On 25 August 2017 the Supreme People’s Court (“SPC”) of the People’s Republic of China (“PRC”) promulgated the Provisions of the Supreme People's Court on Several Issues Relating to Application of the PRC Company Law (IV) (“Interpretation IV”).
Interpretation IV has come into force on 1 September 2017. Interpretation IV focuses on five aspects, i.e. (1) validity of resolutions; (2) shareholder’s rights to review company documents; (3) distribution of profits; (4) pre-emptive rights of shareholders; (5) derivative actions. Interpretation IV aims at strengthening the protection of shareholders’ right and on corporate governance. Please find below information on the key aspects.
1. Validity of Resolutions
Article 1 to Article 6 of Interpretation IV deal with the validity of resolutions of the shareholders’ meeting (in limited liability companies), the shareholders’ general meeting (in companies limited by shares) and the board of directors (collectively “Resolutions”). According to Article 22 of the PRC Company Law, a Resolution can, under certain circumstances, be invalid (due to breach of law by its content) or revocable (due to procedural defects or breach of the Articles of Association by its content). The Interpretation IV introduces a third validity defect of a Resolution, i.e. so-called “non-existence”. Given the above, under PRC law a Resolution now may be invalidated under certain circumstances by claiming to be invalid, revocable or not existent.
According to Article 5 of the Interpretation IV, under any of the following four circumstances a Resolution may be declared by a People’s Court as not existent:
- if a Resolution is adopted without convening a meeting unless all shareholders unanimously agree to the Resolution in writing and all shareholders have duly signed and sealed the Resolution;
- if a Resolution is adopted at a meeting without voting on it;
- if the quorum of a meeting does not meet the requirements of the PRC Company Law or the Articles of Association of the company;
- if the voting result at the meeting does not reach the proportion stipulated in the PRC Company Law or the Articles of Association of a company.
(1) Who is entitled to file a petition to the court to confirm that a Resolution has a validity defect?
Article 1 of Interpretation IV stipulates that shareholders, directors and supervisors, etc. are entitled to initiate proceedings with the court to confirm that a Resolution is invalid or not existent.
Article 2 of the Interpretation IV further states that a shareholder is entitled to file a petition to the court to revoke a Resolution, provided that such shareholder still is a shareholder at the time of filing such petition.
However, it remains unclear whether any person other than shareholders, directors and supervisors can raise a claim to the court that a Resolution is invalid or not existent. The same applies to the question, whether directors and supervisors of a company can also file a petition to revoke a Resolution.
(2) Effect of Validity Defect on Bona Fide Third Parties
According to Article 6 of Interpretation IV, the contractual relationship with a bona fide third party based on a Resolution will not be affected if such Resolution is revoked or declared to be invalid by the court. However, not existent Resolutions are not included in this article. Therefore, the legal effect of a not existent Resolution on a bona fide third party remains unclear.
2. Shareholders’ Right to Review Company Documents Article 7 to Article 12 of Interpretation IV deal with shareholders’ rights to review company documents (“Shareholders’ Right to Know”). Shareholders’ Right to Know are already mentioned in the PRC Company Law (Article 33 and Article 97), which stipulate that a shareholder is entitled to review and copy certain company documents. According to the PRC Company Law, company documents refer to Articles of Association, shareholders’ name list, company bond registers, shareholders’ meeting minutes, board resolutions, resolutions of supervisors’ meetings and financial accounting reports.
(1) Can Shareholders’ Right to Know be waived by agreement?
Article 9 of the Interpretation IV confirms that Shareholders’ Right to Know are mandatory statutory rights stipulated in the PRC Company Law, and thus, cannot be deprived or waived by clauses in the Shareholders’ Agreement or Articles of Association.
(2) Can the company refuse to provide documents to the shareholder?
According to Article 9 of Interpretation IV, where a limited liability company has evidence to prove the occurrence of any of the following circumstances, the People's Court shall rule that the shareholder pursues the "improper purposes" as provided in paragraph 2 of Article 33 of the PRC Company Law and the company can refuse to provide the requested information:
- The shareholder owns or operates for others a business that is substantially competitive with the major business of the company, unless otherwise provided or otherwise agreed with all shareholders;
- The shareholder wants to inspect the accounting books of the company in order to inform third parties of the relevant information which may damage the legitimate interests of the company;
- The shareholder, within the previous 3 years of requesting to inspect company's documents, through the means of inspecting the accounting books of the company, has informed third parties of the information in violation of the lawful interests of the company; or
- The shareholder pursue other improper purposes.
