In practice, shareholding entrustment is quite common due to policy restrictions, privacy or other reasons. Provided that the shareholding entrustment agreement is valid, if the equity in the name of the nominal shareholder is applied for enforcement by its creditor, can the dormant shareholder block the enforcement based on the shareholding entrustment agreement? This article tries to sort out the relevant issues.
Ⅰ. Question: Exceptions to the Commercial Rechtsschein Theory
Both Article 65 of the Civil Code and Paragraph 3 of Article 32 of the Company Law provide that the inconsistency between the actual circumstances of a legal person and the registered information on the legal person shall not be set up against bona fide opposite parties. According to the "Commercial Rechtsschein Theory", the creditor shall have the right to enforce the transfer of shares in the name of the nominal shareholder according to the registered information. For example, in the retrial of the case of Beijing Huishida Logistics Co., Ltd v. Xiang Shuchuan for Objection of the Person not Involved to Enforcement[1], the SPC found that, according to the law, a duly registered shareholder shall be publicly announced, and the dormant shareholder of the company did not have a legally announced legal status in relation to the company. Therefore, the dormant shareholder could not use its agreement with the nominal shareholder to stand up to the external creditor claiming its legitimate rights against the nominal shareholder. In addition, the Company Law and relevant judicial interpretations also do not limit the interpretation of the "third party" to the opposite party with whom the registered shareholder has an equity transaction.
Therefore, exceptions need to be considered if the Commercial Rechtsschein Theory is to be breached. However, what specific exceptions can prevent enforcement?
II. Analysis: Grounds for the Actual Contributor to Block Enforcement by the Creditor
1. Valid Instruments for Confirmation of Ownership Existed in Another Case Before the Equity was Frozen
Following the promulgation of the Provisions of the Supreme People's Court on Several Issues Concerning the Handling of Execution Objection and Reconsideration Cases by People's Courts, Article 26 thereof provides that regarding an ownership dispute between a non-party and the Person subject to Enforcement, or a contract dispute for the purpose of which the ownership of property is not the transfer of property rights, such as leasing, borrowing and custody, if a judgment or ruling is rendered that the subject matter of enforcement belongs to the non-party or the subject matter of enforcement is returned to the non-party, and the non-party's right can preclude enforcement, such claim shall be supported. The people's court shall not support the non-party's application for precluding the objection to enforcement based on the effective legal instrument of another case made after the subject matter of enforcement is seized, retained or frozen.
As can be seen from the above-mentioned provisions, the examination of the enforcement objection filed by the dormant shareholder is subject to strict requirements, which require an effective legal instrument to determine the actual ownership of the equity and such instrument shall be effective before the equity is frozen. Therefore, the exclusion of the enforcement objection may be supported if two conditions are met.
2. The Effectiveness of a Real Claim in Nature Exceeds that of an Obligatory Claim
After the promulgation of the Minutes of the National Courts' Civil and Commercial Trial Work Conference (the “Conference Minutes”), Article 124 further clarifies that if a judgment of another case confirms the equity ownership to the non-party, the principle of property priority over creditor's rights shall be followed, and the dormant shareholder may preclude the enforcement; if a judgment of another case only confirms the validity of the shareholding entrustment agreement or the ownership of investment rights and interests, the nature of the judgment is a creditor's right, and the creditor of the nominal shareholders may not preclude the enforcement. From this, we can see that the Conference Minutes is mainly based on the claim of the dormant shareholder to consider whether it has the right to preclude the enforcement.
Article 6 of the Answers to Several Issues Concerning the Trial of Corporate Disputes issued by the No.2 Civil Tribunal of the Shandong Provincial Higher People's Court provides that, according to the Rechtsschein Theory, if a bona fide third party conducts a civil juristic act with a nominal right holder based on his/her reliance on the rechtsschein, the validity of the civil juristic act shall be protected in priority by the law. However, if the creditor of the nominal shareholder applies for the enforcement of a general creditor's right, formed by the borrower-loan relationship between the creditor and the nominal shareholder, and the creditor does not perform the civil juristic act involving equity transfer with the nominal shareholder, the creditor is not a bona fide third party for the civil juristic act that needs to be protected based on reliance on the rechtsschein, so the creditor’s claim shall not be protected by priority over the actual right holder. Where the actual contributor requests to stop the enforcement, the court shall uphold.
In the retrial of the case of Jiang Zhiquan v. Xie Deping for the Objection of the Person not Involved to Enforcement[2], which was heard by the SPC, the court held that, in terms of the nature of the rights, the creditor of the nominal shareholder seized the equity interest based on a general claim, while the dormant shareholder challenged the enforcement based on its claim for the return of the equity interest. Therefore, the claim of the creditor of the nominal shareholder cannot certainly take precedence over that of the dormant shareholder. No legal relationship of reliance is established between the creditor and the nominal shareholder with respect to the equity involved in this case, nor is the creditor a bona fide third party for a civil juristic act that should be protected based on its reliance on the rechtsschein.
