[Abstract] Dormant investment of a company involves complicated legal relations as well as many legal issues. This article analyzes the juridical interpretation and juridical practice of dormant investment in China by way of introducing a recent, typical court decision. In addition, as tax preferences for foreign investment are being cancelled, it is reasonable to foresee that dormant investments in the foreign investment field will increase. As a result of the increase disputes over dormant investments will certainly increase as well. This article focuses on the present situation and problems of dormant investment in regards to foreign investment, and then offers some suggestions on how to solve these problems.

 

[Key words] Company, dormant investor, apparent shareholder, foreign investment

 

Recently a ruling came out regarding dormant investment, which proves that there are definite standards on the qualification confirmation of shareholders in dormant investment. The following is a quote from the case:

 

“In 2005, New China Life Insurance Co., Ltd (New China) intended to cooperate with Beijing Hotel to establish a company — Zijin Century Company (Zijin Century). The registered capital of Zijin Century Company was RMB 1,000,000,000, of which RMB 600,000,000 was invested by New China and RMB 400,000,000 was invested by Beijing Hotel. New China invested through a dormant investment, entrusting West Credit Guaranty Company Limited and New Industry Investment Co., Ltd (NII) to provide RMB 300,000,000 to Zijin Century Company respectively.

 

After the establishment of Zijin Century, as the nominal shareholder recorded in the industrial and commercial registration, West Credit Guaranty Company Limited and NII each held 300,000,000 of the stock as the agent of New China; while New China, as the owner of the stock rights and the real shareholder, substantially enjoyed all the rights and assumed all the liability provided by laws and the articles of association of Zijin Century. During the operation of Zijin Century, New China dispatched management staff to undertake positions such as general manager, supervisor, financial director and so on at Zijin Century, in this way, it participated in the operation and management of Zijin Century.

 

In 2006, in accordance with policy adjustment by the PRC, New China began proceedings in respect to registration of the transferring of all stock rights from West Credit Guaranty Company Limited and NII to New China respectively. The 300,000,000 in stock held by NII was immediately transferred and registered with the administration of industry and commerce. However, a dispute over the transfer and registration of the stock arose between West Credit Guaranty Company Limited and New China; as a result, New China instituted legal proceedings against West Credit Guaranty Company Limited in Beijing No.1 Intermediate People’s Court, demanding to confirm its stock rights.

 

After hearing the case, Beijing No.1 Intermediate People’s Court concluded that the stock-holding conduct between New China and West Credit Guaranty Company Limited, which didn’t violate the prohibitive provisions of the laws and regulations of the State, was valid. The fact that New China had carried out the investment proceedings and day to day operations; plus the fact that, Zijin Century and its shareholders all were aware of the fact that West Credit Guaranty Company Limited held stock as the agent of New China proved that New China had fulfilled the conditions of acting as the shareholder of Zijin Century, and as a result, New China had the right to demand registration of the transfer of all stock rights and exercise its shareholder’s right as the primary shareholder. For these reasons Beijing No.1 Intermediate People’s Court ruled that the 30% stock rights held by West Credit Guaranty Company Limited belonged to New China; and West Credit Guaranty Company Limited must assist Zijin Century in handling industrial and commercial registration of the transfer procedures within 10 days of the date of the sentence.

 

The ruling in this case shows the PRC’s prevailing attitude toward shareholder’s qualifications in dormant investment in juridical practice; under certain conditions (these conditions will be analyzed in the following article), the shareholder status of the dormant investor must be confirmed to protect his legal rights and interests as a shareholder. This ruling also represents a developing concept in recent years, which is worthy of our attention. Dormant investment is a common commercial arrangement in the PRC; however, the majority of businesses aren’t completely aware of its complicated legal relations and legal risks, which can result in disputes and damages. Only when we completely understand dormant investments and their legal risks can we arrange our commercial operations so as to reduce or avoid disputes.

 

In this article, we put forward some suggestions on solving problems and preventing risks in dormant investment as well as juridical practice in the PRC and an analysis of dormant investment in foreign investments. 

 

 

1. 　　Definition of a Dormant Investment

 

Dormant investments are correlative to apparent investments.

