China Law Library

Supreme Court Rules

 

CBL’s Introduction

The regulations on foreign investment in China establish a regulatory framework for FDI into China, however they do not answer some important questions about its application. The Supreme Court’s rules on the law do apply, and with some surprising results, for example these specific rules legitimize a foreign investor to identify their company as Chinese-owned through a nominee shareholder arrangement if they fear discrimination. However, running afoul of a foreign investor access restriction results in any such agreements being invalidated.

Two separate Supreme Court documents are included below, both translated by the CBL team.

Contents

Interpretation of the Foreign Investment Act

Rules for Resolving Foreign Investment Disputes

 

Interpretation of the Supreme People’s Court of the People’s Republic of China of the Foreign Investment Act

Interpretation of the Supreme People’s Court of the People’s Republic of China on the Foreign Investment Act, adopted by the Judicial Committee of the Supreme People’s Court during the 1787th session on December 16, 2019, is hereby issued and will take effect on January 1, 2020.

The Supreme People’s Court

December 26, 2019

Legal Interpretation No. 20 (2019〕)

The Supreme People’s Court

Interpretation of the Supreme People’s Court of the People’s Republic of China on the Foreign Investment Act

(Adopted by the Judicial Committee of the Supreme People’s Court during the 1787 session on December 16, 2019, is hereby issued and will take effect on January 1, 2020.)

The purpose of the following interpretations is to ensure the courts properly apply the Foreign Investment Act of the People’s Republic of China to disputes arising from investment agreements between equal parties in light of judicial experience, and to provide equal protection for legal rights of investors whether Chinese or foreign, and to enable the rule of law create a business environment that ensures stability, fairness, and transparency.

Section 1 This Interpretation holds that an investment agreement means any agreement made by foreign investors, such as foreign natural persons, entities, or other organizations, that make investment in China, either directly or indirectly, including agreements relating to the formation of foreign owned entities, share purchase agreements, equity purchase agreements, other assignment agreements relating to shares or rights, and agreements relating to newly created projects.

This Interpretation is applicable to any disputes arising from the acquisition of an interest by means of transfer, spousal partition of community property, and business merger, or business division among foreign investors.
Section 2 The court shall deny a party’s petition to void an investment agreement on grounds it lacks approval and registration from the appropriate jurisdictional agency, provided such agreement does not fall within the exception list category established pursuant to Section 4 of the Foreign investment Act.

Under the above rule, the investment agreement shall be deemed lawful and valid if the it was signed before the effective date of the Foreign Investment Act and the court has still not issued an opinion on the validity of the investment agreement after the Act already took effect.

Section 3 The court shall uphold a party’s claim that an investment agreement is void on grounds that the foreign investor enters an industry prohibited by the exception list.
Section 4 The court shall uphold a party’s claim that an investment agreement is invalid on grounds the foreign investors violated the exception list by entering sectors restricted by the exception list.

The court shall uphold a party’s claim the investment agreement is valid under the previous Section if the parties has taken steps to comply with the conditions set forth in the exception list prior to the date of the ruling.

Section 5 The court shall uphold a party’s claim that the investment agreement is valid, if prior to the date of the ruling the foreign investor’s investment is no longer one that is prohibited or restricted by the exception list.

Section 6 The court should apply and refer to this Interpretation when hearing investment dispute cases in mainland China by investors from the Special Administrative Regions of Hong Kong and Macao, as well as overseas Chinese citizens and investors from Taiwan.

Section 7 The Interpretations shall take effect on January 1, 2020.

The Interpretation shall take precedence if this Court issues a legal interpretation that is conflicting with the Interpretation before its effective date.

 

 Supreme People’s Court Rules for Resolving Foreign Investment Disputes (1)

(Passed during the 1487th Supreme People’s Court Judicial Committee Meeting held on May 17, 2010, and amended according to the Decision of the Supreme People’s Court on the Amendment of 29 Judicial Opinions on Commercial Matters, such as the Supreme People’s Court Official Decision on Whether Bankrupt Entity Leasehold Rights Should Be Included in the Bankruptcy Estate passed at the 1823rd Supreme People’s Court Judicial Committee Meeting held on December 23, 2020)

These rules are made under the Civil Code of the People’s Republic of China, the Foreign Investment Act of the People’s Republic of China, the Company Act of the People’s Republic of China, and general jurisprudential practice to ensure that disputes arising from matters such as foreign owned entity formation and changes are properly resolved and the legal rights of all parties involved are protected.

Section 1 All contracts entered into while a foreign owned entity is being formed or undergoing changes may only take effect after approval by the agency appropriate to govern the entity when required by laws and administrative regulations, and the trial court shall deem any contracts lacking such approval ineffective. The trial court may rule against any party making a claim to invalidate a contract.

Invalidation of a contract due to a lack of such approval shall not limit the parties’ obligations to submit such for approval or any other provisions of that contract providing for such obligations.

