Resolution of inter-enterprise loan contract disputes in judicial practice

On 25 September 2013, the People’s Court Daily published a speech by Xi Xiaoming, vice president of the Supreme People’s Court (SPC), entitled “Several issues concerning the application of the law to which attention needs to be paid in commercial adjudication at present”.

In that speech, concerning the issue of the determination of the validity of loan contracts, Xi said: “In commercial adjudication, it is necessary in respect of inter-enterprise loans to differentially determine the nature and validity of different lending acts. Where an enterprise does not have the qualifications to engage in finance business, but in fact engages in loan extension business and the returns from the extension of such loans is the main source of its profits, the loan contract should be found to be invalid. Where enterprises do not have the qualifications to engage in finance business and lending carried out between them on a temporary basis is for production and operational purposes, the loan contract should not be deemed invalid if financing is not the regular business of the party, providing the funds and mandatory provisions of the state on financial control are not violated in doing so.”

Beginning of change

Trial practice regarding inter-enterprise loan contract disputes began to change after the above-mentioned speech. For example, in the appeal of Zhengzhou Guangsha Property Co Ltd and Wu Shangmei v Zhengzhou Jiade Property Service Co Ltd and Li Zhenzhou loan security contract dispute, the SPC held that: “the determination in the Official Reply of the SPC on How to Handle a Situation Where, in an Inter-Enterprise Loan, the Borrower Fails to Repay the Loan on Time, that ‘where an enterprise loan contract violates relevant financial regulations, such contract is invalid’ addresses a situation where recurring inter-enterprise financing could disrupt the financial order. The court at first instance held that what in essence occurred between the two parties was a temporary inter-enterprise loan made for production and operational purposes, and was not an instance of the violation of mandatory provisions of the state on financial control. Therefore, its determination that the loan agreement is valid is not without reason and this court confirms the same.”

This precedent established the rule that temporary lending between enterprises was valid and expressly specified that it is only where there is recurring financing between enterprises and there is the potential for disruption of the financial order that the mandatory provisions of the state on financial control are violated.

Precedents finding that such contracts are valid have also come out of courts in Beijing, Shanghai, Jiangsu and Zhejiang. Although there are as yet no solid figures showing that the validity of temporary inter-enterprise loan contracts has been fully accepted in judicial judgments around the country, it can be anticipated that an increasing number of judgments will uphold the validity of such contracts.

Yet to be resolved

Currently, where the validity of temporary contracts has been confirmed, the problem of dealing with an inter-enterprise loan contract that provides for both interest and for default interest and liquidated damages is yet to be resolved.

In current judicial practice, the validity of the payment of the interest portion under an inter-enterprise loan contract is expressly provided for in article 6 of the Several Opinions of the SPC on the Trial of Loan Cases by People’s Courts. This article provides that the interest rate for private loans may not exceed four times the interest rate on bank loans of the same type, and any amount above that is not protected (strictly speaking, the above-mentioned provision is expressly directed at private lending, but the same is also applied to inter-enterprise loans in judicial practice).

However, where a creditor claims interest, such issues as whether it can also claim default interest and liquidated damages, the limits on such default interest and liquidated damages, etc., still lack a clear and uniform legal basis.

From the spirit of the guiding opinions of local courts in Beijing, Jiangsu, Chongqing, etc., it can be seen that their attitude in respect of upholding default interest and liquidated damages under inter-enterprise loan contracts tends toward the conservative. In their rulings and judgments, they have not broken away from the stipulations in the several opinions.

In the Li Qiao v Mingda Yihang Enterprise Group Co Ltd, Fushun Hengsheng Real Estate Development Co Ltd and Ye Jinzhai loan contract dispute, the SPC held that: “The liquidated damages of 0.7% per day specified in the contract are in effect high interest on the loan. Regarding the issue of the interest rate on private loans, article 6 of the several opinions expressly specifies that it may not exceed four times the interest rate on bank loans of the same type, and any amount above that is not protected.”

Similarly, in trying the appeal in the Dalian Huacheng Tianyu Real Estate Development Co Ltd v Dalian Shahekou Yinfeng Small Loan Co Ltd loan contract dispute, the SPC held that: “If interest is charged at the period interest rate of 4% of the principal per month advocated by Yinfeng, and default interest at the rate of 0.2% per day, it is clearly excessively high … Based on the actual circumstances of the case, the payment of interest is revised so as to be charged at the rate for private loans, namely four times the interest rate of the People’s Bank of China for loans of the same term.”

High interest

From these cases we can see default interest and liquidated damages under loan contracts are in fact “high interest on loans”. Where a loan contract provides for both interest and default interest, and liquidated damages, protection is still accorded in accordance with the maximum determined in article 6 of the several opinions, namely that the maximum amount may not exceed four times the interest rate on bank loans of the same type.

Similar provisions are also found in relevant guiding opinions of the Chongqing high court and Jiangsu high court, that is to say where the lender additionally claims default interest and liquidated damages, the people’s court will uphold such claim if the total of the default interest and liquidated damages does not exceed the interest calculated by multiplying the interest rate for loans of the same term and type posted by the People’s Bank of China by four.