Taking Security from PRC Subsidiaries

The Legislative Framework

The major pieces of legislation in this regard are the Administration of the Provision of Security to Foreign Entities by Domestic Institutions Procedures [PBOC, 1996] and the Administration of the Provision of Security to Foreign Entities by Domestic Institutions Implementing Rules [SAFE, 1998, the Implementing Rules). The core ideas of these two regulations have been incorporated and confirmed in Article 6 of the Several Issues Concerning the Application of the PRC Security Law Interpretations [Supreme People's Court, 2000]. Under the Implementing Rules, the secured parties are limited to "offshore entities that are wholly invested by domestic-invested enterprises, foreign-invested enterprises and other onshore entities, or otherwise partially invested by Chinese capital". This seems to imply that PRC subsidiaries are not allowed to supply security to their foreign parent or other group companies.

Article 8 of the Implementing Rules provides, however, that a wholly foreign-owned enterprise (WFOE) is authorized to provide external security at its own discretion and no approval from SAFE is required. In 1999, SAFE rendered an explanation on the meaning of such a provision in the Interpretation of Relevant Provisions Concerning the Provision of Security to Foreign Entities by Domestic Institutions Procedures Implementing Rules. Here SAFE stated that a WFOE, when providing security to offshore entities, can effect a registration with SAFE by proving that: (i) the outstanding secured amount under all the security provided by the WFOE shall not exceed (a) 50% of the WFOE's net assets of the last finance year (before the registration), nor (b) the foreign exchange revenue of the WFOE in the last year; (ii) the secured party is not operating at a loss; and (iii) the security is not granted to cover up the unpaid registered capital of the WFOE. A reasonable conclusion is that, subject to these requirements, a WFOE is able to extend its security to any entity it deems fit. Prudence should be adopted here, given that the above favourable policies are only applicable to a WFOE, and not to Sino-foreign equity or cooperative joint ventures. These entities are still subject to the abovementioned limitations of the secured parties regardless of whether such parties have controlling equity interests or not.

Global Financing Agreements and the PRC Environment

Under some global financing agreements, certain subsidiaries of the ultimate holding company are also entitled to borrow money. In such cases, the ultimate holding company is often required to tender a guarantee to secure the repayment obligations of these subsidiaries and accordingly subsidiaries' security is required to cover the obligations of the ultimate holding company under the guarantee. Thus, security from these subsidiaries only associates with the obligations of the ultimate company and the existence of plural secured parties is avoided. This arrangement is usually adopted with the intention to make the relevant registration of security flexible and convenient. In practice, however, where PRC subsidiaries' security is involved, it may be challenged by SAFE. To SAFE, the secured parties are still those borrowing subsidiaries, and no others. A very likely outcome is that counsel to borrowers or lenders will need to spend lots of time trying to change the minds of SAFE officials.

Conclusion

In general, currently it is still difficult for lenders of multinational groups to take security from their PRC subsidiaries. Hurdles will remain as long as the control over foreign exchange is not fully relaxed. At the same time, SAFE's experience in this area is rather limited and much communication with SAFE officials will be required even in cases of taking security from WFOEs, which remain the only available security vehicles.