Earth Research | Beware of "Famous Stocks, Real Debt": Legal Pitfalls Behind Investment Cooperation
Publish Time:
Dec 02,2024
Source:
Authors: Chen Xia, Liang Yu
Equity in name, debt in reality: Investment or debt? "Equity in name, debt in reality" refers to a situation where an investment appears to be an equity investment but actually constitutes a loan agreement. This phenomenon is common in capital increase and expansion, and economic disputes arising from unclear agreement nature are frequent. This article will explore how to accurately distinguish between investment agreements and loan agreements through typical cases, and avoid legal risks.
One
Equity in name, debt in reality: The disguised legal relationship
1. What is equity in name, debt in reality?
On the surface, it is a capital increase and expansion agreement, but in essence, it is a debt relationship. This is common when a company uses equity as collateral to obtain financing from investors, but the investors do not actually participate in the company's operations and only enjoy fixed returns.
2. Why does equity in name, debt in reality occur?
Company needs: Alleviate financial pressure and expand business scale.
Investor interests: Avoid operational risks and pursue fixed returns that are "guaranteed in both good and bad times".
Two
How to identify equity in name, debt in reality? Key review factors analysis
In judicial practice, the following points are mainly considered to distinguish the nature of the agreement:
1. Contract purpose
Was the purpose of signing the agreement equity investment or financing loan? Clarify the contract background and the true intentions of both parties.
2. Whether equity procedures are followed
Was a resolution passed by the shareholders' meeting? Was a capital contribution certificate issued, and was the new shareholder registered? Was the industrial and commercial change registration completed?
3. Whether to participate in operations and bear risks
Does the investor participate in the company's substantive management? Does it bear the risk of company losses?
4. Equity and dividend clause design
Is the equity price fair? Is the return calculated as a fixed return, rather than distributed according to the actual operating conditions?
Among them, item 3 is the core of judging the nature of investment and loan, but it is not the only basis. If the contract fails to implement items 2 and 3 above, in most cases, it can be considered a loan agreement.
Three
Analysis of typical cases: Legal judgment of equity in name, debt in reality
1. Case index
A Supreme Court case, a case of a loan contract dispute between Party A and Party B
2. Judgment gist
The "Investment Cooperation Agreement" signed between the parties does not have the characteristics of joint operation, shared benefits, and shared risks of investment cooperation, but stipulates that after one party invests, regardless of the company's operating conditions or whether it is losing money, it will be calculated according to the standard and enjoy fixed investment returns. The nature of the legal relationship between the two parties should be determined as "investment in name, loan in reality".
3. Basic case facts
In April 2015, Party A and Party B signed an "Investment Cooperation Agreement." Article 6 of the "Pre-signing Conditions" of the agreement clearly stipulates: After Party A completes the financing, the total investment amount of the project is 100 million yuan. During the investment and construction of the project, if the operating expenses exceed 100 million yuan, the excess part will be borne by Party A, and Party B does not need to add capital. According to the relevant provisions of Article 2, "Party B's Investment and Return Calculation": Party B invests 13 million yuan, which is paid in installments according to the time nodes agreed by both parties: 3 million yuan will be remitted within three days after the signing of the agreement, and the remaining funds must be remitted to Party A's designated account before April 22, 2015, and Party A must issue a receipt to Party B. During the construction period (1 year), Party B's dividend will be calculated at 15% of the actual return; after the construction period, if the annual net return is less than 30 million yuan, the dividend will still be calculated based on 30 million yuan, and if it is higher than 30 million yuan, it will be calculated based on the actual net return. Party A promises to pay Party B a total return of no less than its investment amount within four years. If the actual return is insufficient, Party A will make up for and pay the insufficient part from its own return. Dividends are settled once a year, with accounts closed on December 30 each year and paid before January 15 of the following year. Article 4, "Breach of Contract Liability," of the agreement stipulates: If the project suffers losses due to Party A's poor management, Party B does not need to bear economic losses and still obtains returns according to the fixed return standard in the agreement. After the signing of the agreement, Party B paid 13 million yuan to Party A in six installments through bank transfer from April 14 to June 2, 2015, as agreed. However, during the performance of the agreement, Party B repeatedly requested Party A's supervisor, Lin, to pay the fixed return, but Party A has never fulfilled its payment obligation as agreed. Therefore, a dispute arose between the two parties, and after repeated unsuccessful negotiations, Party B filed a lawsuit, requesting the first-instance court: 1. To terminate the "Investment Cooperation Agreement"; 2. Party A to repay Party B's loan of 13 million yuan, pay Party B 6.24 million yuan in interest (calculated at an annual interest rate of 24% from June 2016 to June 2018), and pay Party B's lawyer's fees of 190,000 yuan.
