Entrusted shareholding investment has become an increasingly prominent issue in China’s capital market. Many investors choose to entrust others to hold shares on their behalf for various considerations. However, entrusted investment also contains multiple legal risks. This article will focus on the legal risks faced by the actual investors, nominal shareholders and investee companies in the entrusted shareholding model, and propose corresponding risk prevention measures.
The actual investor bears the risk of being unable to become a formal shareholder
According to China’s Company Law Interpretation No. 3, the actual investor cannot request the company to register him/her as a formal shareholder unless more than half of the other shareholders agree. If the actual investor fails to obtain such consent, he/she cannot exercise shareholder rights in his/her own name.
The invested shares may be arbitrarily disposed of by the nominal shareholder
If the nominal shareholder transfers the invested shares without the consent of the actual investor, the transfer may still be valid under China’s civil law if the transferee is in good faith. In this case, the actual investor can only claim damages from the nominal shareholder instead of invalidating the transfer.
The actual investor may lose effective control over the invested company
The actual investor has to rely on the nominal shareholder to exercise shareholder rights on his/her behalf. If the nominal shareholder acts against the will of the actual investor, the latter may lose effective control over the invested company.
The actual investor bears the risk of being unable to receive investment returns
The ultimate purpose of the actual investor is to obtain investment returns. However, the nominal shareholder may refuse to transfer dividends and other benefits to the actual investor as agreed, depriving the actual investor of his/her entitlement to the fruits of investment.
The invested shares may be preserved or executed against the nominal shareholder
As the shares are registered under the name of the nominal shareholder, they can be preserved or executed against by creditors of the nominal shareholder. The actual investor has no recourse in such cases even if he/she is the de facto owner of the shares.
In summary, while entrusted shareholding investment has its advantages, actual investors face multiple legal risks such as inability to become formal shareholders, loss of control over the invested company, and loss of investment returns. To mitigate such risks, actual investors should ensure the validity of entrustment agreements, obtain consent from other shareholders, and consider protective measures such as share pledges.