down 23% year on year. In terms of the nature of enterprises, in the past two years, the proportion of local state-owned enterprises and central enterprises using domestic bonds for financing has been increasing, but it is more difficult for private enterprises to raise funds through domestic bonds. The financing function of overseas bonds in real estate sector decreased significantly. In the first half of 2022, the issuance scale of overseas bonds in real estate sector amounted to CNY58 billion (the exchange rate of US dollar to RMB is 1:6.6899), down 72% year on year; net repayments amounted to CNY177.9 billion, while the net repayments for the whole year of 2021 was only CNY88 billion. According to the data from Wind (Wind Information Co Ltd, a financial information service agency), the yield to maturity of Markit iBoxx Asian dollar bonds in real estate sector issued by China-invested enterprises has risen again since June 2022. Most of the real estate enterprises are difficult to repay the stock of overseas debt by issuing new overseas bonds, only through other channels of financing.

In addition, there was an increase in bond defaults by real estate enterprises in 2021. According to the White Paper on the Credit Status of Chinese Real Estate Development Enterprises in 2021 published by the China Real Estate Association, as of 31 December 2021, there were 12 credit entities in 2021 that had defaulted on offshore real estate bonds for the first time, involving a total of 76 bonds (excluding rollovers), corresponding to an issuance amount of USD47.034 billion and a bond balance of approximately USD45.197 billion. At the same time, there were nine real estate bond issuers confirming substantial defaults or triggering cross-clauses on domestic bonds (excluding rollovers), involving a total issuance amount of USD57.290 billion, an increase of 82.16% over the whole year of 2020.

From the perspective of resolution measures for bonds defaults, upon the emergence of a bond default signal or the occurrence of a substantial default, enterprises may usually avoid and manage the risk event by making active efforts to communicate with creditors to seek rollover, initiate USD bond exchange offers, reorganise after the event, and take other measures. First, in the case of real estate enterprises with tighter liquidity and more evident default signals but not yet in default, they may either pay interest within the grace period or communicate with creditors to reach a rollover agreement or initiate USD bond exchange offers before default to avoid substantial default from occurring. In this case, since the enterprise still enjoys a certain degree of solvency and market recognition, it is easier for creditors to grant rollover, but creditors will generally require the indebted real estate enterprises to provide credit enhancement measures such as equity pledge and asset mortgage in order to prevent third-party creditors from seizing the assets of the indebted enterprises by launching lawsuits in advance. USD bond exchange offer is also one of the measures commonly used by enterprises to avoid bond defaults, specifically, the issuance of new bonds by indebted real estate enterprises in exchange for old bonds before the maturity of the old bonds. Creditors agreeing to the USD bond exchange offer will generally also demand some measures of compensation, such as raising the coupon rate as compensation. Next, in the case of enterprises that have already experienced substantial defaults such as failure to pay principal and interest on time and cross-defaults due to rating downgrades, debt reorganisation may be adopted as a solution. Debt reorganisation means that without changing the counterparties involved in the transaction, an agreement on the debt settlement time, amount or manner is reached by agreement between the creditor and the debtor upon their agreement or by court decision. The specific ways of debt reorganisation in practice mainly include debtor’s settlement of debts with assets, debtor’s conversion of debts into equity instruments and change of the principal or interest of debts, repayment terms of debts, etc. In practice, the more common schemes used by enterprises following real estate bond defaults include payment of principal by instalments, payment of interest by instalments, providing additional credit enhancement measures, etc.

Real estate trust

Real estate trust loan refers to the fund provided by the trustor to the trust company (trustee). As the trustee under the trust plan, the trust company shall provide trust loans to financing parties such as real estate developers or project companies according to the trust documents and contracts. Meanwhile, the financing parties shall provide guarantee measures such as asset mortgage, equity pledge and third-party guarantee to the trust company, and repay the principal and interest on time. After the trust expires, the trust company shall distribute the principal and income to the trustor.

Since May 2019, the China Banking and Insurance Regulatory Commission began to strengthen the supervision of trust financing in the real estate sector, and then the scale of trust financing in the real estate industry continued to decline. According to the China Trustee Association, as of the first quarter of 2022, the balance of trust funds invested in real estate sector amounted to CNY1.57 trillion, shrinking by nearly half from the peak in the second quarter at the end of 2019, while the proportion of the balance also fell by nearly 5 percentage points. In the meantime, the trust default in real estate sector is relatively significant. According to the statistics on the research report of Hwabao Securities, a total of more than 280 projects with trust default risk were disclosed in 2021, involving about CNY150 billion. Among them, a total of approximately CNY91.7 billion was involved for projects with trust default risk in real estate sector, accounting for 60% of the total default amount, becoming the “hardest hit area” for default in the industry. With the increase of defaults by real estate enterprises, most of the trust companies have taken measures to suspend or tighten the real estate trust business.

