Financial leasing has both financing and financial properties. "If there is only financing, but no financial assets, it is likely to be recognized as borrowing in the name of financial leasing.". After financial leasing is recognized as lending, the legal norms governing financial leasing no longer apply, but instead apply to the legal norms and judicial rules governing private lending. How to identify and handle the withholding rent, deposit, handling fee, down payment, consulting fee, interest, overdue interest, liquidated damages, and other related expenses agreed upon by the parties in the financial leasing contract? This article will reveal the answers to the above questions through relevant cases.

Referee gist

After a financial lease is recognized as a loan, relevant legal norms and judicial rules governing private lending apply. Referring to the provisions of Article 2, paragraphs 2 and 4, of the Several Opinions of the Supreme People's Court on Further Strengthening Financial Justice Work, the determination of the principal of a loan shall be based on the funds actually provided by the lender (lessor). Therefore, funds of the so-called "haircut interest" nature such as withholding rent, security deposit, handling fee, down payment, and other folk funds shall be deducted from the principal of the loan in advance.

The upper limit of the borrowing rate must be subject to the restriction of "four times the market quoted interest rate for the one-year loan at the time of the establishment of the contract". The overdue interest, liquidated damages, and other related expenses shall be adjusted together, and the total of the three shall be subject to the restriction of "four times the quoted market interest rate of the one-year loan at the time of the contract establishment". If the contract was established before August 20, 2019, it is subject to an annual interest rate of 24%.

Case: Civil Judgment of Second Instance on Contract Disputes between China Railway No.9 Engineering Group Chengdu Engineering Co., Ltd. and China Railway No.9 Engineering Group Co., Ltd. [Tianjin Higher People's Court (2020) No. 6 Judgment Date: February 25, 2020]

Brief Introduction to the Case

1、 On February 7, 2015, State Grid Corporation and Chengdu Engineering Company signed a "Financial Leasing Contract (After Sale and Leaseback)", which agreed that State Grid Corporation would purchase machinery and equipment such as excavators from Chengdu Engineering Company and lease them back to Chengdu Engineering Company for use. The total contract price is 150 million yuan, the deposit is 15 million yuan (deducted by State Grid Corporation when paying the purchase price), and the handling fee is 4.05 million yuan. The lease term is 36 months, calculated from the date when State Grid Corporation pays the equipment purchase price; The lease rate will be increased by 15% based on the benchmark lending rate of the People's Bank of China for the same period, and adjusted accordingly; The delayed interest is calculated at a monthly interest rate of 2.5%; The penalty for breach of contract is 1% of the total rent, and the limit for breach of contract is 1 million yuan; Delivery of leased property: After State Grid Corporation pays the purchase price for the machinery and equipment, the machinery and equipment shall be deemed to be delivered by State Grid Corporation to Chengdu Engineering Company.

2、 On February 16, 2015, State Grid Company actually paid 130.95 million yuan to Chengdu Engineering Company after deducting the deposit and handling fee.

3、 Since February 16, 2017, Chengdu Engineering Company has been in arrears with the 8th installment of rent of State Grid Corporation. As of the expiration of the financing lease contract, Chengdu Engineering Company has paid the rent of 97053470.87 yuan, and the total rent from the 8th installment to the 12th installment is 68785931.45 yuan that has not been paid.

4、 State Grid Corporation filed a lawsuit with the court requesting Chengdu Engineering Company to pay all unpaid rent, delayed interest (calculated at a monthly interest rate of 2.5%), liquidated damages (calculated at 1% of the total contract amount), as well as attorney fees, property preservation fees, and other expenses for realizing the creditor's rights.

The court held that

The focus of this case is as follows: 1. The nature and effectiveness of the "Financial Leasing Contract" involved in the case; 2、 The amount of principal, interest, interest during the period of delay in performance or liquidated damages and other related expenses payable by Chengdu Engineering Company.
The court of first instance held that:

1、 Regarding the effectiveness of the Financial Leasing Contract.

