Determination of Legal Relation and Assumption of Liability Where the Factor Knows the Accounts Receivable Are Fabricated- Jiangxi Copper International Commercial Factoring Company Limited v. Shanghai Dunzhan Industrial Co., Ltd., Shanghai Changzhan International Trade Co., Ltd., et al. Concerning Dispute over Loan Contract

Abstract

A legal relation of loan will be formed between the factor and the accounts receivable creditor if the factor knows the accounts receivable are fabricated. Absent evidence proving that the factor takes the granting of loans as its main business or main source of profit, the legal relation of loan should be deemed valid, and the accounts receivable creditor is obligated to repay the principal and interest to the factor. However, the factor¡¯s claim for assumption of payment obligation by the accounts receivable debtor is rejected, because there were no genuine accounts receivable; the factor did not grant the loan relying on genuine accounts receivable and payment commitment; and the debtor did not express its intent to provide guarantee or other credit enhancement.

Basic Facts

On August 8, 2016, Jiangxi Copper International Commercial Factoring Company Limited (¡°Jiangtong Factoring¡±) entered into a Factoring Agreement with Shanghai Dunzhan Industrial Co., Ltd. (¡°Shanghai Dunzhan¡±), under which the parties agreed to a domestic recourse factoring. The underlying business contracts for the factoring are a Purchase Contract (No.: DZCZ20160606-02) and a Supplementary Agreement to the Purchase Contract (No.: JF2016LX011£ßBL001£ßBC001) signed by Shanghai Dunzhan and Shanghai Changzhan International Trade Co., Ltd. (¡°Shanghai Changzhan¡±) on June 6, 2016; the target accounts receivable amounted to RMB 272,790,332.58 and were expected to be due on August 8, 2017. According to the Factoring Agreement, (1) Shanghai Dunzhan assigned the target accounts receivable to Jiangtong Factoring in a consideration of RMB 252,790,332.58, i.e. the factoring financing funds; (2) if the assigned accounts receivable cannot be recovered in full and on time, Jiangtong Factoring can demand an unconditional recourse against Shanghai Dunzhan, which shall fulfill the reassignment obligation; in other words, Jiangtong Factoring can, from time to time, require Shanghai Dunzhan to immediately repurchase part or all of the outstanding accounts receivable; the repurchase price = amount of all the assigned accounts receivable ? amount repaid by the debtor + outstanding factoring charge and other fees + liquidated damages for overdue payment + other fees receivable by Jiangtong Factoring; (3) if Shanghai Dunzhan falls behind on the payment of the repurchase price, Jiangtong Factoring can charge Shanghai Dunzhan liquidated damages at 0.7¡ë of the overdue amount for each day of delay; (4) Jiangtong Factoring is still the creditor of the target accounts receivable until Shanghai Dunzhan pays the repurchase price in full or fulfills all of its repurchase obligation.

According to a Receipt from Shanghai Changzhan, an annex to the Factoring Agreement, Shanghai Changzhan stated the following: (1) it had received the Notice of Assignment of Account Receivable, and the accounts receivable thereunder were true, valid and outstanding; (2) the accounts receivable assignor had fulfilled all its goods supply obligations under the underlying business contracts, and there was no breach, dispute, overdue payment, objection or claim involving or detrimental to the recovery of the accounts receivable; (3) it would, in strict accordance with the underlying business contracts, fulfill the payment obligation in full and on time to the accounts receivable assignee (as new creditor) through (and only through) the receiving account stipulated in the Notice of Assignment of Account Receivable; (4) in case of overdue payment, the accounts receivable assignee can charge liquidated damages at 0.7¡ë of the overdue amount from the overdue date to the repayment date; (5) any repayment of the accounts receivable not through the above receiving account (including but not limited to payment by negotiable instruments or otherwise not through the above receiving account, off-set of creditor's rights, and the like, hereinafter referred to as ¡°ultra vires payment¡±) would not constitute a valid payment under the underlying business contracts, nor would it relieve any payment obligation for such assigned accounts receivable under the underlying business contracts; (6) Shanghai Changzhan would compensate all the losses (if any) suffered by the assignee due to the ultra vires payment, and solely deal with any issue or dispute regarding apportionment of liability with the assignor.