A large number of real estate trust projects in default are no longer disposed of by a combination of mortgage security, notarised debt instrument and enforcement. This is because the traditional disposal approach has some disadvantages such as being costly and time-consuming, public disclosure of litigation information with an impact on the reputation of real estate enterprises, and the project company’s assets being subject to the bankruptcy of the debtor group. Instead, the trust company has turned to set up new trust schemes in which the debtor entrusts the equity of the project company as trust property to be held by the trust company in order to divest the project company from the debtor’s assets, thus achieving effective risk segregation. This has become an emerging trend in the disposal of real estate trust projects in default in China.

Commercial acceptance bills

Commercial acceptance bill (trade acceptance) refers to the bill issued by the drawer and accepted by the drawee other than the bank, and it entrusts the drawee to unconditionally pay a certain amount to the payee or the bill holder on a specified date, which is an instrument for deferred payment in corporate transactions. With the narrowing of overall financing channels, real estate enterprises tend to use more commercial financing instruments. According to the statistics of CRIC (a real estate information and consulting service provider), 67 sample real estate enterprises maintained year-on-year growth rates of bills payable of over 40% from 2017 to 2020. However, due to the liquidity problems of some enterprises recently, the problem of overdue trade acceptance has also begun to emerge. The number of real estate enterprises on the overdue list of trade acceptance in August 2022 reached 2,801 based on CRIC’s monitoring, a month-on-month increase of nearly 40%. If the overdue risks of the real estate enterprises cannot be alleviated, the difficulty of trade acceptance financing will increase.

Factoring

Factoring refers to a comprehensive financial service method in which the seller (creditor) transfers its current or future accounts receivable arising from the goods sales and service contract with the buyer (debtor) to the factor, and the factor provides the seller (creditor) with financing, credit evaluation of the buyer (debtor), sales account management, credit risk guarantee, collection of accounts, etc, and the buyer (debtor) directly reimburses the factor when the accounts are due. Bank factoring is the factoring business carried out by banking financial institutions, while commercial factoring is the factoring business carried out by commercial factoring companies.

Since 2020, the development trend of factoring financing instruments in China has been positive. Pursuant to the China Factoring Industry Development Report (2020–21) released by the China Banking Association, the bank factoring business volume of the members of the Professional Factoring Committee amounted to CNY2.49 trillion in 2020, up 17.40% from CNY2.12 trillion in the previous year. In accordance with the China Commercial Factoring Industry Development Report 2021 released by the Professional Committee on Commercial Factoring of China Association of Trade in Services and its estimation, the commercial factoring business grew by 34.7% year-on-year to CNY2.02 trillion in 2021. With the increase of factoring business volume, factoring disputes were also on the rise. From data released by the official website of the Beijing Arbitration Commission, the arbitration institution accepted 29 cases involving commercial factoring disputes in 2021, with a total bid amount of CNY430 million. Compared with 2020, the average bid amount of cases increased from CNY1.72 million to CNY15.08 million, with an increase rate of 776%.

Asset securitisation and real estate investment trusts (REITs)

Asset securitisation is supported by the future cash flows generated from the underlying assets. It achieves the redistribution of risks and benefits through credit enhancement on the structural design and combination of the cash flows in the underlying asset pool. In fact, it transforms the illiquid underlying assets into asset-backed securities (ABS) with different credit ratings. The ABS of real estate enterprises mainly include ABS of house-purchase balance payment, ABS of supply chain, ABS of property fee, commercial mortgage-backed securities (CMBSs), commercial mortgage-backed notes (CMBNs) and REITs, quasi-REITs, etc. The financing of ABS for real estate enterprises has obtained good results since 2022. According to the monitoring by the China Index Academy (a research institution under China Index Holdings that specialises in the real estate sector), ABS financing accounted for 31.2% of the total non-bank financing of real estate enterprises from January to August 2022, up 8.9 percentage points year-on-year.

REITs are worth noting. In the field of infrastructure construction, the “Three Red Lines” regulations and other regulatory policies have reduced the willingness to extend credit. At the same time, the COVID-19 pandemic has led to a downturn in the economy and the national budget for infrastructure has been correspondingly reduced. Since the two traditional sources of funding for infrastructure construction have been greatly restricted, REITs financing instruments thus have become the highlight of financing. REITs are special financial products that collect funds from public investors and are invested and operated by professional investment institutions in real estate and legal-related businesses, and regularly distribute most of the investment income to investors. In April 2020, the CSRC and the National Development and Reform Commission jointly issued the Notice of Promoting the Work Concerning the Pilot Programme of Infrastructure Real Estate Investment Trusts (REITs), marking the official establishment of public offered REITs in China. In June 2021, the first batch of nine publicly offered REITs in the infrastructure sector were officially listed on the Shanghai and Shenzhen Stock Exchange in China. By the end of July 2022, the average gain of the first batch of REITs was nearly 40 percentage points higher than that of the Shanghai Composite Index in the same period, which was highly sought after by the capital market. Since then, China has further expanded the scope of the pilot to include publicly offered REITs in the government-subsidised rental housing sector. The publicly offered REITs are of great significance to broaden the social financing channels and reduce the level of corporate debt. At present, the publicly offered REITs are still in the pilot stage, and there is great room for development in the future.

