Accounts Receivable Financing is widely recognized by suppliers as an effective financing tool to monetize their receivables and improve their cash flow. In a typical open account transaction, certain receivables are due from a buyer to a supplier for goods supplied or services rendered. The supplier may in turn obtain accounts receivable financing from a financier and require the financier to prepay the receivables prior to their due dates. As security for such repayment, the financier as lender may require a pledge* on the accounts receivable from the supplier as borrower, which is a common form of security in supply chain finance in China. mainland and has its own registration requirements.
* Note: The “pledge” in this note refers to a pledge under mainland Chinese law, which is different in concept from a pledge under Hong Kong law.
In situations where an entity incorporated in Mainland China (the “land borrower“) obtains accounts receivable financing (the “AR funding“) with an offshore financial institution (the “Offshore lender“) and pledges its accounts receivable in favor of the offshore lender, how should the offshore lender process the registration of the pledge of accounts receivable (the “Pledge“) in mainland China?
Mandatory registration by the offshore lender
As of February 1, 2022, the Unified Registration Measures for Security Interests in Movable Property and Rights (the “Measures“) unifies and regulates the registration of security interests in movable property and rights, including but not limited to accounts receivable pledges (which are defined as the right of a creditor to demand payment of a debtor for the supply of certain goods, services or facilities, except, inter alia, those arising from negotiable instruments or otherwise prohibited by law).
According to the Measures, the Offshore Lender (as the holder of the security) or its agent is responsible for registering the Pledge at the Credit Reference Center of the People’s Bank of China (the “CRC“) through its unified system of registration and public notification after entering into an agreement with the Onshore Borrower (as the guarantee provider) on the data to be registered.
It is particularly important to note that a pledge of claims governed by the law of the PRC is not created until it is registered in accordance with the Civil Code of the People’s Republic of China (the “Civil CodeIt follows that the registration of the Pledge in the CRC is a mandatory condition, and the Pledge without registration will not be deemed validly constituted, which would render it unenforceable against the Onshore Borrower.
The details of a record should include, but not be limited to: (1) basic information about each security holder and security provider (such as legal name, address/domicile, name of representative legal/responsible person and organization codes or identifiers); (2) a description of the security (ie the accounts receivable subject to the Pledge); (3) a reasonable registration term ranging from 1 month to 30 years, subject to possible extensions; and (4) other relevant information agreed between the security holder and the security provider (including the principal amount of the claim and the extent of the security, etc.).
Please note that CRC only provides registration and public inquiry services, and will not give pre-transaction approvals and/or review any registration details. It is therefore the responsibility of the Offshore Lender to ensure the accuracy, completeness and legitimacy of the registered details of the Pledge and the authenticity of the relevant accounts receivable by: (1) updating the details in case of omission, error or modification; (2) cancel registration after release of security; and (3) rigorously review and verify the authenticity of accounts receivable and review other encumbrances created thereon, in each case within the specified time as set forth in the Measures (if any). Anyone providing false information in the data entered will be solely responsible for any resulting loss or damage.
Priority of Competing Claims
When, in addition to the Offshore Lender, another security holder has provided a pledge on the same claim, the following priorities provided for in article 414 of the Civil Code apply to competing security: (1) a registered pledge prevails over a unregistered pledge (the latter not yet being validly constituted); and (2) where both pledges have been registered, the one registered first prevails.
For the avoidance of doubt, please note that the method of determining the priority of rights to claims under a pledge is different from that under factoring agreements.
Another common question is whether a registration with the State Administration of Foreign Exchange of the People’s Republic of China (“SURE“) will be required. According to the opinion of the national foreign exchange administration on the publication of provisions relating to the foreign exchange administration of cross-border guarantees, a cross-border guarantee (which includes a pledge) given by an onshore entity to guarantee its own It follows that no SAFE registration will be required for the Pledge granted by the Onshore Borrower in favor of the Offshore Lender.
However, since AR Funding is a foreign debt of the Offshore Lender to the Onshore Borrower, the Onshore Borrower is required to report relevant information relating to the cross-border financing transaction to SAFE for registration (“Registration of external debt“). Although it is the duty of the Onshore Borrower (and not the Offshore Lender) to report to SAFE, the Offshore Lender is advised to require proof that such registration has been made. Otherwise, the ‘Onshore Borrower may not be able to remit funds out of Mainland China for repayment by itself.
Accounts Receivable Debtors
In practice, where a pledgee enforces the relevant pledge of receivables, it would normally require the relevant debtor of the receivables to perform its obligations directly in favor of the pledgee. But how does enforcing a pledge against an onshore debtor operationally differ from enforcing a pledge against an offshore debtor?
Receivables from onshore debtors
Where accounts receivable originally due from an onshore debtor to the Onshore Borrower are to be paid to the Offshore Lender pursuant to the Pledge, a foreign debt(s) will be created between the onshore debtor and the Offshore Lender. In exchange control terms, this would mean that the onshore debtor will only be able to remit the funds due under the pledge to the offshore lender if the onshore debtor has duly completed the Foreign Debt Registration.
Accounts receivable from offshore debtors
In general, there are no legal restrictions on an offshore accounts receivable debtor paying the offshore lender. However, where there is a SAFE record relating to the export transaction between the Onshore Borrower and the offshore debtor, the Onshore Borrower must ensure that the SAFE procedures are properly followed to avoid any future sanction for non-compliance. compliance with foreign exchange regulations.
Claims on future debtors
Alternatively, the Onshore Borrower may pledge its accounts receivable from future debtors in favor of the Offshore Lender, which would require the opening of an onshore account designated by the parties for the sole purpose of receiving the accounts receivable from future debtors. , whereby the Offshore Lender shall have priority over the funds in this account in the future performance of the Undertaking, and such funds may be transferred directly outside of Mainland China. However, in order to ensure the correct processing of the remittance of funds, it is recommended that the offshore lender always checks whether a foreign debt registration has been made in relation to the AR financing and whether the collateral has been registered with the CRC.
In order to fully protect the interests of lenders in the creation of pledges over borrowers’ accounts receivable in mainland China, lenders should always remember to perfect this creation by registering them with the CRC and obtaining evidence of borrowers’ foreign debt registrations. and taking into account exchange control requirements taking into account whether the relevant debtor is an onshore or offshore entity, and whether it is an existing or future debtor.