Focus of judicial decision on invalid private bills discounting

Commercial acceptance bills commonly play a crucial role in business as a payment and financing instrument, while discounting is a regular way to boost liquidity.

Unlike commercial banks, private discounting typically involves intermediaries or commercial bill platforms with lower handling fees, faster receipt of proceeds and a flexible review process.

Discounting to commercial banks also requires the underlying transaction relationship to demonstrate legal and regulatory compliance, which is not mandatory for private discounting.

Before promulgation of the Minutes of the National Courts’ Civil and Commercial Trial Work Conference, several affirmative judgments of the Supreme People’s Court (SPC) explicitly elaborated on whether bills acquired by payment of consideration involve a true transaction relationship and creditor-debtor relationship; emphasising whether the holder has legal means of obtaining the bill.

Its conclusion, in summary, states: in the absence of evidence that the holder acquired the bills by means of fraud or coercion, maliciously or through gross negligence, the holder is deemed to have acquired legal rights to the bills, provided the bills are true and the holder has paid consideration for them.

However, China is not a case law country, and even the SPC’s precedents provide limited guidance in practice due to differences and evidence among specific cases.

Since promulgation of the minutes, the act is deemed invalid if a legitimate holder discounts bills to a party ineligible for discounting under the law.

What judicial authorities focus on from factual and legal perspectives is summarised here on analysing several judicial precedents:

Applying article 101 directly, providing extended interpretation.
Discounting is considered a financial franchised operation. In the private discounting of bills, the holder has no real transaction with the prior holder and lacks a true underlying legal relationship. Allowing individuals or institutions in the private sector to engage in discounting would undoubtedly harm public interests and social order. Therefore, such transactions should be deemed invalid.

Applying argumentum a minore ad maius.
Although article 101 of the minutes holds that the factual grounds for invalidity of discounting is that the legitimate holder discounts bills to a person ineligible for discounting, it is not necessarily premised on the literal interpretation of the legitimate holder or the legal judgment on the legality of the holding. In practice, if the prior holder is criminally implicated due to private discounting, applying the principle of argumentum a minore ad maius means that if the private discounting by a legitimate holder is deemed invalid, the private discounting by an illegal holder is also invalid. Therefore, the holder’s status will not affect the determination of invalidity.

Bill exchange generates no interest subsidies; does not conform to bill discounting characteristics.
In addition to delivery versus payment, it is also common to see financing in a disguised form of bill exchange. According to the General Rules for Loans and the Administrative Measures for Acceptance, Discounting and Re-discounting of Commercial Bills, commercial bill discounting can be construed as the financed party (legitimate holder) pays interest subsidies, and the financing party purchases rights to the bills that are not yet mature, thereby financing the financed party. In the bill exchange model, however, the transfer medium is a bill without any interest subsidy generated or money paid for financing purposes, which does not conform to the characteristics of bill discounting. Thus, bill exchange should preferably not be recognised as bill discounting without further evidence.

Restrictions on exercising the right to raise defences.
The Negotiable Instruments Law stipulates that the drawer, endorser, acceptor and guarantor shall be jointly and severally liable for the holder’s outstanding bill debts. However, it does not mean that each of the specific bill obligors has the right to defend with respect to whether the underlying transaction relationship or creditor-debtor relationship exists between the holder and any prior holder. The bill is drawn by the drawer and transferred to the holder on endorsement. However, the underlying relationship the prior holders’ transfers are based on may differ. The adjudication authority generally opines that the underlying relationship defence is a personal defence. Because endorsements have cut off the bill relationship between the holder and other bill obligors, except for the immediate prior holder, the defence of the specific obligor will not be accepted unless the holder acquires the bill while knowing that the underlying relationship defence exists.

Subjective fault affects the payment of overdue interest.
The subjective fault of both parties to discounting will also become a factor considered in the judgment. If the prior holder approaches the discounter requesting discounting of the bill to meet its funding needs, the prior holder is at fault. If the discounter, being aware of its lack of discounting qualifications, accepts the bills endorsed by the prior holder and pays the discounting proceeds to the prior holder, the discounter is at fault. When both parties to discounting are at fault, and the holder fails to return the bill, the holder’s claim for paying overdue interest by the bill obligor will generally not be supported by the adjudication authority.

Based on the above opinions, the bill holder or obligor should reasonably determine the claims and defence points according to their different statuses in litigation and organise relevant evidence.

In particular, where the holder/obligor provides evidence to substantiate the underlying transaction relationship and the creditor-debtor relationship, the subjective criterion that the holder/obligor “is involved in no other litigation, only a large number of bill litigations” cannot be solely relied on to deny any real business relationship on the basis of so-called reasonable doubt.

If the holder returns the bill to the immediate prior holder in strict accordance with article 101, the immediate prior holder may be unable to return the bill, or needs to return the bill to its prior holder, paying the received proceeds. In other words, only when the drawer participates in repayment can the subsequent obligors and holders realise their creditors’ interests, which puts higher requirements on the litigation strategy.

It is therefore advisable to fully negotiate and communicate with prior holders for collaborative participation in litigation under relevant binding agreements among parties to enable repayment to other bill obligors and holders as a whole after returning the bill to the drawer. It also effectively saves judicial resources and improves litigation efficiency.

Sun Qiming is a counsel at Anli Partners