ABSTRACT
The “double lease” model achieves financing purpose through two nested finance lease contracts, i.e., the first lessor concludes a sale-and-leaseback (“leaseback”) contract with the lessee to acquire ownership of the lease property, and then signs another leaseback contract as lessee with the second lessor to secure financing. In this back-to-back finance lease transaction, the lease property remains in the possession and use of the first lessee from start to finish. The second lessor neither acquires ownership of the lease property when signing the leaseback contract, nor can it repossess from the first lessee or dispose of the lease property at will. In reality, the second leaseback contract should be recognized as a loan in disguise as it does not meet the characteristics of a finance lease legal relation considering, among other factors, the party in possession and use of the lease property, assumption of the risks associated with the lease property, and functioning of the property as a security interest.
FACTS
On March 26, 2021, the non-party Xian X Finance Lease Co., Ltd. (“XX Finance Lease”) as lessor entered into a Finance Lease Contract (Leaseback) with Nuo X Finance Lease Co., Ltd. (“NX Finance Lease”), whereby NX Finance Lease would transfer its self-owned office buildings, commercial spaces, hotel supplies, equipment, and other for-lease properties (“lease property”) to XX Finance Lease for a sale price of RMB 260,000,000, and XX Finance Lease would, after acquiring ownership of the lease property, lease it back to NX Finance Lease. After execution of the contract, the parties completed the required registration procedures.
On March 30, 2021, NX Finance Lease issued to XX Finance Lease a Receipt, a Certificate of Transfer of Ownership of Lease Property, and a Property Handover Letter.
Following expiration of the Finance Lease Contract (Leaseback), XX Finance Lease executed a Claims Assignment Agreement with plaintiff Ai X Investment Co., Ltd. (“AX Investment”), transferring all claims and associated rights under the above contract and its supplementary agreements to AX Investment.
Further investigation revealed that in May 2020, NX Finance Lease entered into a Leaseback Contract and an Ownership Transfer Agreement with Chengdu X Company. The lease property under said contract was identical in name, model, and quantity to that listed in the schedule of lease property attached to the Finance Lease Contract (Leaseback) at issue in this case. As of the signing date of the Finance Lease Contract (Leaseback) at issue, the said Leaseback Contract had not been performed in full.
Plaintiff AX Investment brought a lawsuit demanding: (1) payment by NX Finance Lease of all outstanding rent under the Finance Lease Contract (Leaseback), totaling RMB 127,253,135.96, plus overdue interest; (2) payment of attorney’s fees of RMB 400,000 and property preservation liability insurance premium of RMB 46,800; and (3) affirmation of plaintiff AX Investment’s priority claim to the proceeds from the auction or sale of the lease property under the Finance Lease Contract (Leaseback) within the scope of claims established under (1) and (2).
NX Finance Lease contended that the Finance Lease Contract (Leaseback)in dispute constituted a loan disguised as a finance lease. Because XX Finance Lease was not qualified to engage in lending business, this loan transaction was invalid for violating mandatory legal provisions. Consequently, the Claims Assignment Agreement between XX Finance Lease as assignor and plaintiff AX Investment was likewise invalid.
HOLDING
On May 10, 2024, the Shanghai Financial Court (“Court”) rendered civil judgment (2023) Hu 74 Min Chu No. 859, which: (1) ordered NX Finance Lease to pay plaintiff the loan principal of RMB 115,491,197.60 plus interest of RMB 4,937,248.70 and corresponding overdue interest; (2) ordered NX Finance Lease to pay plaintiff attorney’s fees of RMB 200,000; and (3) denied plaintiff’s remaining claims.
Neither party appealed and the judgment has taken effect.
REASONING
The Court held that the issue in this case is how to determine the nature and validity of the legal relationship between XX Finance Lease and NX Finance Lease. XX Finance Lease and NX Finance Lease executed a finance lease contract for a leaseback transaction. This type of transaction, however, like a direct finance lease, is a borrowing of both money and property.
In a leaseback, the lessee puts its self-owned equipment to productive use by selling it to the lessor in exchange for immediate payment, and then leases the equipment back and obtains the right of possession and continuing use. The lessor provides financing and acquires equipment ownership, though such ownership generally only serves as a security for rent payments. During the lease term, the lessor can not repossess or dispose of the lease property at will.
Therefore, from the perspective of a borrowing of property, a legally valid leaseback should satisfy the following conditions: (1) There exists genuine and lawful lease property; (2) The lessor acquires ownership of the lease property, which functions as a security for enforcement of rental claims; and (3) The lessee can retain possession and use of the lease property.
Taking into account the parties’ rights and obligations under the Finance Lease Contract (Leaseback) and their transaction model, it should be determined that said contract between XX Finance Lease and NX Finance Lease did not legally constitute a finance lease due to the absence of a borrowing of property.
The lease property in this case could not function as a security for enforcement of claims. Had the lease property under the Finance Lease Contract (Leaseback) functioned as a security interest, then XX Finance Lease would have had the right to repossess, and be repaid with sales proceeds of, the lease property in case of a breach of contract by NX Finance Lease during the term of the contract. But XX Finance Lease did not have such right.
