Since the PRC Property Law came into effect on 1 October 2007, the Credit Reference Centre (CRC) of the People’s Bank of China has been operating an online registration system for pledges made over receivables. Examples of receivables include those arising from:
- The sale of goods;
- The supply of water, power, gas and heat;
- The leasing of movable and immovable property;
- The provision of services; and
- The fees charged for the use of transportation routes such as highways and bridges.
The CRC’s statistics indicate that there is appetite for this new type of pledge in the market, with more than 74,453 separate pledge registrations having been made as at 30 June 20091.
Interestingly, by the end of its first full calendar year in operation, around 80% of pledges had been registered in favour of domestic national financial institutions. In contrast, only 7% had been registered in favour of foreign-invested financial institutions. Foreign-invested financial institutions have been far more cautious in buying into this type of security. On the face of it, the reason for such a stark difference of approach is not clear. After all, most pledges over receivables registered at the CRC relate to toll road charges, export tax rebates and power grid tariffs – business streams that generate steady and constant flows of receivables. There is however substance to the more conservative response by foreign-invested financial institutions, and not all of it is due to the effects of the global downturn.
1 According to the CRC website
Risk of pledge losing its effectiveness
The key problem appears to be the risk of a pledge over receivables losing its effectiveness even after it has first been duly registered. There is a strict requirement for the information recorded on the CRC register in respect of the pledgor to be accurate, and kept accurate on an ongoing basis. The reason for this is that the CRC registration system is accessible online by the public and is intended to be relied upon by bona fide third parties. As such, great store is placed on the integrity of the CRC’s records, and it is therefore critical that the official name of any pledgor is correct at all times.
What concerns foreign-invested financial institutions is that, under the current CRC registration rules, it is the pledgee that is responsible for the accuracy of any such information, and therefore for updating any changes that have been made – for example, to a pledgor’s name – within four months of any such change. Failure to do so means that the existing pledge registration is no longer effective. There is a clear danger of a pledgor recklessly or intentionally failing to notify a pledgee of its change of name, leading to the pledge falling away.
In such circumstances, although the pledgee may still have recourse against the pledgor under the pledge contract, the pledgee would lose its priority in respect of the pledge and may fail to recover the principal debt. In comparison, under Hong Kong law, a charge over receivables should be registered with the registrar of companies in Hong Kong and details of the charge will be entered into a database (maintained by the Hong Kong Companies Registry) containing all up-to-date registration information of Hong Kong-incorporated companies and companies that are registered as an overseas company in Hong Kong. In the case where the charger changes its particulars (including its company name) after a charge over receivables is created, the charger should register such changes with the registrar. As the details regarding any registration of a charge in Hong Kong or change of company name can be found in one single registry database in Hong Kong, a simple company search on such database against the charger by a third party should reveal any change in registration information of the chargor and any charge over receivables that has been granted by the charger. Under Hong Kong law (unlike under PRC law), the chargee bears no obligation to update the registration information of a charge over receivables after it has been duly registered.
Another peculiarity of pledges over receivables in China is that such pledges automatically terminate at the end of an agreed registration period up to a statutory limit of five years. The pledgee has the right to extend a pledge over receivables by another five years. However, given that a pledgor may naturally be unwilling to extend a pledge after the initial five years have elapsed, there is an inherent weakness in any pledge over receivables that is intended to attach to any medium- to long-term obligation of the creditor.
In our experience, while pledges over receivables are included within security packages, the creditor’s confidence remains low as regards the viability of their enforcement and effectiveness.