Author: Qiu Jian
Recently, the Supreme People’s Court of China (“SPC”) promulgated the Regulations on Hearing Disputes Concerning Foreign Invested Enterprises (I) (“Regulations”), with the intention to resolve disputes in connection with the foreign-invested enterprises’ (“FIE”) formation, share transfer, nominee shareholder, etc. Highlights from the Regulations are set forth as follows:
First, in connection with the validity of an FIE-related contact during the period from the execution date of the contract till the approval date of the contract (if any), the Regulations lay down following rules so as to facilitate the performance of FIE-related contracts:
(a) A contract relating to the formation of or changes to an FIE shall be deemed “formed” and “not effective yet” (but not null or void), after it has been entered into by the relevant parties but before it takes effect upon the approval by the competent governmental authority. Accordingly, a party shall be bound by relevant provisions of the contract relating to application for the concerned governmental approval.
(b) An agreement supplementary to an approved FIE contract shall be considered effective and binding upon the parties (even if the supplemental agreement has not been submitted to the competent governmental authority for approval), unless the supplemental agreement constitutes a “material change” to the approved FIE contract.
Second, in addition to the above general rules, the Regulations further provide more specific protection for parties concerned in transfer of an FIE’s equity. Specifically:
(a) where the transferor or the FIE fails to perform its obligation to submit the equity transfer agreement for government approval, the transferee may, among others, demand specific performance, apply for approval by itself, or terminate the agreement;
(b) where the parties agree that transfer price be paid by the transferee prior to application for government approval and the transferee fails to do so, the transferor may, among others, terminate the agreement and ask for damages, or apply for governmental approval on the equity transfer and request for payment of the transfer price (if approval is granted);
Third, the Regulations require that, in the event that an equity transfer injures the right of first refusal of the FIE’s other shareholders, such other shareholders must exercise their right to void the equity transfer agreement within one year as of the date when such other shareholder knew or should have reason to know that the equity transfer agreement was entered into, or they will lose such right to void. The other shareholders will also lose the right to void an equity transfer agreement in any of following events: the transferor has served transfer notice in writing and none of such shareholders replied within 30 days upon the receipt of the notice; or (ii) the shareholders disagree on the transfer but do not agree to purchase the same either.
Fourth, the Regulations also have made efforts to recognize the nominee shareholder- beneficiary owner relationship. In summary, the Regulations provide that:
(a) the agreement between a nominee shareholder and the relevant beneficiary owner of an FIE (“Investment Agreement”) shall be generally valid (even if the agreement is not submitted to the approval authority of the FIE for approval);
(b) the beneficiary owner of an FIE may be converted into a registered shareholder of the FIE if all the conditions are satisfied as provided for in the Regulations; and
(c) where the Investment Agreement is found invalid, as the case may be, the beneficiary owner may have the chance to recoup his investment in the concerned FIE, request the nominee shareholder to share the proceeds from the investment, and request the nominee shareholder to compensate his losses, etc.
With such Regulations and in line with the SPC’s judicial interpretations on the Chinese Contract Law, the SPC appears to encourage freedom of contract in the highly regulated foreign investment sector, probably with the intention to lessen the impacts of financial crisis. However, it is also worth noting that the implementation of such Regulations will need support from the competent governmental authorities, including particularly the approval authority and registration authority of FIEs; and, on this point, we will have to wait and see.
Lastly, we understand that the SPC is in the process of formulating additional judicial rules with regards to M&A and liquidation of FIEs and we will report on this after the relevant judicial rules are publicized.