By Luo Yanjie
As reported, 24quan.com, a Chinese daily-deal website, is undergoing a contentious conflict (note: the link is in Chinese) between its operation team and investors. Berjaya Corporation Bhd (Berjaya), the biggest investor of the website and registered in Malaysia, accused the operation team of withholding RMB 2 million yuan with no authorization, yet the team responded by saying that the investor was unilaterally deducing the share held by the team from 40% to 3%. Currently, the website and the company is under the control of the team, who has dismissed the staffs appointed by the investor, and in retaliation, the investor announce that their funding cease.
Research on the website of Beijing Industry and Commerce, the operator of 24quan.com Beijing Hongweibo Culture & Art Co., Ltd, indicates that it is a domestic invested company, and by the commercial practices, its shares are held by the local operation team. Yet as far as the news knows, the main investor of the daily-deal website is Berjaya, who is from Malaysia, indicating that the company is actually invested through a dormant shareholding agreement, and the registered shareholder is actually not the actual investor. As to the reason why the registered investor overwhelms the actual investor, in our opinions, is mainly due to the laws in China which benefit the registered shareholder. The analysis is as follows:
The shareholding of foreign investor through local citizens or units in China, is the so-called dormant investment, which in the law refers to the action in which “one party transfers the asset to the other through written or oral arrangement to establish a company of limited liability; and therefore the shareholder indicated in the incorporation articles or shareholder book of the company shall be the other party with no registration of the actual investor.” So we shall see no record of the foreign investor (note: the link is in Chinese) in the company’s Articles of Association.
Although Article 33 of the Corporation Law provides:
“The company shall register its shareholder(s)’ name(s) and the investment to the administration”,
Yet we see the following regulation in the same law that:
“The vacancy of registration or amendment in registration shall not fight against the claims of any third parties”
In the meantime, the judicial interpretation concerning the Company law also contains the articles on dormant investment; therefore, the dormant investment is not in fully violation of the law. However, the operation method of companies may vary in real life, so far we have no unified standard on the determination of the dormant investment. And this essay is our interpretation and opinions on the issue:
I. Validity of dormant shareholding agreement of foreign investments
By the Law of Foreign Invested Corporate:
“The application of foreign invested company’s establishment shall be subject to the approval of foreign economy administration department of the State Council or any other regulatory approval organs authorized by the State Council. And the approval organ shall make the decision of approval or not within 90 days after the application filing”
But according to the “Guideline Catalog of Foreign Industry Investment”, the invested fields could be divided into the “encouraging, limited or prohibitive”, and in these different divisions, the standard for the determination of the dormant investment shall be different as follows:
1. Investment: “Encouraging” or “Permissive” As stated above, all the articles of incorporation and contracts of the foreign invested companies shall come into effect only after the approval by the administration, but in practice as well as in law, the establishment of the company in the name of Chinese individuals or units with dormant foreign investment requires no administrative approval. Therefore, in essence, the agreement concerning the dormant investment or shareholding is violating the law, and in the early judicial cases, is deemed invalid with no exception (note: the link is in Chinese). Like in the dispute of Jieshilaite, who is run and operated through dormant investment and shareholding though the main business of the company is in the “encouraging” class, the Court adjudicated such arrangement violates the mandatory clause that all the foreign investment shall be approved by China laws and regulations, and therefore declared the arrangement to be invalid.
But in the existing judicial practices, to protect the interests of the investor, the court has changed the determination, now considering that the classes of encouraging and permissive are accessible to foreign funds .Based on that, the court tends to sustain the validity of the dormant investment arrangement, after reassuring it results in no other illegal matters or violations of the law.
2. Investment: “Limited” and “Prohibitive”
In such classes, the dormant investment is illegal in itself for the law tends to see no or less foreign investment into the relevant industries. And in such case the dormant arrangement shall be seen as “to conceal an illegal purpose under the guise of a legitimate transaction” as regulated in the Contract Law, therefore it is highly possible to be judged invalid by the court, and the relationship between the parties shall be only based on the loan. In the above 24quan.com dispute, despite the complicated VIE structure we see, it is possible to arrange the dormant investment for control by the foreign investor. Moreover, the arrangement of 24quan.com could be mainly for the avoidance of the regulation on foreign investment, and that implies that neither party would like to settle the dispute through lawsuits.
II. How to determine the shareholder for foreign investors when conflict occurs?
As mentioned, for the fields that are permissive to foreign investors, the dormant investment by foreign companies is valid. If that’s so, which way could the foreign investor determine themselves as the actual shareholder? Regretfully, we have seen no nationwide regulation on it, with only the Shanghai High Court providing its judicial interpretation on it:
“For the agreement that the investment shall be registered in one party’s name (registered shareholder), but actually contributed by the other (the dormant investor), it shall not bind the company; the actual investor shall not claim the shareholder’s right to the company, for who shall file a lawsuit to determine its right first. When more than 50% of the liability limited company be aware of the actual investor, and the company has been admitting it to exercise the right of the shareholder, the People’s Court shall decide the contributor enjoy the share option unless otherwise regulated by the law.”
In addition to the above regulations, which shall be otherwise explained for the dormant investment by the foreign investor, the court will not determine the owner of the shares through judges, but demands to handle the share transfer procedures. Like in the case where the Thai citizen XinPeifeng sued Shanghai HuaqiaoShangwuZonghui Co., Ltd regarding share ownership, the court hearing the case admitted the validity of the contract, and sentenced the defendant to go through the procedures to transfer the share to Xin within 30 days after the effectiveness of the decision.
After all, in China, a country of abundant regulations, dormant shareholding is an effective way to avoid the complicated procedures for market admission. Investors considering this option should always have the following two ideas in their mind; 1) choose a faithful and dependable partner, and 2) choose an experienced lawyer to design a shareholding agreement for you.
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