 

Apparent investments refer to investment made by an investor in his own name, and therefore the investor recorded in the articles of association, register of shareholders and other industrial and commercial registration material is the investor who contributed the capital.

 

Dormant investment refers to investment made by an investor in another person’s name and therefore the investor recorded in the articles of association, register of shareholders and other industrial and commercial registration material is the other person (the apparent investor).

 

2. 　　Legal Relationship in Dormant Investment

 

The legal relationship in a dormant investment can be complicated, therefore, the rights and liabilities regarding the uncertain legal relationship are also complicated, which is one of the reasons why it is easy for disputes to occur in dormant investment. In order to better understand dormant investments, we have to analyze the legal relationship concerned therein.  

 

Usually, there are three parties concerned in a dormant investment; the dormant investor, the shareholder presented in the industrial and commercial registration (hereafter referred to as “the apparent shareholder”), and the company established by the dormant investor (hereafter referred to as “the company”). The legal relationships among the above parties are analyzed as follows:

 

2.1　　Legal Relationship between Dormant Investor and Apparent Shareholder

 

The laws of the PRC don’t contain definite stipulations on the legal relationship between a dormant investor and an apparent shareholder; moreover, the arrangements between the dormant investor and the apparent shareholder can differ, which can also alter the agreements. The most common relationships between a dormant investor and an apparent shareholder are listed below:

 

2.1.1　Commission Relationship

 

Most dormant investments are arranged through a commission relationship, that is, the dormant investor entrusts the apparent shareholder orally or with a written agreement to invest in the name of the apparent shareholder.

 

2.1.2　Fiduciary Relationship  

The apparent investor is entrusted by the dormant investor to manage the latter’s stock rights in the company through a stock rights trust and to act as the shareholder of the company in public announcements (including the articles of association, registration of shareholders, and industrial and commercial registration materials). 

 

2.1.3　Loan Relationship

 

Dormant investments are not normally arranged through a loan relationship (if there is a loan then by definition it is no longer a dormant investment). However, in juridical practice, where the dormant investor cannot be deemed as an actual shareholder who enjoys the rights as a shareholder, the court tends to rule that there is a loan relationship between the dormant investor and the apparent investor.

 

2.2　　Legal Relationship between the Apparent Shareholder and the Company

 

As previously stated, the apparent investor, in the public announcement, is the shareholder of the company who enjoys the rights and performs the liability thereof. However, if the dormant investor is confirmed as the actual shareholder of the company, then the apparent investor is only an agent entrusted by the dormant investor to exercise its shareholder rights and perform its shareholder liability.

 

2.3　　Legal Relationship between the Dormant Investor and the Company

 

As in the public announcement, there is no legal relationship between the dormant investor and the Company, but in fact, many dormant investors engage in the management of the company, exercising their shareholder’s rights and performing their shareholder liability thereof; in addition, the agreement concluded by and between the dormant investor and the apparent investor usually indicates the dormant investor’s status as shareholder. But from a legal point of view, a dormant investor’s shareholder status, before juridical confirmation is obtained and industrial and commercial registration is handled, is not certain, and at least is unable to stand up to a third party.

 

3. 　　Common issues in Dormant Investments

 

As stated above, since there are many uncertain legal relationships in dormant investments, it is rather easy for disputes to occur, especially due to the lack of information in the public announcement, making the rights and interests of the dormant investor easily infringed. According to our summary the following situations often occur：

 

3.1　　The apparent shareholder intends to become the real shareholder as the company is in good operation

 

At the beginning of the company’s establishment, the apparent shareholder is only the trustee of the dormant investor. However, as the company develops, generous profits can be realized, and as a result, some apparent shareholders are not satisfied with their relatively small commissions. For this reason apparent share holders will often attempt to take advantage of their status as the apparent shareholder and become the real shareholders by removing the dormant investors from the company.

 

3.2　　The apparent shareholder illegally encroaches on the company’s assets

 

Some apparent shareholders may take advantage of their status as shareholders to encroach the assets of the dormant investors by mortgaging all the company’s assets to creditors or in another method to produce false debt.

