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New Law Will Open Up China’s Financial Leasing Market
By
Jim Fang and Norm Page
[May 2005]
Along with China’s opening up of its distribution and retail sectors to foreign investment, another recent development deserves special attention: China’s legislative effort to develop a national financial lease law and further open up its financial lease market.
Driving Force
In gaining membership in the WTO, the Chinese government undertook various commitments, including opening China’s financial services industry to foreign companies. China also wants to diversify its financing channels available to small- and medium-sized Chinese companies. In the context of these goals, China has re-initiated its efforts to promote finance leasing transactions, and the National People’s Congress has started its drafting process of a new comprehensive financial leasing law ("Leasing Law") to authorize, regulate and govern finance leasing activities.
Legislative Timetable
The process to produce the Leasing Law began last year with the formation of a legislation steering committee (“Steering Committee”) by the National People’s Congress. Subsequently, a working group (“Working Group”) was established to draft an outline of the Leasing Law ("Outline") and to solicit comments from the local legislatures, government agencies, business leaders and experts in the industry in Shanghai, Beijing and other economic centers in China.
In anticipation of developments foreshadowed by the Outline, on January 21, 2005 MOFCOM amended the existing “Measures on Administration of Examination and Approval of Foreign-Invested Leasing Companies” by promulgating certain measures on Administration of Foreign Investment in Leasing Industry, effective March 5, 2005 (“FIE Leasing Company Measures”). The FIE Leasing Company Measures open up the leasing market to foreign investment by allowing Wholly Foreign-owned Enterprises (“WFOEs”) to operate as leasing companies in China. It is reported that some WFOE leasing companies have been or are in the process of being approved.
The timetable for the Leasing Law is as follows:
- An official draft of the Leasing Law will be proposed to the Steering Committee in the second quarter of 2005.
- A process of comments and proposed changes solicitation will begin with the release and publication of a more refined draft in the second quarter of 2006.
- The draft of the Leasing Law, revised to take into account comments gathered nationwide, will be submitted to the Finance and Economic Commission for review and discussion around the third quarter of 2006.
- The Standing Commission of the National People’s Congress will review the draft of the Leasing Law as proposed by the Finance and Economic Commission.
- The plenary session of the National People’s Congress is expected to adopt the Leasing Law at the beginning of 2007.
Outline Summary
The Outline pulls together several disparate laws that now govern financial leases. With some limitations, the commercial aspects of the proposed law are “gap filling” (similar to the UCC), with the parties being free to vary the terms by mutual agreement.
1 . Definition. A “financial lease” is defined as a transaction in which the lessor purchases leased property selected by the lessee; the lessee has the right to possession and use of the leased property in exchange for payment of rent; and upon expiration of the lease, the lessee may renew the lease, exercise an option to buy the leased property or return it to the lessor. (This definition is similar to the definition of “finance lease” in Article 2A of the UCC.)
2. Regulatory Agency. A functional department under the State Council in charge of administration of financial leasing will be established to supervise and administer the leasing industry throughout China.
3. Lessor. The lessor’s business license must have a scope of business that includes financial leasing operations.
4. Lessee. The “lessee” is defined as any natural person or enterprise/company that enters into a financial leasing contract with the lessor to obtain funds to finance the acquisition of the leased property, and to obtain the right of possession and usage by paying the rent on the agreed terms.
5. Leased Property. The “leased property” is defined as any real property and movable durable property (including the accessory technologies), other than natural resources. Examples include (i) equipment, machinery and instruments; and (ii) vehicle, vessels, aircraft and space shuttles. The Outline does not distinguish between commercial and consumer leases, although other consumer protection laws are also under consideration. These laws could affect financial leases with consumers.
6. Registration of Leased Property. Leased property (other than real property, aircraft, vessels and motor vehicles) must be registered at the State Administration of Industry and Commerce, the government authority in charge of registration of mortgage or security interests of movable assets, or with any industry association authorized thereby. Such registration is needed to protect the parties’ interests against bona fide purchasers or creditors.
7. Nature of the Rights to Leased Property. The financially leased property is excluded from the bankruptcy estate of the lessee. If the lessee fails or delays in making a rental payment, the lessor may terminate the contract and repossess the leased property.
8. Term. In general, the financial lease term should be shorter than the permissible period for depreciation for the leased property, but in no event less than 20% of the depreciation period.
9. Rent. The financial lease rent shall be determined by the cost of the leased property, plus the reasonable profit of the lessor, unless otherwise agreed by the parties.
10. Acceleration and Repossession. If the cumulative past-due rent is more than one-fifth of the rent under the financial lease, or the number of defaults in making the rental payments exceeds one-fifth of the total number of the rental payments, the lessor may demand immediate payment of all the rental payments or terminate the financial lease, repossess the leased property and recover damages including expenses. However, the total amount of the compensation cannot exceed one-fifth of the total rent under the financial lease. The lessee may not prevent the lessor from exercising its right of repossession or resist the lessor in this regard.
