Legal Provisions and Risk Prevention ofthe Related Party Transaction in the U.S.

I. Definition and Classifications of Related Party Transaction

TheRelated Party Transaction is a kind of business transaction or arrangement between two parties who are joined by a special relationship prior to the deal. TheFinancial Accounting Standard Board of United Sates (FASB) and US Securities and Exchange Commission (SEC)defined the related party transaction as the transaction between the company and its directors, executives, shareholders and other interest-related parties or its affiliates. In theory and in practice, Related Party Transactions are mainly classified as follows:

1.1 Fair Related Party Transaction and Non-fair Related Party Transaction

Fair Related Party Transaction refers to the substance content of a specific related party transactionmainly concentrated to the result of the transaction which is fair and reasonable to the relevant stakeholders of the transaction, especially to the non-related parties involved in the transaction. Non-fair Related Party Transaction refers to the substance content of a specific related party transaction mainly concentrated to the result of the transaction which is unfair and detrimental to the transaction related rights and interests of persons,especially to the non-related parties involved in the transaction.

This is the most common kind of classification, because non-fairness is one of the most likely occurring issue and the main reason to be regulated. With proper legal regulation, the positive role of fair related party transaction will be guaranteed, and the non-fair related party transaction parties shall take certain responsibilities as well as provide victims certain relief.

1.2 Actual Related Party Transaction and Fictitious Related Party Transaction

Actual Related Party Transaction refers to the really happened related party transaction in the economic life or company’s operation.Fictitious Related PartyTransaction refers to the related party transaction which has not actually happened in the economic activities or company’s activities, merely contained in the fictitious documents and has been recorded in the companies’ financial statements.

The meaning of this kind of classification lies in the adjustment of accounting statements. In fact, some companies have invented some related party transactions that have not actually happened just in order to whitewash company’s performance.

1.3  Material Related Party Transaction and Non-materialRelated Party Transaction

This kind of classification is generally based on the total transaction amounts, and its main purpose is to apply different requirements when carry out disclosure and approval procedures etc. For instance, some odd lot related party transactions can be approved without the general meeting procedure, and some odd lot related party transactions do not need to be disclosed; and, there are different disclosure requirements between the non-material related party transactions and material related party transactions of the listed companies.

The related party transaction may cause the transaction price, method, etc. under the unfair situation, violating the interests of shareholders and damaging the interests of creditors. Therefore, lots of national laws such as US federal laws have specific provisions on related party transactions.

II.  Legal Regulations of Related Parties and Related Party Transaction in the US

Related PartyTransactionis a common occurrence in business transactions. While this type of transaction is legally and morally right, the special relationship between the related parties will createpotential conflicts of interest.Related party transactionmust be regulated, because they may harm shareholders’ equity. The Statement of Financial Accounting Standards of SAFB, the Securities Act of 1933 andthe Securities Exchange Act of 1934 etc. regulated the related party transactions as follows:

1.1 Related Parties and Related Party Transaction

(1) Related Parties

Pursuant to Statement of Financial Accounting Standards No. 57, the “related parties”include: (a) affiliates of the company; (b) entities for which investments are accounted for by the equity method by the company; (c) trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of management; (d) principal owners of the company; (e) its management; (f) members of the immediate families of principal owners of the company and its management; and (g) other parties with which the company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests. Another party also is a related party if it can significantly influence the management or operating policies of the transacting parties or if it has an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests.

(2) Related Party Transaction

Pursuant to the FASB, related party transactions include transactions between(a) a parent company and its subsidiaries; (b) subsidiaries of a common parent; (c) an company and trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of the company's management; (d) an company and its principal owners, management, or members of their immediate families; and (e) affiliates.

In addition to the above provisions for related parties and related party transactions, the US has also developed a number of regulatory procedures to ensure that the related party transactions do not conflict or affect the interests of shareholders.

1.2.Tax ReportingRequirementsand Disclosures Requirements

(1) Tax Report Obligations

The US Internal Revenue Service (IRS) requires companies to file Form 5472 - Information Return of a 25% Foreign-Owned U.S. Corporationor a Foreign Corporation Engaged in a U.S. Trade or Business, in order to provide informationrequired under sections 6038A and 6038C of Internal Revenue Codewhen reportable transactions occur duringthe tax year of a reporting corporation witha foreign or domestic related party.

IRS also stipulates that if the reporting company and foreign related partieshave non-monetary transactions, the content and process of the transactions shall be written in detail. If the inventory price is higher than the customs valuation when purchasing goods from foreign related parties, the reporting company shall calculate the differenceamount and specify overestimation reasons, in order to avoid the profits retained in foreign related parties.

(2) Listed Companies’ Disclosures Obligations

The Securities Act of 1933 and the Securities Exchange Act of 1934 stipulated that if a company has transacted with a listed related party in the previous fiscal year , and the transactionamountwas more than $120,000, the companyshall disclose and state the following information in company’s registration table, appointment table and other non-financial statements: the listed related parties’ name, the related status, holding rights (including the position, relations, rights in the company and other information), the estimated amount of transactions and other important information relating to the transaction or related parties.