 

3.3　　Divergence which occurs in respect of management

 

In some companies that involve a dormant investment, the apparent shareholders and the dormant investor both engage in operations; it is inevitable that conflict in respect to operational strategies, business management, and the employment of staff members, etc. will occur. Under these circumstances, as only the apparent shareholder may exercise shareholder’s rights, the dormant investor usually has no power to control the company invested by it, which contributes to the fact that the real investor has no right to make a final decision.  

 

3.4　　The apparent shareholder treats their stock rights privately without the agreement of the dormant investor

 

Under the current legal system of the PRC, due to the public announcement of the apparent shareholder, the apparent shareholder may pledge or transfer stock rights owned by it to an unaware third party (i.e. a party that is unaware of the dormant investment) without the agreement of the dormant investor. Under these circumstances, the law tends to protect the legal rights and interests of the third party, and as a consequence, the rights and interests of the dormant investor can suffer heavy damages.

 

3.5　　Divergence occurs in respect to distribution of profits

 

If the distribution of profits between dormant investor and the apparent shareholder hasn’t been stipulated in advance, it is easy for divergence to occur between the two parties. (The apparent shareholder is paid by a fixed reward or a bonus).

 

3.6　　The dormant investor evades debt

 

Under the current legal system of the PRC, shareholders of limited companies and listed, limited companies shall assume liability according to the respective capital invested. When companies involved in dormant investment engage in loss, and debt accordingly follows, if the dormant investor is deemed as shareholder, it shall assume the debt according to the respective capital invested; however, if the relationship between the dormant investor and the apparent shareholder is confirmed as in the above mentioned Loan Relationship, then the dormant investor may demand principal and interest of the investment from the apparent shareholder, which is a way that the dormant investor may evade debt.

 

 

1. 　　Registration Antagonism is adopted to confirmation of shareholder’s qualification in the PRC

 

Confirmation of shareholder’s qualification in the PRC is referred to the Company Law of the People’s Republic of China and the Regulations of the People’s Republic of China on Administration of Company Registration:

 

Article 9 of Regulations of the People’s Republic of China on Administration of Company Registration provides that the registered items of a company shall include “names of the shareholders of a limited liability company, or of the promoters of a joint stock limited company, the amount of capital contributions subscribed and paid up, and the date and form of the contributions made.”

 

Article 33 of the Company Law of the People’s Republic of China provides that:

 

“A limited liability company shall prepare a register of shareholders, which shall specify the following:

 (1) the name of every shareholder and his/its domicile thereof;
 (2) the amount of capital contribution made by every shareholder;
 (3) the serial number of every capital contribution certificate.

 

The shareholders recorded in the register of shareholders may claim and exercise the shareholder's rights.

 

“A company must register every shareholder's name and the amount of its capital contribution with the company registration authority. Where any of the registered items are changed, it shall handle the modification of the registration. If the company fails to do so, it shall not, on the basis of the unregistered or un-modified registration item, stand up to any third party.”

 

Thus it can be seen from the statements above that registration antagonism has been adopted for confirmation of the qualifications of the shareholders of a limited company or the promoters of a joint stock limited company in the PRC, under which the unregistered dormant investor is unable to stand up to any third party. However, the effectiveness of the agreement by and between the dormant investor and the apparent shareholder thereto is not denied by laws. Therefore, it can be considered that the dormant investor can arrange investment matters with the apparent shareholder by way of agreement, stipulating that the dormant investor is the real shareholder. The said agreement can been deemed as effective between the dormant investor and the apparent shareholder, but if any third party is involved, then this agreement can’t stand up to the apparent shareholder registered with the industrial and commercial organ.

 

2.　　Relevant Juridical Interpretation and Opinions on Dormant Investment

 

At present, laws in the PRC don’t contain definite provisions on dormant investment, but some provisions in the relevant juridical interpretations or opinions (including drafts for soliciting opinions) represent a preference for dormant investment in juridical system of the PRC:

 

2.1　　Opinions of the Higher People’s Court of Shanghai Municipality on Several Problems in Handling Cases Involving Company Litigation

 

2.1.1　Issues Concerning Shareholder Qualifications

   

“Where the parties agree that the capital shall be subscribed in one party’s name while actually subscribed by the other party, such agreement shall have no effect on the company; the actual subscriber shall not claim to exercise shareholder’s right, instead, it can only first institute affirmation proceedings. Where more than half of the shareholders other than apparent shareholder of the limited liability company know that the capital is subscribed by the actual subscriber, and the company has been approving his performance of rights as the actual shareholder, without circumstances stipulated by other laws and administration rules, the people’s court may confirm that the actual subscriber shall enjoy the stock rights of the company.”

