A previous article titled Non-causality and causality of commercial acceptance bills, discussed unlawful bill trading in bill recourse dispute cases, with commercial factoring companies or micro-loan companies often seeking recourse as bill bearers, stressing that “non-causality” of bills is “conditional”. This article focuses on defining “bona fide holder” in bill recourse for a commercial factoring company.
A genuine “causal relationship”, as specified in article 10 of the Negotiable Instruments Law, includes a product trading relationship with genuine transactions and a genuine claim-debt relationship. When a factoring company acquires accounts receivable, it becomes the new creditor, and the debt remains unaltered.
Accordingly, the factoring relationship can be a legal and valid causal bill relationship, and the factoring company can acquire bills issued/transferred by the debtor based on that factoring relationship.
Senior Partner
Leaqual Law Firm
However, in right of recourse dispute cases involving factoring transactions, all claims by the commercial factoring company cannot be supported solely by “bill non-causality”. The financial regulator has set out express provisions that bills as negotiable securities are also subject to strict regulatory supervision in the course of their passage from bearer to bearer.
If the acquisition of bills and factoring transaction arises under the violation of laws, regulations or mandatory provisions, the commercial factoring company ceases to be a “bona fide holder”, deeming its bill and factoring transaction invalid. That is, the company lacks the basis for lawful acquisition of a bill and the right of recourse.
For example, a certain local commercial factoring company maintains a long-term factoring business relationship with three local companies: A, B and C. None have been registered for more than five years, and they all have registered capital of about RMB1 million (USD143,000) without a defined main business.
Single item factoring contracts between the commercial factoring company and companies A, B and C amount to at least RMB50 million, respectively, and all contracts are for accounts receivable factoring transactions with commercial acceptance bills as their subject matter. There are no basic materials for factoring transactions concerning the assessment of the three companies’ business status, and no basic financial data on their operations.
In many recourse rights dispute cases, recourse was indiscriminately sought against a prior bearer directly on the grounds of bill “non-causality”, instead of demanding that companies A, B and C bear the liability for repayment.
Article 761 of the Civil Code provides that: “A factoring contract is a contract wherein the accounts receivable creditor transfers current or future accounts receivable to the factor, who will provide services regarding financing, accounts receivable management or collection, security of payment by the accounts receivable debtor, etc.” A factoring transaction involving three entities of the creditor, debtor and factoring company includes two contractual relationships: one under an underlying contract, such as a trade or service contract between the creditor and debtor; and one under the factoring contract, which is concluded based on the underlying relationship.
It is clearly unreasonable for companies A, B and C to “acquire” a large number of commercial acceptance bills from various industries indiscriminately without specifying their main business, lacking the reasonable precondition of “transfer of accounts receivable arising under a contract for the trade of goods or service contract”. As a result, the underlying relationship between the creditor and the debtor is inconsistent with the law. In that case, the commercial factoring company concluded factoring contracts with them without any financial indicator analysis or risk controls, effectively deviating from the essence of the factoring business.
The fourth paragraph of article 1 of the Notice of the General Office of the China Banking and Insurance Regulatory Commission on Strengthening the Supervision and Administration of Commercial Factoring Enterprises specifies that “a commercial factoring enterprise may not commit any of the following acts or engage in any of the following business: … engaging in factoring financing business based on an unlawful underlying trading contract, consignment contract, accounts receivable without clear title, payment claim arising from bills or other negotiable securities, etc. …”
The seventh paragraph of article 2 specifies that: “A commercial factoring enterprise shall comply with the following regulatory requirements:
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- The acquisition of the accounts receivable of any one debtor may not exceed 50% of its total risk assets; and
- The acquisition of accounts receivable of a debtor that is an affiliate may not exceed 40% of its total risk assets.”
It follows that a commercial factoring company can form a lawful and valid causal bill relationship and acquire bills issued/transferred by a debtor based on a factoring relationship.
However, engagement in a commercial factoring business must be based on lawful underlying trading contracts, and a factoring financing business should not be based on payment claims arising from bills or other negotiable securities. Importantly, all factoring business review responsibilities expected by the financial regulator must be fully performed. Where these steps fail, the factor ceases to be a “bona fide holder” of the commercial acceptance bills.
In short, during right of recourse dispute litigation, a commercial factoring company needs to review at least: whether there is a genuine transaction between the creditor and debtor; whether accounts receivable in the factoring relationship genuinely exist; and whether the entire transaction procedure violates laws, regulations or mandatory provisions of financial regulation.
Zhao Dongxu is a senior partner at Leaqual Law Firm
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