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The court rejected a claim by CEK Investment that a default rate of interest of 4% per month (compounded), under a loan it obtained from London Credit, amounted to a penalty clause.

Deputy High Court Judge Richard Farnhill said 4% was above market rates but not, itself, unreasonable and represented the lender protecting itself in offering high-risk, short-term lending, which was legitimate.

Eilidh Smith, a financial services disputes expert with Pinsent Masons, said the decision provided clarity in respect of the application of the test for penalty clauses, as pronounced by the UK Supreme Court in its judgment in Cavendish Square Holdings v Makdessi in 2015, to default interest rates. 

The Makdessi judgment established that a clause will be an unenforceable penalty if it is a secondary obligation – such as an obligation to pay default interest if a primary obligation under a loan agreement, such as a repayment obligation, is breached – and imposes a detriment on the party in breach which “is out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation.”

“This judgment provides guidance as to how courts will approach the application of the Makdessi test to default interest rates in lending, which lenders will need to be aware of,” Smith added.

“It is an indicator that even above market rates can be enforceable, so long as they are commercially justifiable and such justification can be evidenced. This will be welcome news particularly to lenders offering high risk lending, such as bridging loans.”

The long-running case revolved around a £1.88m bridging loan CEK had obtained from London Credit, secured against various properties including the family home of CEK’s directors Mr and Mrs Houssein, which carried interest of 1% per month, plus the 4% per month default interest. London Credit had alleged that CEK was in breach of the terms of the agreement and took enforcement action, including seeking default interest. 

The particular event of default on which CEK relied was that the Housseins resided at the family home contrary to a non-residence requirement in the loan agreement. After London Credit appointed fixed charge receivers to sell the properties the loan had been secured against, CEK and the Houssein family raised the action, arguing that the default interest rate was a penalty clause.

In June 2023 the High Court had ruled that the default ratewas in fact an unenforceable penalty, but this was overturned by the Court of Appeal the following year on the basis that the High Court judge had applied the wrong test, and the issue was sent back down for the High Court judge to reconsider.

“While the decision will be welcomed by lenders, it does demonstrate the need for careful consideration of any proposal to apply a single or ‘static’ default rate of interest in the event of breaches of any of a number of different primary obligations – for example, non-payment by the contractual repayment date and breach of a non-residence requirement,” explained Emilie Jones, a commercial litigation expert with Pinsent Masons.

“The court in this case found that, where this is the approach taken, it is necessary to consider the legitimate interests underlying each of the primary obligations and whether the default interest is extortionate by reference to any of them.  As the judge explained: “If, by reference to any one interest, the provision is extortionate, it fails in relation to all of them.” 

“In this case, the judge identified a number of categories of legitimate interests for the lender which were protected by the default interest rate and concluded that the rate was not extortionate in relation to any of them.  For example, the lender had a ‘very strong interest’ in repayment of the loan, but also had a ‘strong interest’ in the non-residence requirement given the potentially ‘catastrophic consequences’ of providing loans to individuals secured against their primary residence given London Credit’s status as an unregulated lender.

“The default interest rate was not extortionate by reference to either of these interests, nor by reference to further interests which the judge labelled the security interest, the credit risk interest and the representations interest.

“It will, however, be important for lenders who are considering applying a single default interest rate in the event of breaches of diverse primary obligations to consider whether the rate can be justified by reference to legitimate interests underlying each and every one of those primary obligations, and to record their rationale.”

On September 30, 2025, the Supreme People’s Court (SPC) released the Interpretation of the Supreme People’s Court on Several Issues Concerning the Implementation of the Company Law (the “draft judicial interpretation”). This 90-article draft consolidates and revises the Provisions on the Implementation of the Company Law (I)–(V), forming the first comprehensive systematic update to China’s Company Law judicial interpretations since their gradual introduction beginning in 2006. 