The objective existence of the leased object and the transfer of ownership to the lessor are important characteristics of financial leasing contracts that are different from loan contracts. The lease item should exist objectively and be specific. "There is no definite and objective lease item, only the financing of funds, which does not constitute a financial leasing contract relationship.". In this case, although State Grid Corporation and Chengdu Engineering Company signed a "Finance Lease Contract" and made agreements on the leased property and rent, with a list of equipment attached, the specific purchase price, depreciation discounts, and current value of the leased property were not reflected. In particular, State Grid Corporation did not provide that it had conducted on-site surveys or physical inspections of the leased property when obtaining ownership of the leased property The status of the leased property and other evidence that can prove the true existence of the specific leased property. Therefore, relying solely on the equipment list is not sufficient to prove the true existence of the leased property, and the existing evidence cannot identify the relationship between the two parties as a financial leasing contract According to Article 1 of the "Provisions of the Supreme People's Court on Several Issues Concerning the Application of Law in the Trial of Private Loan Cases", which states that "The term" private loan "as used in these Provisions refers to the act of financing between natural persons, legal persons, and other organizations, as well as between them," it should be recognized that the relationship between State Grid Corporation and Chengdu Corporation is a private loan rather than a financial leasing contract. ", The agreement on the loan of funds and the repayment upon maturity in the contract involved in the case is the true expression of the parties concerned, and the loan contract should be recognized as authentic and valid.

2、 Regarding the amount of principal, interest, and liquidated damages payable by Chengdu Engineering Company.

The legal relationship between State Grid Corporation and Chengdu Engineering Company actually constitutes private lending, so the amount of repayment principal, interest, and liquidated damages should be determined in accordance with the legal norms of private lending. First, regarding the principal issue, the total price agreed upon by both parties in the contract is 150 million yuan, the deposit under the contract is 15 million yuan, and the handling fee is 4.05 million yuan. The actual amount paid by State Grid Corporation is 130.95 million yuan, so this amount should be used as the principal of the loan contract between the two parties. Secondly, regarding the issue of loan interest rates, the contract entered into by both parties is a loan contract in nature, and the contract is valid. The agreement on interest between the parties does not exceed the statutory limit benchmark, and should be recognized as valid. According to the agreement of both parties on the interest rate standard and regular adjustment, as well as the announcement of the People's Bank of China on the adjustment of the loan benchmark interest rate, the interest rate of the contract involved during the period from February 16, 2015 to February 15, 2016 is 6.9% per annum; The annual interest rate from February 16, 2016 to February 15, 2018 is 5.4625%. The overdue interest rate of the loan has exceeded 24% due to the contractual overdue interest rate and liquidated damages. The court of first instance adjusted the overdue interest rate to 24% per annum. Thirdly, regarding the amount of principal owed by Chengdu Engineering Company, due to the fact that both parties have not made a special agreement on the nature of repayment, the repayment by Chengdu Engineering Company shall have priority in paying off the interest in accordance with the legal order of repayment, and the remaining part shall be used to offset the principal. Fourth, regarding the issue of attorney fees and property preservation insurance premiums, as this portion of the fees is due to losses caused by Chengdu Engineering Company's failure to pay the rent on schedule, and this portion of the losses can be compensated through the delayed interest paid by Chengdu Engineering Company, the request of State Grid Company is not supported.

The court of second instance affirmed the verdict of the court of first instance and held that:

1、 On the focus issue 1. The court of first instance held that the evidence on file was insufficient to prove the true existence of the leased property, and thus determined that there was no financial leasing contract relationship between the two parties, with sufficient factual and legal basis.

2、 On the focus question two. The court of first instance applied the adjudication rules on legal relationships of private lending to confirm the amount of principal, interest, and liquidated damages payable by Chengdu Engineering Company, which has legal basis.