Section 2 Any amendments related to foreign investment matters entered into by the parties that do not constitute material or substantial changes to the approved contract shall not be deemed ineffective by the trial court on the grounds of lacking approval from the agency appropriate to govern the entity.

Material or substantial changes mentioned above include changes to registered capital, company type, business activities, business term, shareholder capital contribution, and capital contribution methods, as well as matters on company mergers and separations, and equity assignments.

Section 3 The trial court shall hold any foreign investment contract found to be invalid under law or administrative regulations during legal proceedings as invalid, regardless of whether it was approved by the agency appropriate to govern the entity. The trial court may also rule in favor of any parties petitioning the cancellation of contracts eligible for cancellation under law or administrative regulations.

Section 4 The trial court shall determine that a party has already fulfilled its contribution obligations or provided the conditions necessary for collaboration upon the satisfaction of the following three conditions:(1) an investment contract provides that the party shall contribute object of the contract requiring registration of change, (2) the object of the contract has been delivered to the foreign owned entity for practical use, and (3) the party with the obligation to register the change of title has completed the registration within the period of time provided by the trial court. Under the above circumstances, the trial court shall rule against the entity or shareholders who claim that the party in question is not entitled to shareholder rights on the grounds that it has not fulfilled its capital contribution obligations.

The trial court shall rule for the entity or its shareholders claiming indemnification if they can prove that a party’s delay in registering the change of ownership caused the entity to suffer losses.
Section 5 Should the assignor or the entity fail to perform their reporting obligations, the trial court shall rule for an assignee requesting the termination of an entity’s equity assignment contract, return of any amounts paid for the assignment, and indemnification against losses caused by the failure to fulfill its reporting obligations, assuming that the entity equity assignment contract is already in force and reporting does not occur within a reasonable period of time after receiving notice of such from the assignee.

Section 6 In situations where an assignor or the foreign owned entity fails to perform reporting obligations after the entity equity assignment contract comes into effect, the trial court shall rule for an assignee’s petition to enforce an assignor and the entity’s reporting obligations within a specified period of time, where is the assignor the defendant and the entity a third party. The trial court shall rule for an assignee requesting to submit approval reports independently if the assignor and entity do not fulfill their reporting obligations within the specified time limit determined by a court decision.

The trial court shall rule for an assignee who files separate litigation for contract termination and indemnification against losses suffered due to the assignor’s and entity’s refusal to fulfill reporting obligations within the time limit determined by a court decision. The extent of the indemnification may include the difference in the value of the equity, equity returns, and other reasonable losses.

Section 7 The trial court shall rule for an assignee who files separate litigation for the assignor to return the amount already paid for the assignment where the assignor, entity, and assignee have submitted approval requests for the entity equity assignment contract with the approval agency pursuant to Chapter 1, Section 6 of these Rules but such request is not approved by the approval agency. The trial court shall determine whether the assignor is liable for the losses and determine the specific indemnification amount based on the assignor’s degree of fault if the assignee files a claim seeking indemnification for such losses.

Section 8 Where an assignee fails to fulfill its payment obligations under an entity’s equity assignment contract, the trial court shall rule in favor of an assignor’s petition for the termination of the contract and damages for losses suffered if the contract provide for the assignee’s payment as a condition for the assignor to complete the reporting procedures, but  fails to do so within a reasonable period of time after receiving notice of such from the assignor.

Section 9 If neither party has fulfilled such contractual obligations (that is, for the assignee to pay and the assignor and entity to file a report), the trial court shall respond to an assignor’s petition to enforce of the assignee’s payment for the equity assignment, by suspending the proceedings and setting a time limit for the assignor to complete reporting procedures if, provided the foreign owned entity equity assignment contract is already in force. The trial court shall rule in favor of an assignor requesting payment for an assignment, provided that the equity assignment contract has been approved by the agency appropriate to govern the  entity.

Section 10 When an approval agency’s rejects of the equity assignment contract, the assignor may seek the removal of the assignee as an entity manager who participated in entity management prior to then, the trial court shall rule in favor of the petition, and is entitled to transfer of any proceeds arising from the assignee’s actual participation in the management, less the associated costs and expenses.
Section 11 Shareholders of a foreign owned entity may assign all or a portion of their equity to any third party who is not an existing shareholders, provided that there is unanimous consent of the existing shareholders. The trial court shall rule in favor of those shareholders who seek the cancellation of any equity assignment contracts to which they did not consent. An exception exists under any of the following circumstances:

(a) There is evidence proving the consent of the other shareholders;

(b) The assignor already sent notice of the equity assignment and did not receive a reply from the other shareholders within thirty days of its receipt;

(c) The other shareholders did not consent to the equity assignment and refused to purchase the equity.

Section 12 In cases where shareholders of a entity assign all or a portion of their equity to a third party other than the existing shareholders, and the existing shareholders seek the cancellation of the equity transfer contract on the basis of infringement of their right of first refusal, the trial court shall rule in favor of the existing shareholders. Unless where other shareholders do not exercise their right of first refusal within one year of the date they learn about or should have known of the execution of the equity assignment contract.

