Perspective | A Brief Analysis of the Recognition Rules for the Legal Relationship of "Named Investment, Actually Lending"

[Equity Investment]Refers to the economic behavior where the investor acquires shares of the invested enterprise, becoming a shareholder of the invested enterprise, with the aim of obtaining returns and bearing risks in business activities.

The main characteristics of equity investment are:

1. Long-term: Equity investment is a long-term investment behavior that requires holding shares for a long time to obtain returns.

2. Risk and Uncertainty of Returns: Equity investment carries a high level of risk, usually closely related to the operating conditions of the invested enterprise, and the investment return is uncertain due to changes in operating performance.

3. Participation in Management: Generally, to ensure expected returns and keep abreast of the company's developments, investors actively participate in the actual management of the enterprise and exercise various shareholder rights.

[Private Lending]Refers to the behavior of capital flow between individuals, legal persons, and non-legal entities, forming a creditor-debtor relationship between the parties, where the borrower borrows funds from the lender and repays the principal and pays interest as agreed.

The main characteristics of private lending are:

1. Fixed Returns: The lender does not actually participate in the management of the enterprise, and their purpose is to obtain interest in the form of so-called 'investment' and recover the 'investment' principal.

2. No Business Risk: The lender often acts in the name of 'investment' while actually engaging in 'lending.' Even if the borrower uses the funds for actual business operations, the lender does not bear the business risks.

In summary, equity investment is the disposal of the investor's ownership rights (money), where the investor generally participates in the management of the investment project to ensure investment recovery and achieve appreciation, which is an expected return in the future and is uncertain; while private lending is a creditor-debtor relationship that can be secured, with predictable and fixed returns for the lender.

The phenomenon of 'investment in name, loan in essence' is relatively common in judicial practice. Courts will determine the nature of the legal relationship based on the specific terms of the contract and the actual behavior of both parties. For example, in some cases, although the contract is named an investment contract, if the contract has clear provisions on returns and the investor does not bear business risks, the court will consider whether there is participation in the actual management of the company to identify it as a 'contract of investment in name, loan in essence.' Additionally, factors such as whether there is a fixed return agreement and whether business risks are borne will also be considered.

Case 1: Taking the Supreme People's Court (2020) Supreme Court Civil Ruling No. 7050 as an example

[Case Summary]In 2015, a technology company signed an 'Investment Cooperation Agreement' with a certain individual, stipulating that after financing, the total investment amount for the project would be 100 million yuan, and if the operating expenses during the investment and construction period exceeded 100 million yuan, the additional part would be the responsibility of the technology company, and the individual would not add investment; the individual invested 13 million yuan, and during the construction period (1 year), dividends would be calculated at 15% of actual returns; after the construction period, if the annual net income was less than 30 million yuan, dividends would be calculated based on 30 million yuan, and if it exceeded 30 million yuan, dividends would be calculated based on actual net income. The technology company promised to pay the individual returns equal to the individual's investment amount within four years, and if the actual returns did not meet this amount, the technology company would compensate with its own earnings and pay the individual.

After the agreement was signed, the individual paid 13 million yuan as agreed and obtained 13% equity in the technology company through industrial and commercial registration. Subsequently, the individual repeatedly requested the technology company to pay the fixed returns, but the technology company failed to perform, leading to a dispute between the two parties.

[Dispute Focus]The focus of the dispute in this case is whether the 13 million yuan paid by the individual to the technology company is an investment or a loan.

[Legal Analysis]The Supreme People's Court held that based on the content stated in the 'Investment Cooperation Agreement,' the returns obtained by the individual were calculated as fixed returns, and it was agreed that regardless of the company's operating conditions or losses, the individual would receive investment returns according to the standard.Therefore, the provisions of the 'Investment Cooperation Agreement' do not possess the characteristics of joint operation, shared returns, and shared risks typical of investment cooperation.Although the technology company changed the individual to a company shareholder in its industrial and commercial registration, the technology company did not provide evidence to prove that the individual participated in the substantial management activities of the company.The individual did not participate in the management of the technology company, and the funds invested did not bear any business risks, only receiving a fixed amount of returns. The 13 million yuan was named an investment but was essentially a loan.Regarding the legal relationship between the technology company and the individual, the original trial's determination of its nature as private lending is not inappropriate.

After the technology company received the 13 million yuan paid by the individual, it did not pay interest as agreed in the contract, and the technology company should repay the loan to the individual and pay the corresponding interest as agreed. The original trial, in accordance with the relevant provisions of the 'Supreme People's Court's Regulations on Several Issues Concerning the Application of Law in the Trial of Private Lending Cases,' combined with the content and performance of the contract, and determined the interest standard the technology company should pay based on transaction habits, market interest rates, and other factors, which is also not inappropriate.

