Preamble
Majority Rule is a fundamental principle in modern corporate governance, reflecting the democratic ethos of minority shareholders being bound by the majority in corporate law. While this ethos can enhance decision-making efficiency, it also engenders practical concerns about how best to protect the interests of minority shareholders. Due to their limited shareholding and voting power, minority shareholders often struggle to effectively participate in company management and decision-making, leading to potential violations of their rights.
The Company Law of the People’s Republic of China issued on December 29, 2023 (the “New Company Law”) enhances the protection of minority shareholders and provides more avenues for them to assert their rights as compared to the position under the Company Law currently in force (the “Current Company Law”). The new measures introduced include expanding shareholders’ rights to information, empowering minorities to propose initiatives, extending the right to buy back shares, and introducing the concept of a “Double-Derivative action”.
This article outlines the key changes in the New Company Law that aim to better safeguard the rights and interests of minority shareholders whilst striking an appropriate balance with corporate efficiency.
I. The New Company Law broadens shareholders’ rights to information
Shareholders’ access to company information is crucial for understanding the company’s operations and financial health, overseeing management, and making informed decisions that affect their rights and interests. The right to information is particularly important for minority shareholders, who are typically not involved in the day-to-day management of the company.
While the current Company Law already grants shareholders a right to information in both limited liability and joint-stock companies, the New Company Law expands upon this provision, making it more comprehensive.
i. The New Company Law broadens shareholder information rights for shareholders of limited liability companies
The Current Company Law states that shareholders in limited liability companies have the right to access the company’s accounting books. However, the New Company Law goes further by granting such shareholders access to accounting vouchers, which form the basis for the records entered into accounting books. This expansion of information rights allows shareholders in limited liability companies to access more detailed primary accounting information.
Furthermore, the New Company Law also stipulates that shareholders in limited liability companies have the right to access and make copies of the registry of shareholders, which is not a right granted under the Current Company Law.
ii. The New Company Law broadens the information right of shareholders in joint-stock limited companies
The New Company Law also expands the information rights of shareholders in joint-stock limited companies. The Current Company Law barely provides for the entitlement of shareholders of joint-stock limited companies to review company documents, whereas the New Company Law grants significantly greater information rights, including the right to copies of key documents. Such improvement provides an important safeguard for shareholders to access and store important documents, providing a means of holding management to account.
Under the Current Company Law, shareholders of joint-stock limited companies are not entitled to review accounting books and vouchers. However, the New Company Law prescribes that shareholders in joint-stock limited companies who have individually or collectively held more than 3% of the company’s shares for more than 180 consecutive days are entitled to the same rights as shareholders in limited liability companies to review company accounting books and vouchers This access to information better balances the rights of minority shareholders and the interests of the company, allowing minority shareholders to, at the very least, find out about the company’s performance and fiscal health.
Perhaps even more importantly, a joint-stock limited company’s articles of association can only stipulate a lower proportion of shares held by minority shareholders as the threshold to review accounting books and vouchers, . In other words, the joint-stock limited company’s articles may provide that persons holding 1.5% of the company’s shares for the requisite period of time may requisition information, but cannot raise the threshold. This important procedural safeguard demonstrates that while companies are usually granted a high degree of autonomy, controlling shareholders will not be permitted to effectively “contract-out” of the right minority shareholders in joint-stock limited companies to review information. Even provisions in the company’s articles of association will not suffice to abrogate that right.
iii. Right of shareholders in both limited liability companies and joint-stock limited companies to review and duplicate information pertaining to the company’s wholly-owned subsidiaries
Another noteworthy provision in the New Company Law is the newly prescribed right for shareholders in both limited liability companies and joint-stock limited companies to review and obtain copies of information pertaining to the company’s wholly-owned subsidiaries. This coheres with the newly-introduced Double-Derivative action under Article 189 of the New Company Law (as to which see below at Section V). Minority shareholders being entitled to information as to the operational and financial status of the company’s wholly-owned subsidiaries prevents the incorporation of subsidiaries from being used to obscure and obfuscate acts by the majority or management. This ability to procure information about subsidiaries would also assist in minority shareholders directly initiating Double-Derivative actions to safeguard the interests of the company’s wholly-owned subsidiaries.
iv. The New Company Law simplifies procedures for exercising shareholder information rights by not requiring the shareholder’s presence where third-party professionals are engaged to exercise the shareholder’s information rights
Article 10 of the Provisions (IV) of the Supreme People's Court on Several Issues concerning the Application of the Company Law of the People's Republic of China (“Judicial Interpretation of Company Law (IV)”) provides that when shareholders request to inspect company documents based on enforceable court judgments, accountants, lawyers, and other third-party professionals who are bound by confidentiality obligations under the law or professional codes of conduct may assist in the inspection process, but only in the presence of the shareholders.
However, the New Company Law allows shareholders to engage third-party professionals to exercise the shareholders’ information rights without the shareholders’ presence. This is significant in facilitating and simplifying the exercise of a shareholder’s information rights.
II. The New Company Law improves minority shareholders’ right to make proposals
The right to propose is of vital importance for participation in decision-making as to the company’s development and operation. This is especially so for minority shareholders, who can contribute their opinions on the company’s operations through exercising such a right.