This article is the third in our series on the draft judicial interpretation. It examines two major parts of the document: nominee shareholders and the protection of investor rights, including issues of actual investors, disclosure, defective capital contributions, and enforcement and equity transfers and preemptive rights, including acquisition of equity, conflicting transfers, the legal effect of the shareholder register, and the exercise of statutory right of first refusal in both voluntary and judicial transfers. 

Nominee shareholders and protection of investor rights 

Disclosure of the actual investor 

Article 31 of the draft judicial interpretation, which revises Article 24 of the Company Law Judicial Interpretation (III), addresses how actual investors in limited liability companies (LLCs) can obtain legal recognition when shares are held in another person’s name. 

The article first defines the parties to litigation in such cases. When an actual investor seeks recognition of shareholder rights, the investor is the plaintiff, the company is the defendant, and the nominee shareholder is a third party. Other shareholders may also participate as third parties, clarifying the legal roles in nominee shareholding disputes.  

It then sets out two conditions – the “disclosure (显名) conditions” – under which courts should recognize the actual investor as a shareholder and order related registration changes unless otherwise stipulated by laws and regulations or the Articles of Association (AoA): 

1. The company, by resolution of the shareholders’ meeting, acknowledges the investor’s shareholder status; or
2. More than half of the other shareholders agree that the actual investor may exercise shareholder rights, or​ more than half of the other shareholders know or should have known the fact of equity holding on behalf of another party, and have not raised any objection to the actual exercise of shareholder rights by the actual investor. (Alternatively: A majority of the other shareholders consent to or are aware of the nominee arrangement and do not object to the investor exercising shareholder rights.) 

If these conditions are not met, the investor can request the sale or auction of the shares to recover their capital. The revised article also allows the nominee shareholder to claim compensation if agreed in the contract, or otherwise based on their participation and benefits. Either party may seek damages if any losses are caused by the fault of the other party.  

The article also requires courts to carefully assess whether a genuine nominee relationship exists. Relevant factors for assessing this relationship include the existence of a valid agreement, actual payment of capital, the source and capacity of funds, and the relationship between the parties. 

Invalidity of nominee shareholding arrangements  

Article 32 of the draft judicial interpretation, a newly added provision, defines when nominee shareholding agreements are invalid and outlines the legal consequences.  

Nominee arrangements are invalid in the following situations:  

1. They involve financial institutions that are in violation of laws or regulatory rules affecting financial stability;
2. They concern listed company shares that breach securities regulations or disclosure obligations;
3. They are used by civil servants or similar persons to evade restrictions on profit-making activities; or
4. Other cases violating laws or public policy.

When a nominee agreement is declared invalid, courts determine the treatment of shares based on the actual investor’s eligibility. If the investor meets the disclosure conditions outlined in Article 31, the court may recognize them as the shareholder. Otherwise, the shares may be sold or auctioned, and proceeds or compensation are distributed under the Civil Code. This follows the principle of restoring the parties to their pre-contract state or, if impossible, equitably allocating interests.  

If the agreement involves potentially illegal activity or unjust enrichment, courts must report or refer the matter to the relevant regulatory or criminal authorities.   

Unauthorized disposal by nominee shareholders  

Article 33, which is also revised Article 24 of the Company Law Judicial Interpretation (III), governs cases where a nominee shareholder transfers, pledges, or otherwise disposes of shares without the actual investor’s consent.

If such unauthorized actions occur, the actual investor may request that the transferee return the shares or confirm that a pledge was not validly established. Courts generally uphold such claims unless the transferee acquired the shares in good faith under Article 311 of the Civil Code.

A presumption of good faith applies: the transferee is deemed bona fide unless the actual investor proves that the transferee knew or should have known of the nominee arrangement.

This shifts the evidentiary burden to the actual investor, aligning with commercial appearance and transaction reliability principles.

If the unauthorized disposal causes losses, courts will support damage claims against the nominee shareholder.

Company claims for defective capital contributions

Article 34 refines rules for liability in defective or incomplete capital contributions under nominee shareholding structures, amending Article 26 of Company Law Judicial Interpretation (III).

