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Nominee shareholding sits at the intersection of two competing principles: party autonomy, and the certainty of the public register and the protection of third-party reliance. Once an arrangement is voided, the property fallout is often as intricate as the validity question itself. Who owns the shares? How should substantial capital gains be split, and losses shared?

The Supreme People¡¯s Court is drafting a new judicial interpretation of the new Company Law, but significant gaps remain and debate continues. Until that takes shape, the key approaches emerging from existing case law merit close attention.

Who owns the shares?

Courts routinely hold, based on the evidential authority of the share register, that shares ¡°cannot be returned or need not be returned¡± to the beneficial owner. The rationale is that such restitution would prejudice the interests of the company, fellow shareholders and creditors. As a result, judgments typically confirm the nominee as the legal owner of the shares.

The Supreme People¡¯s Court, in article 32 of its Exposure Draft of the Interpretation on Several Issues Concerning the Application of the Company Law, provides that a beneficial owner fulfilling the formalisation criteria may be awarded the shares; otherwise, a claim for auction or sale proceeds, or for damages, may be pursued. It remains uncertain whether the draft¡¯s final version will restore the settled judicial rule that shares belong, in principle, to the nominee.

How to split gains

A steep increase in share value is often the catalyst for conflict between beneficial owners and nominees. If ownership is vested in the nominee, a core dispute then arises: whether the beneficial owner may claim the appreciation, and how much should be awarded.

The above-mentioned draft interpretation refers this matter to the civil law rules governing the liquidation of void contracts: compensation in lieu of restitution shall be assessed by reference to the equity¡¯s market value on the date the voidness is declared by the court, or to a value arrived at by other reasonable means.

Where a party further claims damages, the court shall, in the principle of good faith and fairness, reasonably quantify such damages with regard to the circumstances of restitution or compensation, taking into consideration the equity¡¯s appreciation gains, depreciation losses, and transaction costs incurred in light of each party¡¯s degree of fault and the extent of their causative contribution. Judicial practice reveals case-by-case variation in how appreciation gains are apportioned and at what ratio.

In the case of Hu 02 Min Zhong 2446 (2021), the court stated that the distribution of investment returns shall be governed by the principles of good faith and fairness. The nominee in breach of the nominee agreement was deemed primarily responsible for the invalidity of the arrangement, given its status as a company engaged professionally in investment management.

The beneficial owner, by participating in the financial markets, was bound to observe a standard of commercial care higher than that of an ordinary person and was held secondarily liable for its fault in concluding the agreement in contravention of financial regulatory rules.

Under the general principle that ¡°the party who invests shall reap the gains¡±, the beneficial owner was entitled to the principal share of the returns. The court also took into consideration that the nominee had afforded the opportunity for appreciation and borne certain investment risks. Weighing the parties¡¯ respective degrees of fault, the degree of connection and contribution between each party¡¯s conduct and the returns, with reference to the formula agreed in the nominee agreement, the court ultimately fixed the restitution ratio at 4:1, awarding 80% to the beneficial owner and 20% to the nominee.

In the case of Jing Min Zhong 931 (2021), the court weighed both parties¡¯ relative contributions to the investment returns and their transactional arrangements for apportioning investment risk, holding that the beneficial owner and the nominee should divide the returns at a ratio of 7:3. By contrast, in the case of Min Si Zhong Zi 30 (2002), the Supreme People¡¯s Court ruled that it would be inequitable to determine compensation purely by reference to the dividends actually received by the nominee, and fixed the nominee¡¯s compensation payable to the beneficial owner at 40% of the sum of the shares¡¯ market value and all dividends.

In the case Gui 09 Min Zhong 1312 (2020), the court distinguished between: appreciation gains, which constituted fresh benefits generated after the nominee agreement had been performed, were not liable to be returned; and dividend income, which represented a loss caused by the invalidity of the nominee agreement, was therefore subject to restitution.

How to share losses

When the equity depreciates, the dispute shifts to how losses should be shared, with courts typically distributing them based on the respective faults of the parties. Referencing invalid nominee holdings in foreign-invested enterprises, the Provisions on Several Issues Concerning the Trial of Disputes Involving Foreign-Invested Enterprises (I) (2020 amendment) stipulate that the beneficial owner may either claim the equivalent value of the remaining shares or seek compensation for losses.

The court will decide whether the nominal shareholder bears liability, and in what amount, by assessing whether and to what degree that shareholder was at fault for the contract¡¯s invalidity.

In the case of Yue 03 Min Zhong 950 (2024), the court limited the recoverable loss to the investment amount paid under the nominee agreement and did not include loss from the deprivation of funds. Given that the nominee had acted gratuitously and should not be subjected to an excessively demanding duty of care, the court apportioned the investment loss 30% to the nominee and 70% to the beneficial owner, and ordered the nominee to return 30% of the invested capital to the beneficial owner.

Takeaways

The disposal of property following the invalidation of a nominee equity agreement engages a combined application of the principles of good faith and fairness. In practice, resolving such disputes requires close attention to the specific facts of each case. How the draft interpretation will settle the adjudicative framework is a development worth watching.

Zuo Yuru is a partner and Xin Xiangrong is a paralegal at Zhong Lun Law Firm