 

Interpretation: this clause confirms that the agreement concluded by and between a dormant investor and an apparent shareholder has no effect on the company; thus, if the dormant investor intends to exercise its rights as a shareholder, it needs to institute affirmation proceedings in people’s court. This principle is in conformity with the registration antagonism provided by Company Law.

 

2.1.2　Relevant Affirmation Proceedings  

 

“(1) Where the parties agree that one party actually subscribes capital while the other party engages the company in the name of shareholder, and the actual subscriber shall be the shareholder or shall assume the investment risk, if the actual subscriber claims the nominal subscriber to transfer the stock and property, the people’s court shall hold such claim unless it violates the imperative provisions of law.

 

Where one party provides capital while the other party engages the company in the name of shareholder, but the parities don’t stipulate that the capital provider shall be the shareholder or shall assume investment risk, and the capital provider neither engages in the management of the company nor enjoys shareholder’s rights as the shareholder, the relationship between the parties shall not be deemed as a dormant investment, instead, the relationship should be treated as a debtor-creditor relationship.

 

In the above dispute between a capital provider and a nominal shareholder, the company can be named as the third party when taking part in litigation.

 

(2) Where the creditor claim for compensation liability for providing capital through fraud to the nominal shareholder in documents of industrial and commercial registration, the people’s court shall uphold such claims. After assuming liability for the creditor of the company, the nominal shareholder may recover the loss suffered therefrom to the capital provider in accordance with the agreement.

 

In appeal disputes, where the creditor names the capital provider and the nominal shareholder as joint defendants, the people’s court may rule that both will assume joint and several liabilities in accordance with the details of the case. Where the nominal shareholder has enough evidence to prove that he was falsely named as a shareholder by others, he will bear no liability. ”

 

Interpretation: This provision defines the principles that shall be complied with in interpleader cause:

 

First of all, the conditions for confirming the property rights and interests of the dormant investor are: 1. Agreed to by all parties, the dormant investor (“the actual subscriber in the provision above”) agrees definitely with the apparent shareholder (“the nominal shareholder” in the provision above) that the dormant investor shall be the shareholder or shall assume the investment risks; or 2. Engaged in actual operation, that is, the dormant investor has engaged in the management of the company as shareholder or has actually enjoyed shareholder’s rights; 3. Being in conformity with law, i.e. the affirmation proceeding doesn’t violate the imperative provisions of laws. If the affirmation fails, the relation between dormant investor and apparent shareholder can be treated as a credit and debt relationship, therefore, the dormant investor can only claim for the principal and debt of the property he contributed to the company from the apparent shareholder.

 

Next, in an affirmation dispute, the company may be named as the third party in order to engage in litigation.

 

Finally, as to the liability of providing fraudulent capital, it is common for the shareholder in public announcement or the apparent shareholder to assume liability for invested capital; sometimes, the dormant investor can be named as a joint defendant.   

 

2.1.3　The Effectiveness of the Capital Maintenance Bonds on the Dormant Investor

 

“Though the dormant investor is not the nominal shareholder of the company, the company was established on the basis of its investment, therefore, in accordance with the principle of capital maintenance and capital constant, the dormant investor shall not withdraw his capital for the purpose of evading risk and liability.”

 

In order to maintain the steady and constant development of the company and prevent the dormant investor from evading debts and risks, it is forbidden for the dormant investor to withdraw the registered capital provided by it from the company.

 

2.2　　Opinions of the Higher People’s Court of Jiangsu Province on Several Problems in Handling Cases Applied to Company Law (Trial)

 

The third part of these Opinions, “Confirmation of Shareholders Limited Companies”, gives detailed provisions on matters concerning the confirmation of shareholders in a dispute over dormant investment. Its essential points are similar to the Opinions of Higher People’s Court of Shanghai Municipality on Several Problems in Handling Cases Involved in Company Litigation, therefore we will not elaborate here.  

