Minton explains the law: efficiency and safety in the movement of funds on a P2P platform

A P2P platform, as an information intermediary for private lending, should act only as the publisher of bid information and hold strictly to the legal position of a broker. In theory, then, there is no such thing as a problem of moving funds on a P2P platform. To improve the client's experience, however, to make the matching of bids more efficient and to reduce the default rate, almost every P2P platform takes, by agreement with its clients, a mandate from the bidders to exercise part of the right to transfer money. The author divides the movement of funds on a P2P platform into three parts — the transfer of the loan (including the deposit), the transfer of interest and service fees, and the transfer of money involved in credit enhancement — and analyses the legal problems arising in that process and effective ways of solving them.

Part one: the transfer of the loan (including the deposit)

The movement of funds in this process is as follows: when the bid is published and bids are made, the platform freezes the loan and the deposit of the parties; when the bid is fully subscribed, it transfers the loan to the borrower's account; and when the loan term expires it transfers the principal back to the bidders. The basis on which the platform acts as a "porter" for the lending and repayment of the principal is the "mandate to transfer" clause in the platform agreement, by which the parties "irrevocably mandate" the platform to freeze and transfer their loan and deposit in that way. The practice brings great convenience to the platform's management, but two substantial risks remain.

First, the legal effect of an "irrevocable mandate" is still much disputed in China. Under traditional civil law theory the principal has a unilateral right of termination, which exists to protect him, and an "irrevocable mandate" clause in practice restricts that right to terminate the contract. Platform agreements are moreover usually standard-form contracts, so that such a clause may be held by a People's Court to fall within article 40 of the Contract Law — "the party providing the standard terms exempting itself from liability, increasing the other party's liability or excluding the other party's main rights" — and therefore to be invalid. That opens the way for a borrower, when the loan falls due, to refuse to put sufficient funds in its account to be frozen, greatly increasing the risk of default.

Second, in the early days of P2P platforms, risk control and traffic did not allow a perfect match between online investors and borrowers, and the term and amount of the loan could not be matched to the amount the investor intended to commit, so that the process could readily lead the platform to form a "fund pool". The formation of such a pool does not necessarily amount to unlawfully absorbing public deposits, but if a People's Court finds in the course of a trial that the lending relationship exists between the lender and the platform rather than between the lender and the borrower, the platform's conduct will satisfy the elements of the crime of unlawfully absorbing public deposits, namely "unlawful fund-raising from an unspecified number of persons in society". A very large fund pool also places great pressure on the platform's internal management, and the news has more than once reported senior managers of P2P platforms absconding with vast sums.

Under article 1 of the Interpretation of the Supreme People's Court on Several Issues concerning the Specific Application of Law in the Trial of Criminal Cases of Illegal Fund-raising, where the following four conditions are all present, a person may, unless the Criminal Law provides otherwise, be found to have unlawfully or in disguised form absorbed public deposits: (1) funds are absorbed without the lawful approval of the relevant department, or under the guise of lawful business; (2) the matter is publicised to society through the media, promotional meetings, leaflets, mobile phone messages and other means; (3) a promise is made to repay principal and interest, or to give a return, in money, in kind, in equity or otherwise within a certain period; and (4) funds are absorbed from the public, that is, from an unspecified number of persons in society. The interpretation also provides that criminal liability arises where an individual absorbs funds from 30 or more persons or absorbs 200,000 yuan or more, or where a unit absorbs funds from 150 or more persons or absorbs 1,000,000 yuan or more.

Although a fund pool exposes a P2P platform to great legal risk, it played a very large part in the operation of platforms in their early days. A pool gives the platform funds that it can lend at any time, and leaves it a wide margin for manoeuvre in lending on its own account and in managing liquidity, which in a sense helps to attract high-quality borrowers.