11. Risk Assumption. When the lessee possesses the leased property, unless otherwise agreed upon by the parties, any damages, losses and risks to the leased property shall be the sole responsibility of the lessee.
12. Conditions for Setting Up Financial Lease Companies.
- Minimum registered capital of RMB 80,000,000 (equivalent to slightly less than USD 10,000,000)
- Required management team with professional knowledge of financial leasing and the law
- Adequate organization, management, internal management systems and systems for risk control and handling
- Business premise, safety measures and other required facilities corresponding to the business operation
13. Regulatory Requirements for a Financial Leasing Operation.
- Assets/Debt Ratio.
- Risk assets, including contingent liabilities, shall not exceed ten times the total assets
- Investment in industries other than the financial lease industry cannot exceed 30% of the total assets
- The leased assets under the financial lease and other financial leases cannot be less than 60% of the total assets
- Management of Leased Property. The leasing company shall set up separate accounts for leased property under sublease and entrusted lease business.
- Cost Control for Leased-Back Property. In a sale-and-lease-back transaction, the acquisition cost for the leased property shall not exceed 20% of the actual value or the book value of the leased property.
14. Incentives for Financial Leasing.
- Tax Incentives and Accelerated Depreciation.
- Any tax incentives and holidays applicable to manufacturers apply to the lessor or lessee that is eligible to record the leased property on its books as fixed assets for depreciation.
- Accelerated depreciation is permitted, provided that depreciation period is not shorter than three years.
- Special Reserve. Reserve for uncollectible accounts is permitted for the leasing companies.
- Source of Funding. A leasing company, after its establishment has been approved, may finance its operation through public equity offerings or issuance of corporate bonds.
- Special Treatment for Purchase and Leaseback. The sale/purchase in a purchase and leaseback transaction is not considered as a true purchase; therefore, relevant taxes and fees imposed on sales/purchases will not be imposed.
China’s Existing Regulatory Framework for Financial Leasing Companies
Until the Lease Law is enacted, hopefully in 2007, foreign firms must learn to survive in a legal environment where some issues critical to a developed leasing market remain uncertain.
In the regulatory area, China has a dual-system with respect to FIE leasing companies with two principal sets of regulations: (i) Measures on Administration of Financial Leasing Companies (“Financial Leasing Company Measures”) promulgated by PBC, as central bank, on June 30, 2000 and (ii) FIE Leasing Company Measures, promulgated by MOFCOM last January. These two sets of regulations set forth the procedural and documentation requirements for PBC and MOFCOM to work together in approving the establishment of an FIE leasing company. In addition, the Financial Leasing Company Measures set forth the framework for PBC to supervise and regulate the operation of financial leasing companies, foreign invested or domestic, as a special business. Further guidance is contained in numerous and scattered rules covering commercial, tax, accounting and customs aspects.
Opportunities for Comment on Leasing Law
The existing rules and Outline guide a foreign firm in developing its strategic plan and operations in China’s financial leasing market. Foreign firms now have an opportunity to study and analyze the drafting process and participate in it with the goal of bringing the Lease Law up to international standards. Indeed, the influence of the UCC and U.S. accounting and tax principles can already be seen in the Outline.
United States companies can influence legislation in China through both formal and informal channels. Examples of informal channels include contacting a member of the Working Group or asking a personal acquaintance at a foreign company or law firm to supply samples of United States laws or agreements to the Working Group.
As for official channels, there usually is a period when formal comment is solicited or at least allowed. When making comments, many U.S. companies choose to act through organizations such as the US-China Business Council or the US-China Chamber of Commerce.
For more information about the Outline and opportunities for commenting on the Leasing Law, please contact any member of our China Practice Group. Davis Wright Tremaine was the first U.S. law firm to obtain approval from the Ministry of Justice to set up a representative office in Shanghai, China, which we did in 1994. Consequently, we have extensive experience assisting U.S. companies in their investment projects in China.
For more information, please contact:
R.Z.
Margaret Lu, Seattle, (206) 628-7753, MargaretLu@dwt.com
Jerry Zhu, Seattle, (206) 622-3150, JerryZhu@dwt.com
Ron
Cai, Shanghai, (011) 8621-6279-8541, RonCai@dwt.com
James
Mei, Portland, (503) 778-5315, JimMei@dwt.com
This China Practice Advisory is a publication of the China Practice/Shanghai
Office of Davis Wright Tremaine LLP. Our purpose in publishing
this Advisory is to inform our clients and friends of recent
legal developments in China. It is not intended, nor should
it be used, as a substitute for specific legal advice as legal
counsel may only be given in response to inquiries regarding
particular situations.
Copyright © 2005, Davis Wright
Tremaine LLP.
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