On May 10, Shanghai Financial Court held a press conference to release the Report on Preventing Legal Risks of Financial Leasing Disputes (hereinafter referred to as “Report”). Following the release of the Report on Preventing Legal Risks of Private Equity Fund Disputes and the Report on Preventing Legal Risks of Bond Disputes, this is the third consecutive year for Shanghai Financial Court to release industrial legal risk prevention reports, as part of the implementation of the “Annual Release Mechanism of Legal Risk Prevention Reports on Financial Disputes” established by the court. The Report focuses on the financial leasing industry. In recent years, with the continuous development of China’s financial market, the financial leasing industry has been playing an increasingly active role in revitalizing fixed assets, meeting the needs of technological transformation of enterprises and promoting the development of small and medium-sized enterprises. Financial leasing has gradually become the second largest financing tool after bank credit and an important force in advancing inclusive finance. Meanwhile, there is a high incidence of financial leasing disputes in judicial practice, such as sale-and-leaseback of ineligible leased objects, capital risks arising from third-party co-operation model innovation, improper repossession and disposal of leased objects by the lessor, and illegal collection of extra-rental fees, etc. Considering the number and the subject matter of lawsuits in recent years have remained at a high level, and the risks of the industry have emerged, it is necessary to sort out and analyze the legal risks of the industry, and to urge the industry to continuously improve compliance management and enhance asset quality in order to properly respond to, manage and eliminate the risks. The Report is divided into four parts: the current situation and risk analysis of the financial leasing industry, the financial leasing disputes, difficulties and legal risk revelation in disputes, and the advice on legal risk prevention. The Report offers a comprehensive summarization of the risk in the financial leasing industry, a systematic sort-out of the types of financial leasing disputes, and analysis and revelation of the causes of risks before putting forward targeted countermeasures and advice on legal risk prevention. The Report analyzes and summarizes the risk factors in the financial leasing industry, including the impact of changes in the economic environment, regulatory policies and legal rules, a rise in the number and amount of penalties imposed for non-compliance, changes in regulatory policies that may trigger reactions in the market, a rise in the risks faced by the industry’s assets, an increase in litigation risks as a result of undue self-remedy, and risks easily triggered by the absence of a security function for the leased subjects. In the Report, a statistical analysis of financial leasing contract dispute cases accepted by Shanghai courts from 2019 to 2023 reveals the following features: I. The Number of Cases and the Total Amount of Subject Matter Fluctuated at a High Level From 2019 to 2023, Shanghai courts had accepted a total number of 96675 financial leasing contract dispute cases, with a total amount of 110.891 billion yuan for the subject matter. The number of cases reached its peak at 23223 in 2021. In the past two years, the number had decreased but still maintained a high level, which were both high in 2023, with 22586 cases and 25.803 billion yuan respectively. II. The Subject Matter in Cases were Mainly Small Of all cases, the average amount of subject matter was 1.147 milion yuan, with a median of 76900 yuan; 62% of subject matter were less than 100000 yuan, while only 5% were greater than 1 million yuan. III. Large Subject Matter Cases Reflected Debt Problems of Some Local Urban Investment Enterprises 43.75% of all first trial cases with a subject matter of more than 300 million yuan that were accepted by the Shanghai Financial Court included local urban investment enterprises as defendants. The leased subjects mainly covered road auxiliary equipment, machinery, and optic cable lines. IV. The Plaintiffs were Mainly Commercial Leasing Companies Such plaintiffs accounted for 95.93% among all cases, and 0.68% of the plaintiff were a financial leasing company. The number of which the lessee sued against the financial leasing company was 3.39%, and the reason for the dispute was usually the extended issues in the financial leasing business. V. The Defendants were Mainly Individuals In all cases, individual defendants accounted for 88.01%, with an average subject matter of 166200 yuan; legal person defendants accounted for 11.99%, with an average subject matter of 8368100 yuan. VI.The Types of Dispute in Cases were Relatively Concentrated The lessor usually claimed for an accelerated expiry of the rent or rescission of the contract and return of the leased subjects, and the cases were mostly concluded in favour of the lessor, with only 4.39% of the cases in which the litigants defended that the contract was not in accordance with the nature being upheld. As a result of the preexisted jurisdictional agreements, the courts of jurisdiction were thereafter, relatively concentrated. VII. The Case-Related Business Model was Mainly on Vehicle Leaseback 99.16% of the case-related leased subjects were vehicles, and the leases were mainly leasebacks and structured leasebacks, accounting for 77.41%. The Report divides the types of financial leasing disputes into the following five categories in response to common legal disputes in judicial practice: 1. Disputes over the Legal Characterization Lessees often defended that ‘the financial leasing was actually a loan’, on the grounds that the business in dispute engaged fictitious leased objects, over-valuated leased subjects, ineligible leased subjects, multiple leasebacks of leased subjects or other circumstances. 2. Disputes Arising from Lessor’s Co-operation with Third Parties This mainly included disputes arising from co-operation on the ‘rent loan’ business between banks and financial leasing companies, the involvement of marketing channels in the financing process, the transfer of possession of the leased subjects from lessee to marketing channels, and the guarantees provided by marketing channels for the lessee’s rental payment obligations. 3. Disputes Arising from the Exercise of the Lessor’s Right of Repossession This mainly included disputes arising from repossessing the leased subjects upon minor default, resorting to violent and unlawful means of repossessing the leased subjects, failing to liquidate the loss after repossessing the leased subjects, and exercising the right of repossession in the bankruptcy and reorganization proceedings of the lessee. 4. Disputes over the Financial Leasing Registration This mainly included disputes arising from duplicate registrations of the same leased subject in the CCRC Movables Financing Registry System (hereinafter referred to as the ‘Zhongdeng System’), the subordination of rights of the same property after registrations in different systems, and conflicts between the registration of the same vehicle in the Zhongdeng System and the registration in the competent vehicle authority. 