Now Shenzhen | December 19, 2022
In China, some shareholders ask others to hold their shares due to their special status, and sign the “Share Subscription Agreement” or “Share Proxy Holding Agreement” to regulate the rights and obligations of both parties. If a foreigner with non-Chinese nationality holds the shares of a listed company in China through an agreement, what will be the consequences? We selected a real case to show the Chinese court’s views on such cases.
A. Dispute over a nominee shareholder agreement in a listed company
a. Case Brief:
Tatsumi Sugiura (Japanese) and Gong Yin signed a Stock Option and Nominee Shareholder Agreement in 2005, agreeing that Tatsumi Sugiura would purchase 880,000 shares from Company A from Gong Yin at a price of RMB 4.36 per share and entrust Gong Yin as the nominee holder; Gong Yin would dispose the shares under Tatsumi Sugiura’s instructions and exercise the shareholders’ rights in her name externally and deliver all the proceeds to Tatsumi Sugiura on time. Company A made its initial public offering and listing on the Shanghai Stock Exchange in 2017, and Sugiura Likin learned only after checking the IPO of the company that the actual consideration paid by Gong Yin for the shares in 2005 was only RMB 880,000 (i.e. RMB 1 per share), which was much lower than the price he paid.
During Company A becoming a listing company, Gong Yin as a shareholder had repeatedly promised that the shares were well-defined and not held on behalf of others. In 2018, Company A passed a resolution to pay cash dividends, therefore, Sugiura Lixin requested Gong Yin to return dividends and interests accrued following their agreement, and also to return the overpayment of the shares of RMB 2.9 million, but Gong Yin had not been cooperative. Later, the parties disputed the validity of their agreement and the distribution of dividends. Sugiura Lixin requested the court to rule on his income rights of the shares and requested Gong Yin to return his overpayment, dividends and interests accrued
b. Ruling:
The Stock Option and Nominee Shareholder Agreement is invalid. Gong Yin shall return the principal amount invested by Sugiura Rishi and 70% of the dividends, and the remaining 30% of the investment proceeds belong to Gong Yin.
c. Jurisprudence
- The Share Option and Nominee Shareholder Agreement is invalid:
In the Share Option and Nominee Shareholder Agreement, the parties agreed that Sugiura Lixin would purchase shares from Gong Yin, and at the same time agreed that the subscribed shares would not be actually transferred, but would still be registered under Gong Yin’s name, and Gong Yin would hold and exercise the shareholders’ rights on behalf of Sugiura Lixin, so the above transaction arrangement in essence constituted an implied nominee holding of the shares, with Sugiura Lixin as the actual contributor and Gong Yin as the nominal holder. Therefore, the above transaction arrangement essentially constituted a nominee holding of the shares, with Gong Yin being the nominee shareholder.
Combined with the fact that Gong Yin made the promise that the shares were not held on behalf of others at the time of its initial public offering and listing, that Sugiura Lixin did not disclose the holding status to the company or the regulatory authorities before and after the issuance and listing, the court held that the validity of the agreement should be considered under the provisions of the civil law on the validity of civil legal acts, as well as the relevant legal provisions on security market and listed company.
According to the General Principles of Civil Law, a civil juristic act that offends the public order or good morals is void. Since the definitions for public order vary in different fields, the content of the public order in question should first be judged according to the laws and administrative regulations in that field. When judging whether a certain subordinate rule constitutes public order, it should be examined from two aspects: substantive justice and procedural due process.
Substantively speaking, according to the legislative purpose of the Securities Law and the Administrative Measures for Initial Public Offering and Listing of Shares (“Measures”), an issuer’s equity is well-defined and there shall be no such dispute over the title hood of the issuer’s shares. Moreover, an issuer shall perform his or her information disclosure obligations and the information as disclosed by an issuer according to law shall be authentic, accurate, and integrated. If an issuer’s equity is not well-defined, it will not only affect the continued stability of corporate governance and the company’s implementation of regulatory requirements in securities market such as information disclosure, review of insider trading, and connected transactions but also easily give rise to ownership disputes. In other words, the issuer should truthfully disclose the ownership of shares, and the phenomenon of nominee shareholders is strictly prohibited.
Procedurally speaking, the Securities Law authorizes the The Securities and Futures Commission (“SFC”) to specify the requirements for the issuance and listing of shares, and the Measures formulated by the SFC complies with the due process, in which the requirement of well-difined equity shares has become a basic norm of securities regulation and an industry consensus.
