Earth Research | Judicial Determination and Risk Prevention of Circular Trade

The typical characteristics of a sales contract are that the seller delivers goods to the buyer, and the buyer pays the seller. The basic transaction structure of circular trading is that a channel party is inserted between the fund provider (lender) and the fund user (borrower). The original direct lending behavior between the lender and the borrower is divided into multiple sales contract transactions through a closed-loop circular sale, and finally completes the transfer of loan funds. The review and determination of circular trading need to have the following formal characteristics: (1)

Each party signs contracts in pairs, forming a closed-loop transaction, with each party being both a buyer and a seller. At least three parties actually participate in the transaction in circular trading: the lender, the channel party, and the borrower. In order to increase the concealment of the transaction, more trading entities may be involved in practice to form a channel. Regardless of the number of trading entities, the final trade chain must form a closed-loop cycle.

(2)

The transaction elements in upstream and downstream contracts are highly similar, and the signing dates, types, quantities, qualities, and delivery locations of goods in each contract are often exactly the same, except for the unit price. Since the true intentions of the parties are not buying and selling, the sales contracts in circular trading are only carriers for the transfer of loan funds. Therefore,

Except for the inconsistent transaction prices Multiple parties sign multiple sales contracts on the same or similar dates, and the transaction elements of the contracts, such as the quantity, specifications, quality, and delivery location of the subject matter, are highly similar. (3)

The true intention of the parties signing the contract is to borrow money rather than buy and sell goods, and all parties acknowledge that there is no real flow of goods. In circular trading, the sales contracts signed by the parties are not true expressions of intent. The parties use collusive false expressions of intent to hide the true expression of intent of the lending relationship. Therefore, the establishment of circular trading requires all parties to be aware that the buying and selling relationship is false and to form an agreement.

At the same time, in circular trading, there is no real flow of goods. What the parties buy and sell are "goods ownership certificates", mainly manifested as bills of lading, warehouse receipts, and value-added tax special invoices as certificates for the flow of goods. That is, "walking documents, walking invoices, not walking goods."

(4)

One party (the borrower) has abnormal transactions of buying high and selling low, which means selling goods at a low price in the short term and then buying back the same quantity of goods at a high price in the future. In circular trading, the fund provider and the channel party usually receive fixed income, and both parties do not bear the operating risks brought about by the fluctuation of goods prices in the buying and selling relationship. In practice, courts mainly distinguish between lenders, actual users

Funds, and channel parties based on the time of fund occupation, the size of fixed profits generated by each party based on the contract, and the main flow of funds (see (2021) Supreme People's Court Civil Case No. 435). That is to say, according to the contract, the party with the longest fund occupation time and the largest loss is identified as the user, the party receiving a small fixed income is identified as the channel party, and the party with the largest profit is identified as the borrower. Step Two in Identifying Circular Trading

When applying the provisions of Article 146 of the Civil Code on collusive false expressions of intent to review circular trading, it best reflects the legal application process of "finding law from facts and using norms to encompass facts". After formally meeting the characteristics of circular trading, judges still need to use penetrating scrutiny thinking to ascertain the true intention of the parties and explore whether the true legal relationship is buying and selling or lending. Examine the negotiation process before the conclusion of the contract and whether the trading parties have a real trading background.

In (2021) Supreme People's Court Civil Ruling No. 7834, the judge used "the statements and witness testimonies of the parties involved in the relevant criminal case, the fact that the business representative of Guotou Company did not discuss the main trade issues during the transaction, and the witness testimonies and the defendant's statements can mutually verify that the business representative of Guotou Company knew that the transaction was financing" as the reason for determining that it constituted circular trading.

Each party signs contracts in pairs, forming a closed-loop transaction, with each party being both a buyer and a seller. In (2020) Supreme People's Court Civil Judgment No. 1068, however, it was stated that "Yunlian Company, Jishi Company, and Sanji Company all acknowledged the authenticity of the steel trade in the first instance, and Jishi Company and Yunlian Company

Have a long-term cooperation and have known the content of the contract and the trading model from the beginning.

In addition, Wuyang Company issued a value-added tax special invoice to Yunlian Company for each transaction. 存在长期合作，自始知悉合同内容以及交易模式。此外，五矿公司就每一笔交易均向云链公司开具了增值税专用发票。 Jishi Company did not submit evidence to prove that the parties involved formed a closed loop in terms of fund flow, contractual relationships, and goods flow. Given that in the actual steel trading market's multi-party chain-trading model, it is common for intermediate buyers to deliver goods to the ultimate buyers through instructions for delivery, and in this case, Wumin Company and Yunlian Company have a long-term cooperative relationship, Wumin Company's fulfillment of the contractual obligations in question complies with the transaction habits and agreements of both parties. ” supported the legal relationship in question as a sales contract legal relationship on the grounds of.