Analysis of key points of adjudication

From this case, it can be seen that a contract called financial leasing is actually a loan contract, and cannot produce the legal effect of financial leasing. The court applies legal norms and adjudication rules for private lending to adjudicate claims such as loan principal, interest, overdue interest, and liquidated damages.

First, the determination of the principal of the loan. When a financial leasing contract is recognized as a loan contract, the total amount of funds actually provided by the lender (lessor) to the borrower (lessee) is generally recognized as the loan principal. For example, in the sales and leaseback model, the actual price paid by the lessor to the lessee for the purchase of the leased property is recognized as the loan principal. It should be noted that, Referring to Article 2, paragraph 4, of the "Several Opinions of the Supreme People's Court on Further Strengthening Financial Judicial Work" issued in 2017: "Standardize and promote financing methods that directly serve the real economy, broaden the channels for financial docking with the real economy. Protect financing models that combine financial capital such as financial leasing and factoring with the real economy in accordance with the law, and support and ensure that financial capital serves the real economy. If a contract called a financial leasing contract or factoring contract is actually a loan contract, the rights and obligations of each party should be determined based on the actual relationship between the loan contract formed, to prevent the parties from participating "Raising the financing cost of the real economy in disguised form by withholding rent, margin, etc." According to the provisions of "Financial Leasing", it is actually an agreement to charge withholding rent, security deposit, down payment, handling fees, etc. in a loan. If the amount does not constitute a legal monetary pledge, it should be deducted from the principal of the loan.

Regarding whether the consultation fee can be deducted from the loan principal, there is currently no uniform standard for judicial adjudication. Based on our experience and relevant cases, when the project involved is relatively complex, the parties have signed a consultation service agreement and actually performed it, and the service results have also been accepted by the other party, the consultation fee is generally not deducted from the loan principal. If the parties only sign a consultation service agreement and pay the consultation fee without actually providing the service results, the consultation fee may be deducted from the loan principal.

Second, the determination of borrowing interest rates. The purpose of determining the loan interest rate is to pay interest to the lender (lessor) on the amount that has normally become due and payable after the financial leasing contract is recognized as a loan contract. Although a financial leasing contract is recognized as a loan contract and the agreement on financial leasing is no longer performed, the agreement on the (rental) interest rate should generally be considered as a true expression of intention between the parties regarding financing. Therefore, in this case, the rent rate in the financial leasing contract signed between the parties is generally recognized as the borrowing rate. If there is no explicit agreement on the rent rate in the contract, the court will generally calculate the loan rate based on relevant data such as the rent and rent payment agreed in the contract (such as the case in the extended reading section below). Of course, whether it is the interest rate agreed in the contract or the calculated interest rate, the court may make appropriate adjustments based on the specific circumstances of the case, the degree of fault of the parties, and other relevant factors. It should be noted that the upper limit of the borrowing rate must be subject to the restriction of "four times the market quoted interest rate for one-year loans at the time of the contract establishment".

Third, the determination of overdue interest, liquidated damages, and other expenses. Regarding the nature of overdue interest, there are "theories on the calculation method of damages" and "theories on liquidated damages". After searching for relevant cases, most judicial cases adopt the "penalty theory". Although the "penalty theory" is adopted, according to Article 9 of the Interpretation of the Supreme People's Court on the Applicable Law Issues in the Trial of Financial Leasing Contract Disputes (Revised in 2020), "If the lessee delays in performing its rent payment obligations or other payment obligations, and the lessor requires the lessee to pay overdue interest and corresponding penalty in accordance with the provisions of the financial leasing contract, the people's court shall support it.", Overdue interest and liquidated damages can be claimed simultaneously. Referring to Article 2, paragraph 2, of the Several Opinions of the Supreme People's Court on Further Strengthening Financial Judicial Work: "Strictly regulate usury in accordance with the law and effectively reduce the financing costs of the real economy. Borrowers of financial loan contracts who request a reduction in the total amount exceeding 24% of the annual interest rate on the grounds that the interest, compound interest, default interest, liquidated damages, and other expenses simultaneously claimed by the lender are too high, significantly deviating from actual losses, should be supported to effectively reduce the financing costs of the real economy.", The mainstream practice in judicial practice is to adjust the overdue interest, liquidated damages, and other expenses together, that is, if the total of the three exceeds the "one-year loan market quoted interest rate four times when the contract is established," the part will not be supported.

