Preliminary Study On Shareholder Status Determination And Equity Transfers In Foreign-Invested Enterprises

Abstract

The implementation of the Foreign Investment Law has triggered a wave of corporate restructuring among foreign-invested enterprises, while disputes between Chinese and foreign shareholders have become increasingly prominent. This article focuses on two practical issues arising after the implementation of the Foreign Investment Law: the determination of shareholder status for Chinese shareholders whose equity interests were historically registered as zero, and the approval and filing requirements for equity transfers in foreign-invested enterprises. By reference to current PRC judicial practice, this article also offers practical suggestions for risk prevention.

I. Introduction

The Foreign Investment Law of the People’s Republic of China (the “Foreign Investment Law”), which came into effect in 2020, replaced the previous “Three Foreign Investment Laws”, namely the Law of the People’s Republic of China on Chinese-Foreign Equity Joint Ventures, the Law of the People’s Republic of China on Wholly Foreign-Owned Enterprises, and the Law of the People’s Republic of China on Chinese-Foreign Contractual Joint Ventures.

This article discusses two common practical issues arising after the implementation of the Foreign Investment Law: first, the determination of shareholder status for Chinese shareholders whose equity interests were historically registered as zero; and second, the approval and filing requirements applicable to equity transfers by shareholders of foreign-invested enterprises. On this basis, the article provides practical suggestions for risk prevention.

II. Determination of Shareholder Status for Chinese Shareholders Whose Equity Interests Were Historically Registered as Zero

In the early stages of China’s reform and opening-up, Chinese parties often cooperated with foreign investors to establish Sino-foreign cooperative joint ventures by contributing land use rights, real property or other forms of cooperation conditions. In some cases, however, the cooperation conditions provided by the Chinese party were not valued or appraised, resulting in registration records showing the foreign party as holding 100% of the equity interests, while the Chinese party’s equity interest was registered as 0%. Following the implementation of the Foreign Investment Law, the confirmation of shareholder status for such historically zero-registered Chinese partners has become a key issue in the restructuring of foreign-invested enterprises.

According to current PRC judicial practice, courts will consider both formal and substantive elements when determining the shareholder status of a Chinese party. Where there are defects in the formal elements, courts tend to place greater emphasis on the substantive elements.

In the case of (2023) Yue 0308 Xing Chu No. 3067, the court held that:

“The articles of association filed in the plaintiff’s industrial and commercial registration records since its establishment all contained provisions on the contribution methods of the Chinese investor and the foreign investor. The minutes of board meetings bore the signature of the vice chairman appointed by the Chinese investor. The plaintiff also confirmed at trial that the Chinese investor had exercised shareholder rights during the plaintiff’s operation, and that an equity dispute existed between the plaintiff and that company. Against this background, the plaintiff’s direct application to remove the Chinese investor’s 0% equity interest and shareholder status through an industrial and commercial registration change lacked factual and legal basis. Accordingly, the court did not accept the plaintiff’s claim.”

A shareholder should ordinarily be expressly recorded in documents, including the cooperation agreement, articles of association, industrial and commercial registration records, and capital verification reports. These documents not only establish shareholder status, but also constitute critical evidence for the protection of shareholder rights and legitimate interests.

Substantively, a shareholder shall exercise core shareholder rights, such as participating in major corporate decision-making and receiving profit distribution. Such participation is generally evidenced by signatures or seals affixed to formal instruments such as board resolutions and articles of association, which confirm that the shareholder or its duly appointed representative has effectively participated in the company’s daily operation and corporate governance.

Under current Chinese judicial practice, courts examine both formal and substantive criteria when assessing shareholders’ qualifications. As reflected in the aforesaid case, courts prioritize substantive review where procedural formalities contain defects.

III. Approval and Filing Requirements for Equity Transfers by Shareholders of Foreign-Invested Enterprises

Under the old “Three Foreign Investment Laws”, a full approval regime governed foreign-invested enterprises. Any equity transfer agreement for such enterprises took effect only after approval was obtained from the competent authority. Without such approval, PRC courts would rule the contract ineffective, which could further bar the transferee from claiming shareholder status under the agreement.

Since 1 October 2016, China’s foreign investment administration system has shifted from a comprehensive approval system to a standard filing system, with approval required only for industries on the negative list. For foreign-invested enterprise equity transfers outside the negative list, only filing is needed. This filing is purely informational and no longer a validity prerequisite. These transfer agreements are therefore fully binding even without completed filing. Likewise, contract clauses tying contractual effectiveness to governmental approval are no longer enforceable.

In (2021) Zui Gao Fa Min Shen No. 1074, the Supreme People’s Court held that, after the Foreign Investment Law and its implementing regulations came into force, the Three Foreign Investment Laws and their respective implementing regulations and detailed rules were repealed. The approval administration systems under those repealed laws and administrative regulations are no longer applicable.

As illustrated by the aforesaid Supreme People’s Court case, shareholders conducting equity transfers shall first confirm whether the enterprise’s business scope falls within the negative list under the Foreign Investment Law. Where the business falls within a negative list sector, the equity transfer shall be subject to review and approval by the competent foreign investment authority, so as to eliminate substantive validity defects upon the transferee’s acquisition of shareholder qualifications.

IV. Practical Suggestions for Risk Prevention

1. Confirm shareholder status in writing and complete industrial and commercial registration changes in a timely manner

In the course of foreign-invested enterprise restructuring, internal shareholder disputes may arise, and the original shareholder may refuse to recognize the shareholder status of the new investor. It is therefore advisable to initiate communication and negotiation as early as possible, and, where necessary, to assert rights through legal proceedings to ensure the smooth progress of the restructuring.

Shareholders may formalize their status and agreed contribution methods by way of written agreements during restructuring. Following internal confirmation of shareholding qualifications and amendment of the company’s articles of association, the enterprise shall promptly submit applications to market regulatory authorities for industrial and commercial registration changes, updating registered particulars including shareholder information, contribution methods and equity ratios. Though subject to formal review only, industrial and commercial registration carries strong legal effect for public disclosure, protects shareholders’ lawful rights and interests, and upholds third parties’ reasonable reliance on the company’s equity structure.

2. Review whether the equity transfer is subject to approval, filing or information reporting requirements

Where an equity transfer does not cover industries prohibited under the foreign investment negative list, or where access conditions for restricted sectors are duly met, the equity transfer agreement shall take effect accordingly. Traditional contractual clauses that designate governmental approval as a precondition for contractual validity are no longer enforceable in the same way. Accordingly, shareholders must confirm whether the target enterprise falls within the scope of the negative list before conducting any equity transfer.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.