 

2.3　　Provisions of the Supreme People’s Court on Several Issues Concerning Trials of Company Dispute Cases (one) (draft for soliciting opinions)

 

These Opinions which were announced in December of 2003 by the Supreme People’s Court, though only a draft for soliciting opinions, contain detailed and instructive provisions on dormant investment. This draft is also similar to the above Opinions of Higher People’s Court of Shanghai Municipality on Several Problems in Handling Cases Involved in Company Litigation, except for two differences:

 

2.3.1　The draft provides more detailed provisions on the confirmation conditions of dormant investor’s rights by dividing rights into stock rights and property rights:

 

“Where the investor agrees with others to invest in the name of the latter, the agreement hereof shall not stand up to the company. however, where more than half of the shareholders of a limited company know that the investment is provided by the investor, and the investor has been approved by the company to exercise rights as shareholder, without circumstances which violate the imperative provisions of law, the people’s court may confirm that the investor shall have stock rights of the company.”

 

Where one party invests capital while the other party engages in the company in the name of shareholder, and the parties agree that the investor shall be the shareholder or shall assume the investment risk, if the investor claims the nominal investment to transfer the stock and property, the people’s court shall hold such claim unless there are circumstances that violate the imperative provisions of law.

 

Where one party invests capital while the other party engages in the company in the name of shareholder, but the parties don’t agree that the investor shall be the shareholder or shall assume the investment risk, in addition, the investor has never engaged in the management of the company as a shareholder or claimed for rights in the name of a shareholder, the investor only possesses creditor’s rights against any one engaging the company in the name of shareholders; under these circumstances, the people’s court shall not uphold the subscriber’s claims for stock rights or shareholder’s benefits.  

 

Interpretation:

 

(I) 　the confirmation conditions of stock rights defined by these Opinions are as follows:

 

A.     limited for a limited liability company;

B.     known by the other shareholders;

C.     approved by the company;

D.     conforming with all laws.

 

Under the above conditions, it can be confirmed that the dormant investor shall have the stock rights.

 

The confirmation conditions of the property rights (dividend and other rights and interests resulting from stock) defined by these Opinions are as follows:

2.3.2　As to the transfer of the stock rights to a third party, these Opinions are inclined to protect the legal rights and interests of third parties.

 

“where the nominal investor transfers stock rights without the agreement of the investor, the investor may claim that the nominal investor should compensate for damage suffered due to the transfer of stock rights.

 

Where the actual investor alleges itself as the actual obligee to claim that the transfer of stock rights shall be null and void, the people’s court shall reject such claims unless the transferee has been proven to do so out of bad faith. ”

 

Interpretation: in case the apparent shareholder transfers stock rights to a third party without the agreement of the dormant investor, if the third party accepts the stock rights without knowing the truth (that is, without knowing the arrangement between the dormant investor and the apparent shareholder), the result of the transfer shall still be acknowledged. The dormant investor can only claim for compensation for damage suffered due to the apparent shareholder but can’t claim for dismissing such a transfer of stock rights. This provision is in conformity with the third party system in the civil law of the PRC.

 

2.3.3　Summary

 

Though the laws of the PRC contain no specific definition on dormant investment, in recent year’s juridical rulings, a set of accepted practices have gradually developed and been reflected in juridical interpretations and opinions.

  

3.　　Review of the Case Referred in the Subject

 

It is easier for us to understand the case referred in the subject on the basis of the aforesaid introduction and legal analysis. We analyze briefly as follows:  

 

3.1　　Subjects:

Company invested: Zijin Century Company

Dormant investor: New China Life Insurance Co., Ltd

Apparent shareholders: West Credit Guaranty Company Limited and New Industry Investment Co., Ltd

Other shareholder: Beijing Hotel

 

3.2　　Dispute

Dispute over affirmation of stock rights between New China Life Insurance Co., Ltd and West Credit Guaranty Company Limited

 

3.3　　Result of Sentence

Confirmed the shareholder status of New China Life Insurance Co., Ltd, the dormant investor

 

3.4　　Grounds for Sentence

From the above analysis, especially analysis of the grounds for sentence we can see that in juridical practice, the spirit of the aforesaid juridical opinions and interpretations (including draft for soliciting opinions) has been carried out, which further proves that these juridical interpretations and opinions are of instructive significance in real life.