Considering the above discussion, the court held that the issuer shall truthfully disclose the ownership of shares. The phenomenon of nominee shareholding in the securities market is against public order and shall be prohibited. In this case, before the listing of Company A, Gong Yin held the shares on behalf of Sugiura Lixin and participated in the listing and issuance of the company in her name, concealing the true identity of the actual investor. The acts of both Sugiura Lixin and Gong Yin constituted nominal holding of the shares of the issuer, which violated the public order and harmed the public interest of the securities market, and therefore should be deemed invalid according to the General Principles of the Civil Law and the Contract Law. - Rules for distribution of shares and investment income:
the aforementioned Share Option and Nominee Shareholder Agreement is invalid pursuant to Article 58 of the Contract Law, “the property acquired as a result of a contract shall be returned after the contract is confirmed to be null and void or has been revoked; where the property can not be returned or the return is unnecessary, it shall be reimbursed at its estimated price. The party at fault shall compensate the other party for losses incurred as a result therefrom. If both parties are at fault, each party shall respectively be liable.” The disposal of the property interests of the invalid contract aims to restore the original state and balance the interests, that is, restoring the property to its original state will be given priority. If the property cannot be restored, it should be reasonably distributed among the parties in compliance with the principle of fairness.
According to the above principles, in this case, firstly, the shares of Company A belonged to Gong Yin, and the series of acts implemented by Gong Yin as a shareholder around the listing of the company and its operation were valid. Secondly, there was no investment loss in this case to apply the fault compensation rule, so the investment payment made by Sugiura Lizhi to Gong Yin shall be returned. Thirdly, the profits of the shares of Company A, including the significant appreciation due to dividends and listing of the company, were not the original benefits before the contract was concluded, but the new benefits after the performance of the contract, which did not belong to the situation of restoration, and the distribution plan shall be determined by the parties through consultation, and the principle of fairness shall be applied to reasonable distribution if consultation fails. The parties in this case agreed to distribute the share income between them. Given that they could not agree on the distribution plan, the court will exercise its discretion in compliance with the principle of fairness.
d. Summary
In the abovementioned case, the fundamental reason for negating the validity of the nominee shareholder contract is that the court determined that it involved the public interests of the majority of non-specific investors which fell into the category of public order or good morals.
Therefore, the key to judging the validity of the contract lies in whether it involves public interest and public order, and good morals. Pursuant to Article 31 of the Minutes of the National Court’s Civil and Commercial Trial Work Conference, “in determining whether the regulations involve public order and good morals, the people’s courts shall take into account the intensity of regulation, the protection of transaction security and social influence based on examining the regulated objects, and make sufficient reasoning in the adjudication documents.”
Besides, the Measure stipulates that “where an issuer’s equity is well-defined, there shall be no such dispute over the title hood of the issuer’s shares as held by its controlling shareholders, or by the shareholders under the control of its controlling shareholders or the actual controller.”
It can be seen that nominal shareholding only violates departmental regulations and does not necessarily lead to the invalidation of the contract. However, the failure of regulatory measures such as information disclosure requirements, connected transaction review, and office disqualification of senior executives due to false disclosure will undermine financial security and market order and injure the rights and interests of many investors, which fall into the category of public order or good morals. Therefore, the nominee shareholder agreement is deemed invalid.
B. Practical experience
- For investors, when doing securities, insurance, finance, and other businesses involving public interests, they should be cautious with nominee shareholding.
In recent years, higher or lower courts nationwide have publicized several cases in which the nominee shareholding agreement was invalidated due to a violation of public interest (e.g. (2017) Supreme Court Min Shen No. 2454 Yang Jinguo and Lin Jinkun case). Therefore, investors who plan to step into areas involving public interest such as securities, insurance, finance, and other sensitive areas like military industry, telecommunications, energy, etc. should be cautious about investing through nominee shareholding if the regulations explicitly require shareholders to meet specific qualifications or require transparency of shareholder information.
If investors must remain anonymous, they should endeavor to maintain a solid relationship with the nominee. Otherwise, in the event of a dispute with the nominee, it will be difficult to assess the validity of the nominee shareholder agreement, and thus unable to cognize stockholder qualification in judicial practice.
- The nominee shareholder agreement may include provisions for division of profits in the event of an invalid contract to maximize one’s interests and mitigate risks as much as possible.
Where a nominee shareholder agreement is affirmed to be invalid, the shareholder has the right to claim a refund and the return of profits pursuant to Article 58 of the Contract Law. The question is, with the change in the value of equity, how to determine the amount and proportion of the profits to be returned? Should all profits be returned or just a part of it? In the abovementioned case, the ruling made by Shanghai Financial Court pointed out that the distribution plan shall be decided first based on the prior agreement between the two parties. When there is no agreement, it will be based on the negotiation between the parties afterward, and if the negotiation fails, the court will allocate the investment proceeds based on the actual input, contribution and risk taken by both parties. Therefore, the beneficiary may negotiate the division of profits with the nominee holder at the very beginning to ensure the maximization of his or her investment rights and interests.
