Professional Interpretation

Summary

Share-holding entrustment, by virtue of its confidentiality, flexibility and flavor of evading legal provisions and regulatory requirements, has become a form of investment favored by many investors. However, the legal risks hidden behind the shareholding entrustment shall not to be underestimated. In fact, the shareholding entrustment is not only related to both the anonymous shareholder (principal) and the nominal shareholder (agent, proxy), but also easily leads to disputes or even corporate deadlock for those may well put the company and other shareholders entangled. The dispute resolution team of Beijing Docvit Law Firm will elaborate and analyze the meaning and legal risks of the shareholding entrustment, and select to introduce some of the common judicial standings.

I. Overview

Share-holding entrustment, also referred to as entrusted holdings or implicitly held shares, refers to the agreement of right and obligation arrangement between the actual contributor (the entrusting person, anonymous/hidden shareholder, principal) and the nominal contributor (the entrusted person, prominent shareholder agent or proxy,), in the form of written agreements or other forms, which stipulates that the nominal contributor will perform actual shareholder’s right and obligation in the name of his own.  

In general, shareholding entrustment is a flexible design of trading structures procured mostly for the aim of circumvention measures and remedial measures adopted by actual investors in the evasive consideration of the factors such as the number of shareholders, identities, industrial and commercial registration restrictions, confidentiality and others. Taking the avoidance of shareholder’s identity in the investment as an example, there are certain restrictions on such persons who have the “special identities” including public officials, military personnel, leading cadres of state-owned enterprises, and foreign investors, etc. For instance, foreign investors are limited or prohibited to invest certain industries stipulated by the Investment Catalogue of the Chinese Central Government, what’s more, Chinese representatives of Sino-foreign joint ventures and cooperative enterprises shall not be natural persons. In such circumstances, in order to circumvent like restrictions and burden of approval imposed by the government, investors from various parties will often select qualified domestic institutional legal persons as nominal investors in accordance with relevant regulations and requirements, thereby forming shareholding entrustment.

Presently, domestic legislation and judicial practice hold a “conditional recognition of its legitimacy” attitude on the legality of the shareholding entrustment. Specifically, China’s judicial interpretation recognizes the legitimacy of the shareholding entrustment agreement under normal circumstances unless the compulsory provisions of Article 52 of the "Contract Law" are violated. In addition, laws or administrative regulations may prohibit or limit the implicit investment of foreign investors or investment in specific industries. If an anonymous shareholder belongs to the category of the person who has been banned or restricted from specific investment, or if the industry in which the company intended to invest belongs to a specific industry limited or prohibited by laws or administrative regulations, the behavior of such shareholding entrustment may be annulled and invalidated as having an illegal purpose and constituting the act of “covering illegal purposes in legal form”. Specific provisions are scattered in the regulatory documents of all levels.

II. Judicial Standings on Shareholding Entrustments

In the judicial practice in recent years, the number of disputes caused by the shareholding entrustment has continued to increase. The main types are disputes over the ownership rights of anonymous shareholders, debt disputes of anonymous shareholders, and the validity of the shareholding entrustment agreements, among which, disputes over the ownership rights of anonymous shareholders has attained the largest share. In this article, we will introduce some of the common types of judicial standings in the litigation practice.

1. The first judicial standing

For a shareholding entrustment, the two parties should sign written agreements to prove such entrustment fact negating the shareholders' rights of the nominal shareholders. If there is only the transfer vouchers without any written shareholding entrustment agreement or other written proofs, even if there is a family relationship and testimony rendered in court, there is no way for a court to confirm the ownership of the anonymous shareholder. Additionally, verbal proxy agreements alone will not guarantee the rights of the anonymous shareholder either.

If there is no evidence to prove that there is a legal and effective shareholding entrustment agreement between the anonymous shareholder and the prominent shareholder, and the purpose of the transfer is not clear, thereby the anonymous shareholder cannot be deemed to have shareholder rights even if the investment funds actually come from him.

Let’s take as an example the right confirmation case of Liu Jing v. Wang Hao as shareholder of Jiangsu Shengao Chemical Technology Co. Ltd. (SCF No.0015 and CSFi No.96 ) :

Wang Hao, as a prominent shareholder of Jiangsu Shengao Company’s 39.024% equity, entered the company's capital verification account from his own personal account in the course of the company’s establishment and its first capital increase. Although Liu Jing remitted the same amount to Wang Hao on the same day because there were multiple payments between Liu Jing and Wang Hao, the possibility of Wang Hao’s investment coming from Liu Jing’s loan could not be ruled out. That was, Liu Jing’s remittance could not necessarily and exclusively be deemed as her investment in the company, remittance voucher alone was not presumed to be an investment. In the second round of capital increase, Wang Hao’s capital contribution was derived from the equity transfer consideration paid by Hong Kong Carlyle Co. Ltd., which proved Wang Hao had also been an actual contributor of Jiangsu Shengao Company, and this amount was not related to Liu Jing. The entity of rights and obligations involved in the “Consensus Agreement Letter” were Hong Kong Carlyle Co. Ltd. and Wang Hao, not Liu Jing, which could not prove the entrustment as Liu Jing claimed, nor could it prove that Carlyle’s recognition of Liu Jing’s shareholder status.

The evidence submitted by Liu Jing proved that she had served as a director and chairman of Jiangsu Shengao Company and could have a significant impact on the company’s operations and decision making. However, this did not corroborate her shareholder status. The facts claimed by Liu Jing of authorization to Wang Hao and Cheng Qianwen had nothing to do with the qualifications of her shareholder status; therefore, Liu Jing's proof could not prove that she performed the management and operation of the company as a shareholder and enjoyed the rights and interests of shareholders, but the evidence provided by Wang Hao successfully proved that Wang Hao actually enjoyed the rights of shareholders.

