Onshore guarantees for offshore indebtedness – commonly known as Nei Bao Wai Dai (NBWD) – refers to cross-border arrangements where a guarantee is provided by an onshore guarantor for a debt owed by an offshore debtor to an offshore creditor. Non-bank institutions and individuals in China involved in NBWD arrangements are required to complete statutory registration with the competent local counterpart of the State Administration of Foreign Exchange (SAFE) within the prescribed time period; otherwise performance of the guarantee contract in question may not be achieved due to the potential failure of remittance of funds, even with a court judgment or arbitral award. This article offers some views on commonly encountered issues.
Requirements imposed on the parties concerned
The SAFE is scrutinizing applications, requiring applicants to disclose the debtor’s capital status and the source of funds for repayment, and disclose the debtor’s shareholding structure and the actual controller. In this respect, the following three issues are worth noting.
First, non-compliance in respect of incorporation of the offshore debtor. Despite the multiple layers of the shareholding structure, as long as the offshore debtor’s ultimate controller is a domestic institution or individual, this controller will be required to have already completed all procedures for outbound investment, failing which the SAFE will not accept the application for NBWD registration. This is more restrictive to domestic individuals. Strictly speaking, apart from certain exceptional circumstances permitted by the SAFE, there’s no nationwide legal path for PRC individuals to engage in outbound investment. Therefore, when PRC individuals intend to offer guarantees to those offshore entities under their actual control, they need to pay special attention to the SAFE’s compliance requirement in respect of incorporation of the offshore entities in question.
Second, no correlations between the debtor and the guarantor. The SAFE usually deems “correlation between the debtor and the guarantor” as the basis of “commercial reasonableness”. If the applicant is unable to prove the existence of such a correlation, the SAFE is likely to reject the application. In addition to the common shareholding relationship, other justifiable relations between the actual controller of the guarantor and the actual controller of the debtor, such as kinship or conjugal relations, are generally accepted by the SAFE. In a transaction handled by the author, the guarantor was a domestic company and the debtor was an overseas company set up by a non-Chinese brother of the actual controller of the guarantor. At first, the local SAFE refused to accept the application due to “lack of commercial reasonableness”, but later accepted the application upon further explanation of the kinship between the actual controller of the guarantor and the actual controller of the debtor, and submission of related supplementary evidence.
Third, a high tendency of performance of the guarantee contract. The SAFE is very sensitive about the tendency of performance of the guarantee contract, so an applicant should avoid giving it an impression that the guarantee contract in question is very likely to actually be performed. According to our experience, if the debtor in question has never engaged in real business operations or held any operating entities, or does not have sufficient capital or continuous legitimate sources of income, the SAFE will often challenge its solvency and hold that the guarantee contract in question is very likely to be performed in the context of the disclosed transaction arrangements, or even take the view that the applicant is attempting to remit the funds offshore in the guise of NBWD arrangements.
Most local SAFE offices require the submission of guarantee contracts where the amount and duration of the guarantee should be specified. According to feedback from SAFE staff, the registered amount of guarantee will usually be the cap for the amount that the guarantor can remit abroad when the guarantee contract is actually performed. This causes NBWD arrangements to only serve the financing arrangements with a definite amount and term, such as ordinary borrowings, bank loans, finance leasing, etc.
However, in many transactions that fall under the NBWD structure, the guarantor does not necessarily enter into a separate guarantee contract with the creditor. Instead, the guarantor will sign the underlying transaction documents as a party, and the guaranteed “principal liabilities” are those obligations under the transaction documents as well as the liabilities for breach of contract and damages formed by operation of the terms of the transaction documents. The amount and term of such liabilities are, however, not able to be determined when the documents are signed.
Weighing up the risks, the parties to the transaction in question will sometimes have to sign a separate guarantee contract according to the SAFE’s requirements, in which the principal liabilities are reduced to the transaction amount, specifying in the underlying transaction documents that the actual guarantee liability must be subject to the underlying transaction documents. However, in doing this, parties may be exposed to risk arising from misrepresentation to the SAFE, and may encounter potential disputes concerning the performance of the guarantee contract in future.
Restricted use of funds
Restrictions imposed on use of the funds under NBWD arrangements include: (1) the funds under NBWD arrangements can only be used within the normal business scope of the debtor; and (2) use of proceeds and investment activities in respect of any special type of transactions under NBWD arrangements are required to conform to special requirements imposed by the SAFE.
As one of the focuses of the SAFE review, previously the offshore debtor in question was not allowed to repatriate the funds to China, directly or indirectly. However, on 26 January 2017, the SAFE issued a Circular on Further Promotion of Reform of Administration of Foreign Exchange and Improvement on Compliance Review, where it expressly allowed the funds under NBWD arrangements to be repatriated to China, directly or indirectly, by means of loans and equity investments. Although the practice of the SAFE’s review and the regulatory standards under this new circular need further observation, it is definite that if such repatriation of funds under NBWD arrangements is achieved by means of loans, registration for such offshore loans should be completed in accordance with the existing regulations regarding administration of offshore loans borrowed by domestic entities.
Jessie Fang is an associate of AllBright Law Offices
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