Article 115 of the New Company Law lowers the minimum shareholding requirement for submitting interim proposals. The Current Company Law stipulates that shareholders must hold at least 3% or more of the company’s shares either individually or in aggregate before they may exercise the right to make proposals as to the company’s management. Under the New Company Law, the shareholding requirement is lowered to 1%.
In addition, the New Company Law further requires that the 1% statutory threshold may not be increased through provisions in the company’s articles of association. This serves to more fully protect minority shareholder’s right to make proposals.
III. The New Company Law expands the right to be bought out
If the rights and interests of minority shareholders have been significantly infringed upon in the course of the company’s operation, and trust between the shareholders has irretrievably broken down, Company Law often makes provision to assist minority shareholders in withdrawing from the company so as to avoid more serious damage. This withdrawal typically takes the form of a buyout, where either the majority shareholders or the company purchase the minority’s shares. Although the Current Company Law provides for the right to have one’s shares repurchased / bought out in limited liability companies, the enumerated situations where this right can be exercised may not fully cover the situations in which minority shareholders should have right to withdraw from the company.
The New Company Law provides solutions to this issue.
i. The New Company Law broadens the right to have one’s shares repurchased or bought out in limited liability companies
The New Company Law has augmented the right to have one’s shares repurchased or bought out for shareholders of limited liability companies. Article 89 of the New Company Law provides that “[w]here a controlling shareholder abuses its rights, causing serious harm to the interests of the company or other shareholders, other shareholders shall have the right to have the company repurchase their shares at reasonable price.” This right is of vital importance for minority shareholders to safeguard their interests and prevent minority oppression. Under the Current Company Law, when facing situations where controlling shareholders abuse their rights, the primary recourse for minority shareholders is to initiate a derivative lawsuit on behalf of the company. However, not only there are preconditions which need to be satisfied before initiating a derivative lawsuit, the relief for the minority shareholders is also indirect. The newly-introduced mechanism for dissenting shareholders to have their shares repurchased allows minority shareholders to recover the value of their property rights in the face of majority oppression. This broadens the recourse available to minority shareholders, and strengthens their negotiating position in the face of the majority.
In a nutshell, when faced with oppressive behavior by controlling shareholders, minority shareholders may choose to “vote with their feet” and apply to be bought out of the company.
ii. The New Company Law broadens the right to repurchase shares for dissenting shareholders in non-listed joint-stock limited companies
The Current Company Law prescribes only one situation under Article 142 for shareholders who dissent to a resolution in a shareholders’ meeting (“dissenting shareholders”) in joint-stock limited companies to exercise the right to have their shares repurchased. This is when “a shareholder objects to a resolution of the shareholders’ meeting on the combination or division of the company.” The New Company Law broadens the right to have one’s shares repurchased for dissenting shareholders in non-listed joint-stock limited companies, including situations where “a company that has made profits for five consecutive years fails to (a) distribute any dividends to the shareholders for 5 consecutive years and (b) conform to the profit distribution conditions as prescribed in the company law”; “the company is transferring major assets to others”; and “when the business term as specified in the articles of association expires or other reasons for dissolution as prescribed in the bylaws occur, but a shareholders’ meeting votes to have the company continue as a going concern by adopting a resolution to modify the articles of association”.
Furthermore, compared to the Current Company Law, the New Company Law prescribes in each statute related to the right to have one’s shares repurchased (Articles 89, 161, and 162) that the company should transfer or cancel the repurchased shares within a specified time period after the repurchase, so as to ensure the capital of the company is properly maintained.
IV. The New Company Law introduces “Double-Derivative actions”
The Current Company Law prescribes that in certain cases where directors, supervisors, or senior executives violate laws, administrative regulations, or the company’s articles of association, causing losses to the company, shareholders may lodge a derivative suit to protect the interests of the company. However, where controlling shareholders transfer a company’s operations and personnel to the said company’s wholly-owned subsidiaries such that it is the rights of the subsidiary which are infringed upon, minority shareholders may face hurdles in initiating derivative suits. To address this issue, the New Company Law introduces Double-Derivative actions, which allow a shareholder to directly commence a derivative action to protect the interests of a wholly-owned subsidiary.
The Double-Derivative action provided for under the New Company Law can help minority shareholders in situations where controlling shareholders turn the parent company into what is in effect a “shell firm”, transferring the company’s operational activities to wholly-owned subsidiaries. If the controlling shareholders, directors, supervisors, or senior executives of a wholly-owned subsidiary infringe on the legitimate rights and interests of the said subsidiary, minority shareholders of the parent company can “leapfrog” the parent company and directly initiate a Double-Derivative action in their own name to protect the interests of the subsidiary.
Conclusion
The New Company Law proactively responds to existing issues in practice by reinforcing and improving protections for minority shareholders. On one hand, the New Company Law enables minority shareholders to have a say in the operation and management of a company, thereby providing them with more opportunities to genuinely participate in decision-making. On the other hand, the new legislation grants minority shareholders more flexible mechanisms and a wider range of avenues to vindicate their rights. This dual approach contributes to further optimizing the balance of rights within a company and improving corporate governance.