New Company Law offers exits for minority shareholders

By Yang Liqun, Zhilin Law Firm
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The new Company Law has protections for minority shareholders. If disputes arise between this group and a controlling shareholder, or a controlling shareholder suppresses the minority’s interests at management level, how can minority shareholders make an effective exit?

Share transfer

Share transfer is a way for shareholders to exit a company, allowing them to transfer their shares internally or externally. The new Company Law has streamlined the process of external share transfers.

Prior consent. Under the old company law, a shareholder should secure other shareholders’ written consent before transferring shares externally. Article 84 of the new Company Law has removed this requirement.

Yang Liqun, Zhilin Law Firm
Yang Liqun
Senior Counsel
Zhilin Law Firm

Notification, terms and conditions. Judicial disputes often arise regarding whether a transferor has fulfilled the notification obligation. This occurs when the transferor notifies other shareholders of the share transfer without disclosing the equal terms and conditions necessary for exercising the pre-emptive right, leading to legal action.

Article 84(2) of the new Company Law provides requirements for notification and equal terms and conditions. If a shareholder transfers shares to a non-shareholder, the transferor must notify other shareholders, in writing, of the volume, price, payment method and terms of the transfer. Other shareholders have a pre-emptive right to buy the shares under equal terms and conditions.

The new Company Law has standardised the notification procedure and its elements, facilitating the regulated and free flow of shares, and providing a clear basis for minority shareholders to transfer shares in compliance with regulations.

Share repurchase

The new Company Law allows dissenting shareholders to request a company to repurchase their shares if the controlling shareholder of a limited liability company abuses its rights. Article 74 of the existing Company Law outlines three circumstances where the dissenting shareholders can demand a share buyback:

  • When a profitable company fails to distribute profits to shareholders for five consecutive years despite meeting the criteria for profit distribution;
  • When a company undergoes a merger, split-up or transfer of main assets; and
  • When the business term of a company expires or any other cause of its dissolution arises, the shareholders’ meeting passes a resolution to amend the articles of association to keep the company in existence.

Despite these existing provisions, dissenting shareholders often struggle to exercise their repurchase rights. Minority shareholders typically have limited involvement in company management.

Controlling shareholders sometimes manipulate financial records to avoid profit distribution. Even when a company shows profits, it may fail to adopt a profit distribution resolution under pressure from the controlling shareholder. Minority shareholders also face difficulties in producing evidence of profitable but undistributed earnings.

The new Company Law grants minority shareholders the right to request a share buyback when controlling shareholders abuse their rights. Article 89(3) of the new Company Law specifies that if the controlling shareholder severely damages a company’s or other shareholders’ interests through abuse of rights, other shareholders can demand the company to acquire their shares at a fair price.

If a controlling shareholder illegally withdraws its capital contribution, transfers the company’s funds into the account of an affiliated company, or provides a guarantee for an affiliated company or the shareholder itself that severely impairs the interests of the company and other shareholders, other shareholders may request the company to acquire their shares at a fair price.

As there are no clear criteria for determining the abuse of shareholders’ rights in judicial practice, it is suggested that shareholders outline such circumstances in the articles of association, promptly exercise their rights to access and reproduce company data, retain evidence of misconduct by controlling shareholders, and initiate legal action if necessary.

Targeted capital reduction

Targeted-specific capital reduction is a method for shareholders or investors to exit a company, commonly used in such scenarios as private equity exit and equity incentives.

The new Company Law has established the doctrine of “proportional capital reduction as the principle, targeted-specific capital reduction as the exception”. Article 224 clarifies that the statutory condition for targeted-specific capital reduction of an LLC shall be the unanimous consent of shareholders or otherwise provided by law.

“Otherwise provided by law” generally refers to article 52(2) of the new law, which mandates that shareholders deprived of their rights must be able to transfer or reduce their registered capital and relinquish equity rights in accordance with the law.

As the new law stipulates more stringent legal consequences for illegal capital reduction, shareholders and responsible directors and supervisors shall also be liable to pay damages for losses to a company.

Therefore, if a shareholder decides to exit by way of targeted-specific capital reduction, the statutory procedures must be strictly followed. Specifically, the board of directors must formulate and submit a capital reduction plan to the shareholders’ meeting for a resolution by voting.

The result must be a unanimous consent of all shareholders, followed by preparation of the balance sheet and property list, notification of creditors, public announcement and debt pay-off or provision of guarantee.

Company dissolution

Shareholders holding more than 10% of a company’s voting rights, individually or collectively, may petition the people’s court for company dissolution when three conditions are met: Significant operational and managerial challenges; continued existence resulting in a substantial loss of shareholders’ interests; and no feasible resolution is available.

In legal practice, the determination of significant operational and managerial challenges typically involves a company’s inability to pass any valid resolutions at shareholders’ meetings for two consecutive years. Companies with no business activity, losses, or inclusion lists of entities with abnormal operations are unlikely to meet this criterion.

Controlling shareholders wield power over minority shareholders, enabling them to push through resolutions despite objections. It is challenging for minority shareholders to satisfy the “inability to pass valid resolutions for more than two consecutive years” when seeking company dissolution through litigation. Courts are also cautious in resolving disputes on company dissolution. As a result, minority shareholders face significant hurdles using company dissolution as an exit strategy.

Yang Liqun is a senior counsel at Zhilin Law Firm

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E-mail: liqun.yang@zhilinlaw.com
www.zhilinlaw.com

 

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