Lending Contract Dispute Case Involving a Company in Shenyang and a Company in Jiangsu, among Others

Ma Linping

[Keywords] Finance / Loan Contract Disputes / Financing Interest Rate / Supreme People's Court /

【Key Points of the Ruling】 The key issues in this case are as follows: First, whether the request by a certain company in Shenyang for payment of interest and liquidated damages should be upheld; second, whether the interest and liquidated damages claimed by the Shenyang company should be subject to the upper limit on interest rates applicable to private lending. To begin with, collecting interest on loans is not an exclusive right reserved for financial institutions. After the Shenyang company acquired the debt in question, it naturally acquired the right, pursuant to the relevant contract, to demand that the debtor—namely, a certain company in Jiangsu—pay interest. The appeal by the Jiangsu company arguing that interest should be paid to the Shenyang company at the rate of similar loans published by the People's Bank of China for the same period lacks both contractual and legal basis and should therefore not be upheld. Second, Dalian Trust Company is a financial institution approved by the financial regulatory authority to engage in lending activities. Disputes arising from its loan disbursements fall under the category of financial loan disputes rather than private loan disputes. Since the Shenyang company obtained its claim from Dalian Trust Company, the relevant provisions governing private lending should naturally not apply to this claim. The argument advanced by the Jiangsu company—that the original financial loan has been converted into a private loan and thus the interest and liquidated damages stipulated in the loan agreement should not exceed four times the rate of similar loans published by the People's Bank of China for the same period—lacks legal basis and is therefore not supported.

[Basic Facts of the Case] On November 4, 2013, a trust company in Dalian (hereinafter referred to as the “Trust Company”) entered into a financing agreement and a supplementary agreement with a certain company in Jiangsu, agreeing that the Trust Company would extend a loan of RMB 250 million to the Jiangsu company. The loan term would run from the date the lender credited the funds to the borrower’s account until November 3, 2015, with a daily interest rate of 14% per annum based on a 360-day year. If the borrower failed to repay the principal and interest in full as agreed, the Trust Company would have the right to terminate the agreement, declare the entire loan due and payable immediately, and, starting from the date of default, impose a default penalty at a daily interest rate of 14% per annum based on a 360-day year. After the contract was signed, the Trust Company disbursed the loan as agreed; however, the Jiangsu company failed to pay the interest on time.

On September 28, 2014, a company in Shenyang entered into a “Debt Assignment Agreement” with a trust company, under which the trust company agreed to assign its claims against a certain company in Jiangsu, together with all rights and obligations arising from the relevant agreements, to the Shenyang company. After the contract was signed, the Shenyang company paid the trust company the full assignment price, and the trust company fulfilled its obligation to notify the debtor of the debt assignment.

A company in Shenyang filed a lawsuit with the court, requesting that a company in Jiangsu be ordered to repay its debt, pay interest at a daily rate of 14%/360 from September 28, 2014, until the debt is fully repaid, and pay default damages at a daily rate of 14%/360 from September 28, 2014, until the debt is fully repaid. In the first-instance judgment, the court upheld the plaintiff’s claim, reasoning that the financing agreement was lawful and valid, the creditor rights of the Shenyang company against the Jiangsu company had been lawfully assigned to it by the trust company, and thus the Shenyang company lawfully enjoyed all rights under the relevant agreement.

A company from Jiangsu filed an appeal with the Supreme People’s Court, dissatisfied with the original judgment. A company from Shenyang entrusted our firm’s lawyers to represent it in the defense. The Supreme Court held that the primary court had clearly established the facts, correctly applied the law, and rendered an appropriate judgment. Consequently, the Court dismissed the appeal and upheld the original judgment.

【Judgment Result】

In the first-instance judgment, the Liaoning Provincial Higher People's Court upheld the plaintiff’s claim, ruling that the financing agreement is lawful and valid.

The Second Circuit Court of the Supreme People's Court, in its second-instance judgment, dismissed the appeal and upheld the original judgment.

【Reasoning of the Ruling】 The second-instance court held that the key issues in this case are: First, whether the request by a certain company in Shenyang for payment of interest and liquidated damages should be upheld; and second, whether the interest and liquidated damages claimed by the Shenyang company should be subject to the upper limit on interest rates applicable to private lending.