US law requires listed companies to disclose all transactions with executives, partners and their families and other stakeholders in the annual report, if companies fail totimely, accurately and completely disclose, they will be punished by the SEC. As a result of the increased reporting requirements, many companies have established special policies and compliance procedures to ensure that the transactions are properly recorded and disclosed.

III.  Risk Prevention of Related Party Transactions in the US

In the US, the related party transactions between the non-listed companies shall mainly commit the accounting standards for audit and tax reporting obligations, and have no other clear illegal elements; and the listed companies shall timely and accurately complete disclosure obligations according to the SEC requirements; Except for the aforesaid obligations, the related party transactions shall also comply with the banking regulatory obligations and some special provisions upon the energy companies.In addition, due to the nature and characteristics of related party transactions, companies shall also pay attention to guard against the following risks:

1. Business Operational Risks

Transactions between the related parties can easily affect the normal operation of the company: unreasonablepricing will lead to profit transfer; delay checkout will lead to the occupation of funds and waste of resource; unauthorized changes to the rights and obligations clause in the related party transaction agreement will result in a risk of unclear liability and so on.

To prevent such business operational risks,companies shalltighten the screws to define and control the related partiesin the internal control of the related party transactions; and strictly prohibit unauthorized change of the transaction agreement items to prevent related parties or false related parties occupy or transfer company’s resources.

2. Financial Risks

When carry out related party transactions,companiesbarely record and account the related itemsseparately, alternatively, the financial department of companies often recordsthese items in advance or fails to timely record, which will cause the related partiesidentity confusion and records lackingor missing, then lead to the statistical accounting bias, financial accounting distortion, inaccuratedisclosure and other financial risks.

Companies shall establish the accurate related partytransactions files and accounts, check the accounts with the related parties on a regular basis, and report the accounting statements of related party transactions in a timely and accurate manner.The accounting records and price implementation mechanism of related partytransactions shall be accurate and appropriate; the successive examination and approval system and the general meeting of shareholders and the board ofdirectorsdeliberation system shall be established to ensure fairprices,accurate financial accounting, and true disclosure.

3. Compliance Risks

The unclear property rights relationship or investment relationship between the related parties will result in profitsdrainage, damage the shareholders’ equity, and lead to litigations against the companies, the directors and senior executives. Related party transaction irregularities and audit loopholes will cause companies to be punished by regulatory authorities, then the companies will face economic and credibilitylosses.The lack of trading contracts or the irregularcontracts andthe negligence of the contract laws and the internal rules and regulations, will result in the lack of evidence when the company suffers fraud or error, and will have no compensationrecourse.

Companiesshall verify the background and identity of the transaction parties regularly, and require the directors, senior executives, shareholders, and key customers to submit the related party declaration to demonstrate the relationship with the companies; and the shareholders can use their checks and balances rights to regulate the related party transactions, such as the independent director system andthe related shareholders’votingwithdrawing system.

In conclusion, the US companies shallcomply with the tax reporting requirements and the listed company’s disclosure requirements to avoid SEC’s entanglement; at the same time, companies shall also try best to prevent the business operationrisk, financial risk and compliance risk. To avoid risks and prevent problems in business operations andloss of assets caused by improperly related party transactions, it is bestto hire professional lawyers for companies to provide legal advice in the daily business and business negotiations.

美国 WK 国际律师事务所

The WK Law Firm（“WK”）于1984年在美国成立，总部位于纽约曼哈顿中城747大厦，并在中国设有代表处，主要从事跨境并购、银行业务、国际贸易、国际商业诉讼与仲裁等法律业务。WK 代表许多国际著名企业，例如：海航集团、中国建筑、威特集团、中国人民保险公司、中华航空公司、美林公司、 JPMORGAN、 HSBC、交通银行、中国银行、中华嘉华银行、东亚银行、大华银行、国泰银行、国际银行等。

WK首席代表吴异军（Allen Wu）先生是常春藤宾州大学法学博士、艾利斯岛杰出移民奖章得主、共和党亚裔总党部执行主席、亚太总裁协会全球副主席、中国国际经济贸易仲裁委员会仲裁员。作为知名中美贸易投资专家，吴律师在美国主流社会法、政、商界均享有良好声誉及知名度。吴律师在跨境投资、国际贸易，及商业诉讼领域有超过30年的专业经验，近年来，吴律师与其精英团队协助客户成功完成了多项重大标志性收购项目，受到业界广泛认可与关注。

WK中国代表处律师赵姝女士（Alice Chao）毕业于中国政法大学，擅长跨境并购、国际贸易、争议解决、资本市场等业务。多次协助客户成功完成大型跨境并购项目，长期担任中美跨国企业项目顾问。

业务联系：alice.chao@wklaw747.com