Viewpoint | Exit of investment in "famous stocks and real bonds" under the background of state-owned capital supervision

"Famous shares and real debt" contains two meanings: "famous shares" and "real debt", which is the organic unity of the two. As the name implies, "nominal shares and real debts" means that investors invest funds in the target company in the form of equity investment and register as shareholders of the target company, but the investor's investment purpose is only to obtain fixed income and does not enjoy the right to participate in the operation and management of the company. It is agreed to recover the investment principal and obtain the return of shareholders' interests at the expiration of a certain period of time or under certain conditions.

The Second Civil Division of the Supreme People's Court defined the nature and effect of the "real debt agreement" in the form of minutes of the meeting, which provided a basis for judicial practice for our study of "real debt. There is no uniform trading model for "famous shares and real bonds", and the trading structure is diverse. In practice, its nature is usually determined according to the investment purpose, actual rights and obligations of the parties, exit arrangements and other factors. If the investor's purpose is not to obtain equity in the target company, but only to obtain fixed income and does not enjoy the right to participate in the management of the company, it shall be considered as a debt investment, and the investor shall be a creditor of the target company or a shareholder with a repurchase obligation.

Although "famous shares and real bonds" is not a legal concept, in order to effectively supervise the new investment model of "famous shares and real bonds" and prevent management risks, the State Council, SASAC, CBIRC and CBI and other departments, in accordance with their management authority, clearly stipulate "famous shares and real bonds" in relevant regulatory matters. In terms of classification, the norms are mainly embodied in conceptual norms and regulatory norms, which are divided into the following categories:

(1) "Securities and futures institutions private asset management plan filing management norms No. 4"

The term "real debt" as mentioned in this specification refers to the investment return not linked to the operating performance of the invested enterprise, not distributed according to the investment income or loss of the enterprise, but provides the investor with the promise of capital preservation and income, pays fixed income to the investor regularly according to the agreement, and redeems the equity or repays the principal and interest by the invested enterprise after meeting specific conditions, common forms include buybacks, third-party acquisitions, gambling, and regular dividends.

(2) Notice of the China Insurance Regulatory Commission on Matters Relating to the Establishment of Equity Investment Plans with Insurance Funds

In order to implement the spirit of the National Financial Work Conference, standardize the establishment of equity investment plans for insurance asset management institutions, and effectively prevent insurance funds from raising the financing costs of real enterprises in disguised form through channels, named stocks and real debts, and prevent insurance institutions from directly or indirectly passing equity investment plans. Violations to increase the scale of local government debt, and to better play the role of insurance funds in serving the real economy, the relevant matters are hereby notified as follows:

Article 3 The investment income obtained by the equity investment plan shall be linked to the operating performance of the invested unlisted enterprise or the investment income of the private equity investment fund, and shall not adopt the following methods to promise to protect the principal and investment income:(1) Set a clear expected Return, and pay fixed investment return to investors on a regular basis every year;(2) It is agreed that the investment principal shall be redeemed by the invested enterprise or a related third party at maturity;(3) Other circumstances determined by the CIRC.

(1) "Private Investment Fund Filing Notice"

Article 1 (II) private investment funds shall not be borrowing (deposit) loan activities. The following activities that do not conform to the essence of "fund" do not fall within the scope of private investment fund filing:

Private investment funds engage in borrowing (deposit) and lending activities in disguise by setting up unconditional rigid repurchase arrangements, and the fund's income is not linked to the operating performance or income of the investment target;

Engage in the above activities indirectly or in disguise through investment partnerships, companies, asset management products (including private investment funds, the same below), etc.

(2) Notice on Matters Relating to Strengthening the Management of Equity Participation in Central Enterprises (State-owned Assets Reform Regulations [2019] No. 126)

Article (III) of Part I. Reasonable determination of the manner of equity participation. Combined with the needs of enterprise operation and development, the shareholding ratio is reasonably determined, and the rights and interests of shareholders of all parties are agreed upon in accordance with the law, with capital as the link and property rights as the basis. It is not allowed to carry out equity participation cooperation in the form of "equity participation cooperation, actually borrowing and financing", such as fixed dividends.

(1) Notice of the State Council on Strengthening Capital Management of Fixed Asset Investment Projects (Guo Fa [2019] No. 26)

Article 10 The funds borrowed from the project and the funds borrowed from shareholders and "real debts of famous shares" that do not comply with the provisions of the State shall not be used as capital for investment projects.