I. Whether the request by a certain company in Shenyang to be paid interest and liquidated damages should be supported.

Article 8 of the Contract Law of the People’s Republic of China provides: “A contract lawfully established shall be legally binding upon the parties. The parties shall perform their respective obligations in accordance with the agreement and may not unilaterally alter or terminate the contract. A contract lawfully established is protected by law.” The Financing Agreement, Supplementary Agreement, Pledge Contract signed between a trust company in Dalian and a company in Jiangsu, as well as the Pledge Contracts and Guarantee Contracts entered into with other third parties, all reflect the true intentions of the respective parties and do not violate any mandatory provisions of laws or administrative regulations; hence, they are lawful and valid, and all parties must perform their obligations accordingly. After the trust company in Dalian assigned the debt rights involved in the case to a company in Shenyang and fulfilled its notification obligation to the debtor, the assignment of the debt rights became effective. From the moment the debt rights were assigned, the rights previously held by the trust company in Dalian under the relevant contracts were transferred to the assignee, the company in Shenyang. Article 2, Paragraph 2 of the Supplementary Agreement stipulates that the loan interest rate during the loan term shall be 14% per day based on a 360-day year. This provision does not violate any legal requirements. Therefore, after the trust company in Dalian disbursed the loan, the company in Jiangsu, as the borrower, was obligated to pay interest according to the agreed-upon terms. Moreover, collecting loan interest is not an exclusive right reserved for financial institutions; thus, after the company in Shenyang acquired the debt rights involved in the case, it naturally acquired the right to request payment of interest from the debtor—including the company in Jiangsu—pursuant to the relevant contract. The appellant’s argument that the company in Jiangsu should pay interest to the company in Shenyang based on the prevailing loan interest rate standards published by the People’s Bank of China lacks both contractual and legal basis and should not be upheld.

Regarding the issue of collecting liquidated damages, from the perspective of the relationship between the Financing Agreement and the Supplementary Agreement, Articles 1 and 2 of the Supplementary Agreement actually clarify the legal relationship between the parties as set forth in the Financing Agreement, explicitly characterizing the financing relationship between a certain trust company in Dalian and a certain company in Jiangsu as a loan contract relationship. At the same time, the Supplementary Agreement modifies the names of the consideration paid by the borrower for obtaining the loan principal and the fees payable upon default: the financing income stipulated in the Financing Agreement is renamed loan interest, and the liquidated damages are renamed penalty interest. However, the agreed-upon calculation standards and methods remain unchanged, indicating that, with respect to both liquidated damages and penalty interest, the substantive content remains essentially the same except for the change in name. Since the company in Shenyang has acquired the contractual rights from the trust company in Dalian, and current laws and regulations do not prohibit non-financial institutions from charging penalty interest, the request by the company in Shenyang, based on the contractual agreement, for the company in Jiangsu to pay liquidated damages—in essence, a request for payment of the penalty interest agreed upon in the Supplementary Agreement—is well-founded and should be upheld. The appeal raised by the company in Jiangsu claiming that the company in Shenyang is not entitled to collect penalty interest cannot stand. However, it should be noted that, given that the parties have already changed the name of liquidated damages to penalty interest, the court of first instance’s continued use of the pre-change term “liquidated damages” was somewhat imprecise. Considering that the calculation standard for liquidated damages determined in the first-instance judgment is identical to the penalty interest calculation standard stipulated in the Supplementary Agreement and does not prejudice the substantive interests of the company in Jiangsu, this Court will not correct such error.

II. Regarding whether the interest and liquidated damages claimed by a certain company in Shenyang should be subject to the maximum interest rate limit for private lending.

Article 2, Paragraph 1 of the “Administrative Measures for Trust Companies” stipulates: “For the purposes of these Measures, a trust company refers to a financial institution established in accordance with the Company Law of the People’s Republic of China and these Measures, whose primary business is the conduct of trust-related activities.” Article 20, Paragraph 1 provides: “Under its proprietary business activities, a trust company may engage in interbank deposits and loans, interbank lending, loans, leasing, and investments. Investment activities are limited to equity investments in financial enterprises, investments in financial products, and investments in fixed assets for its own use.” The business scope section of the business license of a certain trust company in Dalian explicitly states that its business scope includes loan activities. Furthermore, Article 2, Item 11 of the “Reply of the China Banking and Insurance Regulatory Commission on the Change of Name and Business Scope of Dalian Huaxin Trust & Investment Co., Ltd.” (Yin Jian [2007] No. 409) specifies that the business scope of the aforementioned trust company in Dalian includes the use of its proprietary assets through interbank deposits and loans, interbank lending, loans, leasing, and investments. Therefore, the trust company in Dalian qualifies as a financial institution and, in accordance with the law, possesses the requisite qualifications to extend loans. Private lending refers to the act of financial circulation among natural persons, legal persons, and other organizations, as well as between them. Disputes arising from the provision of loans and related financial services by financial institutions and their branches approved by financial regulatory authorities do not fall under the scope of the regulations governing private lending. Since the trust company in Dalian is a financial institution approved by the financial regulatory authority to engage in lending activities, any disputes arising from its loan disbursements constitute financial loan disputes rather than private lending disputes. Moreover, the claimant, a certain company in Shenyang, acquired its debt rights from the trust company in Dalian; thus, the claimant’s assertion that the relevant provisions on private lending should not apply to its claim naturally lacks legal basis and is therefore not supported. The argument advanced by a certain company in Jiangsu—that the original financial loan has been converted into a private loan and that, consequently, the interest rate and default penalties stipulated in the loan agreement should not exceed four times the prevailing similar loan rate published by the People’s Bank of China—lacks legal foundation and is accordingly rejected.