 

 

On the basis of the above introduction and analysis of the essential situation and juridical practice of dormant investment, we will discuss dormant investment in the foreign investment field. For various reasons, dormant investment is common in the foreign investment field, foreign businessman invest in China as a dormant investor by leaving domestic shareholders as the apparent shareholders. The new income tax law announced in March of 2007 and effective on the 1^st of January, 2008, unifies the income tax rate to 25%, which means that foreign-invested enterprises will no longer enjoy a tax preference. Thus, it is anticipated that in the next few years, dormant investment in the foreign investment field will increase gradually.

 

It is easy for disputes to occur if dormant investment is carried out without careful evaluation of the risks. In addition, as the specificity of the investment subject and relevant law and administrative rules are not well developed, it is of great difficulty to confirm shareholder’s qualifications for foreign dormant investors, who usually are at a disadvantage in a dispute. Becasue of this fact it is necessary to give specific analysis on legal matters concerning dormant investment in the foreign investment field：

 

1.　　Reasons for the Occurrence of Dormant Investment in the Foreign Investment Field

 

1.1　Evasion of Legal Barriers

 

Though the Chinese government continues to adopt a more open policy in regards to foreign investment, in the Catalogue for the Guidance of Foreign Investment Industries issued by National Development and Reform Commission, a lot of industries are still limited or prohibited for foreign investment to enter. Therefore, in order to enter industries limited or prohibited by the State, some foreign businessmen will invest in these industries through a domestic campany, adopting dormant investment to evade the laws and policies of China.     

 

1.2　To Simplify Procedures

 

Complicated examination and approval procedures are needed for establishment of a foreign-invested enterprise; moreover, sometimes such enterprises may fail to pass examination and approval, therefore making it much easier to establish a domestically invested enterprise. Simplifying procedures then becomes one reason for dormant investment to occur.

  

1.3　Other Reasons

Matters concerning management and so on are also reasons for dormant investment to occur in the foreign investment field.

 

2. 　　Problems with Dormant Investment in the Foreign Investment Field

 

Despite the different investment subject, dormant investment in the foreign investment field is similar to normal dormant investment, therefore we can refer to the above .

 

3. 　　Legal Barriers Existing in the Affirmation of Shareholder’s Rights of Dormant Investor in the Foreign Investment Field

 

3.1　　Validity Is the Major Barrier

 

As stated above, in juridical opinions and interpretations of the PRC confirmation of personal rights (shareholder’s status) and property rights (dividends and other shares and property rights and interests) both involve validity, or the confirmation of the dormant investor as the shareholder 

 

Dormant investment made by foreign businessman for the purpose of evading legal limitations or prohibitions to industry obviously violates the imperative provisions of the law; under these circumstances, it is difficult for the court to find in favor of foreign businessman. Therefore, under these circumstances, the best way to protect the benefits of the dormant investor is to define the relationship between the dormant investor and the apparent shareholder as a debtor-creditor relationship.   

 

3.2　　Validity must be present in the Subjects and in the Process

 

There are industries where foreign investment is encouraged and industries where foreign investment is restricted, when complying with investment policies in the Catalogue for the Guidance of Foreign Investment Industries, affirmation of the share rights of the foreign dormant investor can still meet problems in the process of validity.

 

The establishment of all foreign invested enterprises must be approved by the competent department of the government. The examination and approval, is an essential condition for the establishment of a foreign-invested enterprise. But in the process of affirmation of dormant investment, the court shall violate the procedural regulations of the law and surpass its jurisdiction, exercising rights that normally are exercised by the competent department of the government, in order to directly confirm the dormant investor as the shareholder of the company. Therefore, in these industries, affirmation of the share rights of the foreign dormant investor still meets barriers in respect to validity. How to arrange such a dormant investment, so as to protect the benefit of the dormant investor to the fullest extent, while realizing its shareholder’s rights and interests when disputes arise is a difficult question to answer. 

