I. Introduction

In equity investment activities, the author often encounters investors who do not wish to be registered as显名 shareholders and therefore choose to have others hold shares on their behalf. Many actual investors are more or less aware that nominee shareholding entails significant legal risks. Therefore, before entering into a nominee shareholding arrangement, they still choose to sign a nominee agreement with the nominee.

However, can a nominee shareholding agreement once and for all eliminate the risks of nominee shareholding?

II. Risks of Nominee Shareholding

(A) Risk of Invalidity of the Nominee Agreement

According to Article 24 of the Judicial Interpretation (III) of the Company Law, a nominee shareholding agreement is valid if there are no statutory grounds for invalidity.

But the question is, what constitutes “statutory grounds for invalidity”?

1. Are Nominee Shareholding Agreements for Insurance Companies, Commercial Banks, and Companies Planning to List Valid?

According to the relevant regulatory rules of the China Banking and Insurance Regulatory Commission and the China Securities Regulatory Commission on commercial banks, insurance companies, or listed companies, insurance companies, commercial banks, and listed companies are required to truthfully disclose their equity structures during the initial establishment/public offering approval and subsequent regulatory processes, and must ensure that their equity is clear and free of nominee arrangements.

From the perspective of previous judicial interpretations on contracts, the determination of contract invalidity should be based on the mandatory provisions on validity in laws or administrative regulations. However, according to cases from the Supreme People’s Court ([2017] Zui Gao Fa Min Zhong No. 529 and [2017] Zui Gao Fa Min Shen No. 2454), even if the nominee shareholding agreement only violates departmental regulations in the financial regulatory field, the agreement is still deemed invalid.

In the aforementioned two cases, the parties entrusted others to hold shares in insurance companies and companies planning to list, respectively. The “Administrative Measures for Equity of Insurance Companies” issued by the former China Insurance Regulatory Commission prohibits nominee shareholding in insurance companies, and the “Administrative Measures for Initial Public Offerings and Listing” issued by the China Securities Regulatory Commission also prohibits nominee shareholding during the listing process. The Supreme People’s Court held that nominee shareholding in the financial regulatory field violates national financial regulatory policies and may harm public interests, thus declaring both nominee shareholding agreements invalid.

The author believes that the financial regulatory field is特殊. For example, banks, insurance companies, and listed companies all have the ability to raise funds from the unspecified public. Failure to accurately disclose the equity of companies in the financial field can easily lead to internal control of such companies, providing convenience for actual controllers to engage in利益输送 through related-party transactions or to circumvent share reduction rules, ultimately harming the interests of the company and the public. In the previous bankruptcy of Baoshang Bank and many rural commercial banks that experienced asset liquidity risks, the cause of the banks’ liquidity depletion was that nominee shareholding of bank shareholders resulted in the bank being实质上 controlled by an individual or interest group internally, thus becoming their “cash machine.” Therefore, if an investment involves nominee shareholding in financial sector companies, its validity risk should be carefully assessed.

2. Is a Nominee Shareholding Agreement Where a Civil Servant Entrusts Another Person to Hold Shares Valid?

Article 53 of the Civil Servant Law provides that civil servants shall not “engage in or participate in for-profit activities, or hold concurrent positions in enterprises or other for-profit organizations.”

However, from judicial cases, courts tend to regard this provision as a “administrative mandatory norm.” Where a civil servant invests in company equity, the relevant authority may pursue corresponding administrative liability, but this does not affect the validity of the contract.

Therefore, an agreement under which a civil servant entrusts another person to hold company equity is valid. However, the civil servant may be subject to administrative liability by the competent authority.

(B) Risk of the Nominee’s Unauthorized Disposal

If the nominee experiences a资金 shortage, they may dispose of the nominee shares without authorization to raise funds. If the purchaser of the shares is a bona fide third party, the actual investor will basically be unable to recover the nominee shares.

Of course, the actual investor can pursue the nominee’s liability for breach of contract based on the nominee agreement after the fact. However, this is an ex-post remedy. If the nominee’s financial situation deteriorates, even if the lawsuit is won, enforcement may not be possible.

(C) Risk of Inability to Restore Nominee Shares

When the actual investor terminates the nominee agreement, the nominee shares may not necessarily be restored to the actual investor’s name. Restoration of nominee shares to the actual investor’s name is equivalent to an equity transfer. According to the Company Law and its judicial interpretations, such restoration requires consent from more than half of the other shareholders; otherwise, restoration cannot occur. From this perspective, if the actual investor wishes to avoid this risk, the nominee should include provisions on equity restoration in advance in the joint venture agreement with other shareholders.

(D) Risk of Confusion Between Nominee Shares and the Nominee’s Property

Since nominee shares are registered in the nominee’s name, on the surface, they appear to be the nominee’s property, which容易 causes confusion between nominee shares and the nominee’s自有 property.

1. When the Nominee Experiences a Change in Marital Status, Nominee Shares May Be Confused as Marital Joint Property

When the nominee experiences a change in marital status, the nominee and their spouse need to divide marital joint property. If the nominee shares were acquired during the marriage, in the absence of contrary evidence, courts generally determine that the nominee shares are marital joint property.

