Authored by: Zhong Yi, Attorney at Law - Shanghai Runhe Law Firm
Editor by:Corinna Qian

Case Background

First-instance court: the Higher People’s Court of Shanghai Municipality
Appeal court: the PRC Supreme People’s Court
Appellant (Defendant in the first instance): Company A
Appellee (Plaintiff in the first instance): Company B

On March 3 1992, Joint Venture Company D was established in Shanghai. Its shareholders and equity percentages are as follows: the Chinese party Company C contributed 2 million USD, the foreign party Company E contributed 2.5 million USD and the foreign party Company B contributes 5.5 million USD. Among them, Company B was registered by the Head Office of Hong Kong Company Registry and was so established on July 18, 1991, and each of its shareholders (Persons A, B, C, D and E) hold 20%.

On September 16, 1995, upon the application by Company A (registered and established in Canada on June 1st 1994 whose directors are Person D and Person E) and Person D, People’s Government of Changning District, Shanghai Municipality (hereinafter referred as Changning Government) confirmed that Company B, the former investor, has moved its address to Canada and its name has changed into Company A; Changning Government so approved that after the adjustment, the investors of Company D were Company A, Company C and Company E and the equity percentages and profits distribution of each party remained same.

On May 25, 1998, Shanghai Municipal People’s Government issued the WJMHHZ No. xxxx (1997) “PRC Certificate of Approval of the Foreign-funded Enterprise” to Company D, which stated that the three investors of the joint venture Company D should be Company A, Company C and Company E. Relevant procedures for company modification registration with Administration of Industry and Commerce (AIC) have been settled.

The result of the first instance

In May 1998, Company B brought a lawsuit again Company A, Company C, Company E and Person D to Shanghai Higher Court alleging that Company B had never moved its address to Canada and had never changed its name，thus, Company A encroached upon Company B’s 55% of equity rights in Company D; that Company A shall immediately amend its registration in AIC and return its 55% equities in Company D（5.5 million USD） to Company B.

Shanghai Higher Court held that: before September 16, 1995, Company D had three investors, namely, Companies B, C and E. As for the fact whether Company B was renamed as Company A and moved to Canada after September 16, the existing evidence could sufficiently prove that Company B was never renamed as Company A, nor was it moved to Canada, or legally speaking, there never existed the renaming fact between companies of different nationalities or the move. Even if there existed disputes over rights between Company B’s shareholders, there was no factual basis for Company A to obtain the status as a shareholder of Company B by the abovementioned means. Meanwhile, it violated the legal provisions, and its act infringed Company B’s rights and interests.

The first-instance court decreed that: (1) Company B shall be confirmed to be one of the shareholders of Company D, and to have totally invested USD 5.5 million; (2) Company A shall stop its tort, and shall, within 10 days as of effectiveness of the judgment, go through the corresponding procedures for modification of industrial and commercial registration, and Company B shall be deemed as an investor and to have contributed the capital; and (3) Company B’s other litigation claims shall not be supported. The RMB 237,701.75 Yuan of case acceptance fee shall be born by Company A.

The result of the second instance

Company A was dissatisfied with the first-instance judgment, and appealed to the Supreme Court of PRC by alleging that: on December 8, 1992, Company B borrowed 5.5 million USD from Company A due to lack of funds. The principal shall become due two years later and shall be repaid once for all and if Company B fails to repay, it shall assign all its shares in the project to Company A. The shares in the mainland project referred in this agreement are the 55% shares of Company D in this dispute. After paying the fund pursuant to the agreement, Company A demanded repayment for many times, but Company B was unable to repay them. Upon the expiration of the loan term, Company A received the shares in question pursuant to the agreement with the assistance of Company B, Company D and other shareholders. The modification of shares was approved by Changning Government, and the industrial and commercial registration of modification was also completed. Therefore, Company A’s receiving Company B’s 55% of shares in Company D was not a tort, but the result of the assignment of shares between both parties pursuant to the agreement.