Under the revised article, in a shareholding arrangement where a shareholder has failed to fully pay their capital contribution obligations, if the actual investor meets the disclosure conditions outlined in Article 31, and the company sues for unpaid capital, the court will hold the investor liable. The investor cannot avoid liability by arguing that they are not on the shareholder register.

If the company sues the nominee shareholder instead, the nominee cannot simply deny responsibility. However, the nominee may request to add the actual investor as a third party. If the nominee proves the investor meets the disclosure conditions, the court may guide the company to adjust its claim toward the actual investor. If the company refuses, the case will be dismissed.

The article also specifies that the company cannot demand joint and several liability from both the nominee and the investor, and that it must select one responsible party.  

Creditors’ claims for defective capital contributions

Article 35, a newly added article, extends the principles outlined in Article 34 to company creditors. When a shareholder in a nominee arrangement fails to fully contribute capital, creditors may sue either the nominee or the actual investor within the limits of Articles 21 to 24 of the draft judicial interpretation. Courts apply the framework outlined in Article 34 to determine liability.  

This reflects the principle that nominee shareholding is an internal company arrangement and cannot defeat external creditor claims. Creditors can therefore pursue either party to ensure that corporate capital remains available for debt repayment.  

Additionally, the article states that when a nominee shareholder transfers shares to the actual investor, courts must determine which of the following two legal relationships applies: 

1. A genuine equity transfer; and
2. Recognition of the actual investor’s ownership.

The issue must also be handled by the courts under the provisions of Article 34. 

By closing this loophole, Article 35 prevents evasion of capital obligations through delayed registration or proxy holding, ensuring creditors’ protection and the integrity of corporate capitalization.  

Protection of actual investor equity from enforcement 

Article 36 of the draft judicial interpretation, a newly added provision, clarifies when an actual investor can prevent enforcement against equity registered in the name of a nominee shareholder, and when creditors may instead execute against that equity to satisfy debts.

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Specifically, when a creditor seeks compulsory enforcement over equity recorded under the nominee’s name, an actual investor who either fulfills the disclosure conditions in Article 31 or has fully paid all subscribed capital can file an action for execution objection requesting that the equity be excluded from enforcement. If these requirements are met, the court must uphold the objection. However, this protection is not unlimited, and if the actual investor fails to raise the objection within a reasonable time after the court’s first seizure of the equity, they lose the ability to prevent enforcement, even if they otherwise qualify for recognition.

The article also addresses the reverse situation in which enforcement is initiated by the monetary creditor of the actual investor. If that creditor can show that the actual investor satisfies the disclosure conditions or has fully completed capital contributions, the court must allow enforcement directly against the equity registered under the nominee’s name. In this case, the nominee shareholder cannot block enforcement simply by pointing to the shareholder register or company registration records. 

Validity and performance of valuation adjustment mechanisms

Article 37 of the draft judicial interpretation, a newly added provision, addresses the validity, enforceability, and limits of valuation adjustment mechanisms (VAMs, also commonly referred to as bet-on agreements).

The article first upholds the general validity of VAMs, stipulating that courts should not invalidate VAM terms on the grounds that the agreement stipulates that if the company fails to meet agreed performance targets or fails to achieve listing conditions within a certain period, the company or its shareholders or actual controller will repurchase the shares or assume monetary compensation obligations, unless exceptions are otherwise stipulated in the interpretation. 

The article then clarifies that courts will not support the following requests regarding VAMs: 

• A request for continued performance of a VAM in the event that an investor enters into a VAM with a company, and the company fails to legally fulfill the capital reduction procedure or legally distribute profits.
• A request by the investor for the company to bear liability for breach of contract or guarantee liability based on such agreement, if the parties agree that the company will bear liability for breach of contract or provide collateral due to the company’s failure to legally fulfill the capital reduction procedure or legally distribute profits. 

However, the article also clarifies that where a third party provides a guarantee, the court will support the investor’s request for the third party to bear the guarantee liability. 

Article 37 confirms the validity of VAMs in principle but ties their enforceability to strict adherence to statutory processes. To mitigate risk, investors should secure guarantees from shareholders, actual controllers, or third parties rather than relying on direct contractual penalties against the company for procedural failures. 

