Issues Concerning the Trial of Disputes Involving Foreign-invested Enterprises Go back »

2011-05-11 | Nanjing

Brief Introduction
Provisions on Several Issues Concerning the Trial of Disputes Involving Foreign-invested Enterprises (I) (hereinafter referred as Provisions) was issued by Supreme People’ Court (hereinafter referred as SPC) on May 17, 2010 and took effort on August 16 the same year.The Provisions can be considered as SPC’s endeavor to institute rules for disputes in foreign invested enterprises (hereinafter referred as FIEs), which have not been clearly explained by the current legislations. Such issues include validity of unapproved FIEs contracts, unproved share transfer contracts and nominee shareholding arrangements.

It is noted that all FIEs talking about in the Provisions are limited liability companies because limited liability company is the organization form favored by foreign investors in China. Unless otherwise stated, FIEs hereinafter are limited liability companies.

Confirm the validity of unapproved contracts
It is provided in Chinese laws and regulations, such as Law of the People's Republic of China on Chinese-Foreign Joint Ventures, Law of the People's Republic of China on Foreign-Funded Enterprises and their enforcement regulations, FIEs contracts - FIE contract means the contract signed by parties of investment regarding the establishment or management of FIE - will not come into effort (even they are legally formed/signed) before being approved by competent authority, typically the Ministry of Commerce and its branches at different levels.

Before the entry into force of the Provision, unapproved contracts were always deemed to be invalid and unenforceable in China. According to the Provision, however, the signed FIEs contracts will have the binding force to parties in form and can not be canceled or terminated by any single party. Moreover, the obligation to seek administrational approval stipulated in FIEs contract is enforceable, which confirms the severability of relevant clauses of “obligation to apply for approval”.

Please be noted that any supplemental agreement regarding FIEs shall not be considered as not come into effort only because the supplemental agreement has not been administrational approved, unless such agreements constitute a material and substantial changes to the approved FIEs contract. The Provision also lists “material and substantial changes” in a wide range, which are changes to the FIE’s registered capital, legal form, business scope, term of business operations, subscribed capital of the shareholders, methods of capital contribution and the merger, division or equity transfer of the FIE.

Optional remedies of unapproved share transfer contract
In case that the transferor or the target company fails to enforce the administrational approval obligation after a share transfer agreement is formed, the transferee will have several options to get remedy based on the Provision, such as to terminate the share transfer agreement, to ask for return of any paid transaction price and compensation for actual loss and damage.

Also, the transferee can request the transferor or the target company to enforce the administrational approval obligation with a certain time limit. In case that the transferor or the target company fails to do that, transferee can apply for a permit in court to do the administrational approval procedure it self or terminate the share transfer contract and claim for actual loss and damage.

On the other hand, if it is stipulated in the share transfer contract that only be paid the transfer price, will the transferor or the target company start the approval procedure, the transferee can request the court to terminate the share transfer contract and claim for actual loss when the transferee fails to make the payment within a reasonable period of time.

Protection of Dormant shareholders rights
Dormant shareholder arrangements are often seen in FIEs but its legal status and consequence had been not very clear until the Provision was issued, which is the breakthrough regarding rights of dormant shareholders. It is the first time that SPC gives a protection of dormant shareholders, although the legal standard of such protection is very high.

In case that it is agreed between two parties that one party shall make the actual investment (dormant shareholder) and the other party shall serve as its nominee shareholder in a FIE, the request from dormant shareholder to confirm its shareholder status in FIE or to change shareholder in FIE will be accepted only if:
(1)    the dormant shareholder has actually made the investment;
(2)    the shareholders in FIE other than the nominee shareholder recognize the dormant shareholders status as a shareholder; and
(3)    the people’s court or a concerned party secures the consent of the FIE’s examination and approval authority for the change of the dormant shareholder into a shareholder while the legal action is pending.

Please be noted that the dormant shareholder arrangement shall not violate Chinese laws or administrational regulations, otherwise will be deemed as invalid. In this circumstance, the nominee shareholder can choose to retain the equity interest in the FIE by making payment to the dormant shareholder or to be deregistered as a shareholder of the FIE.
According to SPC’s explanation, however, the Provision can not be considered as an encouragement of dormant shareholder arrangement in China but only to find a remedy approach within the current legal framework. In fact, the Provision has not clarified some issues such as what does “actually made the investment” mean, in full or just partial? More over, it seems that the administrative organ will have the final power based on the third standard mentioned above other than court. It is still difficult to say the attitude of administrative organs towards the Provision even more than half year has past.

Conclusion
Although foreign investors prefer foreign arbitration or CIETAC arbitration as dispute resolution for issues concerning the establishment or equity transfer of FIEs, the Provision might be influential in practice for clarifying the rules regarding disputes in FIEs, especially considering the fact that Chinese law will govern the establishment and equity transfer of FIEs in China, which means that even in arbitration the Provision will be applicable. Hence, it is strongly suggested that foreign investors shall keep an eye on the Provisions.




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