ABSTRACT
If a Mainland financial institution which holds a lawful qualified domestic institutional investor (QDII)/RMB QDII (RQDII) license invests in RMB-denominated exchangeable bonds issued in an overseas financial market with RMB funds of its own or raised from Mainland institutions and individuals, then its investment does not constitute a “money-lending transaction” regulated by Hong Kong’s Money Lenders Ordinance (MLO) and the Mainland financial institution itself does not qualify as a “money lender” under the MLO, as long as it holds the bonds and collects interest thereon without exercising the exchange right.
FACTS
In September 2015, plaintiff Hua X Trust Co., Ltd. entered into a trust agreement with third party Zhu X Wen to establish the “Hua X – Overseas Market Investment Series 5, Issues 3-5 RQDII Single Fund Trust,” with the purpose of investing in an RMB-denominated exchangeable bond in Hang X Holdings, a Hong Kong-listed company.
On the same day, Gao X Company, a company incorporated in the British Virgin Islands, executed a Document in the form of deed to issue a corporate bond that would be exchangeable into its shares in Hang X Holdings. The terms of the Document were: (1) the bond offered an annual coupon rate of 11 percent calculated from the issue date, accruing until the date of redemption or exchange in the case of early redemption or share exchange; (2) bondholders could demand immediate redemption upon occurrence of a default event; (3) default events included without limitation failure to pay principal or interest when due; and (4) the redemption price upon default would equal to the bond principal plus accumulated interest calculated at a 20 percent annual compound interest rate during the holding period, minus interest already paid at an 11 percent annual rate during the same period.
The plaintiff, as trustee of Hua X – Overseas Market Investment Series 5, Issues 3-5 RQDII Single Fund Trust, subscribed to the above exchangeable bond and entered into a Letter of Guarantee and Indemnity with defendant Xiao X Yong, whereby the defendant: (1) guaranteed to the beneficiary the punctual performance by each guarantor of all the guarantor’s obligations under the bond documents, including but not limited to payment of any amount due under or in connection with the bond; (2) undertook that upon any guarantor’s failure to pay any amount due under or in connection with the bond documents, Xiao X Yong (as the surety) would, upon demand, immediately pay the sum to the beneficiary as if it were the principal debtor; and (3) agreed that if the surety failed to pay any amount payable by it under this letter on its due date, interest would accrue on the overdue amount from the due date up to the actual payment date at a rate which was 2 percent above the rate which would have been payable if the overdue amount had, during the period of non-payment, constituted a loan in the currency of the overdue amount for a successive interest period selected by the beneficiary (acting reasonably). Gao X Company, as pledgor, executed a Share Pledge Agreement with plaintiff to pledge the 27 million shares it held.
Thereafter, Gao X Company failed to pay bond interest to plaintiff, which constituted a default. In October 2016, plaintiff served a Notice Regarding Resolution of Default on Exchangeable Bondon, among others, Gao X Company and defendant, demanding redemption of the bond and payment of both the outstanding interest and the liquidated damages for late payment by Gao X Company and defendant. In September 2020, plaintiff further sent a Redemption Notice to Gao X Company and defendant et al. As Gao X Company and defendant never did fulfill their obligations, plaintiff instituted a lawsuit seeking the following relief: (1) order defendant to pay the bond redemption price of RMB 48,694,712.54, plus default interest thereon of 20 percent per annum accrued from September 29, 2020 until actual date of repayment; and (2) order defendant to reimburse the attorney’s fees of RMB 200,000.
Defendant contended that plaintiff’s subscription to the exchangeable bond without ultimately exercising the exchange right constituted a money-lending transaction under Hong Kong’s Money Lenders Ordinance (“MLO”), which meant that, pursuant to section 23 of the MLO, plaintiff had no right to assert the above claims because it did not hold a Hong Kong money lender license; and that even if plaintiff had the right of recovery, both the 20 percent annual redemption interest and the guaranteed default interest constituted punitive clauses and hence were inapplicable, and any payments already received by plaintiff should be deducted against the principal ahead of the interest.
During trial, the parties each submitted an ascertainment report on the application of Hong Kong law addressing, inter alia, the applicability of the MLO to this case.
HOLDING
On July 28, 2023, the Shanghai Financial Court (“Court”) issued a civil judgment (2022) Hu 74 Min Chu No. 2696, ordering defendant Xiao X Yong to pay plaintiff Hua X Trust Co., Ltd.: (1) RMB 46,076,142.51; (2) liquidated damages accruing on RMB 46,076,142.51 at an annual rate of 20 percent from September 29, 2020, until the date of actual payment; and (3) attorney’s fees of RMB 200,000.
Following the pronouncement of the first-instance judgment, defendant Xiao X Yong appealed to the Shanghai High People’s Court, which issued civil judgment (2023) Hu Min Zhong No. 710 on January 25, 2024, that dismissed the appealand affirmed the original judgment.