 

Validity is an obvious legal barrier in the confirmation of share rights in a dormant investment. With regard to industries where foreign investment is prohibited or restricted by law, validity is an impassible hurdle for foreign investors. Even though some investors do participate in those industries through dormant investment, when disputes arise, it is hard for them to have their status as shareholders and their interests in the property recognized and protected by Chinese laws. In terms of procedural law and with regard to industries where foreign investment is encouraged or allowed by the law, it is necessary to pass examination and approval processes first, which then creates procedural barriers in directly recognizing foreign dormant investors in those industries as shareholders who enjoy equity interest.   

 

4. 　　Opinion on how to move forward

In view of the legal analysis mentioned above of dormant investment in the foreign investment field, there are legal barriers to the confirmation of share rights. For better protection of every party’s interests, it may be more prudent and  betterorganized to engage in a commercial arrangement.

 

4.1.1　Avoid engaging in industries where foreign investment is prohibited or restricted by law.

 

With regard to industries where foreign investment is prohibited or restricted, foreign investors can not have their investment legalized through dormant investment. When a dispute arises, foreign investors can not get legal recognition for their status as shareholders in the PRC leaving foreign investors open to significant risk.

 

Foreigners wishing to invest in the PRC should complete thorough research prior to their investment so as to avoid industries within the range prohibited or restricted by the law. In terms of Chinese policy and judicial practice, any industries within the range of  being a prohibited or restricted inustry, has no possibility of being recognized legally for foreign investors including through indirect investment. Therefore considering the investment risk, we do not advise foreign investors to invest indirectly into these industries through dormant investment.

 

In regard to creating a good arrangement between the creditor’s rights and it’s debts, it is suggested to consider holding assets of the company as security. Under the aforementioned circumstances, since foreign investors may not be recognized as shareholders, they should at the very least protect their principals. Therefore, foreign investors should try to use the corresponding assets of their companies as securities so as to ensure their creditor’s rights.

 

4.1.2　For industries encouraged or allowed by the law, proper arrangements must be made.

 

There are no substantial barriers for industries in which the state allows foreign investment but relevant approval procedures must still be preformed. Dormant investment in these industries is not infeasible and foreign investors may protect their rights and interests by following these arrangements:

 

Firstly, foreign investors should enter into investment agreements properly with chosen apparent shareholders. Besides normal clauses, the following clause should also be added: in the event that dormant investors (foreign investors) desire to change the shareholders making the dormant investors the actual shareholders, the apparent shareholders are entitled to cooperate in the approval procedures of the relevant governmental departments and in the alteration of the industrial and commercial registrations.

 

Secondly, dormant investors’ share rights (according to public notice, these share rights are listed under the apparent shareholders’ name) should be pledged to dormant investors so as to guarantee the performance of the investment agreement. In this way dormant investors may apply for execution of the pledged share rights in case of any dispute or when it is desirable,.

 

Thirdly, the company and other shareholders must be aware that the dormant investor is engaged in company management. This is a standard by which practice is determined judicially in the PRC. Please refer to the discussion mentioned above on judicial interpretation and practice in the PRC.

 

4.1.3　Apparent shareholders must also pay attention to protecting their own rights and interests.

 

The paragraphs above are focused on the protection of the rights and interests of foreign investors in dormant investment, but for domestic apparent shareholders, there are also risks. Especially when a company is not profitable, foreign investors may also claim that they are not shareholders of the company and there only remains a debtor-creditor relationship between the two parties. Therefore, in the agreement concluded, domestic apparent shareholders shold also pay attention to clauses stating that they shall bear no investment risks so as to avoid unecessary risks.

 

 

Although dormant investment is not a new idea in China, it is still far from being well established. Disputes arising from dormant investment are quite frequent. In these disputes, most parties do not have a solid understanding concerning dormant investment and the relevant laws and judicial practices in the PRC, or pay enough attention to the risks involved. Due to the cancellation of favorable policies for foreign direct investment, for the evasion of prohibition or restrictions, and to aid in the convenience of setup foreign investors’ preference for choosing dormant investment is growing. In this article, we introduced and analyzed characteristics of dormant investment and the judicial practice surrounding it in the PRC and then proposed some advice concerning foreign dormant investment. In conclusion, only when the basic knowledge of the subject is mastered, the investors are aware of all the risks of dormant investment, and arrangements are made according to law can all interested party’s legal rights and interests be protected.