(2) Notice on Regulating the Investment and Financing Behavior of Financial Enterprises to Local Governments and State-owned Enterprises (Caijin [2018] No. 23)

Article 2 State-owned financial enterprises providing financing to state-owned enterprises (including local government financing platform companies) or PPP projects participating in local construction shall strengthen capital review in accordance with the "penetration principle" to ensure that the sources of capital of financing entities are legal and compliant, and that financing projects meet the prescribed capital ratio requirements. If it is found that there are debt funds such as "nominal shares and real debts", shareholder loans, loan funds and other debt funds, as well as public welfare assets, land reserves and other forms of illegal capital contributions or false capital contributions, state-owned financial enterprises shall not provide financing to them.

(3) Guiding Opinions on Strengthening the Supervision of Non-financial Enterprises' Investment in Financial Institutions (No. 107 [2018] of the Bank of China)

Article (VIII) of the third part strengthens the supervision of the authenticity and compliance of the source of investment funds. Enterprise investment financial institutions shall make capital contributions with their own funds, and the source of funds is true and legal. They shall not invest in financial institutions with non-self-owned funds such as entrusted funds, debt funds, "famous shares and real debts", and shall not make false capital injection, circular capital injection or withdraw capital, and shall not become the main shareholder or controlling shareholder of financial institutions in the form of financial management funds, investment funds or other financial products. Penetrate the identification of the actual controllers and ultimate beneficiaries of financial institutions, strictly regulate the behavior of concerted actors and beneficial owners, and prohibit the holding of equity interests in financial institutions in the form of proxy holdings and illegal associations. Where an enterprise obtains an administrative license by improper means such as concealment or deception, the relevant administrative license shall be revoked by the financial supervision and regulation department in accordance with the law.

The minutes of the meeting of the Second Civil Division of the Supreme People's Court held that in practice, the nature of the parties should be comprehensively determined based on factors such as the investment purpose and actual rights and obligations of the parties. In judicial practice, the people's court found that "real debt" usually examines the following factors:

1. Purpose of capital contribution and source of income.In equity investment, the income of shareholders comes from dividends, which is linked to the company's operating performance, and the operating performance is uncertain. In contrast, the debt corresponding to the claim is rigidly paid and is not linked to the debtor's operating performance. If the purpose of the investor's capital contribution is to obtain fixed income, the fixed income has nothing to do with the operating performance, and the investor does not bear the operating risk, it shall be considered as "creditor's rights".

In the case of "(2019) Supreme Law No. 793", the Supreme People's Court held that if the contents of the so-called investment agreement signed by both parties do not conform to the legal relationship of income sharing and risk sharing investment, it should be regarded as investment, which is actually a legal relationship of private lending. The guarantee clause agreed upon by the parties therein is in fact an agreement between the borrower and the lender on interest.

2. Management of the target company.The right to operate and manage the target company is a distinctive feature of equity, which is different from creditor's rights, and shareholders have the right to vote on major matters of the company, have the right to select directors, supervisors, managers and other senior management personnel, and have the right to manage the company's finances and business, but creditors do not have the above rights.

In the case of "(2019) Supreme Law Minzhong No. 355", the Supreme people's Court held that after the capital increase of IFAD, Hanchuan Company amended the articles of association, IFAD obtained the qualification of shareholders and enjoyed the right to vote, although it did not directly participate in the daily operation of Hanchuan Company, but still participated in the management to a certain extent through examination, approval, notice and other ways, which is also the normal operation as an investor in the fund investment mode, obviously, it cannot be used to deny its shareholder status.

3. Equity exit arrangements.The term of equity investment is uncertain, and the creditor generally agrees on a clear time for repayment of principal and interest, or even if there is no express agreement, the creditor has the right to claim repayment of principal and interest at any time. The exit clause is the core clause of the "real debt", and whether the exit conditions are determined to materially affect the determination of the "real debt.

In the case of "(2021) Jingmin Zhong No. 102", the people's court of first instance held that the nature of the agreement involved in the case should be based on the content of the contract, combined with the transaction background, purpose, mode and contract performance and other factors. Although there is a guarantee clause in the agreement, the repurchase conditions are not a deterministic matter, and the investment income is not a fixed amount, which does not conform to the debt financing model characterized by obtaining fixed income within a fixed period of time. The court of second instance held that the performance compensation and share repurchase agreed upon in the gambling agreement in the case depended on the operation of the target company, which was uncertain at the time of signing the gambling agreement and was significantly different from the fixed income in the private lending contract. Therefore, it is not a "real debt".

4. Registration and publicity of equity changes.The registration of equity change is an important content of equity transfer, and it is a legal element for shareholders to enjoy the effective equity against third parties.

In the case of "(2018) E Min Zhong No. 12", the Hubei Provincial Higher People's Court took "the parties have not yet gone to the industrial and commercial administration department to go through the registration procedures for the change of equity" as the reason for determining that the relationship of rights and obligations agreed in the agreement involved in the case is the relationship of equity transfer contract, which is actually the relationship of loan contract.