Characterization and enforcement of equity repurchase agreements 

Article 38 of the draft judicial interpretation, another newly added provision, creates a structured framework for three common forms of equity repurchase arrangements: conditional repurchase, conditional repurchase with investor choice, and fixed term repurchase mechanisms.

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The first paragraph addresses conditional repurchases, where equity is transferred to the investor, and the shareholder must buy it back once a defined condition occurs. In these arrangements, the investor is treated as a real shareholder before the repurchase is completed and must bear shareholder obligations, including outstanding capital contribution responsibilities. In disputes, the company must be added as a third party, and any judgment must specify that, once the shareholder pays the repurchase price, the company must update the shareholder register and complete registration. If the shareholder cannot pay, the investor may auction or sell the equity and satisfy its claim from the proceeds.

The second paragraph concerns conditional repurchase agreements with investor choice. Once the triggering condition occurs, the investor must exercise their repurchase option within the agreed period or, if none is specified, within a reasonable period after the shareholder issues a demand. Failure to exercise the option in time bars the repurchase claim unless the shareholder consents, thereby ensuring transactional certainty.

The third paragraph governs fixed term repurchases, where equity is transferred as part of a financing arrangement requiring the shareholder to repurchase it at maturity with principal plus premium. When such agreements function substantively as security interests, courts apply the rules on equity transfer-as-collateral in the Civil Code’s Security Interest Interpretation. However, if the investor actually exercises shareholder rights in a manner exceeding the security purpose, the relationship is re-characterized as a conditional repurchase under paragraph one, with all corresponding shareholder obligations. 

Shareholder requests for share repurchase 

Article 39 introduces a clearer exit right for minority shareholders where controlling shareholders abuse their rights to the extent that participation in company management or the realization of investment returns becomes impossible.

The court will support a request by shareholders of a company to repurchase their shares at a reasonable price if a controlling shareholder of a company abuses their shareholder rights and prevents the other shareholders from participating in the company’s management or obtaining investment returns. Moreover, the court will not support a defense raised by the company that the controlling shareholder has already borne liability for damages in accordance with Article 21, Paragraph 2 of the Company Law.

If, instead, a controlling shareholder of a company abuses their shareholder rights, causing losses to other shareholders, but does not prevent the other shareholders from participating in the company’s management or obtaining investment returns, and the other shareholders request the controlling shareholder to bear liability for damages, then the court will support such a request. However, in this instance, the court will not support a request by the other shareholders of the company to repurchase their shares. 

When shareholders request the company to repurchase their shares, the repurchase price of the shares must be clearly specified. The court will, in conjunction with the adversarial proceedings between the parties, consider a variety of factors such as the number of shares transferred, the company’s net assets as recorded in the previous year’s balance sheet, and the transaction prices of shares in the company and similar companies within the past six months to determine a reasonable price for the shares. If it is still difficult to determine the price, it can be determined through judicial appraisal or other means. 

Equity transfers and preemptive rights 

Equity acquisition in LLCs 

Article 40 of the draft judicial interpretation, a new provision, clarifies at what point a transferee in an LLC legally acquires equity and obtains shareholder status. 

These are stipulated thus: 

• If parties transfer shares in an LLC, except where it is legally required that the contract requires approval, the transferee acquires the shares from the date of their registration in the shareholder register.
• However, ff the company does not maintain a shareholder register, then the transferee acquires the shares from the date they actually exercise their shareholder rights or notify the company of the share transfer. 

Additionally, the article stipulates that if the transferee is registered in the shareholder register but the change of registration has not been completed with the company registration authority, and the transferor’s monetary creditors apply for enforcement against the shares in the transferor’s name, the court will support the transferee’s request to exclude enforcement. This means that the transferee’s share rights are effective even if the change of registration has not been completed, and the transferor’s debtors cannot claim rights in this regard. 