Although the actual investor can defend based on the nominee agreement, the court may suspect that the nominee fabricated the nominee agreement for the purpose of reducing marital joint property. Therefore, the nominee agreement may not necessarily be recognized by the court.

2. When the Nominee Dies, Nominee Shares May Be Confused as Estate

When the nominee dies, in the absence of contrary evidence, nominee shares are generally classified as part of the nominee’s estate. Although the actual investor can claim based on the nominee agreement that the shares are held on their behalf, since the nominee has passed away, the authenticity of the nominee agreement may again be questioned.

3. When the Nominee Incurs Debts, Nominee Shares May Be Subject to Enforcement

When the nominee owes large debts and is unable to repay, the nominee’s creditors may apply to the court to freeze and enforce the nominee shares. Although the actual investor can defend based on the nominee agreement, the court may suspect that the nominee fabricated the nominee agreement for the purpose of evading debts, and the nominee agreement may not necessarily be recognized by the court.

(E) Risk of High Tax Burden When Restoring Nominee Shares

In the equity transfer cases handled by the author, many nominees and actual investors, holding a simple economic perspective, believe that restoring nominee shares to the actual investor is like retrieving items entrusted to a friend for safekeeping and is not a normal transaction. Therefore, they believe the restoration should be at a price of RMB 1 or RMB 0. However, the restoration of nominee shares does not fall within the circumstances expressly listed in Article 13 of the “Administrative Measures for Individual Income Tax on Income from Equity Transfers (Trial)” as having “obvious low equity transfer income that is deemed to have justifiable reasons.”

Therefore, if the company’s equity premium is very high at the time of restoration, the nominee faces a very high tax risk.

III. Preventive Measures for Nominee Shareholding Risks

(A) Preventive Measures for Agreement Validity Risks

From the foregoing analysis, the primary risk of nominee shareholding is the validity of the agreement. If the nominee agreement involves nominee shareholding in the financial regulatory field, there is a high probability that the agreement will be deemed invalid. Particularly when listed companies are involved, the failure to truthfully disclose and restore nominee shareholding may also result in the listing applicant being deemed to have made false statements, triggering not only severe regulatory penalties but also claims by securities investors.

Therefore, the author strongly advises against nominee shareholding arrangements involving the financial regulatory field.

A founder of a company planning to list once consulted the author. The founder wanted to transfer some shares to another person to improve their own生活, but the transfer would not be registered, and the founder would continue to hold the shares on behalf of the transferee (the company had already introduced institutional investors who did not allow the founder to transfer shares before the company’s listing, so the share transfer was not disclosed to other shareholders). The founder believed this nominee arrangement was very covert and planned to carry this secret through the IPO. After analysis, the author considered this extremely risky. First, do not underestimate the capabilities of listing intermediaries. During the verification process, listing intermediaries generally check the personal bank account statements of the founder and close relatives before and after capital contributions and during the reporting period. This share transfer and nominee arrangement would likely be discovered by intermediaries through trace evidence. Second, even if the intermediaries failed to detect the nominee arrangement, the founder would容易 become vulnerable to leverage by the hidden shareholder during the listing application process, which could become a major隐患 for the entire listing effort. After heeding the author’s advice, the founder abandoned the idea of the share transfer and nominee arrangement.

(B) Preventive Measures for the Risk of Unauthorized Disposal by the Nominee and Inability to Restore Shares

The author recommends that actual investors, when investing in a company, inform other shareholders of the nominee arrangement and include provisions in the internal investment agreement stating: “When the nominee transfers or pledges the nominee shares, the consent of the actual investor must be obtained; when the actual investor terminates the nominee agreement, the nominee shares shall be restored to the actual investor’s name.”

(C) Preventive Measures for the Risk of Confusion Between Nominee Shares and the Nominee’s Property

The author believes that the key to this risk lies in the质疑 of the authenticity of the nominee agreement. The authenticity of the nominee agreement can be evidenced from the following aspects:

1. The signing process of the nominee shareholding agreement should be notarized by a notary public. A notarial certificate issued by a notary public has strong evidentiary force and can directly eliminate future challenges to the authenticity of the nominee agreement.

2. If notarization is considered too cumbersome, the following measures can also be taken:

(1) After the actual investor and the nominee sign the nominee agreement, the nominee should scan the signed agreement and send it to the actual investor via a实名 authenticated email, explaining the signing process of the nominee agreement in the email (since the nominee agreement is uploaded to the email client via email, and the email is实名, this can evidence the authenticity of the nominee agreement).

(2) When the actual investor pays the capital contribution to the nominee, the transfer should include a备注 stating “capital contribution on behalf of XX Company.”

(D) Preventive Measures for Tax Risks in Restoring Nominee Shares

For the purpose of reasonable tax savings, if it is anticipated that the nominee shares are likely to have significant appreciation in the future, the actual investor should give special consideration when selecting the nominee. According to Article 13(2) of the “Administrative Measures for Individual Income Tax on Income from Equity Transfers (Trial),” when the transferor transfers equity to their spouse, parents, children, grandparents, grandchildren, siblings, or the person who bears direct抚养 or赡养 obligations for the transferor, the transfer need not be at fair value. Therefore, actual investors can make arrangements accordingly when selecting nominees.