3. The Creditors of the Nominal Shareholder Know or Should Know the Existence of the Actual Contributor
According to Article 18 of the Guidelines for the Trial of Enforcement Opposition and Lawsuits Regarding Objection to Enforcement (Ⅲ) (promulgated in March 2019) by the Jiangsu Provincial Higher People's Court, when an execution court enforces the equity interest registered under the name of the party subject to enforcement, if the non-party objects to such enforcement on the ground that it is a real shareholder or actual contributor and requests to preclude the enforcement or to confirm its shareholder qualification, such request shall not be supported. Where the non-party files a lawsuit to object to the enforcement, and the evidence it provides can fully prove that the party applying for enforcement know or should know that it is the dormant shareholder or actual contributor, such lawsuit shall be supported.
It indicates that there is no "good faith" circumstance if the creditor is aware of the existence of the dormant shareholder, and the dormant shareholder may preclude the enforcement.
4. Creditor Has No Reliance Interest When the Creditor's Right is Formed before the Shareholding Entrustment
In the retrial case of Huang Deming v. Li Kaijun for the Objection of the Person not Involved to Enforcement heard by the SPC[3], the court held that, in terms of the time when the rights were formed, if the shareholding entrustment was formed first, pursuant to the Commercial Rechtsschein Theory, the right of the creditor shall be more preferentially protected; if the creditor's right was formed first, there is no condition for the Commercial Rechtsschein Theory to be applied, and the rights of the dormant shareholder shall be preferentially protected.
In addition, in the retrial case of Yi X-ping v. Pingxiang Fuxin Energy Saving Service Co., Ltd. for the Objection of the Person not Involved to Enforcement[4] heard by the SPC, the court held that the debt relationship between the creditor and the nominal shareholder arose prior to the establishment of the company involved in the case, the shares held by the nominal shareholder had not been disclosed to the public, so that the creditor is unlikely to place reliance on the equity held by the nominal shareholder. The creditor, who applies for enforcement of the equity based solely on his/her reliance on the registration of shareholder, shall not stand up against any substantive rights of the dormant shareholder.
As can be seen from the above cases, it is crucial to determine the time when shareholding entrustment and debts arise, for it determines whether the reliance interests of the creditor shall be protected.
Ⅲ. Basis for Solution: Balance of Interests between the Dormant Shareholder and the Creditor of Nominal Shareholder
There is no specific regulation on the protection of interests of the dormant shareholder or the creditor of nominal shareholder from a legislation perspective. Based on the above-mentioned provisions and practical cases, it can be seen that the existing legal system, which takes the Rechtsschein Publicity Principle as the major prerequisite and examines special circumstances as exceptions, is conducive to the comprehensive protection of the rights and interests of all parties, and is more in line with the idea of balance of interests. The original intention of the system design can be analyzed from the following three perspectives:
1. Transaction Security and Order
China’s company registration system aims to guide the third party to understand the company's status, and help the third party to make transaction decisions. It is difficult for the third party to know the shareholding entrustment relationship between the nominal shareholder and the dormant shareholder. In the event of an application for enforcement of the nominal shareholder’s equity, the risk is borne by the dormant shareholder, which is relatively less disruptive to the normal transaction order, and even if the equity is enforced, the dormant shareholder still has legal remedies to claim damages from the nominal shareholder based on the shareholding entrustment agreement.
2. Equivalence Between Risk and Return
The reason why a dormant shareholder adopts the mode of shareholding entrustment is based on business interests. Then, while obtaining benefits that a dormant shareholder cannot obtain in the revealed state through shareholding entrustment, the dormant shareholder has to bear the risks associated with the model.
3. Value Orientations of Legal System
The shareholding entrustment model disturbs the social good faith system and violates the regulations on company registration. Through shareholding entrustment, both the dormant shareholder and the nominal shareholder create a rechtsschein of right inconsistent with the real situation, which increases the transaction risks and costs for the third party and imposes on the judicial authorities an additional duty of review. If the balance of interests is tilted to the dormant shareholder, then it will have the objective legal effect of encouraging the behavior of nominal holding, then dormant shareholders and nominal shareholders will be more motivated to pursue illegal business interests or avoid debts through "shareholding entrustment". Therefore, it is more conducive to the realization of the values of fairness, efficiency, and security by determining that a dormant shareholder cannot preclude the enforcement of creditors of nominal shareholder.
References
[1]Supreme People's Court, (2019) SPC Min Shen No. 4710, Civil Adjudication for Retrial Review and Trial Supervision of Case of Beijing Huishida Logistics Co., Ltd v. Xiang Shuchuan for Objection of the Person not Involved to Enforcement.
[2]Supreme People's Court, (2018) SPC Min Shen No. 5464, Civil Adjudication for Retrial Review and Trial Supervision of Case of Jiang Zhiquan v. Xie Deping.
[3]Supreme People's Court, (2019) SPC Min Zai No. 45, Civil Judgment for Retrial of Case of Huang Deming v. Li Kaijun.
[4]The Supreme People's Court, (2018) SPC Min Shen No. 3511, Retrial Case of Yi X-ping v. Pingxiang Fuxin Energy Saving Service Co., Ltd. for Objection of the Person not Involved to Enforcement.