Under the above circumstances, the trial court shall rule against the assignee or assignor seeking the cancellation of an equity assignment contract on the grounds that the existing shareholder’s right of first refusal was not granted.

Section 13 Any pledge contract entered into by an entity’s shareholder shall take effect on its signature date, unless otherwise provided by law, administrative regulations, or as otherwise agreed upon in a contract. The failure to register a pledge shall not affect the validity of the pledge contract.

The trial court shall rule against any party petitioning the invalidity of a pledge contract on the sole basis that it has not been approved by the entity’s approval agency.

The pledge shall be effective upon its registration, provided that the pledge contract was registered pursuant to the Civil Code.
Section 14 The trial court shall rule against investors seeking to affirm their shareholder status in an entity or to change the shareholders if the parties agree that one party will be the beneficial owner and the other party will act as a nominee shareholder, unless all of the following conditions are met:

(a) The beneficial owner has actually invested;

(b) Shareholders other than nominee shareholders recognize the beneficial owner as a shareholder;

(c) The trial court or the parties involved have obtained the entity approval agency’s approval to recognize the beneficial owner as a shareholder during the litigation.

Section 15 The trial court shall hold a contract is valid if it specifies that a party may act as a beneficial owner and the other as a nominee shareholder in the entity, provided that the contract is valid under the statutes and administrative regulations. The trial court shall rule against a party petitioning the invalidity of a contract on the sole basis that it has not been approved by the entity’s approval agency.

The trial court shall rule in favor of a beneficial owner petitioning the enforcement of a foreign owned entity’s nominee shareholder’s obligations under their agreement.

The trial court shall rule in favor of a beneficial owner petitioning for a foreign owned entity’s nominee shareholder to deliver the income earned from the entity where the parties have not otherwise agreed to an income distribution. The trial court may, at its sole discretion, rule for an entity’s nominee shareholder petitioning for a beneficial owner to pay the necessary remuneration.

Section 16 If a an entity’s shareholder fails to perform a contract, resulting in the frustration of contract, the trial court shall rule in favor of a beneficial owner’s petition to terminate of a contract and to hold the counterparty liable.

Section 17 The trial court shall rule against a beneficial owner petitioning for the distribution of profit or exercise of other shareholder rights pursuant to the agreements between the beneficial owners and foreign owned entity’s nominee shareholders.

Section 18 If the nominee contract between the beneficial owner and the nominee shareholders is deemed invalid, the trial court shall rule for beneficial owners seeking the return of contributions and the reasonable distribution of equity gains between the parties based on the actual investment amount and nominee shareholder involvement in the operation and management of the foreign owned entity, assuming that the value of the equity held by nominee shareholders exceeds the actual investment amount.

Where a nominee shareholder of a foreign owned entity expressly renounces their equity or refuses to continue holding equity, the trial court may order the return of such to an beneficial owner via auction or sale, and the remaining income shall be reasonably distributed between the parties. The distribution will be based on the amount invested by the beneficial owner and the nominee shareholder’s involvement in the operation and management of the foreign owned entity.

Section 19 If a contract between an beneficial owner and nominee shareholders of a foreign owned entity is deemed invalid, the trial court shall rule for beneficial owners who makes a claim for the return of the equivalent value of equity currently held by the nominee shareholders, assuming that the value of the equity held by the nominee shareholders is less than the actual investment amount. Where the entity’s nominee shareholder expressly renounces their equity or refuses to continue holding the equity, the trial court may order the restitution of the entity’s equity to an beneficial owner via auction or sale.

The trial court shall determine whether the nominee shareholder is liable for damages and shall determine the specific damages amount based on the extent of such fault when assessing a beneficial owner’s damages claim against a nominee shareholder.

Section 20 If the contract between an beneficial owner and nominee shareholder is deemed invalid due to conspiracy against the state, collective, or a third party, the trial court shall revert title in the entity’s assets to the state owned by the  or order their to the collective or a third party .

Section 21 An entity’s original shareholders shall be upheld by the trial court when claiming to affirm their shareholder status where falsification or other deception had deprived them of shareholder status or original equity, in circumstances where the other shareholders or the entity filed a request to change the shareholders included in the original certificate of approval issued by the entity’s approval agency. An exception is where the third party has acquired the equity in good faith.

The trial court shall rule for the original shareholders claiming indemnification against infringing shareholders or the foreign owned entity.

Section 22 These rules shall also govern disputes arising from the investment in or formation of domestic foreign owned entities by investors from the Hong Kong Special Administrative Region, Macau Special Administrative Region, Taiwan, and Chinese citizens resident overseas.

Section 23 These rules shall also govern any cases still in the initial trial or review stages at the time they come into effect, but not to reopened cases as these rules were not in force when those cases were originally closed.

Section 24 These rules shall control in the event of any conflicts with judicial opinions passed by the Court prior to these rules taking effect.

 

 

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