It should be noted that for the determination of interest, overdue interest, liquidated damages, and other expenses, if the contract is established before August 20, 2019, the relevant determination limit is subject to an annual interest rate of 24%.

Fourth, whether the retention and purchase price of the leased property should be supported. As the essence of a financial leasing contract is private lending, there is no issue of disposing of the ownership of the leased property, so the claim of retaining the purchase price is not supported.

Practical Experience Summary and Suggestions

The contract known as financial leasing, which is actually a loan, has undergone a change in the applicable law and judicial rules, that is, it no longer applies the legal norms related to financial leasing, but instead applies the legal norms of private lending. Although both parties have an intention to finance regardless of the legal relationship, the important difference between the two is:

First, the recognition and treatment results of financing amount, financing interest, overdue interest, liquidated damages, and other related expenses are different. As previously analyzed, when financial leasing is recognized as private lending, payments with the so-called "haircut interest" nature such as withholding rent, deposit, down payment, handling fees, and consulting fees should be deducted when determining the principal of the loan. Therefore, for lenders (lessors), in fact, compared to effective financial leasing contracts, due to the decrease in the financing principal, their interest, overdue interest, and other benefits will also be correspondingly reduced;
Secondly, due to the application of private lending laws and regulations, the sum of the interest originally agreed upon when signing a financial leasing contract, as well as overdue interest, liquidated damages, and other expenses, should be subject to restrictions that do not exceed "four times the quoted interest rate in the loan market". However, if it is a valid financial leasing contract, According to Article 1 of the "Reply of the Supreme People's Court on the Application Scope of the Judicial Interpretation of New Private Lending" (implemented from January 1, 2021): "On the issue of the scope of application. After consulting with the financial regulatory authorities, seven types of local financial organizations regulated by the local financial regulatory authorities, including small loan companies, financing guarantee companies, regional equity markets, pawnshops, financial leasing companies, commercial factoring companies, and local asset management companies, are financial institutions approved by the financial regulatory authorities to be established, and disputes arising from engaging in relevant financial businesses are not applicable to the new private sector." "Judicial interpretation of lending." In combination with the mainstream practice of relevant judicial practice, if the interest, overdue interest, and liquidated damages agreed between the parties are not particularly high, the court will generally respect the agreement between the parties and will not adjust it, that is, in principle, not be bound to exceed the "loan market quoted interest rate of four times.".

In summary, whether a financial leasing contract signed between the parties can produce the legal effect of financial leasing is of greater importance to the lessor. Therefore, for lessors, if they want to achieve the legal effect of financial leasing, first of all, they must be based on the essential characteristics of financial leasing - both financing and financing, and have a relatively complete embodiment in the contract. Secondly, the lessor should have a relatively strict obligation of review and attention regarding whether the leased item truly exists, whether it meets the criteria for being used as a leased item in financial leasing, and whether the ownership of the leased item is transferred according to law, and should retain relevant evidence. In addition, in judicial practice, after financial leasing is recognized as private lending, the court adjusts the determination of loan interest, overdue interest, and liquidated damages within the constraints of "four times the quoted interest rate in the loan market", but there is still some discretion. In addition to considering whether the loan interest, overdue interest, and liquidated damages themselves are too high, the court will also consider the performance of the contract The specific value of various factors such as the degree of fault of the parties shall be determined. Due to the large amount of financing generally involved in financial leasing, it can be said that it is very poor