(3) Responsibility of directors and senior managers on formulation and keeping of company documents
According to Article 12 of Interpretation IV, in case directors or senior managers of a company fail to perform their duties to formulate and keep company documents and, thus, cause any losses to a shareholder, such shareholder is entitled to file a lawsuit against the relevant directors and senior managers for compensation.
(4) Can accounting vouchers and underlying records be accessed by the shareholders?
Accounting vouchers and underlying records are not included in the company documents that are open to the shareholders according to the PRC Company Law. The draft of Interpretation IV for public opinion stipulated that such documents can be accessed by the shareholders of a limited liability company. The formally promulgated Interpretation IV no longer contains such stipulations. Thus, in practice, whether accounting vouchers and underlying records are open to the shareholders is still disputable.
3. Distribution of Profit Article 13 to Article 15 of Interpretation IV deal with distribution of profit. According to Article 14 and Article 15 of Interpretation IV, a shareholder who files a lawsuit for distributing profit shall bear the burden of proof and submit the resolution of the shareholders’ meeting containing the profit distribution plan to the court. Otherwise, the court will not uphold the shareholder’s claim unless other shareholders abuse their rights to cease distributing profit and cause damages to that shareholder.
4. Pre-emptive Rights of Shareholder
Article 16 to Article 22 of Interpretation IV deal with share transfers, especially the pre-emptive right of shareholder during a share transfer.
(1) Definition of “same conditions” of the pre-emptive right
According to the PRC Company Law, if a shareholder of a limited liability company intends to transfer its shares to a third party, the other shareholders have a pre-emptive right under the same conditions. Article 18 of the Interpretation IV stipulates that the term “same conditions” in the PRC Company Law shall take reference to the conditions of quantity, price, payment method and payment term, etc. of the share transfer.
(2) Term to exercise the pre-emptive right
The PRC Company Law does not contain stipulations as to the term during which a pre-emptive right can be exercised. According to Article 19 of Interpretation IV, after receiving the notice of share transfer, shareholders who wish to exercise their pre-emptive right shall do so within the term as stipulated in the Articles of Association of the company first. If the Articles of Association do not contain such term or the stipulation of the term is not clear, then the term shall be subject to the stipulation in the notice. If the term stipulated in the notice is shorter than 30 days or is not clear, the term to exercise the preemptive right shall be 30 days after receipt of the notice.
(3) Revocation of share transfer intention after other shareholders have exercised the pre-emptive right
A frequent question in legal practice is whether the transferor is still entitled to revoke his intention of share transfer after other shareholders exercised their pre-emptive right. Article 20 of Interpretation IV now confirms that unless otherwise agreed by all shareholders or stipulated in the Articles of Association, the transferor can still decide not to transfer the shares after other shareholders have exercised their pre-emptive right. However, in such case, the transferor shall compensate any reasonable losses of the other shareholders, if required by them.
5. Derivative Actions
Article 23 to Article 26 of Interpretation IV deal with the derivative actions. Derivative actions aim at protecting the right of minority shareholders. They are originally stipulated in Article 151 of the PRC Company Law. The concept is that minority shareholders under certain circumstances are entitled to require the board of directors (or executive director) or the board of supervisors (or supervisor) to initiate a lawsuit against a director or senior manager who violated his/her duty and caused damages to the company, or may even initiate such lawsuit directly on his/her own behalf to protect the interest of the company if the board of directors (or executive director) or the board of supervisors (or supervisor) refuses his/her request.
Article 23 to Article 26 of Interpretation IV focus on the legal procedures for derivative actions and their consequences to both the company and the minority shareholders, if the minority shareholders initiate a lawsuit directly on his/her own behalf. If a minority shareholder initiates a lawsuit directly on their own behalf, the benefits resulting from winning the lawsuit will belong to the company, and not to the minority shareholder. However, in that case, reasonable costs of the lawsuit shall be undertaken by the company.
In China, the SPC is entitled to supplement statutory regulations through formal interpretations. Often, stipulations contained in laws and regulations are vague or incomplete so that the interpretations of the SPC considerably help to interpret the law and to avoid disputes. This also applies for Interpretation IV. A number of frequent questions referring to shareholders’ rights and corporate governance issues have now been clarified.