(2) Examine whether the stipulations in the contract in question comply with the characteristics of a sales contract, mainly by reviewing whether the clauses regarding delivery, quality inspection, settlement, breach of contract liability, and assumption of transaction risks conform to the general commercial common sense.

In circular trade, sales contracts are merely a false expression of common intent by all parties, who do not care whether the goods genuinely exist or are actually delivered. Therefore, in the contract text, the parties do not focus on the issue of risk assumption in the transaction, but rather on the specific loan proceeds that can be obtained. This significantly differs from a genuine sales contract. For example, the contract lacks title retention clauses, or even directly stipulates earning fixed returns, which significantly violates market price laws, and the liquidated damages setting includes clauses such as 'fund occupation fees' that are clearly elements of a loan contract.

(3) Focus on examining whether the contract in question was actually performed, whether there was real goods circulation and delivery, and whether it resulted in the transfer of real rights.

There are no real goods in circular trade Therefore, the party claiming the establishment of a sales relationship needs to focus on collecting and presenting evidence such as bills of lading, waybills, delivery confirmation notes, delivery notes, warehouse receipts, release orders, inbound notices, and goods receipt confirmations, which represent ownership transfer or goods transportation.

For example, Civil Judgment No. 756 of the Supreme People's Court in 2020 (Min Zhong) provided a detailed discussion on this point: 'The performance of a sales contract must be confirmed by actual delivery. In the absence of actual delivery of goods, Nanjing Huaneng Company should have been aware that the validity of the receipt confirmation notes self-stamped and confirmed between it and its upstream and downstream parties cannot be entirely equivalent to statutory cargo right certificates and circulation procedures,' It may therefore face the commercial risk that ownership cannot genuinely transfer due to the non-existence of the subject matter. Furthermore, for coal transactions of immense tonnage and volume in this case, the delivery method specified in the receipt confirmation notes stamped by the parties was all by road transport, but there were no records of vehicle entry/exit from warehouses or transportation information whatsoever, This can also corroborate that the parties did not care whether the goods actually existed, and the transactions in question did not genuinely circulate. 。 In addition, for specific batches of coal the sales contracts stipulated quality standards and inspection requirements, but none of the parties ever submitted evidence of performance in this regard, This does not conform to the normal expected judgment and urgent concern of sales contract parties regarding whether the quality of the subject matter is qualified. 。”

(1) Contractual Risk

Once identified as circular trade, the sales contract, being a false expression of common intent by all parties, grants no party the right to enforce its binding force. After the sales contract becomes invalid, if a state-owned enterprise is the lending party in the circular trade, and in practice, when disputes are brought to court, the borrowing party often loses its repayment ability, thus posing a risk of loss of state assets. Even if the channel party is sued, according to relevant meeting minutes of the Second Circuit Court of the Supreme People's Court, the channel party only bears corresponding compensation liability based on fault, thus unable to fully compensate for the loss of state assets.

(2) Tax Risk

Since there is no real movement of goods in circular trade, if it is deemed a false transaction, state-owned enterprises may face the administrative penalty risk of being identified by tax authorities as issuing false VAT invoices. In serious cases, it may even constitute economic crimes such as issuing false special VAT invoices.

(3) Criminal Liability Risk

Circular trade, due to the large amount involved and the large number of parties involved, is highly susceptible to criminal activities, and therefore often involves cross-criminal and civil procedural issues. Common crimes include contract fraud, usurious lending, abuse of power by state-owned company personnel, and dereliction of duty in signing and performing contracts leading to deception.

(1) Strengthen due diligence and standardize contract management

Before conducting a transaction, enterprises should conduct a comprehensive investigation into the background, reputation, and operational status of the trading entity. Simultaneously, review the authenticity and legality of the goods. Sign authentic and reasonable contracts. If the transaction involves a price that does not match market conditions, or a transaction volume that significantly exceeds the supplier's capacity, then it should be handled cautiously.

(2) Closely monitor the business operations of trading partners during the transaction process and confirm the corresponding payment relationship between cargo rights and payments.

Enterprises should closely monitor the business operations of their trading partners and continuously observe the corresponding relationship between the transfer of cargo rights and the payment of goods. If the trading partner's ability to perform declines, consider temporarily suspending performance or demanding security. This reduces the risk of not receiving goods after payment. At the same time, during the transaction process, pay attention to retaining evidence such as correspondence between parties, existence of goods, and delivery.

(3) Seek professional legal advice

When engaging in transactions or encountering complex legal issues, enterprises should promptly seek professional legal advice. This helps enterprises accurately determine the nature of legal relationships, analyze legal risks, and provide corresponding effective risk prevention recommendations.