As to those two risks, the author considers that a P2P platform should bring in a third-party payment platform, requiring borrowers and bidders by the platform agreement to bind their platform accounts to accounts with the payment platform, and effecting the freezing and transfer of the loan (including the deposit) through that payment platform. This has two advantages. First, by bringing in the payment platform the P2P platform can rely on the "interest of a third party" to restrict the unilateral right of the parties to terminate the mandate to freeze and transfer funds. Second, because the loan and deposit are held, frozen and transferred on the third-party payment platform, and the P2P platform holds only authority to freeze and transfer, no fund pool can possibly form within the platform, which greatly reduces the pressure of risk control on the platform itself.

Part two: the transfer of interest and service fees

This process is as follows: some P2P platforms, to secure payment of the borrower's interest and service fee, transfer the interest and service fee payable by the borrower to the platform account when the bid is fully subscribed, and transfer the interest to the bidders' accounts when the loan term expires.

The legal character of this process, its legal risks and the ways of resolving them are similar to those of the first part, and the author does not repeat them here.

Part three: the transfer of money involved in credit enhancement

It should first be understood that the People's Bank of China, leading ten ministries and commissions, stated expressly in the Guiding Opinions on Promoting the Sound Development of Internet Finance that a P2P platform may not provide credit enhancement. Because the credit system in private lending is incomplete, however, P2P platforms more or less provide some credit enhancement for their own development. How to provide it without crossing the legal red line has become a major problem for P2P platforms, and the transfer of the money involved is closely connected with the form the enhancement takes. The author lists several forms commonly seen on P2P platforms today.1

1. A suretyship. Commonly given by a guarantee company or a party connected with the borrower, the guarantor undertaking to provide joint and several liability where the borrower cannot repay the debt when due.

2. Advance payment. Generally made by the P2P platform, which undertakes to advance funds where the borrower cannot repay the debt when due, and then pursues the borrower on the investor's behalf. Advance payment and suretyship are similar in their legal character.

3. A promise to buy the claim. This may be the P2P platform's own promise to buy, a third party's promise to buy, or the seller of the claim's promise to repurchase, depending on the structure of the transaction.

4. Liability insurance. The P2P platform takes out performance liability insurance for investors as beneficiaries, the insurer bearing liability to pay where the debtor cannot repay.

5. Mortgage or pledge. The borrower or the guarantor provides property by way of mortgage or pledge to secure performance of the debt.

6. A risk fund. The P2P platform sets aside a proportion of the income from each transaction as a risk fund, or collects a proportion of the money from the borrower in each transaction for that purpose, and where the debtor cannot repay, the platform compensates investors to a certain proportion out of that fund.

Because the Guiding Opinions state expressly that a P2P platform may not provide credit enhancement, whether a platform's enhancement complies with the rules is judged by reference to who provides it: the platform itself may not provide it, but a third party may. Two points call for attention where a third party provides it. First, the third party must be a guarantee company with the qualification to give guarantees. Second, money involved in enhancement provided by a third party usually no longer passes through the P2P platform, so that no legal risk attaches to the platform in transferring it.

Of the forms listed above, the only one in which the platform takes part in the movement of funds is enhancement by way of a risk fund — to be precise, the borrower pays a proportion of each loan as a special fund which the P2P platform manages. Because the money comes from borrowers and does not form part of the platform's own assets, it cannot be regarded as credit enhancement by the platform itself. New questions arise, however: how is the money to be characterised? If it is a trust fund with investors as beneficiaries, is the P2P platform qualified to manage such a trust fund, and do the terms of the risk fund clearly provide for the legal relationship of trust? The author considers that, although the management of funds by way of trust requires a specific qualification, a P2P platform should still make clear contractual provision for such a risk fund, defining the class of beneficiaries and the trust character of the fund. An agreement cannot necessarily exclude the risk of invalidity, but it can at least reduce dispute.

1 Part of the content of this paragraph comes from Yinhang.com; the original is at http://www.yinhang.com/a_2015_0514_340454.html

Special notice: copyright Minton Law Firm. The information above is for general reference only and should not be treated as legal advice or a basis for any particular matter.