For most enterprises, the provision of foreign guarantees is often closely related to the obtaining of foreign loans. Following our last article on the legal framework concerning foreign loans obtained by foreign investment enterprises (FIEs), in this article, we will continue to explain the major legal requirements regarding the provision of foreign guarantees by FIEs. I. Substantial and formal requirements of foreign guarantees In providing financial facilities to an FIE, overseas lenders often request the borrower to provide some sort of foreign guarantee to secure the repayment of principal and interest. In the context of the Chinese legal system, foreign guarantee means any guarantee provided by a domestic entity (including FIEs that are not financial institutions; the FIEs referred to hereinafter do not include FIEs that are financial institutions) by way of a letter of guarantee, standby letter of credit, promissory note and bill of exchange, etc., whereby it promises a foreign entity, or a foreign investment financial institution in China, that if the party being guaranteed (the “Guarantee”) fails to settle its liabilities as agreed in the contract, then the obligation of repayment shall be fulfilled by the Guarantor. There are several types of foreign guarantees, which include guarantees for financing, guarantees for financial leasing, guarantees under compensatory trade, guarantees in foreign contracted works, and any other guarantees with a foreign debt nature. They usually take the form of surety, security or pledge, however, the Guarantor should not provide foreign guarantee by way of a lien or deposit. In a foreign guarantee, there are four main types of Guarantees, namely: domestic enterprises in China, foreign investment enterprises, overseas incorporated wholly-owned subsidiaries of a domestic entity in China, and enterprises with Chinese equity holding. Where the Guarantee is a foreign entity, the following conditions must be satisfied: (i) If the Guarantee is a foreign enterprise carrying on trading, basically the proportion of its net assets to total assets shall not be lower than 10%; if the Guarantee is a foreign enterprise carrying on a business other than trading, basically the proportion of its net assets to total assets shall not be lower than 15%. (ii) The Guarantee shall not be a deficit enterprise. In terms of substantial requirements, the Chinese laws have imposed certain restrictions on foreign guarantees provided by FIEs, for example, (i) In providing guarantee to a beneficiary for the liabilities of a third party, the balance of liabilities guaranteed by the FIE shall not exceed its foreign exchange revenue in the preceding year; (ii) The balance of foreign guarantees provided by an FIE shall not exceed 50% of its net assets, nor exceed its foreign exchange revenue in the preceding year. In respect of the statutory procedures, for each foreign guarantee provided by an FIE (wholly foreign-owned enterprises excluded) by way of surety, the approval of the foreign exchange departments is required. Where the foreign guarantee is provide by the FIE by way of security or pledge, the situation is more complicated. II. Statutory procedures of providing foreign security Generally speaking, FIEs are required to obtain the approval of / file with the foreign exchange departments, as well as register with the domestic security registration departments, in order to provide foreign security, although there may be some exceptions. Under the Chinese laws, the statutory procedures of providing foreign security are as follows: If an FIE provides foreign security for its own liabilities with its own property, it is not required to obtain prior approval of the foreign exchange departments; only the registration of foreign guarantee is required. If, however, an FIE provides foreign security with its own property for the liabilities of a third party, prior approval of the foreign exchange departments is required. In addition, if there is a collateral registration department specified under the Guarantee Law in respect of the property with which the foreign security was created by the FIE, then the FIE must also complete the registration of collateral with such collateral registration departments (such as the bureau of land resources and housing management, vehicle management stations, etc.; different types of collateral have different collateral registration departments). In practice, the foreign exchange departments may require the FIE to complete the security registration with the relevant collateral registration departments before registering the foreign security contract. III. Statutory procedures of providing foreign pledge Like foreign security, if an FIE provides foreign pledge for its own liabilities with its own chattels or interests, it is not required to obtain prior approval of the foreign exchange departments; only the registration of foreign guarantee is required. If the FIE provides guarantee for the liabilities of a third party by way of pledge, approval of the foreign exchange departments shall be obtained in advance. Moreover, if the collaterals being pledged by the FIE in the foreign pledge are legally assignable stocks, shares, exclusive trademark rights, patent rights and property rights in copyrights, then such pledge collaterals shall also be registered with the relevant departments in charge (such as clearing house, intellectual property office, etc.; different types of pledge collaterals have different pledge registration departments). IV. Special provisions on foreign guarantees provided by wholly foreign-owned enterprises It should be noted that while wholly foreign-owned enterprises may provide foreign guarantee without obtaining approval of the foreign exchange departments on each and every occasion, they are still required to complete the registration of their foreign guarantee with the foreign exchange departments. For wholly foreign-owned enterprises, the statutory procedures of providing foreign guarantee are as follows:   (i) the wholly foreign-owned enterprise shall register its foreign guarantee with the foreign exchange departments, which shall verify the substantial conditions of the foreign guarantee in accordance with the laws, and the relevant conditions must be satisfied before the guarantee can be registered; (ii) the wholly foreign-owned enterprise shall obtain approval of the commerce departments and file with the industry and commerce departments before providing the foreign guarantee;   (iii) the wholly foreign-owned enterprise shall register with the specified collateral registration departments for security (or pledge) in accordance with the Chinese laws, if necessary. If any foreign guarantee is provided by a wholly foreign-owned enterprise without the approval of the commerce departments, the guarantee contract in question shall have no effect. Alternatively, if a foreign guarantee has not been registered with the foreign exchange departments, when the wholly foreign-owned enterprise tries to perform its obligations to the relevant foreign entity, the foreign exchange departments will not approve the purchase of foreign exchange and outward remittance.

IMPORTANT: The law and procedure on this subject are very specialized and complicated.  This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.

For enquiries: Please contact members of our China Practice Group:

Albert Leung Consultant China Attesting Officer +(852) 2107 0391 albert.leung@onc.hk

Ludwig Ng Senior Partner +(852) 2107 0315 ludwig.ng@onc.hk

Published by ONC Lawyers © 2009