Can nominee shareholding arrangements exclude enforcement?

A frequent point of contention in enforcement proceedings is whether the actual investor can preclude enforcement applications brought by creditors of the registered shareholder on the basis of a nominee shareholding arrangement.

Highlighting the significant controversy and divergence of views, as early as November 2019, Interpretation (I) of the Supreme People’s Court on Issues Concerning the Application of Law in Enforcement Objection Case (draft for solicitation of opinions) proposed two options: one allowing exclusion, and the other not.

The new Company Law remains cautious regarding nominee shareholding. In article 140, it explicitly prohibits nominee arrangements of listed company shares that violate laws and administrative regulations. Yet it does not provide further provisions for nominee arrangements in non-listed companies. However, article 34 of the new Company Law may offer a new solution to this issue.

Commercial appearance

In judicial practice, a significant number of cases applying the doctrine of commercial appearance maintain that when a registered shareholder becomes the judgment debtor, nominee-held equity may be deemed enforceable to protect creditors’ reliance on the company’s registration information.

For example, in Tuo Siwei v Liu Jin (2019), concerning third-party objections to enforcement, the collegiate bench stated: “When the registered shareholder is the judgment debtor, the equity registered in their name should be treated as part of their liable assets. The identity of the actual investor, if not recorded, cannot be used to counter claims by the creditors of the company or the registered shareholder.

“The nominee holding arrangement is not a normal shareholding relationship; it runs counter to the company registration system and the social credit framework, as shareholders arbitrarily create an appearance of rights, which diverges the registered right holder from the actual one. Consequently, risks and costs should be borne by the actual investor.

“Recognising the actual investor’s rights does not preclude enforcement and serves to uphold the values of safety, order and efficiency pursued in the commercial sphere.”

Conversely, differing views contend that the doctrine of appearance is fundamentally a protection of reliance interests. In commercial practice, unless there is a specific transactional context, creditors seldom transact solely on the appearance of equity held by the registered shareholder.

Rather, creditors typically scrutinise shareholding assets during preservation, litigation or enforcement stages through property investigations, rendering the notion of a “reliance interest” questionable.

Article 34 of new Company Law

Article 32(3) of the former Company Law stated that unregistered or unmodified registrations cannot be asserted against third parties. Article 34(2) of the new Company Law provides that if the company registration information is not registered or modified, it cannot be asserted against bona fide counterparties.

By limiting “third parties” to “bona fide counterparties”, the law clarifies that public credibility of the company registration system protects those who engage in civil legal actions with the registered shareholder based on their reliance on the registration.

Therefore, in the absence of a reliance interest, determination of the substantive ownership of equity should revert to the fundamental framework of shareholding nominee arrangements.

In Zhang Jianjun v Golden Domain Management (2022), concerning third-party objections to enforcement, the Supreme People’s Court held that in such proceedings courts must not only verify the registration status but also ascertain: identity of the true equity holder; reasons behind any errors in equity registration; and relevant factual circumstances such as shareholder participation in dividend distribution.

Ultimately, the court determined that the actual shareholder held civil rights sufficient to preclude enforcement, annulled the first and second-instance judgments, and ruled that the nominee-held shares should not be enforced.

In recent years, when adjudicating enforcement objection cases relating to share transfers that have not yet completed registration changes, the Supreme People’s Court and local courts have generally adhered to the principle of ascertaining the substantive ownership of the shares.

If it is determined upon review that the transferee has indeed acquired the shares in practice and is exercising shareholder rights, the courts tend to support the request to exclude creditors of the registered shareholder from enforcement.

Determining ownership of equity

Provisions of the Supreme People’s Court on Several Issues concerning the Application of the Company Law of the People’s Republic of China (III) and article 28 of the Minutes of the National Courts’ Civil and Commercial Trial Work Conference establish the basic framework for confirming nominee shareholding.

The required elements include:

1. 1. an agreement to hold shares on behalf of another;
   2. actual capital contribution; and
   3. either the exercise of shareholder rights or recognition by other shareholders.

However, unlike disputes between actual investors and nominee shareholders over shareholder qualification, in enforcement objection actions brought by actual investors against creditors the evidentiary value of the nominee agreement and recognition by other shareholders is relatively limited.

In these cases, actual capital contribution and the exercise of shareholder rights play a more critical role. If a nominee shareholder has indeed contributed capital and exercised shareholder rights, the equity may be deemed to substantively belong to the actual investor.

Any enforcement action against nominee-held equity should be precluded to safeguard the actual investor’s property rights.

Under this judicial approach, the burden of proof regarding the exercise of shareholder rights becomes pivotal in disputes between actual investors and creditors, necessitating thorough preparation and detailed argument.

Furthermore, the doctrine of appearance, which serves as an exception to protect transactional security, should not form the basis for establishing the substantive ownership of nominee-held equity.

Since implementation of the new Company Law, the Supreme People’s Court has been actively revising its judicial interpretations, recognising that the issue of nominee shareholding cannot be overlooked.

Jiang Xuan is a partner and Zhou Yueqin is an associate at Zhong Lun Law Firm