It is reported in the People’s Court Daily, issued by the Supreme People’s Court (hereinafter referred to as “Supreme People’s Court“) on 25 April 2018, that the the 3rd Circuit Court of the Supreme People’s Court recently held an open hearing of the case of Fujian Weijie Investment Co., Ltd. (hereinafter referred to as “Weijie Company“) (appellant) vs. Fuzhou Tiance Industry Co., Ltd. (hereinafter referred to as “Tiance Company“) (appellee) with Junkang Life Insurance Co., Ltd. (hereinafter referred to as ” Junkang“) as the trial third party and made a ruling. As the Supreme People’s Court decided that the shareholding entrustment arrangement with respect to insurance companies was invalid, the case caused great concern in the financial industry.

1.Case Review

  • Facts

In 2011, the dormant shareholder Tiance Co., Ltd. and the nominal shareholder Weijie Co., Ltd. signed a Shareholding Entrustment Agreement, which stipulated that Tiance Company entrusted Weijie Company to hold 200 million shares of Junkang. After the signing of the agreement, Weijie Company obtained 200 million shares of Junkang from Fuzhou Development Zone Taifu Industrial Co., Ltd. (hereinafter referred to as “Taifu Company“). In 2012, the shareholders of Junkang increased their registered capital in proportion to their respective equity interest percentage, thereafter, Weijie Company totally holds 400 million shares after the capital increase. Later, Tiance Company requested that Weijie Company transfer the 400 million shares held by it to Tiance Company. Dispute occurs when Weijie Company refused to do so.

In 2015, Tiance Company sued to the Higher People’s Court of Fujian Province (hereinafter referred to as the “First Instance Court”), claiming the termination of the Shareholding Entrustment Agreement and requested that Weijie Company transfer the 400 million shares of Junkang held by it to Tiance Company. The First Instance Court held that the Shareholding Entrustment Agreement was legally entered into and remained effective, based on which, it ordered Weijie Company to transfer the disputed shares to Tiance Company. Weijie Company appealed to the Supreme People’s Court against the rule. During the second instance, Taifu Company applied to join in the case as a third party with independent claim rights and requested to transfer 200 million shares of Junkang shares held by Weijie Company to Taifu Company.

  • Grounds of Parties

Weijie Company has the grounds as below: 1. Tiance Company is not the actual shareholder of the 200 million shares in accordance with the Shareholding Entrustment Agreement. 2. Measures for the Administration of the Equities of Insurance Companies promulgated by China Banking and Insurance Regulatory Commission (“CBIRC”) prohibits any shareholding entrustment arrangement in insurance companies. 3. Wuhu Longwei Industry & Trade Co., Ltd. is the beneficiary owner of the 200 million shares and should join in the case.

Tiance Company has the grounds as below: 1. Weijie Company has admitted that the 200 million shares are held for Tiance Company, Weijie Company is directed to contribute increased capital and finally held 400 million shares for Tiance Company, which should be the actual shareholder with respect to the 400 million shares. 2. Measures for the Administration of the Equities of Insurance Companies promulgated by CBIRC cannot be used as a basis for denying the validity of the Shareholding Entrustment Agreement since it is promulgated by a state commission or committee. 3. Even if it is determined that the arrangement of shareholding entrustment with respect to an insurance company is invalid, Tiance Company has already been a shareholder of the insurance company, recognized by CBIRC and satisfied the shareholders’ qualifications of the insurance company. On these grounds, it should be ruled that Weijie Company has the obligation to transfer its nominal shares to Tiance Company.

Taifu Company has the ground as below: The 200 million shares were transferred to Weijie Company without its authorization in 2011 by way of faked company seals and faked share transfer agreements. Taifu Company is the actual shareholder of the 200 million shares transferred to Weijie Company.

Jun Kang has the grounds as below: 1. We leave the decision on the effect of Shareholding Entrustment Agreement to court. 2. Both Tiance Company and Weijie Company are expected to exit from Jun Kang from CBIRC’s perspective and we would like Tiance Company and Weijie Company to abide by the order of CBIRC.

