At the beginning of November 2019, a ruling in the Ping An Pratt & Whitney Finance Guarantee (Ping An Pratt) recovery dispute case drew a great deal of attention. A small loan company that is an affiliate of Ping An Pratt (Ping An Small Loans) extended a loan and charged interest to a borrower, with Ping An Pratt providing security for, and charging a security fee to, the borrower.

After bearing its security liability, Ping An Pratt sought recovery against the borrower. The trial court held that Ping An Pratt and Ping An Small Loans extended a large number of loans by establishing affiliates and, through such means as interest, security fees, penalty interest, etc., raised the actual loan interest far above the statutory interest standard, potentially constituting an economic crime, and dismissed the suit in accordance with the law.

According to the ruling, Ping An Pratt lacked lending qualifications but extended the loan through co-operation with its affiliate, Ping An Small Loans, potentially constituting an illegal loan. Furthermore, both the interest on the loan and the security fee should be counted together in calculating the overall funding costs borne by the borrower when determining lawfulness and compliance. The trial judge’s approach of penetrating the surface to get to the bottom of the matter is worthy of note.

Commonly seen interest and charge plans

Two methods of charging interest and charges are commonly seen in consumer finance projects: (1) Loan co-operation model. A financial institution co-operates with a co-operating firm (e.g., a security provider, insurance company, etc.), with the lender charging the borrower interest and the co-operating firm charging the borrower other fees. The co-operating firm’s charge models include: (i) the security fee model, where the financing security company charges the borrower a security fee, or (ii) the insurance premium model, where the insurance company charges the borrower a premium; and (2) Instalment service charge model. A factoring company or other such enterprise acquires the merchant’s account receivable from, and provides an instalment service to, the consumer, and the consumer repays the amount in instalments, and pays an instalment service charge to the transferee.

The motivations in the different interest and charge plans differ. In the loan co-operation model, the charge motivation of the co-operating firm lies in its being inconvenient for it to directly charge the financial institution a co-operation fee, avoiding overly high overall funding costs borne by the borrower, etc. The motivation in the instalment service charge model is the relevant enterprise’s lack of lending qualifications.

Legal risks

The legal risks involved in consumer finance projects mainly include criminal liability risks, civil liability risks and administrative liability risks.

First, with respect to criminal liability, pursuant to the Opinions on Several Issues Concerning the Handling of Criminal Cases Involving Illegal Lending, if an entity lacking lending qualifications regularly extends loans, and the annual interest rate exceeds 36%, the crime of illegal operation may be constituted.

In the loan co-operation model, if the overall funding costs charged to a borrower by the financial institution and co-operating firm exceed an annualised 36% in total, and through a penetrative analysis it is determined that it is the co-operating firm that is in effect extending the loan, the same may potentially be found to constitute illegal operation.

In the instalment service charge model, the actual essence of the business is little different from extending loans, and if the transferee lacks lending qualifications, and the service charge rate borne by the borrower exceeds an annualised 36%, the transferee may potentially be found to be operating illegally.

Second, with respect to civil liability, pursuant to the Provisions of the Supreme People’s Court on Several Issues Concerning the Application of the Law in the Trial of Civil Private Lending Cases, a court will not support the portion of the annual interest rate on a loan that exceeds 24%, and the borrower has the right to demand the refund of any portion above 36%.

In the loan co-operation model, if the overall funding costs charged to a borrower by the financial institution and co-operating firm exceed an annualised 24% in total, the relevant portion will not be supported by the court, and there is the additional risk of being required to refund a portion to the borrower. A similar risk also exists in the instalment service fee model.

Third, with respect to administrative liability, pursuant to the Notice on Regulating and Rectifying the “Cash Loan” Business, the overall funding costs charged to the borrower, in the form of interest rate and various charges by an institution, are required to comply with regulations of the Supreme People’s Court on the interest rate on private loans.

Pursuant to the Notice on Strengthening the Oversight of Commercial Factoring Enterprises, a commercial factoring enterprise is not permitted to extend loans. Whether in the loan co-operation model or instalment service fee model, excessive overall funding costs charged to the borrower may result in a violation of regulatory regulations. When a commercial factoring enterprise applies the instalment service fee model, it is potentially in violation of regulatory regulations against the extension of loans.

Guarding against risks

The author believes that the legal risks associated with interest and charge plans for consumer finance projects may be guarded against in the following ways:

• An entity without lending qualifications should avoid engaging in acts that actually constitute lending, an absolute red line for criminal liability;

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• The overall funding costs borne by a borrower may not exceed an annualised 36%, a redline for both criminal liability and civil liability; and

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• All participating entities should at all times keep a close eye on the regulator’s most recent standards and moves, so as to guard against administrative liability.

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Lending qualifications and the overall funding costs have always been the key issues in consumer finance projects, but the relevant laws and regulations are relatively ambiguous, which is the main reason why the Ping An Pratt case drew so much attention.

In such innovative business as consumer finance projects, the speed at which laws and regulations are updated lags far behind the speed of innovation in business models. Participating entities should carefully design and adjust their transaction structures in light of the most recent moves of the judicial and regulatory authorities so as to better manage legal risks.