In September 2011, a VIE (variable interest entity) analysis report purportedly issued by the China Securities Regulatory Commission (CSRC) caused a stir in the industry. After the news came out, the relevant regulators quickly refuted the rumour, saying the conjectured source of the report was false and the claim of a “high-level approval” was also baseless.
In the two years since then, regulators have kept mum on the legality of the VIE, both in word and in deed. Foreign securities regulators that had been in a high state of nervousness for a time, gradually relaxed their worries about the VIE framework. In recent foreign listing projects we have handled, even though foreign securities regulators still ask for further clarification of VIE frameworks, they maintain a relatively relaxed attitude towards the responses, not pursuing the issue to excess.
However, with the disclosure in June 2013 of the judgment of the Supreme People’s Court in the Chinachem entrusted investment case, the investment world has again fallen into a “VIE panic”. In the case, Chinachem wished to invest in and acquire an equity stake in Minsheng Bank, but, hemmed in by provisions of PRC laws that prohibit foreign investors from acquiring equity stakes in financial institutions, it entrusted China Small and Medium Enterprise Investment to invest in Minsheng Bank on its behalf in the latter’s name. Subsequently, as China Small and Medium Enterprise Investment refused to pay to Chinachem the dividends from Minsheng Bank, Chinachem sued it in court.
Following a trial that dragged on for more than 10 years, the Supreme People’s Court rendered a final judgment at the end of 2012, finding that the intent of Chinachem’s entrusted investment was to circumvent prohibitive provisions of PRC law, constituting what is called in the Contract Law “a lawful form covering an illegal objective”, and declared in accordance with the law that the entrusted investment agreement between Chinachem and China Small and Medium Enterprise Investment was invalid.
Notwithstanding the fact that the judgment in the case did not directly touch on VIE anywhere in the text – because at the heart of the creation of almost all VIE frameworks is the intent to circumvent this or that – there does not seem to be a substantive difference between this common “sensitive spot” when compared to Chinachem’s predicament and course of action at the time.
If, in accordance with the law, Chinachem’s entrusted investment was invalid, how are the mass of VIE frameworks to be handled? Although the PRC is not a case law country, the judgments and analyses of the Supreme People’s Court constitute for courts at every level important adjudication reference and bases. Accordingly, does this not imply that the entirety of the PRC judicial adjudication system has rendered a negative “judgment” on the legality of VIE frameworks?
The judicial attitude manifested in the judgment by the Supreme People’s Court should make the investment world take notice. In 2011, this firm served as counsel in an arbitration case that involved a dispute over VIEs and successfully obtained an arbitration award declaring a series of VIE agreements invalid. In the course of acting as counsel in the case, our lawyers argued before the tribunal that the enterprise involved in the case was operating online games.
Not only is that industry governed by stringent approvals and controls, but Notice Xin Chu Lian  No. 13 issued by such authorities as the General Administration of Press and Publishing, and the National Copyright Administration, in respect of the approval of online games also expressly specifies that, “the indirect actual control and participation by a foreign investor in the online game operations of a domestic enterprise by such means as the execution of relevant agreements or the provision of technical support is prohibited”.
In the Chinachem entrusted investment case, the Supreme People’s Court only vaguely mentioned in passing that “Chinachem’s entrustment of SME Investment to acquire an equity interest in Minsheng Bank clearly runs counter to mandatory provisions of the mainland’s rules for financial administration”, but neither mentioned specific “mandatory provisions of … rules for financial administration” nor further analysed the precedence ranking of “mandatory provisions of … rules for financial administration”, indicating that its judicial attitude is even stricter than that of the above-mentioned arbitration case, which could almost be understood as meaning that “so long as there is circumvention of the law, it is invalid”.
No need to worry excessively
However, this author does not believe the investment world needs to worry too much about the recent judgment – for the time being. First, at the time of publication of this column, the full text of the judgment in the Chinachem entrusted investment case had not yet been officially released, and to date the case has not been included in the Supreme People’s Court’s case reports or guiding cases. Accordingly, the judgment not only does not constitute an official source of PRC law, but its reference and guiding function in adjudication practice also requires further observation. In fact, as the PRC is not a case law country, even if the Chinachem entrusted investment case could in theory assist in forecasting the possible outcome of future trials, no one can guarantee that a court in a judgment on a future VIE dispute will definitely hold fast to the analysis in this case (and courts are under no obligation to hold fast thereto).
Second, notwithstanding the fact that the cause and the legal framework of the entrusted investment in the case have similarities to a VIE framework, the differences are similarly obvious, thereby leaving uncertainty as to the outcomes of future trials of genuine VIE frameworks.
Third, as arbitration is the means of dispute resolution opted for in almost all of the commonly seen VIE agreements and arrangements, and as PRC courts show a marked preference for mediating difficult cases, the possibility of the appearance in the short term of judicial judgments directly addressing VIE should not be exaggerated.
Fourth, this case represents the judicial attitude of the PRC court system towards an individual case, whereas the attitude of silence of such regulatory authorities as the Ministry of Commerce and the CSRC still continues. With respect to current VIEs, the silence of the regulatory authorities not only gives much food for thought, but also seems valuable. No attitude may just be the best attitude.
Vincent Mu is a senior associate at Martin Hu & Partners
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