2. The Second Judicial Standing

Anonymous shareholders’ claim of the status of prominent shareholders must be agreed by more than half of other shareholders.

In accordance with the provisions of Article 23, paragraph 3 of the Supreme People's Court's Provisions on the Application of Certain Issues (III), the anonymous shareholders’ claims to confirm their shareholder status, request the company to issue capital certificates, record it in the shareholders' registration book, in the company's articles of association and in the registration with the Industrial and Commercial Department, it shall be approved by more than half of the other shareholders of the company.

In judicial practice, if an anonymous shareholder is unable to provide relevant evidence approved by more than half of the company’s shareholders, even if the anonymous shareholder is the actual investor in the equity involved, his claims to be a prominent shareholder in the court or requests to be recorded in the shareholders registration book and the article of association are more likely not supported by the courts.

Take the example of a shareholder qualification Case of Shanghai Baiqin Machinery Co., Ltd. v. Wu.

This case concerns the merger of shareholder qualification confirmation and the company's request for change registration. After the audit, Wu’s facts about the capital contribution of Baiqin Company were established, for which the Baiqin Company, Zhuang, and Zhang had no objection, and the court confirmed it. The amount of capital contribution was based on Wu’s cumulative investments over several years, the stock certificate, and the “certificate” issued by Baiqin Company and Zhuang, the court held that Wu’s contribution was RMB 300,000, and consequently 3.75% shares of Baiqin Company. Appellants Baiqin Company, Zhuang and Zhang’s appeal were rejected by the court. As for Wu’s other request to change the registration in the company, however, combined with the historical formation of Baiqin’s organizational structure, the court held that it could be confirmed that there was always such a long-term and stable trend that Baiqin had had a mix of prominent and anonymous shareholders’ co-existing and jointly governing the company. All investors, including prominent and anonymous shareholders, have agreed and followed for years. The original judgment decided that Baiqin Company had no fourth-party shareholders other than the parties to the case, and there was obviously some deviation.

At the same time, based on his “Contribution Certificate” and other evidence, Wu can be identified as one of the investors, and he also recognizes that the shares he holds are implicit shares and is held by Zhuang. This situation has existed for a long time and has not affected Wu’s participation in Baiqin’s internal decision-making and dividend distribution. Now Wu’s sole appeal seeks to name himself, which in essence breaks the stability and humanity of Baiqin’s corporate governance structure, and other investors in the company unanimously opposed his appeal. Based on this, Wu, as the actual investor, has not been approved by more than half of the company's other shareholders (investors), so his claim for naming in the registration book cannot be established according to law and should be rejected. In view of the new evidence submitted by Baiqin, Zhuang and Zhang in the second instance, the facts found in the case have materially changed, so the first instance judgment should be revoked.

3. The Third Judicial Standing

When the creditor of the prominent shareholder seeks to enforce the entrusted shares in the company, and the anonymous shareholder proposes objection to the implementation on the ground of the actual shareholder, the court will refuse to support the request to suspend execution.

Take for instance the retrial case of Chengdu Guangcheng Trading Co., Ltd. v. Fuzhou Feiyue Group Co., Ltd. ((2013) CR  No. 758 Civil Ruling by the Supreme People's Court):

Although it was the actual investor in the equity involved in the case, Guangcheng Company signed an agreement with Feiyue Group that the equity is owned by Guangcheng Company, but this equity was registered in the name of Feiyue Group and confirmed by China Securities Depository and Clearing Corporation Limited. Feiyue Group and and their investment target Lengguang Co. Ltd. also announced to the public that it had a publicity effect. Therefore, in internal relation between Guangcheng Company and Feiyue Group, according to the agreement between both parties, Guangcheng Company shall be the holder of the equity; in external relations, however, it shall be prominent shareholder Feiyue Group who would enjoy the equity for persons other than Guangcheng Company and Feiyue Group. On July 9, 2008, the court accepted the case of Minfa Securities Co., Ltd. applying for Feiyue Group’s bankruptcy and repayment. On October 28, 2009, the court ruled that it had declared Feiyue Group's bankruptcy. Based on the publicity and credibility of the registration and announcement, Minfa Securities was reasonable to believe that Feiyue Group held shares in Lengguang Company and it had the right to realize its claims on the equity. If the court supported the claim of Guangcheng Company to confirm the equity, it was bound to damage the interests of other creditors of Feiyue Group. Therefore, although the first and second instances both held it was the fact that there was a shareholding entrustment between Quangcheng and Feiyue Group, it was still correct that the court did not support the claim of Guangcheng Company. As for the issue of how Guangcheng Company, as an actual investor, realized its claims, the first-instance ruling had clearly informed that it should apply for debt settlement through bankruptcy procedure.

III. Conclusion

It is not difficult to understand, through the foregoing analysis and explanation at the legislative level and judicial practice, that shareholding entrustment indeed provides investors with “convenience”, but at the same time it does contain a variety of risk factors, and these risk factors may jeopardise the exercise and protection of the rights of anonymous shareholders, prominent shareholders, companies and other shareholders, and creditors. Therefore, the dispute resolution team of Beijing Docvit Law Firm recommends that all investors and companies conduct a comprehensive understanding and consideration of shareholding entrustment, from signing of the entrustment agreement, setting of terms and the selection of the agents, the protection of shareholder rights, to the company's business management, and other aspects, so as to maximumly reduce its adverse impact on all parties.