Can I make foreign investment in China via a dummy shareholder?
This is a very practical question raised many times by inquirers and clients in the past.
For various reasons (in particular, circumventing regulations), foreign investors intend to sit behind curtain when making some investments in China. For that end, they will find and use a Chinese person who will act as the shareholder of the invested company and all corporate documents and government records will show the Chinese person is the shareholder of the invested company, a dummy shareholder.

Such arrangement used to be viewed as void by courts on the ground that such investment has violated China’s foreign investment regulations which require foreign investments be approved by governments, as indicated by many decided cases.

On November 23, 2009, China Supreme Court issued a draft judicial interpretation in regard of foreign investment issues, namely, Provisions on Several Issues concerning Trial of Foreign Investment Disputes (“Judicial Interpretation”) which cast lights on those hot issues that have vexed many courts, among which is the dummy shareholder issue.

Section 10 of the Judicial Interpretation consists of four paragraphs all relating to dummy shareholder investment which is termed as “entrustment investment” therein meaning that foreign investors entrust the nominee Chinese shareholders in making investment.

Paragraph 1 provides that: where the parties agree that one party makes actual investment and is entitled to shareholder rights and benefits and the other party acts as the nominee shareholder of the foreign invested enterprise, such agreement shall be considered as effective provided that such agreement is not in circumvention or violation of compulsory provisions in any laws, administrative regulations as well as public interests. This marks the fundamental shift towards dummy shareholder investment. However, it remains to be seen how the court will interpret the proviso part of the provision. Personally, I am of the opinion that such entrustment investments arranged in industries that belong to the “encouraged” and “allowed” categories in the Catalogue of Industries for Guidance of Foreign Investment shall be held as valid and otherwise, such entrustment investments in “restricted” and “prohibited” categories shall be nullified.

Paragraph 2 provides that: if the actual investor asks the court to affirm his shareholdership or to substitute the shareholder in the foreign invested enterprise, the people’s court shall not support such request, unless the actual investor has obtained the approval permitting him to be changed as shareholder prior to the end of debate in the trial of first instance.

Paragraph 3 provides that: if the actual investor requests the entrusted dummy shareholder to perform agreed obligations, the people’s court shall support such request.

Paragraph 4 provides that: in the absence of agreement on distribution of interests between the parties, the actual investor requests the dummy shareholder to hand over benefits received from the foreign invested enterprise, the people’s court shall support such request; if the dummy shareholder claims for necessary remuneration, the people’s court shall support such claims in light of the circumstances thereof.

Of course, the Judicial Interpretation is now a draft only and has not been turned into an effective interpretation. But, we are expecting that such shift regarding dummy shareholder arrangement will stay in the final and effective version of the Judicial Interpretation.

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