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1 Jun 2016

The Supreme People’s Court Issues the Fourth Draft Interpretation of the Company Law - Enhanced Protection of Shareholders’ Rights

On 12 April 2016, the Supreme People’s Court (“SPC”) released the Draft Provisions of the Supreme People's Court on Several Issues on the Application of the Company Law of the People’s Republic of China (IV) (“Draft”) for public comment.  The SPC has issued judicial interpretations on the Company Law of the People’s Republic of China (“Company Law”) on three previous occasions in 2006, 2008 and 2010, which were later amended and republished in 2014.

The Draft is relatively comprehensive, and includes 36 articles and five sections. Overall, it appears to focus on the protection of shareholders’ rights, and if adopted would significantly strengthen those rights. Below, we set out some of the more salient and significant provisions of the Draft. 

Consequences of Violations of Rights of First Refusal

Under the Draft, if a shareholder of a limited liability company infringes another shareholders’ rights of first refusal and transfers any equity subject to those rights to a third party, the transfer contract will be deemed invalid.  The Draft includes examples of such infringement, including procedural infringement (e.g., failing to notifying the other shareholders of the equity transfer) and substantive infringement (e.g., malicious collusion with a third party). Once the transfer contract is deemed invalid, the other shareholders of the company will be given an opportunity to purchase the equity according to the “actual trading terms” offered to the third person transferee. The Draft is unclear, however, on how a situation would be handled in which the rights of first refusal granted to the other shareholders provide for more (or less) favorable terms than the “actual trading terms” offered to the third party transferee.

The Draft further provides that the third-party transferee may only seek damages from the transferor, rather than specific performance, regardless of whether the transferee is a bona fide transferee acting without fault.

Derivative Actions May Apply to Wholly-owned Subsidiaries

Under the derivative action mechanism stipulated in the Company Law, in certain circumstances shareholders may bring a lawsuit against directors, supervisors and senior management of the company for conduct that infringes the company’s interests. The Draft further expands this right to allow shareholders to sue directors, supervisors or senior management of wholly owned subsidiaries for conduct that harms the wholly owned subsidiaries.

Similar judicial or statutory mechanisms exist in common law jurisdictions, but this requirement is not yet stipulated under Chinese law and will do much to strengthen shareholders’ rights and close a possible loophole for violating directors, supervisor and senior management. 

Obtaining Corporate Documents is an Intrinsic Shareholder Right

The Draft expressly stipulates that examination and reproduction of corporate documents is an intrinsic shareholder right; no restrictions on this right can be made via a company’s articles of association or any agreement between shareholders. This right is only limited by a prohibition on shareholders examining and reproducing corporate documents for an “improper purpose”. The Draft provides a non-exhaustive list of what constitutes an “improper purpose”.

In addition, the Draft makes clear that this right also covers supporting evidence relating to the company’s books and records, which can be examined by the shareholder or their authorized agents. Under the current Company Law, it is somewhat unclear on whether shareholders would be entitled to request and examine such supporting evidence if there was any suspicion regarding the authenticity of a company’s books and records. The Draft would close this potential gap.

Validity of Corporate Resolutions may Face More Challenges

The current Company Law sets out situations in which a resolution of a company’s Board of Shareholders (or the General Meeting of Shareholders) or the Board of Directors (together “Corporate Resolution”) should be deemed invalid or rescinded. The Draft expands and clarifies the legal causes of these situations, such as stating that a Corporate Resolution to conduct “significant improper affiliated transactions” that harm the interests of the company’s creditors will be deemed invalid. 

The Draft also clarifies that – in addition to a company’s shareholders, directors and supervisors – a company’s senior management, employees, creditors and other parties will have the right to request that a court confirm that a Company Resolution is invalid, non-existent or improperly made, so long as such parties have an interest in the applicable Company Resolution.

The Draft also expressly introduces preservation measures into cases of Corporate Resolution validity. For instance, in an emergency, the court may prohibit a Corporate Resolution from being implemented.  Under current judicial practice, such measures are rarely seen.

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