Classified share system post Company Law implementation

The new Company Law formally introduces a classified share system, allowing companies to issue shares with different rights and characteristics, such as preferred shares and special voting shares. This article compares pre-implementation practices with the new classified share system to provide insights.

Case studies of classified shares practice before the implementation of the new Company Law: A focus on special voting rights. Special voting rights can ensure that key shareholders maintain control over company management and shareholder meeting resolutions. Before the new law, listing rules had established provisions for such rights. For instance, the Shanghai Stock Exchange (SSE) Star Market Listing Rules outlined shareholder qualifications and voting rights.

Some listed companies had already adopted a classified share structure. For example, UCloud is the first company listed on China’s A-share market to adopt a differentiated voting rights arrangement structure. Its co-actual controllers hold class A shares, each with five times the voting power of class B shares.

After the issuance, the co-actual controllers hold 23.12% of the shares and 60.06% of the voting rights, giving them absolute control over company management and shareholder meeting resolutions.

Sichuan Huiyu Pharmaceutical, listed on the SSE Star Market, has its actual controller, Ding Zhao, holding class A shares, each with five times the voting power of class B shares. Post-issuance, Ding and his affiliates hold a total of 31.27% of the shares and 60.95% of the voting rights, enabling them to decisively influence both ordinary and special resolutions at shareholder meetings.

Jingwei Hirain, also listed on the SSE Star Market, has special voting shares, with each class A share carrying six times the voting power of class B shares. Following the issuance, the actual controller, directly and through an employee stock ownership platform, controls 44.36% of the shares and 62.24% of the voting rights.

Before the new Company Law, special voting shares were typically held by those significantly contributing to the company or by actual control entities. These shares could not be traded on the secondary market but could be transferred per exchange regulations. Special voting rights were limited in certain decisions, like amending articles of association or changing company structure, and had strong personal attributes.

Analysis of the classified shares system under the new Company Law. Article 144 of the new Company Law states: “A company may, as stipulated in its articles of association, issue the following classified shares with rights different from ordinary shares:

1. Shares with preferential or inferior rights to profit distribution or residual assets;
2. Shares with voting rights per share greater or lesser than those of ordinary shares;
3. Shares whose transfer is restricted by requiring the company’s consent; and
4. Other classes of shares prescribed by the State Council.

Companies with publicly traded shares may not issue shares specified in items (2) and (3) of the previous clause, except for those issued before the public offering. For companies issuing shares specified in item (2) of the first clause, the voting rights per share for the election and replacement of supervisors or audit committee members must be the same as those of ordinary shares.”

This provision clarifies the classified share system, covering dividend preference, liquidation preference, special voting rights and share transfer restrictions.

1. Dividend preference: shares with preferential profit distribution. Before the new law, the validity of dividend preference clauses was widely recognised, with common types including participating/non-participating preference shares, cumulative/non-cumulative preference shares, and fixed/floating rate preference shares.

   The new law clarifies the validity of dividend preference clauses, allowing companies to directly stipulate such terms in their articles of association. However, if these clauses are improperly stipulated, they may be deemed invalid.

2. Liquidation preference: shares with preferential distribution of residual assets. The new law stipulates that during the liquidation of a limited liability company, the residual assets are distributed according to the proportion of capital contributions by shareholders. In a joint-stock company, the distribution is based on the shareholding ratio. However, the law does not specify exceptions for provisions stated in the company’s articles of association or shareholder agreements.

   Regarding the effectiveness of liquidation preference clauses, article 144 of the new Company Law and article 72 of the Civil Code indicate that clauses agreed on in the company’s articles of association or by all shareholders are generally considered valid.

   Courts have also supported this view. Nonetheless, in practice, some liquidation committees might strictly adhere to shareholding ratios during compulsory liquidation processes, and further judicial interpretation is needed for specific guidance.

   Additionally, the revisions to the new Company Law do not affect “deemed liquidation” scenarios such as company mergers, since the company does not actually enter a liquidation process. These situations remain governed by shareholder agreements.

3. Special voting rights: shares with more or fewer votes per share than ordinary shares. Under the new law, listed companies are prohibited from issuing shares with special voting rights, except for those issued before listing. Special voting shares have the same voting power as ordinary shares in the election and replacement of supervisory or audit committee members.

   The new law does not, however, exempt other significant shareholder meeting resolutions, such as amending the articles of association or changes in capital, from this restriction, and further judicial interpretation is needed on this point.

4. Restrictions on share transfers: shares whose transfer requires company approval or are otherwise restricted. The regulations of the new Company Law regarding classified shares may include restrictions on transfers by the founding team or investors, other shareholders’ pre-emptive rights, lock-up periods and investors’ veto rights.

Common transfer restrictions encompass conditions such as transfer timelines, restrictions on transferees, transfer conditions, transfer prices and transfer quantities. The new law clearly permits the establishment of restricted shares.

The new law’s regulation of the classified shares provides greater flexibility in corporate financing strategies and control arrangements, meeting diverse investment needs. Companies should fully utilise this system, tailoring their equity structures to their specific situations, optimising capital and maximising corporate value.

Qiao Zhaoshu is a senior partner at DOCVIT Law Firm. DOCVIT associate Huang Zhaoyan and paralegal Miao Miao also contributed to the article.