After years of effort and preparation, the PRC Supreme People’s Court finally published the 4th interpretation on the Company Law (Interpretation) on 25 August 2017. The Interpretation mainly aims at strengthening protection for shareholders, promoting corporate governance in PRC companies, fostering a stable and transparent environment for investment, as well as improving the mechanism for resolving the increasing number of disputes relating to corporate governance and shareholder rights. The Interpretation primarily covers five areas, namely: (i) validity of resolutions: (ii) shareholders’ information and inspection rights; (iii) profit distribution; (iv) pre-emptive rights; and (v) shareholders’ derivative actions. The Interpretation took effect on 1 September 2017.
Validity of resolutions
Under the Company Law, defects in company resolutions may result in the resolutions being invalid or revocable. The Interpretation, for the first time, introduces the concept that a resolution can be “not established”, for example where the meeting was not held, quorum was not met, attendees did not vote on the proposed items, or the voting result did not achieve the required approval threshold under the Company Law or articles of association of the company. This will provide an additional ground to challenge the validity of a resolution where there is a dispute.
The Interpretation also clarifies that the company’s shareholders, directors and supervisors can bring a claim that a shareholder or board resolution is invalid or not established. This is a change from the draft Interpretation where senior management, employees and creditors were previously proposed to be able to bring such claims.
To prevent abuse, if there are only slight procedural defects to a resolution in convening procedure or voting manner which have no substantial effect, a court will not support a claim to revoke a resolution. Similarly, the rights of bona fide third parties dealing with a company are protected. Bona fide civil relationships formed with a company on the basis of a resolution will not be affected if a resolution is subsequently held to be invalid or revoked.
Shareholders’ information and inspection rights
The Interpretation reaffirms the protection on shareholders’ information and inspection rights and provides greater details to strengthen such rights, such as:
a company’s articles of association or shareholders’ agreement cannot substantially deprive a shareholder of its information and inspection rights;
shareholders may engage accountants, lawyers or other intermediaries to inspect the company’s documents; and
shareholders may claim damages against the directors or senior management responsible for performing relevant obligations where their actions cause the company failed to prepare relevant corporate governance documents or well store relevant corporate governance documents thus caused losses to the shareholders.
That said, the Interpretation also provides for circumstances where a company may reject a shareholder’s inspection request where it is for “improper purposes”. Such circumstances include a shareholder operates a competing business, or is seeking information intending to provide it to third parties which may damage the company’s legitimate interests.
The Supreme People’s Court takes that view that the decision as to whether to distribute profits should sit with the company exercising its own business judgment and autonomy. The Interpretation provides that the court will generally reject a shareholder’s request for the company to distribute profits absent a valid shareholders’ resolution authorising it. However, to balance the interests of minority shareholders and to prevent abuse by a controlling shareholder, the Interpretation provides that a shareholder may claim for distributing profits where failure to distribute profits results from an abuse of other shareholders’ rights which causes losses to such shareholder.
The general principles of pre-emptive rights in equity transfers are set out in the Company Law. The Interpretation sets out more detailed guidance on the exercise procedures and rules. For example:
the transferring shareholder can notify other shareholders of the terms of the proposed equity transfer in writing or other reasonable ways where receipt can be confirmed, which provides more flexibility and efficiency to the notification process;
the timeframe for exercising pre-emptive rights shall be as prescribed by the articles of association of the company, (absent any requirement under the articles of association) the terms specified in the notice, or (absent any requirement under the notice or the notice provides less than 30-day timeframe, by default) 30 days; and
shareholders must be offered the “same terms” which should take into account of the amount, price, payment method and payment term of the transferred equity interest.
The Interpretation sets limits on the operation of pre-emptive rights. Unless the articles of association specifies otherwise, where a transferring shareholder later on changes its mind and refuses to transfer its shares after other shareholder(s) have exercised their pre-emptive rights, the other shareholder(s) cannot force the transfer but can seek compensation from the transferring shareholder in default for reasonable losses resulting from the transferring shareholder’s withdrawal of the transfer.
The Interpretation also provides remedies where pre-emptive procedures are not complied with. If the transferring shareholder transfers its equity interest to a third party without consulting other shareholders on pre-emptive right or where shareholders’ pre-emptive rights are prejudiced by way of fraud or malicious collusion, the other shareholders may request for purchase of the transferred equity interest under the same terms (subject to certain time periods). The third party transferee of the equity interest is entitled to claim damages from the transferring shareholders.
Shareholders’ derivative actions
The Interpretation clarifies that if supervisors claim against directors or senior management for breach of obligations, the company shall be the plaintiff, with the supervisors handling the litigation on the company’s behalf. The same principle applies to a director claiming against the supervisors for breach of their obligations, that is, the company shall be the plaintiff, with the director handling the litigation on the company’s behalf.
The Interpretation also provides further guidance on aspects such as the rights of parties in shareholders’ derivative actions, title to the benefits of the prevailing party and litigation cost.
The Interpretation provides further clarification and guidance on various aspects of disputes among shareholders and corporate governance from both substantive and procedural perspectives. It embraces several innovative systems and principles as well as experience from China and abroad. The Interpretation also strengthens protection for minority shareholders.
There remains, however, lots of issues and ambiguities which still need to be addressed. For example, with respect to the validity of resolutions, the grounds for resolutions to be “revocable” under the Company Law and the grounds for resolutions to be “not established” under the Interpretation are largely similar. This raises the questions as to how to differentiate the two grounds in practice and how to resolve any conflicts when applying the two grounds.
With respect to shareholders’ information and inspection rights, shareholders may claim damages against the company’s directors or senior management responsible for performing relevant obligations where their actions have caused losses to the shareholders. However, in practice, minority shareholders would have difficulty in proving the losses they have actually suffered without getting access to the company’s documents.
Similarly, although the Interpretation sets out a new principle that a shareholder is entitled to claim that a failure to distribute profits is an abuse of shareholders’ rights where it causes losses to other shareholders, in the absence of implementing rules on what constitutes “abuse” and the definition of “losses”, there are practical difficulties and considerable challenges for shareholders (particularly minority shareholders) to establish a claim for forced profit distribution.
We expect further clarification to be made through future judicial practice.