Conflicting transfers (one share sold twice) 

Article 41 of the draft judicial interpretation, which is an amendment of Article 27 of the Company Law Judicial Interpretation (III), addresses disputes arising from double transfers of the same equity. 

In a scenario in which a share transfer agreement has been concluded but the change of registration has not been completed, the original shareholder disposes of their shares through transfer, pledge, or other means, and a third party claims to have acquired the shares or established a pledge on the shares, the court will refer to the unauthorized disposition rule of Article 311 of the Civil Code. 

If the transferee claims that the third party is not acting in good faith, the court will consider a range of factors such as: 

• Whether the company maintained a shareholder register when the third party acquired the shares or established the pledge;
• Whether the transferee was recorded as a shareholder in the shareholder register;
• Whether the shareholder register record is consistent with the company registration; and
• Whether the third party inspected the shareholder register or company registration, and asked the company about the share transfer. 

In these circumstances, the court will support a request by a third party or the share transferee who has not legally acquired the shares or established a pledge for the transferor to bear liability for breach of contract based on the contract. The court will also support requests by the transferee that the directors or senior managers who are at fault for failing to promptly complete the change of registration bear liability for damages in the case that a third party acquires equity or pledge rights in good faith. However, the liability of the directors or senior managers at fault may be reduced if the transferee is found to have failed to promptly cooperate in completing the change of registration. 

Validity of shareholder register entries 

Article 42, a new provision, defines when entries in the shareholder register have legal effect and how courts should address inconsistencies among contracts, internal records, and registration filings.

The article first confirms that the court will not support a claim that a transfer agreement is invalid on the grounds that it violates provisions of the law in cases where the capital contribution obligations stipulated in an equity transfer agreement are inconsistent with those stipulated in Article 88 of the Company Law. This means that the provisions of an equity transfer agreement have a higher legal effect than those stipulated in Article 88 of the Company Law.

However, such an agreement cannot be asserted against the company or its creditors, and the court will not support a claim from a party that the relevant agreement has been approved by the company through a shareholders’ meeting or board resolution and asserts that they should bear liability according to this agreement. 

Equity transfer under subscribed capital contribution 

Article 43, a new provision, details how existing shareholders may exercise statutory preemptive rights when another shareholder transfers equity to a non-shareholder.

It clarifies that when a shareholder transfers equity that has not yet reached the capital contribution deadline, and the statutory grounds for acceleration of maturity have been met, the court will not support the company, company creditors, or other parties that request the transferor to bear liability or the transferor and transferee to bear joint and several liability within the scope of insufficient capital contribution, as stipulated in Article 88 of the Company Law. However, the court may organize the parties to fully examine and debate the application of law and related factual issues as the focus of the dispute, and then directly make a judgment in accordance with Article 88 of the Company Law. 

In the enforcement of monetary claims, if the applicant for enforcement applies to change or add the shareholder transferring equity that has not yet reached the capital contribution deadline as the judgment debtor, the court will reject the application for change or addition and inform the applicant to file a separate lawsuit. If the applicant is dissatisfied with the ruling, then they may apply to the higher-level court for reconsideration. However, a directly filed objection to enforcement will not be accepted. 

Equity transfer in cases of incomplete capital contribution 

Article 44, an amendment of Article 18 of the Company Law Judicial Interpretation (III), outlines the allocation of liability when equity is transferred before capital contributions have been fully paid, and clarifies how responsibility is determined in cases involving insufficient contributions or withdrawn capital.

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The article stipulates that where a shareholder transfers equity without fully fulfilling their capital contribution obligations, and the company, company creditors, or other parties request the transferor and transferee to bear joint and several liability for the insufficient capital contribution in accordance with Article 88 of the Company Law, the transferee bears the burden of proof if they assert a defense that they did not and could not have known that the transferor had failed to fully perform their capital contribution obligations. After assuming liability, the transferee may seek recourse from the transferring shareholder, unless otherwise agreed by the parties. 

The article further clarifies that where a shareholder transfers equity after withdrawing their capital contribution, the court will not support requests by the company, company creditors, or other parties for the transferee to bear joint and several liability under Article 88 of the Company Law.  

