OPINION – Building a Unified National Market: 10 Necessary Rules for Supply Chain Finance
In April, the State Council began to build a unified national market. In July, the Supreme People’s Court affirmed to speed it up with efficient judicial services. These are both exciting and long-awaited developments.
For SCF (supply chain finance), defined and clarified rule system is a required facility which at present is mainly implemented from UCC-9 (Uniform Commercial Code Article 9) and also incorporates case law from the civil law system. Here are the 10 most pressing issues affecting trading model options.
1-Draw a line between real factoring and disguised lending
Factoring and lending are two types of financing, along with bill acceptance, bill discounting, and secured financing. They are usually covered by a single line of credit, which is intended to share a maximum amount guarantee for all specific credits. They are not of the same nature, but rather are parallel ratings subordinated to the terms of finance.
However, there is a new trend to break through existing financing, including factoring to lend when all under the umbrella of a single line of credit. This is partly due to the recent and popular approach to substantive determination in trial practice, as well as the limitation of individual recognition of each judge. But that’s horrible for factoring, since collateral can become invalid as a result when the nominal primary legal relationship is found to be void, where recourse factoring, a typical transfer as security, can lose its cushion. The term test line should be clarified.
2-Who owns the capital gain in the event that a factor without recourse collects more
A non-recourse factor can advance a partial commercial AR but recover the whole, if all goes well. So who has the right to keep the spread, the seller or the factor? The Chinese civil code gives its answer for the latter despite this against the international custom of factoring and national banking practice
This is not a simple formula of recovery amount minus advance amount, rather it is an explanation of the basic legal relationship. What is comprehensive bad debt protection, basic factoring functionality? Is it an AR outright sale or a guarantee to the customer against the credit risk of the payer which authorizes the factor to recover all but to keep only the indemnity which he has suffered.
3-What elements work to determine the certainty of future AR
Uncertainty about the value of future accounts receivable (AR) is distinct from the unidentifiable. The first falls within the sphere of the creditor’s autonomy, while the second refuses him to be qualified as a guarantee.
Here is a question: when an agreement on a subject, material and quantity is reached, is this sufficient to bind? Is the underlying monetary debt also qualified AR collateral? It seems a logical consequence. So, are the advertising costs under a one-year agreement between Guangdong TV and Gree AC identifiable? Also, will all AD (advertising) costs that GD TV will collect in 2023 be taken into account? Is this a warranty qualified as a highway tax? The answer to this question can determine the scope of the AR warranty.
4-How to claim an AR guarantee
When taking legal action for an unpaid debt, what is allowed to be seized? Inform the payer and wait for its active execution, or attach these desired assets with the RA amount at the creditor’s discretion, since the debtor must eventually pay with all his assets for the RA.
The extent and procedure of enforcement make a huge difference when the creditor seeks a remedy for the default. The AR collateral itself is intangible and elusive, while the payor’s assets as a whole can effect the credit substantially.
The effectiveness of applying AR affects the willingness to accept it as collateral.
5-Would the rule of good faith apply in the case of a transfer of ownership with maintenance of possession
Sale-leaseback is a widely used sub-type of financial lease, where possession of an asset is unchanged, only title is transferred. The lessee thus capitalizes their assets efficiently, while gaining space to commit fraud by selling the asset multiple times due to its possession status. The difficult question is left to the court: who to protect? The former buyer or the last? What doctrine could the court rely on and will the rule of good faith apply?
In fact, most Chinese jurists are against protecting the prior transaction, since the former buyer chooses the business model knowing that the possession status may misleadingly indicate ownership, so it is their turn to assume the risk when a third party is involved in good faith. However, the two conflicting transactions are of the same structure, and the only difference is in the luck of the latter, without any real risk having occurred. How to make a reasonable distribution of risks? This may be a general problem, not limited to leasing, but to all sales transactions with reserve, such as sale + consignment.
6-How to classify securities against warehouse receipts and related inventory.
China does not have a separate law on warehouse receipts, where related issues are mainly governed by a specific chapter on warehouse receipts in the Civil Code. Meanwhile, China is accelerating a transferable warehouse receipt system.
So what if the owner grants the receipt to bank A as security while granting consideration of the inventory to bank B? The related SPC judicial interpretation provides for priority by date, which differs from the UCC-9 style of locking inventory in receipt upon issuance.
A derivative problem is: what would happen if the fixed inventory load were converted to a floating load? In China, inventories are specifically listed as qualified collateral for the floating charge, but not the warehouse receipt, although the underlying asset is identical. Would the prior floating charge cover the receipt pledge attached later?
7-What is the perfect way for digital warehouse receipt, registration or possession?
China has implemented a centralized mobile registration database, which can facilitate an advanced warehouse receipt system. The rule regarding digital receipts, on the other hand, depends on whether the receipt is defined as having a certificate or not. The one with a certificate is perfected by possession, while the other is by registration. Who can define the question of with or without certificate? The issuer of the receipt.
It may cause confusion when the issuer offers different explanations to various backers, what happened in the Qindao port event and the recent Foshan aluminum raw materials event, and obviously could to reproduce. The key point may not be economic efficiency, but economic interests over separate but sparse digital systems.
8-Any need to further divide goods into inventory and equipment
It is closely linked to the PMSI (purchase money security interest) mechanism. China requires a perfection period of 10 days after delivery. It is standardized without further discernment of equipment inventory, contrary to the UCC requirement of 20 days for equipment and before delivery date for inventory.
The Chinese version PMSI is more suitable for the equipment. Potential risks can appear in the case of a very fluid inventory. In the event that a bank spots another PMSI held by the seller retaining the PMSI when it is registered but after its advance, the seller can benefit from the priority based on the time sequence, which a bank can hardly expect before its advance. .
9-How to determine the priority among the PMSIs attached consecutively when there were conflicts
A supply chain generally includes many links, and each unpaid link can define a PMSI, which means that several PMSI can coexist on the same batch of movable goods. Take a car, for example. If the engine manufacturer, the manufacturer and the dealer keep all their titles and perfect them, the car is subject to several valid PMSI as long as the creditor has not reimbursed. Who could benefit from the PMSI first?
In another circumstance, if all prior PMSIs die in the ordinary course of business when the titles are transferred, only the final PMSI survives. But if so, how could the old parties be protected for their unmet credits.
10-The ratio between the fixed charge on furniture and receivables on furniture sales
A question regularly raised in supply chain finance is which style is better, versus goods or AR. Since China’s warranty on goods does not cover its sales proceeds, the two could coexist separately. Take Gree AC as an example again. A dealer gives bank A a guarantee on inventory AC while giving a guarantee to bank B on AR. Who ranks higher when the dealer defaults? According to the first rule of timing or the rule of normal course of business, the result can be absolutely opposite.
In the case of a floating charge, could the security agreement provide for the sale proceeds to be covered after acquisition? If so, does this mean that a security on the evolution of ARs can only be perfected once, even if the AR does not fall under a qualified category of floating charge?
These 10 questions are some of the most burning questions in supply chain practice. Clear and unified answers play a crucial role in business development.