4. Judgment result
4.1 First-instance judgment result
The first-instance court held that the "Investment Cooperation Agreement" clearly stipulates that Party B's return is calculated in a fixed return manner, and there is a guaranteed clause. From this, it can be seen that the nature of the 13 million yuan involved is actually a loan rather than an investment. The agreement stipulates that Party A's operating losses are borne by itself, and Party B does not need to share them, and regardless of profit or loss, Party A must pay Party B according to the agreed standard. This shows that Party B did not participate in Party A's management, and its invested funds do not bear any operational risks, only obtaining fixed returns. Therefore, Party A's true intention in signing this agreement is to borrow money from Party B under the guise of investment, using equity as collateral, and the legal relationship between the two parties is essentially a private loan, not an investment cooperation relationship.
According to the agreement, Party A has been slow to pay the principal debt and interest, and after Party B repeatedly urged and gave a reasonable performance period, Party A still failed to perform. According to the relevant provisions of the Contract Law, Party B has the right to terminate the agreement. Regarding the payment of funds and interest, after Party A received 13 million yuan, it failed to pay interest as agreed, resulting in the failure to perform the agreement, and the agreement should be terminated according to law, and Party A should return the principal of the loan and pay the corresponding interest. In addition, the agreement clearly stipulates that the litigation costs shall be borne by the losing party, so Party A shall also bear the lawyer's fees. Based on this, the first-instance court ruled to terminate the "Investment Cooperation Agreement" and ordered Party A to repay the principal of 13 million yuan, pay 6.24 million yuan in interest (based on 13 million yuan, calculated at an annual interest rate of 24% from June 2016 to June 2018), and 190,000 yuan in lawyer's fees within ten days after the judgment takes effect.
4.2 Second-instance judgment result
The appellate court held that the provisions of the "Investment Cooperation Agreement" did not exhibit the characteristics of a joint venture involving shared operation, profits, and risks, but rather that Party B, after investing, was entitled to a fixed return, indicating that the agreement was more consistent with a loan. Although Party A's business registration changed Party B to a company shareholder, Party B argued that this action was merely to provide security for its loan claim. Party A failed to submit evidence of a share transfer agreement signed between Party B and the original shareholders of the company; therefore, it did not have the characteristics of a standard share transfer. Party A also claimed that the agreement was for capital increase, but the payment of 13 million yuan did not match the amount of capital increase, Party B's equity ratio, and the amount of investment, and during the period of capital increase or decrease, Party B's equity ratio remained unchanged; therefore, it did not meet the characteristics of a standard capital increase.
Party B denied participating in Party A's operations, and Party A also failed to provide evidence to prove its participation in substantial operational activities. Therefore, Party B's defense that it became a shareholder of Party A as a guarantee for its debt claim was deemed valid. The company's registration of the equity in the name of Party B was merely as a guarantee for its debt claim, not a true equity transfer or capital increase. As for Party A's claim that the agreement did not stipulate a principal repayment period, it did not constitute a loan relationship. According to relevant provisions of the Contract Law, the absence or ambiguity of the loan term does not affect the establishment of the loan relationship. The appellate court ultimately determined that the first-instance judgment's determination of the legal relationship between the two parties as a private loan was correct, and it dismissed the appeal and upheld the original judgment.