  • Supreme People’s Court’s Grounds
  1. Since the dispute between Tiance Company and Weijie Company involves the major interests of Taifu Company, and Taifu Company has explicitly filed an application to participate in the case, we find it difficult to conclude that there is indeed an entrusted relationship between Tiance Company and Weijie Company with respect to the 400 million shares of Junkang if Tiance Company did not provide sound evidence to support that either the buying of these shares by Wei Jie from Taifu Company or contribution of increased capital is conducted as Tiance Company instructed.
  2. The entering of Shareholding Entrustment Agreement obviously violates the mandatory requirement by CBIRC in Article 8 of Measures for the Administration of the Equities of Insurance Companies, which provides no entity or individual may authorize others to hold, or hold on behalf of others, the equities of an insurance company, unless otherwise specified by the CBIRC. Such a violation, somehow, has the same legal consequences as a direct violation of Insurance Law of the People’s Republic of China and other laws or administrative regulations, which might undermine national finances and damage public interests. According to Article 52(4) of Contract Law of the People’s Republic of China, the Shareholding Entrustment Agreement entered into by and between Tiance Company and Weijie Company shall be deemed invalid.

2.Case Indication

Article 8 of Measures for the Administration of the Equities of Insurance Companies provides no entity or individual may authorize others to hold, or hold on behalf of others, the equities of an insurance company, unless otherwise specified by the CBIRC.

Article 52 of Contract Law of the People’s Republic of China provides that a contract shall be null and void under any of the following circumstances: (1) a contract is concluded through the use of fraud or coercion by one party to damage the national interests; (2) malicious collusion is conducted to damage the interests of state, a collective entity, or a third party; (3) an illegitimate purpose is concealed under the guise of legitimate acts; (4) damaging the public interests; (5) violating the compulsory provisions of laws and administrative regulations.

In this case, the Supreme People’s Court didn’t rule that the Shareholding Entrustment Agreement invalid because it violates the Measures for the Administration of the Equities of Insurance Companies. Instead, the Supreme People’s Court’s rationale is the entering of Shareholding Entrustment Agreement obviously violates the mandatory requirement by CBIRC in Article 8 of Measures for the Administration of the Equities of Insurance Companies, and such violation, somehow, has the same legal consequence of direct violation of Insurance Law of the People’s Republic of China and other laws or administrative regulations, which might undermine national finances and damage public interests. Base on this, the Shareholding Entrustment Agreement entered into by and between Tiance Company and Weijie Company shall be deemed invalid in accordance with Article 52 of Contract Law of the People’s Republic of China.

In this case, it is true that the rules promulgated by a state commission or committee cannot be a legal basis to challenge the effect of a legal contract in accordance with Interpretation I of the Supreme People’s Court of Several Issues concerning the Application of the Contract Law of the People’s Republic of China, however, when it comes to issues relating to the banking, insurance, securities, and other financial industries, the Supreme People’s Court has the discretion to refer to these rules promulgated by a state commission or committee to conclude whether the contract is invalid by reason of violation of public interests. Therefore, when a company enters into a contract, it is advisable to pay attention to whether the contract violates the mandatory requirements of applicable laws and administrative regulations as well as rules promulgated by a state commission or committee. It means if there is any possibility that the content of the contract might violate these rules promulgated by a state commission or committee, it is advisable to set a specific term on what consequences would be if the contract is deemed invalid.

In addition, the case will be an alarm for entrusting any third party to hold equities in insurance companies. There is a possibility that any Shareholding Entrustment Agreement entered into by dormant shareholders and nominal shareholders might be ruled invalid by the court. For a dormant shareholder, it is advised to reach a prior arrangement with the nominal shareholder before a dispute arises and consider entering equity transfer or seeking other approaches to remove the shareholding entrustment arrangement so as to meet relevant regulatory requirements and avoid such risks.