Risks borne by investors from fixed-return clauses

By Li Weiming, Tiantai Law Firm

Fixed-return clauses are fairly common for corporate investment and financing activities. Investors would often insert a fixed-return clause in an investment agreement, under which the financing party is required to pay an investment return of a fixed percentage or amount. It is therefore necessary for investors to be familiar with key risks involved in such fixed-return clauses, to avoid unnecessary losses.


In practice, if a fixed-return or a fixed-investment return rate is specified in the investment agreement, the court may characterise the investor’s financing of the target company as a loan.

Li Weiming, Tiantai Law Firm, Risks borne by investors from fixed-return clauses
Li Weiming
Tiantai Law Firm

Should the court find the investor engaging in granting loans by way of “de jure investment, de facto loan”, harming the interests of the company and other creditors by earning a fixed return from the target company, such agreement would be deemed invalid. In the 2012 capital contribution dispute involving Suzhou Industrial Park Haifu Investment and Gansu Shiheng, the Supreme People’s Court held this view.

There is no uniform transaction model for “de jure investment, de facto loan”. If the investor’s intent is to acquire equity in the target company and has the right to participate in its operation and management, the transaction should be determined as an equity investment. In contrast, if the investor only aims to earn a fixed return and does not have other rights, it should be deemed a debt investment, with the investor as a creditor of the target company.

From our findings after mass case analysis, we believe that the factors considered by courts in determining the legal relationship of “de jure investment, de facto loan” mainly include: (1) the correlation between the fixed returns under the investment agreement and the target company’s profit or loss, as well as the rate level of the fixed returns; (2) whether the investor expressed any intent to become a shareholder; (3) whether the investor participates in the operation and management of the target company, and whether it has appointed any directors or senior management; (4) fairness and reasonableness of the price at which the investor acquired the equity; and (5) the divestment arrangement by the investor on expiration of the term, and whether any changes were made to the business registration, articles of association, or register of shareholders.

In general, courts are cautious when it comes to determining creditor-debtor legal relations. Out of respect for party autonomy, and support for financial aid and innovation, courts generally will not superficially deem the equity transaction a debt investment. In the case of China Agricultural Development Key Construction Fund v Tonglian Capital Management and Hanzhong Hantai People’s Government (2019), although the investor contributed to the target company by way of a capital increase, and received fixed returns via year-by-year divestment and buyback, the Supreme People’s Court maintained that the model was in line with commercial practice and common in transactions, and was not an attempt to evade regulation by way of “de jure investment, de facto loan”.


Generally, a capital contribution by a shareholder is considered an equity investment, not a debt investment, and the contributor should not receive fixed returns from the company. However, in practice, if the capital contribution enables the shareholder to participate in the operation and management of the company, and the payment by the target company or other shareholders of a fixed return forms part of the agreement, the investor will likely not be found to have engaged in “de jure investment, de facto loan”.

There are even shareholder agreements under which one party waives its management rights and the right to dividends, while the other party pays him/her an annual fixed return. The court will likewise regard it as a special arrangement between shareholders based on party autonomy, which does not violate mandatory provisions of the Company Law, nor the lawful rights or interests of the state, the public, third parties or the company, and is thus valid. In Greenland Energy Group v Lu Guowei (2016), the Shanghai High People’s Court held this view.

The author believes that, when analysing the issue, one must further examine whether the fixed-return clauses or the payment of such returns is premised on the company’s profit, and whether such returns should be paid by the company or other shareholders. In an equity transfer dispute between a government-led industry investment fund in Zhejiang and an enterprise for which the author is currently acting as counsel, it is set out in the government industry investment agreement that the target company would pay a high fixed return, regardless of whether the company makes a profit or loss. Despite the debatable validity of such a clause, the author would argue that it should be deemed invalid regardless.

If the target company is profitable, there is little argument for paying a fixed return to an investor according to the investment agreement, after it has made up for past years’ losses and made allocations to its statutory reserves and discretionary reserves pursuant to the Company Law. However, if the target company consistently records losses after the capital contribution, and the investor still draws fixed returns at a rate significantly higher than the investment return rate, such payment would clearly impair the interests of the company and other creditors. Accordingly, such a provision should be deemed invalid as it violates mandatory provisions of the Company Law, and the investor may even be held liable for illegally withdrawing its capital contribution.

If the payer of fixed returns is another shareholder rather than the target company, it would be a different scenario, as the payment is based on a special arrangement between the shareholders on risk sharing and claims/debts, neither of which violates mandatory provisions of the law nor harms the interests of the company or its creditors. Accordingly, even if the target company were in the red, the investor’s receipt of fixed returns is likely to be found valid.

In summary, the author recommends that investors comprehensively examine the fixed-return clause in the investment agreement, taking into consideration the target company’s operating status, development prospects, investment objectives and reasonable payback period, to arrive at a proper arrangement that avoids any clearly biased clauses based solely on financial speculation or purely in the interest of investment protection.

Li Weiming is a partner at Tiantai Law Firm


Tiantai Law Firm
29/F, T1 Building, Raffles City
No.1133 Changning Road, Changning District
Shanghai 200051, China
Tel: +86 21 5237 7006
Fax: +86 21 5237 7009