[Relevant Statutes] Article 8 of the Contract Law of the People’s Republic of China stipulates: “A contract established in accordance with the law shall be legally binding on the parties. The parties shall perform their respective obligations in accordance with the agreement and may not unilaterally alter or terminate the contract. A contract established in accordance with the law, Protected by law.

《 Contract Law of the People's Republic of China 》 Article 207 The regulation states: “If the borrower fails to repay the loan within the agreed-upon term, they shall pay overdue interest in accordance with the agreement or relevant national regulations.”

《 Administrative Measures for Trust Companies 》 Article 2, Paragraph 1 The regulation states: “For the purposes of these Measures, ‘trust company’ refers to a company established in accordance with the…” Company Law of the People's Republic of China “and financial institutions established under these Measures that primarily engage in trust business.” Article 20, Paragraph 1 stipulates: “Under their proprietary business, trust companies may engage in activities such as deposits with and lending to peer institutions, loans, leasing, and investments. Investment activities are limited to equity investments in financial enterprises, investments in financial products, and investments in fixed assets for their own use.”

[Lawyer’s Perspective]

First, does the judicial interpretation on private lending apply to situations where a general civil entity acquires claims from financial institutions?

In this case, a certain company in Jiangsu argues that, as a general civil entity and non-financial institution, the Shenyang-based company, upon acquiring the debt rights, has transformed the legal relationship between the Jiangsu company and the Shenyang company from a financial loan to a private loan, and thus the relevant provisions governing private lending should apply. Moreover, during the second-instance proceedings in this case, the "Provisions of the Supreme People's Court on Several Issues Concerning the Application of Law in the Trial of Private Lending Cases" (hereinafter referred to as the "Judicial Interpretation on Private Lending") was under review and about to be promulgated. The cap on the maximum interest rate for private loans stipulated in this judicial interpretation will significantly influence the outcome of this case.

Regarding the application of the Judicial Interpretation on Private Lending, firstly, the debt transfer agreement in this case was signed on September 28, 2014, which predates the implementation date of the Judicial Interpretation on Private Lending—September 1, 2015. Secondly, the filing date of this case also predates the implementation date of the Judicial Interpretation on Private Lending. Based on these two points, in accordance with the principle that laws do not apply retroactively, the Judicial Interpretation should not be applied to this case.

With regard to the issue of the underlying legal relationship in this case, as the Supreme Court held in its second-instance judgment, the trust company is a financial institution approved by the financial regulatory authority to engage in lending activities. Consequently, any disputes arising from its loan disbursements are classified as financial loan disputes rather than private loan disputes. Since a certain company in Shenyang obtained its creditor’s rights from the trust company, its claim for those rights naturally falls outside the scope of application of the relevant provisions governing private loans.

Second, if a general civil entity acquires a creditor’s right from a financial institution, can it claim interest and liquidated damages as stipulated in the financing agreement?

A company in Jiangsu believes that a company in Shenyang is entitled only to claim interest based on the prevailing loan interest rate for similar loans issued by the People's Bank of China at the same time, and does not have the right to demand payment of interest and penalty interest from the debtor as stipulated in the financing agreement.

First, as mentioned above, the Shenyang company, as the lawful successor to the trust company’s entire claim against the Jiangsu company, is naturally entitled to claim interest at the rate stipulated in the financing agreement. This interest rate is not subject to the provisions governing private lending. Moreover, the daily interest rate of 14% based on a 360-day year does not exceed four times the prevailing benchmark lending rate for similar loans set by the People’s Bank of China at the same time. Second, relying on Article 81 of the Contract Law of the People’s Republic of China (hereinafter referred to as the “Contract Law”), the Jiangsu company argues that the collection of penalty interest is an exclusive right of financial institutions and should not be transferred along with the assignment of the claim to the Shenyang company. As a general civil entity, the Shenyang company does not have the right to collect penalty interest. In this case, the so-called “penalty interest” is essentially a liquidated damages clause. According to Article 207 of the Contract Law, if a borrower fails to repay the loan within the agreed term, it shall pay overdue interest as stipulated in the contract. Furthermore, in accordance with Article 25 of the Regulations on RMB Interest Rate Management, the accrual of compound interest is an exclusive right of financial institutions. The Jiangsu company has confused the concepts of penalty interest and compound interest; its assertion that the Shenyang company is not entitled to continue exercising the rights pertaining to penalty interest under the financing agreement lacks any legal basis, and its view has not been upheld by the Supreme People’s Court.

The key to the successful representation in this case lies in an accurate grasp of the law. The trial phase of this case coincided with the entry into force of a new judicial interpretation; thus, correctly understanding the spirit of the new judicial interpretation and safeguarding the legitimate rights and interests of the client became the primary focus that the representing lawyer had to pay close attention to. It was particularly crucial to fully comprehend the legal principles conveyed by the new judicial interpretation. It was precisely because of the representing lawyer’s solid legal foundation and his highly responsible attitude toward the client that this case ultimately received support from the Supreme People’s Court and has since become a benchmark reference for other cases in the field of creditor protection.