5. The expression of the contract or related legal documents.Whether there are claims in contracts, correspondence, minutes of meetings, memoranda and other documents can assist in determining the relationship between "nominal shares and real debts. If the principal, interest, compound interest, etc. are agreed under the investment contract, or if the amount under the contract is agreed to repay the loan that is not repaid on time under other contracts, and it constitutes the substance of the contract, it may be recognized as a legal relationship of creditor's rights.

If the facts of creditor's rights investment are clear, according to the investor's investment decision-making documents, relevant investment agreements, post-investment management files, and investment data such as the repurchaser and investor's accounting records, the nature of the investment is comprehensively determined to be creditor's rights investment. On the basis of respecting the nature of the investment project, the repurchaser can fulfill the repurchase obligation and the investor can recover the investment according to the agreement.

This method is simple and fast, but the form is not in line with the state-owned equity withdrawal provisions, and is based on the "name shares real debt" of the nature of the creditor's rights accurately determined on the basis of the nature of the creditor's rights determined error will directly affect the compliance of the withdrawal, there is a certain degree of creditor's rights identification and state-owned regulatory risks.

According to Article 54 of the "Enterprise State-owned Assets Law", the transfer of state-owned assets shall follow the principles of equal compensation and openness, fairness and justice. Except for those that can be transferred by direct agreement in accordance with the provisions of the State, the transfer of state-owned assets shall be carried out openly in the property rights trading places established in accordance with the law. The transferor shall truthfully disclose the relevant information and solicit the transferee; if there are more than two transferee parties resulting from the solicitation, the transfer shall be carried out by means of public bidding. The state-owned equity held by the investor may be withdrawn by way of listing and transfer on the property rights exchange.

However, under this path, there is a lack of determination as to whether the nature of the asset is transferred according to equity or debt, and there is a certain risk of determination. In the case of equity transfer, audit and evaluation procedures are required and are carried out through public bidding, resulting in uncertainty of the transferee and transfer price of the equity. As the repurchaser enjoys the right to repurchase shares at a fixed premium in accordance with the agreement, the consideration of the equity transaction and the object of the transaction under the entry transaction mode are uncertain, there is a risk of transferring the shares below the contractual price, and there is also a risk that the repurchaser will not be able to repurchase the shares at the agreed price and thus lead to litigation disputes.

Directed capital reduction is a way for shareholders to exit the company, the so-called directional capital reduction, refers to the shareholders do not reduce the proportion of capital contribution, but to a particular shareholder directed capital reduction, directional capital reduction shareholders through the capital reduction process completely exit the company. Investors can withdraw and recover their investment through a targeted capital reduction by the target company.

This path can avoid the risk of uncertainty of the transferee of the entry transaction, but necessary capital reduction procedures are required under this path, such as shareholders' meeting resolution procedures, preparation of balance sheet and property list, asset evaluation, notification of creditors and announcement, and approval of state-owned capital reduction, etc. The procedures are complicated, and there is also the risk of "withdrawal below the price agreed in the contract.

In order to effectively avoid the risk of "famous shares and real debts" and the supervision and approval of state-owned assets, investors can also choose to request the repurchaser to buy back the shares through litigation, so as to achieve the purpose of withdrawing from the target company and recovering the investment. At the same time, judicial withdrawal also has the uncertainty of the determination of "famous shares and real debts", the progress of withdrawal is limited by judicial procedures, and the need to pay certain litigation costs and other risks.

As mentioned above, there are many uncertain legal risks in the exit of "open shares and real debts". In order to reduce the uncertainty in the exit of "open shares and real debts" of state-owned enterprises and safeguard the interests of state-owned assets, on the one hand, specific agreements on the exit path of equity can be made in the investment agreement according to the investment situation. For example, it is clearly agreed that the equity transfer of the target company held by the state-owned enterprise shall enter the market for trading in accordance with the state-owned assets supervision regulations, and the repurchase party shall perform the repurchase obligation in the listing procedure in accordance with the listing trading rules in accordance with the listing bidding price. At the same time, other listed bidders have the right to obtain equity at the listing bidding price, so as to maximize the state-owned interests and withdraw from the equity compliance, strengthen the pre-investment due diligence of the target company and the repo, set up corresponding legal safeguards in the transaction structure, and do a good job of post-investment management to prevent the risk of insufficient performance of the repo.

(Special statement: This article is a theoretical and practical discussion of related issues, for learning and exchange only, not as the legal opinions and suggestions of the firm and its lawyers)