4.3 Retrial Judgment Result
After review, the Supreme People's Court held that the content of the "Investment Cooperation Agreement" shows that Party B's return is calculated on a fixed return basis, and Party B can obtain the return according to the agreed standard regardless of whether the company's operation is profitable or not. This shows that the agreement does not have the characteristics of joint operation, profit sharing, and risk sharing. Although the business registration changed Party B to a company shareholder, Party A failed to prove that Party B participated in the company's actual operation and management. Party B did not participate in the operation and management, did not bear the operational risks, and only received a fixed return. The 13 million yuan involved was a loan, not an investment.
Regarding Party A's failure to pay interest on time, its actions constituted a breach of contract, and it must return the principal of the loan to Party B and pay the corresponding interest. The original court's determination of the interest standard that Party A should pay based on the contract content, performance, and market interest rate was appropriate. Based on this, the Supreme People's Court ruled to dismiss Party A's retrial application and uphold the original judgment.
Four
Legal Risks and Countermeasures of Equity-in-Name-Only, Debt-in-Substance Agreements
1. Risk Alert
Enterprise Party: After being identified as a loan, it needs to bear high interest rates, and may even face contract termination and debt recovery.
Investor: When the agreement is invalid or the clauses are unclear, rights and interests are difficult to protect.
2. Matters to Note When Signing Agreements
Clarify the purpose of the contract: Contract clauses must reflect the true nature of the investment or loan.
Standard procedures: Complete the legal procedures for equity changes, including shareholder resolutions and business registration.
Reasonable dividend clauses ： Avoid stipulating fixed returns and guaranteed clauses.
Written record ： The true expression of intent needs to be fully recorded to avoid disputes.
Five
Conclusion: Invest cautiously, and contracts must be rigorous
High-return investments are often accompanied by high risks. The essence of equity-in-name-only, debt-in-substance agreements is to try to avoid risks, but the law does not tolerate ambiguous handling. When signing capital increase agreements, both parties should ensure that the content truly reflects their intentions, eliminate speculative mentality, and sign cautiously to avoid disputes and losses.
This article aims to remind enterprises and investors that the wording of the contract content not only concerns the return but also determines the scope of legal protection. Honesty is the basis for avoiding legal risks and achieving win-win cooperation.
Lawyer Profile
Chen Xia
Chen Xia
Heilongjiang Dadi Law Firm
Director
Currently serves as a member of the Construction and Real Estate Business Committee of the All-China Lawyers Association; Heilongjiang Provincial Committee Member of the CPPCC; Member of the Heilongjiang Provincial Committee of the China Democratic National Construction Association; Director of the Social and Legal Affairs Committee of the Heilongjiang Provincial Committee of the China Democratic National Construction Association; Arbitrator of Harbin Arbitration Commission; Arbitrator of the Korean Commercial Arbitration Court; Arbitrator of the "Belt and Road" Wuhan Arbitration Institute; Member of the Heilongjiang Provincial People's Government Administrative Review Expert Committee; Member of the Harbin Municipal People's Government Administrative Review Expert Committee; Ranked among "Top 60 Construction Lawyers in China" by ENR magazine and Construction Times; Arbitrator of Wuhan Arbitration Commission.
Liang Yu
Liang Yu
Heilongjiang Dadi Law Firm
Lawyer
Past Review
Dadi Honor | Dadi Wins 2024 Commercial Law Excellent Law Firm Award (Regional Award)
Earth Research | Judicial Determination and Risk Prevention of Circular Trade
Earth Research | Determination of Mortgagor's Liability When Mortgage Rights Are Unregistered
Earth Performance | Our Firm Appointed as Legal Counsel for Beidahuang Grain Group Co., Ltd.
Other content
Sep 04,2023
Telephone：+86 0451-86722111 / +86 86222345
Supervision Telephone：+86 0451-85891028 / +86 86206845
Address：14-15th Floor, Zhongmeng Fortune Center, No. 261 Taishan Road, Nangang District, Harbin
Official Account QR Code
Copyright © 2024 Heilongjiang Dadi Law Firm