Judicial direction regarding dormant investment in FIEs
November 09, 2010 | BY
clpstaff &clp articlesJin Mao PRC LawyersDonald Liu and Grace [email protected]; [email protected] have recently paid much attention to the issue of dormant investments…
Jin Mao PRC Lawyers
Donald Liu and Grace Wu
[email protected]; [email protected]
Investors have recently paid much attention to the issue of dormant investments following publication of a new judicial direction – Provisions of the Supreme Court of China Regarding Several Issues of Dispute Involving Foreign-Invested Enterprises (I) (the Provisions) – on August 5 2010. It is the first time in China that the authorities have specified the rules on dispute resolution towards dormant investments in foreign-invested enterprises (the FIEs). Neither the PRC Company Act 2005 nor related regulations on FIEs expressly clarified dormant investments in the field of foreign investment, although the issue has been there for a long period.
The dormant investment refers to a legal situation where the actual investor (the Dormant Investor) who makes capital contributions to the enterprise is not the one whose name is documented on the articles of association, the register of shareholders or other legal documents (the Nominal Shareholder). Some Dormant Investors intend to circumvent the law, while more of them are just unwilling to make their wealth known – or that their identities are being illegally used by others.
Because of the legislative deficiency as well as the strict regulations on shareholder registrations implemented by Chinese registration authorities, the dormant investment was always on the wrong road and led to a series of disputes. These are usually classified into two categories: (1) those recognising the status of the Dormant Investor as a shareholder; and (2) those among the Dormant Investor, the Nominal Shareholder and the bona fide third party.
Remedies to different kinds of dormant investment in FIEs, as specified as below, are stipulated respectively in the Provisions so as to fairly and squarely protect the legitimate rights and interests of the parties.
1) A request by a Dormant Investor in a FIE for recognising its status as a shareholder will be conditionally supported by the court. Only if the dormant investment satisfies the following three requirements concurrently can the court recognise directly the status of a Dormant Investor as a shareholder along with its equities in the FIE:
a) The Dormant Investor has actually made the investment in the FIE;
b) Shareholders other than the Nominal Shareholder recognise the Dormant Investor's status as a shareholder; and
c) The people's court or the parties concerned have obtained the consent of the FIE examination and approval authority for changing the Dormant Investor into a shareholder during the legal process.
2) The validity of the dormant investment contract reached by and between the dormant and nominal investors will be determined according to different circumstances.
The courts shall regard the dormant investment contract as valid provided there's no circumstances set out in laws and administrative regulations that would make the contract invalid. Further, the dormant investment contract shall not be deemed as invalid solely on the grounds that approval by the FIE examination and approval authority is not granted.
On the contrary, any evasion of law, such as evasion of restrictions on investment fields, investors' identities, investment proportions and violating the compulsory provisions of laws and administrative regulations, will cause the dormant investment contract to be null and void.
3) The Provisions also provide that, for the purpose of balancing interests, the equities held by the Nominal Shareholder shall be handled subject to different circumstances in the event that the dormant investment contract is regarded as invalid:
a) If the equity value is higher than the actual investment amount, the Nominal Shareholder can either continue to hold the equities or reimburse the Dormant Investor the actual investment amount according to the requirements of the parties. In that event, the share proceeds shall be reasonably distributed between both parties;
b) If the equity value is lower than the actual investment amount and the Dormant Investor requests the reimbursement of the actual amount, the Nominal Shareholder is obliged to repay an amount equivalent to the equity value to the Dormant Investor. Any losses incurred shall be borne by the Nominal Shareholder subject to the extent of its fault.
4) The dormant investment contract shall be confirmed as null and void due to malicious collusion conducted by the Dormant Investor and the Nominal Shareholder. This is where the interests of the State, collectivity or a third party are damaged, and the property acquired therefore shall be confiscated by the State or returned to the collectivity or the third party.
The release of the Provisions is indeed a breakthrough in justice for dormant investment in China. It is undeniable however that the Provisions, though released, intend to establish remedies within the current legal framework to protect the legitimate rights and interests of parties concerned, instead of encouraging dormant investment. On account of the many legal risks in dormant investment, prudential investors are proposed to apply real name investment in compliance with the laws and regulations rather than dormant investment.
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