The Supreme People’s Court holds that: this case is affirmative petitory action. Normally speaking, affirmative dispute can be solved by civil litigation. However, this case is a special one in which an share modification of joint venture has been involved. According to PRC Law on Sino-foreign Equity Joint Venture，with respect to the modification of shares of a Chinese-foreign joint venture, the approval of relevant administrative departments constitutes an essential element, instead of a procedural or formal requirement, and unapproved modification shall of course be ineffective. In the present case, Company B’s 55% of stock rights in Company D were approved by relevant competent departments, and Company D has completed the corresponding registration procedures, hence it fulfilled the elements of effectiveness prescribed in law. Although Company B brought the civil lawsuit with the people’s court regarding the dispute over stock rights, in essence, it aimed to deny the reply of Changning Government, the registration of Shanghai Municipal AIC, and the certificate of approval on foreign-funded enterprise as issued by Shanghai Municipal Government, that is, to deny the relevant specific administrative acts made by the administrative departments. Generally, a people’s court may modify relevant administrative acts directly or indirectly through the adjudication results from the civil litigation, but these administrative acts shall be understood as procedural or formal acts, such as archival filing, registration, etc. While substantive administrative acts, such as the approval involved in the present case, are special powers authorized by the laws of China to relevant administrative departments, and may not be modified through civil litigation procedures or civil judgments. Even if an approval is not appropriate, it may only be corrected through administrative reconsideration procedures or administrative litigation procedures.

Therefore, in the present case, Company B’s pleading of confirmation on its stock rights in the Chinese-foreign joint venture may only be resolved through administrative reconsideration or administrative litigation avenue, instead of civil litigation. It is not appropriate for the first-instance court to judge directly through civil litigation that the specific administrative acts shall be modified and so this judgment shall be corrected. Company B’s civil lawsuit in the present case is inappropriate, and shall be rejected. Finally, the second-instance court ruled that the first judgment should be overruled and Company B’s lawsuit should be rejected.

Case analysis

The essence of the dispute in this present case is a dispute between Company B and Company A regarding the ownership of the 55% of stock rights in Company D. In the first instance, Company B claimed that since it has never changed its name to Company A，Company A infringed Company B’s right on stock ownership due to its action of obtaining Company B’s shares in Company D by stating that Company B’s name has changed; and so that Company B brought this civil lawsuit with the first-instance court. We think that obviously, Company B was not aware that although the basis for Company A to obtain such shares is not real, this stock modification has gained the approval of administrative departments and this approval has come into force; for this reason, there existed relative big risks for Company B to get back its shares by bringing a civil lawsuit in order to modify the effective administrative act. Because Company A and the first-trial court also failed to recognize that this case has a concurrence of civil and administrative legal relationships which leads the cancellation of the judgment of the first trial. In the second instance, this legal point did not attract both parties’ attention. The second-instance court found this key point and made a correct judgment.

Analysis from the angle of Company B:
China laws state that the modification of joint ventures’ shares shall become effective upon the approval of competent administrative departments, so when one shareholder believes its stock right is infringed, it shall first carry out legal check on the administrative approval for such shareholder modification. In this case, Company B shall first go to relevant administrative bureaus to check documents and information provided by Company D when it applied for the shareholder modification. If the documents do not comply with form conditions, Company B can bring an administrative litigation or reconsideration and request rescission of such approval administrative act. Otherwise, it shall check the effectiveness of relevant documents, for example if the shareholder meeting or BOD resolution of Company B are not fully valid, it shall bring an affirmative litigation to confirm the invalidity of such documents. Then, request the administrative bureau to rescind the approval of this shareholder modification.

Analysis from the angle of Company A:
The amount of the shares in dispute is huge, however Company A did not carry out legal risk evaluation when it carried out the shareholder modification and its plan for such modification had obvious defects. This caused that both parties born big litigation costs for no reason. If Company A hoped to obtain Company B’s shares in Company D based on the Agreement on Mortgage of Stock Rights, it shall first reach Stock Transfer Agreement based on mortgage of stock rights with Company B then settle relevant administrative procedures for modification of stock rights, strictly following PRC laws, with the reason of change of shareholder but not change of shareholder’s name. If both parties cannot reach an agreement, Company A can still request the court to confirm the validity of the Agreement on Mortgage of Stock Rights and apply for enforcing implementation if the affirmative litigation successes.

As is mentioned above, we suggest all shareholders that regarding the modifications or litigations concerning stock rights in foreign-Sino joint ventures, lawyers with significant experience in company and administration laws shall be invited. Only through this way, the legal interests of shareholders can be protected in the best way.