Case 2: Taking a retrial civil ruling from the Shandong Provincial High Court as an example

[Case Summary]In 2019, Plaintiff A signed a "Cooperation Agreement" with Defendants B and C, which stipulated that the three parties would cooperate on a project through a company in Shandong, established in 2017, with a registered capital of 5 million yuan. The original shareholders transferred all their shares to the three parties at zero price, with A acquiring 24% of the shares, B acquiring 45%, and C acquiring 31%. A contributed 3 million yuan in working capital, B contributed the rights to use existing factory buildings and equipment, and C contributed production technology, production equipment, products, and raw materials. The company established a shareholders' meeting and a board of directors, composed of the three parties.

Explanation regarding A's profit distribution: 1. At the end of each year, the cooperative enterprise shall advance A a dividend based on a monthly interest of 2% on A's investment of 3 million yuan (including tax), referred to as the guaranteed dividend. 2. If the profit distributed to A according to the shareholding ratio is greater than or equal to the guaranteed dividend, the actual dividend will be distributed according to the shareholding ratio, and no additional payment or advance of the guaranteed dividend will be made. 3. If the profit distributed to A at the end of the year is zero or the cooperative enterprise incurs losses and cannot distribute dividends, A will enjoy the guaranteed dividend advanced by the cooperative enterprise. 4. In subsequent years when the cooperative enterprise reaches the point of distributing profits according to the actual shareholding ratio, the profit distribution to A will be made after deducting the previously advanced guaranteed dividend. 5. If the cooperative enterprise's book losses exceed 10% of the registered capital, all three parties have the right to propose termination of the cooperation.

After the agreement was signed, A transferred 3 million yuan to the company in Shandong as stipulated in the "Cooperation Agreement." From the end of 2019 to the present, the company in Shandong has not paid A the dividends or interest on the 3 million yuan investment as stipulated in the "Cooperation Agreement," leading to a dispute brought to court.

[Dispute Focus]

1. How to determine the legal relationship involved in the "Cooperation Agreement." 2. Identification of the repayment responsibility subject.

[Legal Analysis]The first-instance people's court held that: The plaintiff A's lawsuit for a private lending dispute is inappropriate, as the original defendants signed a "Cooperation Agreement" to operate the company in Shandong. Plaintiff A's contribution was working capital, and he provided necessary operational assistance to the company, which should be recognized as a partnership relationship, and the case should be classified as a partnership contract dispute. The focus of the case is whether defendants B and C should return the 3 million yuan working capital invested by plaintiff A and the interest calculated at four times the bank's similar loan rate. The guaranteed dividend agreement is a commitment by the two defendants to the investment made by the plaintiff, and the two defendants should fulfill their obligations.

The second-instance people's court held that: Regarding the first dispute focus, according to the explanation of A's profit distribution in the "Cooperation Agreement," the three parties do not have the characteristics of joint operation, shared profits, and shared risks in investment cooperation, but rather stipulate that the company in Shandong shall calculate a fixed income for A regardless of whether it is profitable. Although the business registration changed A to a shareholder of the company, B and C did not provide evidence to prove that A participated in the substantial operational activities of the company in Shandong. According to the agreement, A receives a fixed amount of income or dividends, and the 3 million yuan payment conforms to the characteristics of a private lending legal relationship, which should be recognized as a private lending nature between the three parties. Although the first-instance court's recognition of the legal relationship of the three-party agreement as a partnership contract was erroneous, the procedure was not improper, and the first-instance judgment result also complies with the legal provisions of private lending disputes.

Regarding the second dispute focus, although the three-party cooperation agreement stipulates that the company in Shandong shall pay A the guaranteed dividend, the company in Shandong is not a party to the "Cooperation Agreement," and none of the three parties submitted evidence that the company in Shandong has paid A the guaranteed dividend as agreed. According to the above legal provisions, B and C should bear the liability for breach of contract to A. The second-instance people's court ruled to dismiss the appeal and uphold the original judgment.

In the retrial, applicant B argued that the "Cooperation Agreement" and the company’s articles of association never stipulated that A would not bear operational risks but would only receive fixed returns. B provided evidence such as the resolutions of the shareholders' meeting, board of directors, company meeting minutes, and A's instructions to company personnel via WeChat to purchase relevant raw materials, proving that A actually participated in the company's operational management activities, enjoying decision-making rights, personnel appointment and dismissal rights, profit distribution rights, and the right to know. At the same time, it was indicated that A's remittance to the company was marked as "equity investment" and "investment funds," demonstrating A's genuine intention to invest in the company and that A has fulfilled the statutory capital contribution obligation to become a shareholder of the company.