However, if the transferor and the responsible directors, supervisors, and senior managers are unable to compensate the company for losses caused by the withdrawal of capital, the court will support a claim by the company requiring the transferee, who knew of the withdrawal of capital, to bear supplementary compensation liability. If the company fails to assert its rights through litigation or arbitration, resulting in its creditors being unable to realize their due claims, the court will also support actions brought by the company’s creditors against the transferor, the responsible directors, supervisors, senior managers, and the transferee, with the company as a third party, seeking that the transferee bear supplementary compensation liability for their due unrealized claims. 

Shareholders’ waiver of the right to transfer equity 

Article 45, which is an amendment of Articles 18 and 20 of the Company Law Judicial Interpretation (III), adjusts principles from prior interpretations by addressing transfers where the actual transfer price differs from the price disclosed to shareholders. 

First, when a shareholder of an LLC transfers shares to a person other than a shareholder, and other shareholders claim the right to purchase the shares under the same conditions but then disagree with the transfer, the court shall not support the other shareholders’ request for preemptive rights, unless otherwise stipulated in the company’s AoA or agreed upon by all shareholders. 

When determining the “same conditions”, the court will consider a variety of factors, including the quantity, price, payment method, performance period of the share transfer, as well as other matters that constitute conditions of the transaction, such as loans or services provided by the transferor to the company, as evidenced by the transferring shareholder. 

Consequences for infringing preemptive rights 

Article 46, an amendment to Article 21 of the Company Law Judicial Interpretation (IV) revises earlier provisions by clarifying how preemptive rights apply when a shareholder’s equity is sold through judicial auction or enforcement. 

First, if a shareholder of an LLC transfers shares to a person other than a shareholder without notifying the other shareholders, or uses fraud, malicious collusion, or other means to impair the other shareholders’ preemptive rights, the court will support a claim by the other shareholders to purchase the shares under the same conditions. However, this does not apply in the following circumstances: 

1. Where the other shareholders have not asserted their preemptive rights within 30 days of the date they knew or should have known of the same conditions for exercising their preemptive rights;
2. Where the other shareholders have not asserted their right within one year from the date of the change of the shareholder register;
3. Where, if the company does not maintain a shareholder’s register, the other shareholders have not asserted their right within one year of the date of registration of the company’s change of registration. 

However, the court will not support claims in cases where the other shareholders only request confirmation that the share transfer contract is invalid, but do not also claim the right to purchase the shares under the same conditions, and still do not claim the right to purchase after the court has explained the situation. 

The court will support requests by the other shareholders for the transferor to bear liability for damages because their preemptive right has been infringed if the shareholders were unable to exercise their preemptive rights due to no fault of their own. The court will also support requests from the transferee for the transferor to bear liability for breach of contract based on the share transfer agreement if the transferee is unable to acquire shares due to other shareholders exercising their preemptive right. 

Preemptive rights in competitive contractual situations 

Article 47, an amendment of Article 22 of the Company Law Judicial Interpretation (IV), addresses the transfer of equity through competitive contracting methods.

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When transferring equity in an LLC to persons other than shareholders through competitive contracting methods such as auctions, issues concerning preemptive rights can be handled with reference to the relevant provisions of the Provisions of the Supreme People’s Court on Auctions and Sales of Property in Civil Enforcement by People’s Courts. The court will not support requests from other shareholders who did not participate in the auction or sale due to no fault of their own to exercise their preemptive rights. However, the court will support their requests for the transferor or auction institution at fault to bear liability for damages. 

No preemptive rights in non-listed joint-stock companies 

Article 48, a new provision, clarifies preemptive rights of shareholders in a non-listed joint-stock company.

Specifically, if a shareholder of a non-listed joint-stock company claims a  preemptive right against the transferor based on the provisions in the company’s AoA that other shareholders have the preemptive rights under the same conditions, the court will not support such a claim, unless the transferee knew or should have known of the provisions in the company’s AoA.