On August 17, 2016, Jiangtong Factoring disbursed to Shanghai Dunzhan factoring financing funds of RMB 250,000,000 after deducting a performance bond of RMB 2,790,332.58.

On February 2, 2018, Jiangtong Factoring sent a Notice of Reassignment of Accounts Receivable to Shanghai Dunzhan. As Shanghai Dunzhan failed to fulfill the repurchase obligation, Jiangtong Factoring instituted this lawsuit, requiring Shanghai Dunzhan to pay the repurchase price and Shanghai Changzhan to be jointly and severally liable to the extent of the sum of the accounts receivable and the liquidated damages for the overdue payment thereof.

According to the evidence provided by Jiangtong Factoring, the documents of underlying obligation for the factoring in question include the Purchase Contract and the Supplementary Agreement to the Purchase Contract, dated June 6, 2016, between the seller Shanghai Dunzhan and the buyer Shanghai Changzhan, as well as related tax invoices and delivery orders; all of the said documents are photocopies and stamped with the common seals of the Shanghai Dunzhan and Shanghai Changzhan.

The Economic Crime Investigation Division of the Pudong Branch of Shanghai Municipal Public Security Bureau once inquired of Zheng X, Jiangtong Factoring¡¯s deputy general manager in charge of risk control and Zhang X, Jiangtong Factoring¡¯s money manager. According to Zheng X, Shanghai Dunzhan was in effect not eligible for engaging in factoring, because no accounts receivable had been created as its goods payment had already been paid pursuant to the cash on delivery terms of the trade contracts between it and Shanghai Changzhan. As a result, the legal affairs department was required to draft a trade contract including credit period terms for the parities to re-sign. According to Zhang X, who handled Shanghai Dunzhan¡¯s RMB 250 million factoring at Jiangtong Factoring in August 2016, he knew when receiving the task that the trade contract underlying the factoring provided by Shanghai Dunzhan had no credit period and did not qualify for factoring financing. Therefore, Zhang¡¯s supervisor asked him to help draft a trade contract including credit period terms and fill in the specific transaction data as per the amount and quantity indicated on the tax invoices and delivery orders provided by Shanghai Dunzhan.

In the trial of this case, Zheng X, and Zhang X, appeared for testimony at the application of Jiangtong Factoring, confirming the authenticity of the signatures and fingerprints on the records of question of the public security authority. The witness Zheng X said that he was responsible for reviewing the project for the factoring in question. According to Zheng X¡¯s statement to the public security authority, the contract provided by Shanghai Dunzhan and Shanghai Changzhan itself was not eligible, which was why Jiangtong Factoring provided a template; no supporting materials were provided to prove the existence of the accounts receivable for the factoring in question, but he was later told by his supervisor that they existed. Zhang X stated that he had assisted the legal affairs department in drafting a contract for the factoring in question as require by his supervisor; the contract template drafted by him was consistent with the Purchase Contract underlying the factoring in question. He also noted that there was no payment period in the original contract provided by the client, and the payment period in the contract drafted by him was set as required by his supervisor.

Holding

On January 29, 2021, the Shanghai Financial Court rendered the following civil judgment ((2019) Shanghai 74 Min Chu No. 553)[Ubica1] : 1. Shanghai Dunzhan shall repay to Jiangtong Factoring a loan principal and interest of RMB 270,000,000 and an delayed repayment interest on the loan principal of RMB 250,000,000 from August 9, 2017 to the date of actual repayment at an annual interest rate of 24%; 2. Shanghai Dunzhan shall pay Jiangtong Factoring an attorney fee of RMB 200,000; 3. The remaining claims of the Plaintiff Jiangtong Factoring were dismissed.