REASONING
The key legal issues of this case are: (1) whether the transaction in question was regulated by the MLO; and (2) whether plaintiff was legally entitled to the 20 percent annual redemption interest and the guaranteed default interest. In reviewing these issues, the Court examined the full text and the judge’s opinions in Pearldelta Group Limited v. Huge Winners International Limited, a case cited in both parties’ ascertainment reports on the application of Hong Kong law.
The Shanghai Financial Court held as follows:
Regarding the first issue, the MLO specifies in its preamble that its objects are “[to] provide for the control and regulation of money lenders and money-lending transactions, the appointment of a Registrar of Money Lenders and the licensing of persons carrying on business as money lenders; to provide protection and relief against excessive interest rates and extortionate stipulations in respect of loans; to provide for offences and for matters connected with or incidental to the foregoing[.]” Accordingly, the MLO is designed to regulate “money lenders” and “money-lending transactions.”
In the present case, the subject of investment was an overseas exchangeable bond issued by a company not registered in Hong Kong. This transaction was in nature an investment that entitled the holder to, under certain conditions, exchange the bond into shares at a pre-determined price on a future date. Alternatively, the holder may, based on such factors as the profit potential of the shares and its own financial needs, opt not to exercise the exchange right and instead require the issuer to redeem the bond. These features were far beyond what “money-lending transaction” entails.
Furthermore, section 5, Part 2 (“Exempted Loans”) of Schedule 1 to the MLO provides that exempted loans include “[a] loan made by a company or a firm or individual whose ordinary business does not primarily or mainly involve the lending of money, in the ordinary course of that business.” The plaintiff, as a licensed non-bank financial institution, principally engaged in the operation of trusts rather than lending of money. Even if plaintiff lent trust funds to specific parties, such activity would constitute a loan made in the ordinary course of business and performance of its duty. For the sake of argument, even if the transaction in question was construed as a lending of money, it would still fall within the above-cited scope of exemption.
Section 12 of the same Part 2 provides exemption for “[a] loan made to a company that has a paid up share capital of not less than $1,000,000 or an equivalent amount in any other approved currency.” This exemption reflects a legislative intent of not wanting to restrict genuine business decisions made by contracting parties capable of obtaining independent legal advice. Regardless of whether Gao X Company’s paid-up capital meets this threshold, the fact that it pledged its 27 million shares as security for plaintiff demonstrates it possessed certain business judgment and negotiation skills and substantial financial strength. The question of whether the transaction concerned qualified for exemption under Section 12 should be answered through a substantive analysis based on what the legislation intends to protect.
In conclusion, plaintiff’s subscription to the exchangeable bond using trust funds cannot be characterized as a lending of money to the issuer. Even if the transaction were considered a loan, it would still fall within MLO’s scope of exemption. Therefore, the MLO should not be applied to determine the validity of the transaction.
Regarding the second issue, although the transaction in question, as an investment transaction with some elements of financing, did not constitute a money lending activity regulated by the MLO, MLO’s standards for interest rate may shed some light on whether the interest rate should be viewed as excessive.
First, according to Sections 24(1) and 25 of the MLO, loans with an annual interest rate not exceeding 48 percent are protected by law. None of the agreements in this case exceeded the judicially protected rate cap under Hong Kong law, and moreover, plaintiff later voluntarily changed compound interest to simple interest and did not make a claim on the 2 percent markup for the guaranteed default interest rate.
Second, under Hong Kong law, the guarantee under the Letter of Guarantee and Indemnity is a “joint and several guarantee liability,” which is essentially an “indemnity agreement” and has the features of both that and a guarantee agreement.
Third, from September 2020 when the bond in question matured till the time of this lawsuit, defendant never paid the principal and interest as agreed. Therefore, the liquidated damages claimed by plaintiff was mostly meant as a compensation for its losses incurred from the prolongeddelinquency, at a rate within reason. In summary, no circumstance in this case warrants invalidation of the default clauses triggered, as alleged by defendant, by the punitive clauses.
SIGNIFICANCE
This case involves a foreign-related financial dispute arising from an overseas securities investment made by an RQDII. The dispute concerns whether the transaction in question should be characterized as a money-lending activity regulated by Hong Kong’s Money Lenders Ordinance, given that the agreements between the parties were governed by the law of Hong Kong and that the plaintiff did not exercise its right to exchange the relevant bond into shares but instead sought for a purportedly excessive default interest rate.
Following a study of the full text of the MLO, the Hong Kong case cited in both parties’ legal opinions, and the applicability and legislative intent of MLO, the Court identified the essential differences between the transaction at issue and money-lending activities. This judgment involves the application of trust law theories and contract law principles, as well as the ascertainment and application of Hong Kong law. It not only offers guidance for similar cases in the future, but also enables Mainland financial institutions to better assess the risks of comparable business activities.
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