The Shandong Provincial High People's Court accepted the retrial of this case. After examination, the provincial high court believed that regarding the nature of the "Cooperation Agreement" involved in the case,it should be determined based on the content stipulated in the agreement, A being registered as a shareholder of the company in Shandong, and the actual performance situation, as well as the relevant evidence submitted by B in the retrial regarding A's actual participation in the operation of the company in Shandong.The agreement involved in the case stipulated a guaranteed dividend, but there was no expression of intent to guarantee the repayment of A's invested amount of 3 million yuan.Whether the agreement on the guaranteed dividend is valid and whether it can be recognized as a bottom line clause to determine that the "Cooperation Agreement" involved in the case is a legal relationship of 'named investment, actual lending' should be recognized based on the nature of the "Cooperation Agreement" involved in the case and according to relevant legal provisions.

Combining the above cases, the recognition of the legal relationship of 'named investment, actual lending' should be defined from the following four aspects: First, whether the investor does not bear operational risks while obtaining fixed returns; second, whether the investor participates in the enterprise's operational management, i.e., the actual performance situation; third, whether the investor has fulfilled the legal capital contribution procedures to become a true shareholder; fourth, whether there was a genuine investment intention among the parties at the time of contract signing, analyzing their true transaction purposes, contractual stipulations, etc. The impact of being recognized as 'named investment, actual lending' mainly includes:

1. The impact on the legal relationship.

Being recognized as 'named investment, actual lending' will lead to a redefinition of the legal relationship between the parties. The investment contracts signed between the parties are aimed at concealing debts to achieve financing and interest acquisition. Concealment behavior is not inherently invalid but should be handled according to the legal provisions related to the concealment behavior. In the absence of statutory invalidity reasons, the lending relationship between the parties should be recognized as legal and valid.

2. The impact on interest.

The current judicial interpretation, "Supreme People's Court on Several Issues Concerning the Application of Law in the Trial of Private Lending Cases (2020 Second Amendment)," Article 25 states: "If the lender requests the borrower to pay interest according to the contractually agreed interest rate, the people's court should support it, except for cases where the agreed interest rate exceeds four times the one-year loan market quotation rate at the time the contract was established." When the investment contract signed between the parties is recognized as 'named investment, actual lending,' the agreed fixed income will be subject to the regulation of the above judicial interpretation, meaning that interest exceeding four times the one-year loan market quotation rate at the time the contract was established will not be protected by law.

In practice, when investors make investments, to ensure the safety of funds and obtain returns, they tend to choose projects with stable returns. Based on the choice of transaction methods, relevant contracts may be recognized as 'named investment, actual lending,' which in turn affects the nature of equity investment. From the perspectives of pre-investment investigation, contract terms, and operational management, we suggest that investors pay attention to the following points:

1. Conduct necessary investigations before investment to understand the true operating conditions of the invested enterprise.

When making equity investments, investors should conduct necessary investigations to understand the true conditions of the invested enterprise, such as its operating conditions, debt situation, ongoing or upcoming litigation, arbitration cases, credit status, etc. They may also investigate the original shareholders of the invested enterprise to understand the business model of the project and the potential risks it may face. If necessary, they should hire third-party institutions to conduct due diligence. Of course, while investors expect to obtain returns, they should also be prepared to bear investment risks, avoid potential risks through reasonable and legal contractual agreements, and help mitigate legal uncertainties.

2. Carefully stipulate contract terms to avoid legal risks.

When signing an investment agreement, both parties should clearly stipulate their respective rights and obligations, paying attention to profit distribution and risk-bearing clauses. The methods and prices for investment exit should be related to the actual operating conditions of the invested enterprise, avoiding fixed exit deadlines or unconditional exits; in terms of obtaining returns, avoid setting fixed percentage returns or guarantee clauses to prevent being classified as private lending.

3. Investors should actively participate in the management of the invested enterprise.

First, in the investment contract, stipulate that the investor participates in the actual management of the invested enterprise as a shareholder; second, after signing the investment contract and paying the capital increase or transfer funds, the invested enterprise should be required to promptly record the investor in the shareholder register, amend the articles of association, and quickly handle the business registration changes; finally, the investor should actively exercise shareholder rights and fulfill shareholder obligations regarding the invested enterprise, participating in management activities, enjoying decision-making rights, personnel appointment and dismissal rights, profit distribution rights, and the right to know, while also retaining relevant evidence to avoid legal risks.