Pipeline Network Eligibility for Securitization of Finance Lease Assets

As one of the most common types of underlying assets in asset securitization, receivables under a finance lease have long been at the forefront in terms of scale and size of emission. In practice, when local platform leasing companies screen leased assets for asset-backed securities (ABS), in addition to the requirement that the lease receivables meet the underlying asset standards, the leased assets underlyings must also be eligible.

But the question of eligibility for securitization can sometimes be thorny in a gray area such as a network of pipes, raising many questions.

Q: What leased assets can be used?

Daniel Hsu
Partner
AnJie & Broad law firm

A: The Chinese Civil Code and other laws and regulations clearly state that assets leased under financial leasing agreements must not be fictitious. Otherwise, the contract will be invalid. The Provisional Measures for the Supervision and Administration of Leasing Companies, issued by the China Banking and Insurance Regulatory Commission in 2020, provides that assets leased under leasing transactions must be fixed assets. But they failed to clarify the definition and scope of fixed assets beyond the requirement that leased assets be “genuine”, “clearly owned” and capable of “generating revenue”.

In practice, reference is often made to Accounting Standards for Business Enterprises No. 4 – Fixed Assets, which provides that “fixed assets are tangible assets: (1) held for the purpose of producing goods, providing services, labor, hire or management; and (2) whose life span exceeds one fiscal year. »

According to judicial practice, in addition to equipment, construction machinery, transport tools and other movable property, factory buildings, commercial buildings and other operating buildings meeting the above standards can also serve as leased property.

Real estate such as housing under construction, urban roads and security housing, as well as intangible assets such as trademarks, patents and software cannot serve as leased assets because they do not generate income, their disposal is limited or they are not tangible assets.

Q: What are the requirements?

A: Typically, leased assets must meet the following requirements: (1) clear and uncontroversial ownership; (2) not subject to restrictions of rights such as mortgage and pledge; (3) specific and disposable; (4) commercially reasonable; and (5) does not involve national defense, military or other state secrets.

Availability and commercial rationality are particularly important. When applying for a project, it is generally necessary to specify whether the leased assets are available and profitable.

Q: Does a pipeline network meet ABS requirements?

A: Rig leasing companies typically focus their business in utilities, infrastructure construction, and other areas of government lending. Their leasing often affects the public good, rendering the leased assets unable to meet availability and commercial rationality requirements.

Since 2020, regulators have banned the use of urban roads, bridges and culverts as leasing assets and restricted the proportion of structures. However, due to the particularity of the network of pipes, opinions differ as to whether it is a works.

Q: Is a pipe network a structure or movable property?

Adam Chen, AnJie & Broad Law Firm
Adam Chen
Partner
AnJie & Broad law firm

A: Chinese laws and regulations state that “immovable property” includes buildings, structures and attached land, but the structure is not clearly defined. The national classification and fixed assets code defines “structures” as man-made structures not intended for production or residence, supplemented by a list of structure types.

Of these, water pipelines (water diversion pipelines, drainage pipelines, etc.) and municipal pipelines are clearly classified as “works”; water distribution pipelines as “transport pipelines” as part of the general equipment; and oil and gas pipelines as “special petroleum and chemical equipment”, under special equipment. All are determined as moveable property.

Q: Is a pipeline network eligible if it is attached to real estate?

A: Although the pipe network must be attached to land, a dwelling or other immovable property to fulfill its function, its status as tangible personal property is not affected. As leased property, it retains the attribute of movable property and its independence.

Attaching such assets to real estate may weaken the lessor’s ability to use them as collateral. However, this is an operational risk for the financial lessor and does not affect the identification of the pipe network as movable property.

The Supreme People’s Court also upheld this view during the review and supervision of the 2017 litigation disputes over a loan contract between Sinohydro Beigu Construction Machinery and Chengdu Yuyi Silk.

Q: Is a pipeline network disposable and commercially reasonable?

A: A pipe network is movable property and is therefore specific and independent. Although after real estate detachment, it may suffer from reduced utility and moderate market liquidity, which means that it cannot be disposed of or realized in time. However, in the event of breach of contract, there is no legal obstacle to the transfer of the rented goods in accordance with the rental contract.

Furthermore, although most pipeline networks do not charge users directly for the provision of transmission services, most of these charges are in fact included in the overall costs, with the exception of pipeline transmission networks. water and heat in industrial parks for which pricing standards are clearly provided. Pipe networks are therefore auxiliary equipment essential to the principal activity and to the profitability of the lessee, justifiable in their commercial rationale.

Q: Suggestions for entering the pipeline network as a pool asset?

A: Judging from recent successful rig lessor leasing ABS issuances, there are no impediments to pipeline networks entering the leased asset pool as long as the availability criteria , commercial rationality and other eligibility criteria are met.

The authors suggest that managers reviewing pool assets focus on the following aspects when reviewing pipeline network eligibility: (1) confirming ownership certificate, such as purchase agreement, invoice, certificate of acceptance or receipt of the equipment; (2) inspect the registration of rights, for example by checking the completion of the registration of the lease on the website of the central bank’s credit reference center; (3) conduct on-site inspection and due diligence to confirm the true specificity of the Leased Assets; and (4) review the Leased Asset Valuation Report and internal project review documents to avoid buying at full price and reaffirm business rationality.

Adam Chen and Daniel Hsu are partners at AnJie & Broad Law Firm

Dong Xiao Zhao Huili AnJie Law Firm International Arbitration

AnJie & BB Law Firm

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Shanghai 200031, China
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