Investment trust to acquire shares and capital of foreign investors under Vietnamese law

According to Article 26 of the Law on Investment 2020, the purchase of shares or capital of enterprises established in Vietnam is one of the investment forms for foreign investors. It can be said that the above investment form brings great convenience to foreign investors as they do not have to go through the procedures of obtaining the Investment Registration Certificate or opening a Direct Investment Capital Account ("DICA") compared to setting up a new company in Vietnam. At the same time, investing in a company already operating in the market also saves foreign investors time and resources in market research. However, when investing in Vietnam in this form, the foreign investor must comply with investment and foreign exchange procedures and market access conditions for foreign investors. To avoid such procedures and conditions, many foreign investors choose to appoint an individual or organization to purchase shares or capital in a Vietnamese company. In fact, such activities pose many risks to foreign investors.

1. Benefits of investment trust

This article only mentions investment trust in the purchase of shares or capital, which does not include other forms of investment trust, such as the establishment of companies or the purchase of securities on the stock market.

As mentioned above, investment trust creates a favorable condition for foreign investors. This is due to the Vietnamese laws that regulate the form of investment for the purchase of shares or capital by foreign investors as follows:

First, in terms of market access conditions for foreign investors. When choosing the investment form of acquiring shares or capital of a Vietnamese enterprise, foreign investors must examine the sector of the target enterprise to meet the market access conditions for foreign investors. In reality, there are many sectors in which foreign investors are not allowed to operate (e.g. services for the transfer of workers to work abroad under contract), or sectors in which foreign investors have limited ownership (e.g. for internal waterway transportation services, foreign investors are not allowed to own more than 49% of the capital in the joint venture), or have limited scope of operation (e. g. For example, foreign-invested pharmaceutical enterprises are not allowed to distribute drugs in Vietnam except for drugs produced by the enterprise itself), or must obtain a license to operate (e.g., foreign-invested enterprises must have a retail business license or a retail establishment license to engage in retail business). The above conditions are considered significant barriers to foreign investors' entry into the Vietnamese market in the above sectors.

Second, although the foreign investor is not required to obtain the Investment Registration Certificate, the foreign investor is still required to obtain the approval of the competent authority for the acquisition of shares or capital ("M&A approval") under certain circumstances, such as the acquisition of more than 50% of the shares of the target company. Although the M&A approval process takes less time than the investment registration certificate process, many foreign investors still find it difficult to make such investments.

Third, according to the current foreign exchange regulations, specifically Article 3.2.b.(i), Article 5.1.a, and Article 4.3 of Circular 06/2019/TT-NHNN on Foreign Exchange Management for Foreign Direct Investment Activities in Vietnam, if foreign investors purchase shares or capital contributions in the target company that increase the foreign ownership ratio in the target company to more than 51%[1], the target company becomes a foreign direct investment company. At that time, the target company must open a DICA, and foreign investors must pay for the purchase of shares and capital contributions to the DICA. Many investors and target companies often neglect this regulation, resulting in the payment transaction for the purchase of shares and contribution of capital not being properly carried out, and causing many difficulties and risks when carrying out capital transfer, profit transfer or capital withdrawal.

For the above reasons, many foreign investors have chosen to entrust an individual or organization in Vietnam to purchase shares or capital of a target enterprise. By choosing to entrust their investment, foreign investors can avoid the conditions and procedures applied to foreign investors.

2. Vietnamese law

Although foreign investment in the form of shareholding or capital acquisition has gradually become more popular today, the legal framework for such activities remains unclear under Vietnamese law.

In terms of foreign investors' investment trust, there are only regulations on foreign investors' indirect investment in the Vietnamese stock market in the form of entrustment of capital to securities fund management companies or the branch of securities fund management companies. However, the securities investment fund management company and the branch of the foreign investment fund management company in Vietnam receive entrusted capital from foreign investors, and investments in the stock market are made in the name of foreign-invested economic organizations[2], and are still subject to the regulations on foreign ownership ratio when investing in the Vietnamese stock market[3]. Therefore, in essence, this activity is not an investment trust mentioned in this article.

Although there is no clear regulation on investment trust, the 2015 Civil Code contains provisions on civil transactions that are invalid due to falsification[4]. Accordingly, (i) if the parties enter into a civil transaction to conceal another civil transaction, the falsified civil transaction is invalid and the concealed civil transaction is still valid, unless such transaction is also invalid under the provisions of the Civil Code or other relevant laws; and (ii) if a falsified civil transaction is entered into to evade obligations to a third party, such civil transaction is invalid. According to these provisions, if a foreign investor and a Vietnamese individual/organization enter into an agreement to record the entrustment of a Vietnamese individual/organization by a foreign investor to invest in Vietnam, the investment transactions of the individual/organization in Vietnam are still likely to be declared invalid if they rely on this provision. This is because the foreign investors' investment trust agreement is intended to help foreign investors avoid compliance with regulations and obligations with state agencies. However, based on our observation, there have been no cases where a foreign investor's investment trust agreement has been declared invalid by the Vietnamese court.

The unclear legal framework for investment trusts may result in a lack of legal grounds to protect foreign investors in the event of a dispute with the trustee or third parties.

3. Legal risks for foreign investors

Although investment trust takes the form of purchasing shares and capital of a target company in Vietnam, investment trust activities can pose many potential risks for foreign investors. Here are the potential risks:

First, foreign investors may lose control over investment activities. The only basis that binds the trustee to the foreign investor is the trust agreement. Therefore, if the trustee fails to comply with its obligations under the trust agreement, the foreign investor's rights and interests may be affected, for example, if the trustee fails to report to the foreign investor or fails to abide by the foreign investor's decision when making decisions in the target enterprise.

Second, disputes over the ownership of the investment amount. Normally, the investment trust can be terminated within a certain period of time when the trustee must transfer the purchased shares and contributed capital to the foreign investor (to officially become a shareholder or member of the target company) or transfer it to another party designated by the foreign investor to be able to recover the amount of money that foreign investors have invested. However, the risk at this stage is that the trustee does not comply with these agreements or the requirements of the foreign investors, but arbitrarily decides to continue the investment or transfer the capital to another third party. This leads to risks in the recovery of the foreign investors' capital. The same happens if the trustee does not pay profits to the foreign investors.

Third, the ownership dispute may arise in case of divorce or death of the trustee (if the trustee is an individual), dissolution or bankruptcy (if the trustee is an organization). When such events occur, the foreign investor may be involved in disputes not only with the trustee, but also with his spouse, heirs, creditors, etc. of the trustee.

In conclusion, foreign investors will face numerous challenges as mentioned above, including the lack of a legal framework to protect themselves when disputes arise with the trustees or other parties. Foreign investors must carefully consider the benefits of this activity and the potential risks that may arise. In order to minimize the risks, thorough due diligence of their partners as well as drafting strict and clear provisions in the trust agreement will be tasks to which foreign investors will need to pay special attention.

Read more at: Ủy thác mua cổ phần, phần vốn góp của nhà đầu tư nước ngoài và quy định của pháp luật Việt Nam