Financial leasing through gratuitous transfers of assets

By Xu Rundong, AnJie & Broad Law Firm
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Financial leasing, as a capital-intensive industry, is characterised by the high value of leased assets and long asset recovery cycle, which requires leasing companies to pay special attention to preventing and controlling legal risks in business activities.

According to the Civil Code, a financial leasing contract based on fictitious leased assets shall be invalid, with leasing companies subject to stricter requirements regarding the compliance of underlying assets.

In practice, the leased asset obtained through a gratuitous transfer, meaning a transfer for no consideration, requires special attention due to the uniqueness of its ownership acquisition.

ELIGIBLE ENTITIES

A gratuitous transfer is a special type of state-owned asset transaction, and to avoid loss of state-owned assets there are clear restrictions on eligible entities.

Financial leasing by transfers of assets
Xu Rundong
Partner
AnJie & Broad Law Firm

The Interim Measures for Transfer of State-owned Property Rights of Enterprises in 2005 limited gratuitous transfers to transactions among government agencies, public institutions, solely state-owned companies and solely state-owned enterprises.

In 2014, the Circular on Promoting Transfer of State-owned Property Rights of Enterprises expanded eligible entities to wholly state-funded enterprises, namely “enterprises 100% funded by state-owned capital”. The underlying logic is that gratuitous transfers will not result in the loss of state-owned assets because wholly state-funded enterprises are 100% state-owned, either directly or indirectly.

The latest Circular on Trading and Transfer of State-owned Assets of Enterprises, recently issued by the State-owned Assets Supervision and Administration Commission (SASAC), explicitly permits gratuitous transfers among enterprises under the control or actual control of state and/or their wholly (directly or indirectly) owned subsidiaries. This circular expands the scope of entities eligible for gratuitous transfers and no longer requires 100% state ownership.

STATUTORY PROCEDURES

As noted, a gratuitous transfer means transferring state-owned assets for “no consideration”. To avoid the loss of state-owned assets and protect the interests of creditors of the transferors, the procedure of gratuitous transfer is divided into the following three steps.

(1) Internal resolution. After confirming that ownership of state-owned assets to be transferred for free is clear and undisputed – without encumbrances or litigation, arbitration or other judicial proceedings – parties to the gratuitous transfer transaction shall: (i) conduct a feasibility study and issue a feasibility report; (ii) conduct internal deliberation to form a written resolution; (iii) formulate a staff placement plan; (iv) conduct an audit or asset and capital verification; and (v) sign a gratuitous transfer agreement.

(2) External approval. The approving authority varies based on circumstances. All gratuitous transfers – with the exception of transfers of state-owned assets within state-funded enterprises – are subject to approval by the state-owned asset regulatory authorities.

More specifically: (i) if the transfer is subject to supervision by a single state-owned asset regulatory authority, the regulatory authority shall approve it; (ii) if the transfer is supervised by more than one state-owned asset regulatory authority, the state-owned enterprise shall report the transfer to all such regulatory authorities respectively for approval; (iii) any gratuitous transfer to a state-owned enterprise owned by the upper-level government shall be approved by both the lower-level government and the upper-level state-owned asset regulatory authority; (iv) for enterprises whose management is separated from government functions, such transfers shall be approved by the state-owned asset regulatory authority and the supervisory authority at the corresponding level respectively.

(3) Notification to creditors. Before implementing a gratuitous transfer, the transferor shall formulate a debt resolution plan and notify its creditors.

In practice, the debt resolution plan should fully consider and properly deal with the assets and debts of the transferor to avoid circumstances where the transferor exercises its revocation right to invalidate the gratuitous transfer.

The debt resolution plan needs approval only by the state-owned asset regulatory authorities. However, certain matters such as ensuring the debtors’ prior confirmation or subsequent verification could provide an additional guarantee for the legal effect of gratuitous transfer.

PROCEDURAL RISKS

If both parties to the gratuitous transfer transaction fail to comply with the statutory procedures, or if there are any procedural flaws, the following risks may arise:

Transfer agreement fails. The Interim Measures for Transfer of State-owned Property Rights of Enterprises provides that a gratuitous transfer agreement shall not take effect unless approved. Although these are ministerial rules only, a contract violating any rules concerning financial security, market order, national macro policy or any other public order or good morals should be deemed invalid in judicial practice.

This viewpoint is upheld in Buffett Investment v Shanghai Water Supply Investment and Construction, a case regarding disputes over equity transfer, published in the Supreme People’s Court Gazette.

Creditor revocation or debtor joint liability. If debtors transfer their properties for free and affect realisation of creditors’ rights, creditors may exercise the revocation right. In practice, if the transferor is unable to pay debt due to the gratuitous transfer, and the debt resolution plan provides no effective guarantee or other solutions for relevant creditors, the court will usually uphold the creditors’ revocation right.

In addition, since the transferees also need to resolve the gratuitous transfers, they will likely be deemed to have co-operated with the transferors in evading the debts, and be held liable for debts to the extent of value of the transferred asset.

Unable to obtain ownership. If a gratuitous transfer is invalid or revoked due to failure to comply with the statutory procedures, the lessee’s transfer of the leased asset will constitute unauthorised disposal. If the financial leasing company (normally a local financial organisation) fails to conduct adequate due diligence on the source of the leased property, it will most likely be deemed not in good faith; and therefore unable to obtain ownership of the leased asset.

REQUIRED DOCUMENTATION

When conducting due diligence on the underlying assets of gratuitous transfer, leasing companies should pay special attention to the following documentation to avoid major legal flaws in the leased property: (1) gratuitous transfer agreements; (2) internal resolution documents; (3) external approval documents; and (4) debt resolution plans and notification certificates to the creditors.

In addition to these four types of documents, in practice, lessees often need to provide application documents, feasibility reports, audit reports and staff placement plans for gratuitous transfers. These materials mostly involve administrative provisions and have limited impact on the legal effect of gratuitous transfers.

In addition, since the practices and criteria vary among different local state-owned asset regulatory authorities, flexible adjustments should accord to specific local policy on state-owned assets when carrying out specific projects.

Xu Rundong is a partner at the AnJie Broad Law Firm

AnJie Broad Law Firm

AnJie Broad Law Firm

19/F Tower D1, Liangmaqiao Diplomatic Office Building
19 Dongfang East Road

Chaoyang District
Beijing 100600, China

Tel: +86 10 8567 5988

Fax: +86 10 8567 5999

E-mail: xurundong@anjielaw.com

www.anjielaw.com

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