After the first-instance judgment was rendered, Jiangtong Factoring filed an appeal according to law. On March 4, 2022, the High People¡¯s Court of Shanghai Municipality[Ubica2]  issued a civil judgment ((2021) Shanghai Min Zhong No. 236 ), dismissing the appeal and affirming the original judgment.

Reasoning

The Shanghai Financial Court held that the issues of this case are as follows: (1) how to determine the nature and validity of the legal relation in dispute; (2) whether and how Shanghai Dunzhan and Shanghai Changzhan should assume payment obligation.

Regarding the first issue. A factoring is conditional on authentic, legal and valid assignment of accounts receivable. In this case, Jiangtong Factoring staff¡¯s statements in the trial were basically consistent with their statements in the records of question from the public security authority, and their testimonies corroborated each other. This is sufficient to prove that (1) the Purchase Contract underlying the factoring in question was prepared by Jiangtong Factoring based on a performed purchase contract between Shanghai Dunzhan and Shanghai Changzhan; (2) the factoring in question did not have authentic, valid accounts receivable; and (3) Jiangtong Factoring, Shanghai Dunzhan, and Shanghai Changzhan all knew that the accounts receivable concerned were fabricated. Therefore, the legal relation in this case should be determined as a loan relation between Jiangtong Factoring and Shanghai Dunzhan. The loan relation should be determined as valid because the loan is an expression of the parties¡¯ true expression of intent; no situation exists that statutorily invalidates the loan; and no evidence can show that Jiangtong Factoring takes the granting of loans as its main business or main source of profit.

Regarding the second issue. As Jiangtong Factoring paid the factoring financing funds in question to Shanghai Dunzhan, Shanghai Dunzhan should be liable for repaying the principal and interest as agreed. As this case does not constitute a factoring relation, it is baseless in law for Jiangtong Factoring to collect and deduct performance bond from Shanghai Dunzhan. Rather, the RMB 250,000,000 actually disbursed by Jiangtong Factoring to Shanghai Dunzhan should be taken as the principal of the loan in this case. As stipulated in the Factoring Agreement, the factoring repurchase payment less the principal and the liquidated damages accruing from August 9, 2017 that can be claimed by Jiangtong Factoring as agreed are, by nature, the interest and delayed repayment interest under a loan contract, provided that the delayed repayment interest claimed by Jiangtong Factoring should not exceed the statutory interest rate cap for lending.

Regarding whether Shanghai Changzhan should undertake the payment liability. First, Jiangtong Factoring has no right to require Shanghai Changzhan to assume the payment obligation for the accounts receivable for the ascertained facts have showed that Shanghai Dunzhan had no accounts receivable from Shanghai Changzhan. Second, according to the Receipt issued by it, Shanghai Changzhan only undertook to Jiangtong Factoring as to the payment method of the fabricated accounts receivable and the consequences of breaching the payment method terms; it did not express its intent to perform the repayment obligation for the factoring financing funds or to do so when Shanghai Dunzhan fails to perform the repayment obligation. Third, the loan in this case is between Jiangtong Factoring and Shanghai Dunzhan. Jiangtong Factoring still disbursed the financing funds though it had known the accounts receivable were fabricated and could not guarantee the repayment of the financing funds. That is to say, Jiangtong Factoring did not grant the loan relying on genuine accounts receivable and Shanghai Changzhan¡¯s payment commitment. Hence, the risk of non-repayment of the loan is not causally connected with Shanghai Changzhan¡¯s act and should be solely borne by Jiangtong Factoring. For the above reasons, Jiangtong Factoring¡¯s claim that Shanghai Changzhan should be liable for repaying the principal and interest of the financing funds in question has no basis in law and is rejected.

To sum up, the Shanghai Financial Court ruled that Shanghai Dunzhan shall pay Jiangtong Factoring the principal and interest of the loan and Jiangtong Factoring¡¯s claims against Shanghai Changzhan are dismissed.