Regarding the lease property in this case, although NX Finance Lease acquired its ownership through leaseback from Chengdu X Company, this ownership only served as a security interest, as stated above. During the term of the underlying Leaseback Contract and Ownership Transfer Agreement, and assuming both parties complied with the contract, NX Finance Lease would be required to guarantee the lessee’s possession and use of the lease property, and refrain from any arbitrary repossession, repayment-in-kind based on the appraised value, auction, or sale of the lease property. In other words, NX Finance Lease’s ownership did not come with the full bundle of rights, in particular lacking the right of disposal at will.
Following signing of the above underlying contract, while XX Finance Lease derivatively acquired ownership of the lease property on the surface, its scope of ownership could not have exceeded NX Finance Lease’s, as dictated by the nature of derivative acquisition. That is, XX Finance Lease’s ownership similarly did not come with the full bundle of rights for lacking the right of disposal at will. Furthermore, as the underlying finance lease claims were pledged as security for the principal claims in this case, XX Finance Lease, though having clearly known the nested financing and security arrangement at the signing of the Finance Lease Contract (Leaseback), signed the contract with NX Finance Lease, showing it was not concerned with whether the lease property could function as a security interest.
The “sale-and-leaseback” model under the Finance Lease Contract (Leaseback) at issue in this case was not in line with the established rules and regulations for a genuine leaseback. Notably, the lessee NX Finance Lease did not continue to possess and use the lease property. The reason why leaseback exists and is legally recognized is that its innate constructive delivery enables the lessee’s continued possession and use of the lease equipment without material business disruption while addressing its cash flow and financing needs. It follows that the lessee already has use interest in the relevant equipment before entering such arrangement. Typically, the lessee uses the equipment for its own business operations. Though it may also allow third-party use for revenue-generating and other purposes, the equipment can still be used by the lessee upon repossession.
The lessee’s continued use of the lease property after entry into leaseback is one of the purposes and defining characteristics of such an arrangement. However, the leaseback in this case diverged from the above purpose and characteristics. The disputed lease property in this case was a hotel and the related facilities; NX Finance Lease neither engaged in this line of business nor had preexisting use interest in such property. Rather, it acquired ownership of the property, which functioned as security interest, solely by signing the underlying Leaseback Contract and Ownership Transfer Agreement with Chengdu X Company. Following the signing of the disputed Finance Lease Contract (Leaseback), NX Finance Lease’s leaseback was still not meant for the continuing use of the lease property, but rather to disguise a loan transaction in the name of a leaseback of genuine properties as office buildings, commercial spaces, hotel supplies, and related facilities. Furthermore, XX Finance Lease was aware of this circumstance.
In conclusion, the lease property in this case, while did exist, does not qualify as an eligible subject matter for leaseback, and cannot function as a security interest like that under a finance lease agreement. NX Finance Lease’s “leaseback” was not intended for the continuing use of the property either. Accordingly, absent the characteristics of a borrowing of property, the Finance Lease (Leaseback) Contract could not legally constitute a finance lease.
Although XX Finance Lease signed a finance lease contract with NX Finance Lease and ostensibly transferred property ownership through a certificate of transfer, these masqueradingtransactions should be deemed void. The parties’ true intent was to use the leaseback as a guise for a borrowing of money, which is legally a loan relationship. Therefore, plaintiff AX Investment’s assertion of priority claim to the proceeds from the auction or sale of the lease property should not be supported.
Regarding the validity of the loan relationship, NX Finance Lease argued that XX Finance Lease was not a financial institution qualified for lending, therefore the loan contract in this case should be declared invalid. However, the Court held that the transaction between XX Finance Lease and NX Finance Lease constituted a single inter-institutional loan. There was no evidence that XX Finance Lease offered loans to unspecified external parties for profit. Accordingly, NX Finance Lease’s argument is untenable. According to Article 10(2) of the Measures for the Administration and Supervision of Finance Lease Enterprises issued by the Ministry of Commerce, finance lease enterprises are prohibited from interbank lending without the approval of competent authorities. But because the Measures is ministry-level rule rather than a law or administrative regulation, the above Article is not mandatory provisions on validity and thus cannot be cited to invalidate the loan contract in this case. Hence, the loan contract shall be deemed valid as no ground for invalidation existed.
SIGNIFICANCE
Finance lease comprises a borrowing of money and property, thus sits at the intersection of traditional civil law transactions including lease, sale, loan, and security, adding to the complexity of judicial ruling. This multifacetedness, coupled with legislative and regulatory lag, makes cases involving novel transactions like nested finance lease a longstanding priority and challenge in judicial practice.
This case arose precisely from such a “double lease” transaction, in which the first lessor signed a sale-and-leaseback contract with the lessee to acquire ownership of the lease property, and then entered into another sale-and-leaseback contract as lessee with the second lessor to secure financing.
In contrast to a sublease where the lessee first leases the subject property from the lessor before subleasing it to others, this “double lease”， despite also involving two finance lease relations, is different in a sense that the lessor in the first leg, who simultaneously acts as the lessee in the second leg, cannot actually possess and use the lease property in either of the two finance lease transactions, nor can the lease property function as a security interest as intended. Therefore, the second finance lease contract should more appropriately be seen as a loan.
In handling the case, the Court conducted a full analysis, starting from the characteristics of the purported legal relationship to contractual terms and actual performance. The adjudicating rules established in this judgment shed light on how cases over similar transactions may be resolved.
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