5. Disputes over Financial Leasing Interests and Extra-Charges This mainly included disputes arising from the lessor’s collection of service fees, consultancy fees, commission charge, insurance premiums, and the calculation of overdue interests or liquidated damages. The Report summaries and reveals the legal risks in the aforementioned types of disputes. The Report puts forward respective countermeasures and advice for lessees, financial leasing enterprises and regulatory bodies on the basis of a comprehensive examination of the current situation, disputes with their respective types, and relevant legal risk revelation of the financial leasing industry. I. Advice for Lessees First, make clear identification and prudent verification of the contract and its terms. The nature of the model contract provided by the financial leasing enterprises should be carefully identified, and attention should be paid to the signing parties and business model of the contract to avoid confusion between the financial leasing contract and other different types of contracts; focus on whether the agreed interests and charge terms, accelerated expiry terms, collection terms are reasonable, and ensure that both parties reach a mutual assent on the terms of contract before signing. Second, understand the counter-party and specify the party for performance. Where negotiating with third-party agencies such as marketing channels, lessees should authenticate whose actual identity, relationship with financial leasing enterprises, and specific status in transaction; pay careful attention to the transaction of personal account, and be alert to the frequent transfer of third-party agencies; and make clear the receiving party when returning the leased subjects. Third, reduce the debt stock and raise financing in a transparent and compliant manner. Local urban investment enterprises shall strictly comply with the regulations of regulatory bodies, and shall not to carry out non-equipment sale-and-leaseback, so as to avoid affecting the normal provision of public services by the Government after the disposal of leased subjects. Fourth, respect the spirit of contract and fulfill agreements in good faith. Lessees should make reasonable arrangements for their own cash flow, pay the rent in a timely manner, avoid disposing of leased subjects at will and privately removing the safety equipment on the leased subjects. II. Advice for Financial Leasing Enterprises First, stick to the nature of the industry and strengthen compliance. Financial leasing shall not be carry out as illegal loan business; Strengthen the examination of eligibility of leased subjects, focus more on whether the leased subjects are public facilities or road auxiliaries, and on the authenticity of invoice, purchase contract, the registration certificate of titles, carry out on-site inspections, and verify the model number of leased subject. At the same time, the focus should also be on assessing whether the valuation of leased subjects is reasonable. Second, strengthen internal governance and carry out innovations with prudence. Enhance the assessment and supervision of third-party agencies such as marketing channels, track the use and flow of funds in a timely manner, make regular check of the status of leased subjects, and promptly terminate the co-operation of third-party agencies that do not meet the standards. Third, make clear of contract terms, especially on interests and extra-charges. A service or consultancy should be ‘consistent with its quality and price’, and should be clearly agreed with the lessee after full consultation on important terms such as calculation of the residual value of leased subjects, security arrangements, accelerated maturity, and self-remedy. Fourth, make timely registration and publicity, and exercise the rights in compliance with the law. Where registering in the Zhongdeng system, examine carefully whether there is prior registration; where carrying out vehicle financial leasing business, timely registration of movable property mortgage should be made in the vehicle administration office to prevent lessees from repeated financing on the vehicle; where repossessing the leased subjects, it is recommended to take measures such as photographing to keep a file to prove that one are free from fault, and where realizing the leased subjects, it is necessary to ensure that the leased subjects are realized in a standardized process and at a reasonable valuation. III. Advice for Regulatory Bodies First, fight against illegal activities and guide the healthy development of the industry. Focus more on issues such as ineligibility of leased subjects, inadequate management of leased subjects, imprudent management of sale-and-leaseback business, purchasing of undervalued leased subjects, untruthfulness of important financial data, lax supervision of the use of funds, inconsistency between the fund flow and the agreed use, and lack of caution in selecting marketing channel partners for co-operation. Second, improve regulatory policies and unify industry standards. Advocate for reasonable division of regulatory powers and responsibilities between the central and local authorities, and unify standards such as the ‘blacklist’ of leased subjects. Third, strengthen data sharing and enhance judicial collaboration. Link regulatory policies with judicial determinations, and work together to curb problems such as deviation from the nature of leasing and under-standard operation so as to achieve synergistic governance. Fourth, track the debt stock and strengthen risk prevention. Advise relevant government regulatory bodies monitor and count hidden debts through multiple channels in an all-round manner, analyze and sort out the reasons for the emergence of unlawful new local debts in the form of finance leasing and their specific problems, and continue to follow up on the risk prevention of hidden debts and the elimination of debt stock by some local governments and financial institutions. Shan Suhua, Vice President of Shanghai Financial Court, said, “Shanghai Financial Court will adhere to Xi Jinping’s thought of Socialism with Chinese characteristics in the new era as its guide, resolutely shoulder the judicial responsibility to prevent and eliminate financial risks, constantly innovate new patterns of participating in the governance of the financial market in accordance with the law in a dynamic manner, further improve the Annual Release Mechanism of Legal Risk Prevention Reports on Financial Disputes, and continue to perform in the forewarning, prevention and elimination of financial risks, promoting the high-quality development of finance, and providing more powerful judicial services and guarantees for the construction of a financial powerhouse and Shanghai’s international financial center.”
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