M&A and bankruptcy reorganisation

Real estate enterprises in trouble can also obtain financial support through mergers and acquisitions or bankruptcy reorganisation to tide over the difficulties. Mergers and acquisitions of real estate refer to the sale of troubled project assets or equity interests of the project company by real estate enterprises to obtain funds. After acquiring project assets or project equity, the investor shall continue to invest funds for development and construction. Real estate enterprises can choose the mode of “mergers & acquisitions” for projects whose assets are greater than liabilities. For insolvent projects or projects for which no one is involved, the “bankruptcy reorganisation” mode (including pre-reorganisation mode in practice) may be adopted.

In December 2021, the People’s Bank of China and China Banking and Insurance Regulatory Commission jointly formulated and issued the Notice on Doing a Good Job in M&A Financial Services for Risk Disposal Projects of Key Real Estate Enterprises, in which “M&A Loan” and “M&A Bond” were proposed to provide financial support for “M&A” of risky real estate enterprise projects. However, according to the statistics of the Focus Research Institute, a market research institution in the real estate industry in China, the number of mergers and acquisitions of real estate enterprises is currently not high. In the first half of 2022, there were 42 M&A cases in the real estate sector, with an amount of CNY40.16 billion. The two data are only about one quarter of those of previous years. Therefore, it can be seen that the financing effect of real estate enterprises through mergers and acquisitions is not ideal at present.

The number of bankruptcy reorganisation cases of real estate enterprises has increased dramatically in the past two years due to the COVID-19 pandemic and the overall recession in the real estate market. The progress of bankruptcy reorganisation cases of real estate enterprises is related to the people’s housing problem, thus involving a wide range of issues and having a significant impact. As there are various forms of financing in the operation of real estate projects, there are also various legal relationships in the sale of commercial housing, such as the sale of one house to multiple buyers, rent after sale, and use of houses to offset debts. Given the aforesaid, the bankruptcy reorganisation of real estate enterprises features the involvement of numerous parties, complex legal relationships and intense conflicts of interest. At the same time, in order to renew a real estate enterprise’s project, it is necessary to complete various registrations with and obtain relevant permits from various government authorities, such as land, planning and taxation. Therefore, bankruptcy reorganisation of real estate enterprises requires the establishment of a unified co-ordination mechanism between government authorities and courts. Currently, there are 18 provinces in China that have established government-court co-ordination mechanisms, which have become a noteworthy emerging trend in the bankruptcy restructuring of real estate enterprises in China in recent years.

To sum up, the project financing of real estate enterprises faced great pressure on the whole in the first half of 2022. Influenced by the “Three Red Lines” regulations and other regulatory provisions, financial institutions and investors are more cautious in providing financing support to real estate enterprises. For real estate enterprises, it is usually private enterprises with good financial standing or central and state-owned enterprises with good reputation that can successfully issue bonds or trusts. Compared with traditional financing instruments such as bank loans, debenture bonds and trusts, new financing instruments such as trade acceptance, factoring and REITs are increasingly favoured by real estate enterprises. In particular, REITs, as a kind of equity financing, are not affected by the “Three Red Lines” regulations and other regulatory provisions, which will be helpful in reducing the level of corporate debt. That is why REITs will be a new highlight of future infrastructure project financing, which deserves close attention and study.

Zhonglun W&D Law Firm

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Jingtian & Gongcheng is one of the first private partnership law firms in China. Since its establishment, Jingtian & Gongcheng has been dedicated to providing clients with high-quality and efficient legal services and has grown into one of the top full-service business law firms in China. The firm is active in a wide variety of practices and is recognised as an industry leader in capital markets, banking and finance, mergers and acquisitions, outbound investment, dispute resolution, and private equity (PE)/venture capital (VC) investments. It has always been deeply committed to serving its clients and maximising their interests, and can therefore boast a long list of many first-of-its-kind matters in various practices and sectors. Jingtian & Gongcheng has won numerous awards and recommendations from leading legal publications. The firm is headquartered in Beijing, with offices strategically located in Shanghai, Shenzhen, Chengdu, Tianjin, Nanjing, Hangzhou, Guangzhou, Sanya and Hong Kong.

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Zhonglun W&D Law Firm originated in Beijing in 1992 and is one of the earliest-established Chinese law firms approved by the Ministry of Justice. Today, it has become a large comprehensive law firm rooted in China with international perspectives, as well as the first law firm in China to set up branches in London and Saudi Arabia. The firm is headquartered in Beijing and has 24 offices in Shanghai, Chengdu, Shijiazhuang, Tianjin, Taiyuan, Wuhan, Guangzhou, Jinan, Shenzhen, Qianhai, Changzhou, Chongqing and other mainland cities. In addition, it has an established service branch in Hong Kong, and provides legal services in major cities in Europe and the Middle East, such as London, Riyadh, Paris and Lyon. The firm has more than 2,500 practising lawyers and professionals, who are equipped with solid theoretical knowledge and intensive practical experience, providing comprehensive, quality and efficient legal services for Chinese and overseas clients alike.

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