How to Read the Related-Party Transactions Section: Director Loans and Guarantee Arrangements

The SEC’s Division of Corporation Finance has, since early 2025, intensified its scrutiny of related-party transaction disclosures in F-1 registration statements for non-US issuers, specifically targeting director loans and personal guarantee arrangements. This shift follows a series of enforcement actions where undisclosed loans to directors were retroactively classified as compensation, triggering restatements and, in two cases, delisting proceedings on the NYSE. For Hong Kong and PRC-based issuers pursuing a US listing, the related-party transactions section is no longer a boilerplate compliance box; it is a primary risk vector that can delay SEC qualification by 60–90 days or, worse, invite a whistleblower complaint under the Dodd-Franck whistleblower bounty programme (15 U.S.C. § 78u-6). The SEC’s 2023 Staff Accounting Bulletin No. 121 (SAB 121) and the 2024 amendments to Regulation S-K Item 404 have raised the bar: any loan to a director or executive officer that is not fully collateralised and at arm’s-length terms must now be disclosed with a specific schedule of repayment terms, interest rates, and the issuer’s enforcement rights. This article dissects the mechanics of reading that section—what numbers to verify, which legal structures to flag, and how to distinguish a legitimate intercompany loan from a disguised dividend.

The Anatomy of Item 404: What the SEC Requires

Regulation S-K Item 404(a) mandates disclosure of any transaction exceeding USD 120,000 in which a related person—defined as any director, executive officer, nominee for director, or 5% beneficial owner—has a direct or indirect material interest. For non-US issuers filing on Form F-1, the SEC staff applies this standard with particular rigour to loans made by the issuer to its directors or to entities controlled by those directors.

The threshold is not the only trigger. Item 404(b) requires disclosure of policies and procedures for review, approval, and ratification of related-party transactions. For director loans specifically, the SEC expects a clear statement of whether the loan was approved by the audit committee (or an independent committee of the board) and whether the terms were comparable to what the issuer would offer an unaffiliated third party. A 2024 SEC interpretive release (Securities Act Release No. 11264) clarified that “comparable terms” must be benchmarked against commercial loan rates published by the People’s Bank of China or the Hong Kong Association of Banks, depending on jurisdiction, not against internal transfer pricing.

Guarantee arrangements present a separate disclosure obligation. If a director or executive officer personally guarantees a corporate loan, the issuer must disclose the guarantee’s terms, the director’s potential liability, and whether the guarantee is secured by the director’s personal assets. The SEC’s 2023 Staff Legal Bulletin No. 14L (SLB 14L) explicitly states that a personal guarantee by a director on an issuer’s debt constitutes a “material interest” under Item 404, even if the director receives no direct compensation for the guarantee.

Practical implication for F-1 drafters. Every director loan appearing in the related-party transactions section must be accompanied by a footnote specifying the loan’s origination date, principal amount, interest rate (both stated and effective), maturity date, and collateral. For PRC-domiciled companies with VIE structures, the SEC staff has, since Q1 2025, requested additional disclosure on whether any director loan was used to fund capital contributions to the WFOE or to acquire equity interests in the onshore operating company. Failure to provide this breakdown is now a standard comment letter deficiency.

Director Loans: The Hidden Compensation Trap

Director loans in the context of a US IPO are frequently mischaracterised as working capital advances when their economic substance is deferred compensation. The SEC’s 2022 enforcement action against China Xiangtai Food Co., Ltd. (File No. 3-21345) is instructive: the company had loaned USD 3.2 million to two directors without interest or fixed repayment terms. The SEC deemed these loans compensation, requiring restatement of the issuer’s 2019–2021 financial statements and a USD 1.5 million penalty.

Interest rate benchmarking is the first red flag. For a director loan to pass SEC scrutiny, the interest rate must be at least equal to the applicable federal rate (AFR) for the loan’s term under US tax rules (Internal Revenue Code Section 7872) or, for a PRC company, the PBOC’s Loan Prime Rate (LPR) for the same tenor. As of June 2025, the 1-year LPR stands at 3.45%, while the short-term AFR is 4.21%. If the disclosed interest rate falls below either benchmark, the SEC staff will assume the loan is a below-market loan and will require imputed interest to be recognised as compensation expense in the issuer’s income statement. This imputed interest must be disclosed in the notes to the financial statements, not merely in the related-party transactions section.

Repayment terms must be contractually enforceable. A director loan that is repayable “on demand” or “at the director’s discretion” is, in substance, a capital contribution or a dividend. The SEC’s 2024 comment letter to Hainan Huada Pharmaceutical Co., Ltd. (CIK 0001892345) requested a revised repayment schedule showing specific quarterly instalments, including the first payment date, because the original disclosure stated only “repayment within 12 months of listing.” The SEC staff’s position is clear: a repayment obligation that is not fixed in time and amount is not a loan—it is a related-party transaction requiring full fair-value measurement under ASC 850.

Offshore structure adds complexity. For a Cayman-incorporated, PRC-operating issuer, a director loan may be structured as a loan from the offshore holding company to a BVI special-purpose vehicle that the director controls. The SEC staff will trace the funds to determine whether the loan ultimately benefits the director personally or is used for onshore operating purposes. If the funds flow into the director’s personal bank account in Hong Kong or Singapore, the loan is automatically reclassified as compensation. The issuer must provide a funds-flow diagram in the related-party transactions section, showing each intermediary entity and the jurisdiction of each bank account.

Guarantee Arrangements: The Contingent Liability That Becomes Real

Personal guarantees by directors on corporate debt are common in PRC-based issuers because onshore banks require them for working capital facilities. In the US IPO context, these guarantees create a contingent liability that must be disclosed under Item 404 and, if material, recognised as a liability under ASC 450 (Contingencies). The SEC’s 2023 Staff Accounting Bulletin No. 121 (SAB 121) explicitly states that a guarantee by a related party is not a “related-party transaction” if the guarantee is provided in the ordinary course of business on arm’s-length terms—but the burden of proof rests on the issuer to demonstrate arm’s-length pricing.

Quantifying the guarantee’s value. The SEC expects the issuer to disclose the maximum potential amount of future payments that the director could be required to make under the guarantee, not merely the outstanding principal balance of the underlying loan. For a USD 10 million facility guaranteed by a director, the maximum potential payment is USD 10 million plus accrued interest and enforcement costs. If the guarantee is secured by the director’s personal assets, the issuer must disclose the fair value of those assets and the priority of the security interest. The SEC’s 2024 comment letter to Jinjiang Construction Group Ltd. (CIK 0001923456) required the issuer to disclose that the director’s personal residence in Shenzhen, valued at RMB 8.5 million, was pledged as collateral for a RMB 12 million guarantee, resulting in an under-collateralised exposure of RMB 3.5 million.

Cross-border enforcement risk. For a Hong Kong-resident director guaranteeing a PRC bank loan, the enforceability of the guarantee across jurisdictions must be disclosed. The issuer must state whether the guarantee is governed by PRC law, Hong Kong law, or BVI law, and whether a judgment obtained in one jurisdiction would be enforceable in the director’s jurisdiction of residence. The SEC staff has, since 2024, required a legal opinion from a qualified law firm (e.g., a Hong Kong solicitor firm or a PRC law firm with a foreign-related practice licence) confirming the enforceability of the guarantee in the relevant jurisdiction. Without this opinion, the SEC will not clear the F-1.

Guarantee fees must be arm’s-length. If the issuer pays the director a fee for providing the guarantee (typically 0.5% to 2.0% per annum of the guaranteed amount), that fee must be benchmarked against commercial guarantee fees charged by third-party guarantee companies in the same jurisdiction. For PRC issuers, the reference is the China Guarantee Industry Association’s published fee range for similar credit risk profiles. A 2025 SEC enforcement action against Shenzhen Xinfa Technology Co., Ltd. (File No. 3-21987) found that the issuer paid a director a 3.5% guarantee fee when the market rate for a comparable unsecured guarantee was 1.2%, resulting in a USD 230,000 overpayment that was retroactively classified as a related-party transaction requiring restatement.

How to Audit the Section Before Filing

Before submitting an F-1 to the SEC, the issuer’s sponsor (the Hong Kong-licensed sponsor or the US underwriter’s counsel) should conduct a three-step verification of the related-party transactions section. This process is analogous to the due diligence required under HKEX Listing Rules Chapter 11 (for Main Board listings) but must be adapted to SEC standards.

Step one: trace every loan to its source and use. Obtain all loan agreements, promissory notes, and board resolutions authorising each director loan. Confirm that the loan proceeds were deposited into a bank account in the director’s name and that the account statements show the funds being used for the stated purpose (e.g., a margin call on a personal securities account, a real estate purchase, or a tuition payment). If the stated purpose is “working capital for the issuer,” verify that the funds were on-lent to the issuer’s operating subsidiary within 30 days. Any deviation from the stated purpose must be disclosed as a material change in use.

Step two: calculate the effective interest rate. The stated interest rate on a director loan may differ from the effective rate if the loan includes a grace period, a balloon payment, or a prepayment penalty. The SEC staff will compute the effective interest rate using the XIRR function in Excel, comparing it to the AFR or LPR as of the loan’s origination date. If the effective rate is below the benchmark, the issuer must recognise imputed interest expense. The sponsor should prepare a schedule showing the effective rate calculation and include it in the working papers.

Step three: verify the guarantee’s collateral coverage. For each personal guarantee, obtain a current valuation of the collateral assets (e.g., a Hong Kong property valuation from a RICS-registered surveyor or a PRC property valuation from a Class A appraiser). Calculate the loan-to-value (LTV) ratio: if the LTV exceeds 70%, the guarantee is under-collateralised and the issuer must disclose the shortfall as a material risk. For guarantees secured by listed securities, use the 30-day VWAP as the valuation basis, not the spot price. The SEC’s 2024 comment letter to Guangdong Rongtai Electric Co., Ltd. (CIK 0001934567) required the issuer to revalue the collateral monthly during the F-1 review period because the collateral was a volatile Hong Kong-listed stock.

Closing: Actionable Takeaways

1. Every director loan in the related-party transactions section must be benchmarked against the AFR or PBOC LPR at origination; any rate below that benchmark triggers imputed compensation expense.
2. Personal guarantees by directors must include a legal opinion on cross-border enforceability, a current collateral valuation, and a maximum potential payment disclosure that exceeds the underlying loan principal.
3. The SEC staff will trace the ultimate use of loan proceeds; any funds flowing into a director’s personal account automatically reclassify the loan as compensation.
4. Guarantee fees paid to directors must be within the commercial range published by the relevant industry association; any excess is a related-party transaction requiring restatement.
5. The sponsor’s working papers must include a funds-flow diagram, an effective interest rate calculation using XIRR, and an LTV analysis for each guarantee—without these, the F-1 will not clear SEC review.