Shareholder oppression describes a situation where majority stakeholders use their position to exclude and take advantage of other shareholders to prevent them from properly participating in the management of a business, or from receiving a reasonable return on investment through such means as dividend distribution, personnel appointment and removal, and compensation policies.
Principle of fairness
The key to company governance is autonomy of shareholders, and in the field of private law, public power should not intervene arbitrarily when there is no prohibition in law. But private rights cannot operate normally without the protection of public power. When the contradictions between private subjects cannot be resolved through fair negotiation, public power must intervene and mediate to achieve the value of fairness. Otherwise, it would harm public interest and public order.
Therefore, the Civil Code stipulates that civil legal acts that are obviously unfair, or made by fraud or coercion, are revocable, and that civil legal acts made under malicious collusion, and in violation of the mandatory provisions of laws and administrative regulations, or against public order and morality, are invalid.
But “fairness” is still a relatively abstract concept, and in judicial practice it can prove impossible to determine shareholder oppression, because it is difficult to accurately grasp the boundaries of obvious unfairness and malicious collusion. It requires not only the legal knowledge of legal professionals, but also that the legal professionals grasp the shareholders’ real intentions through the details of cases.
The principle of reasonable expectation refers to the shareholders’ expectation of their investment returns, remuneration, positions, benefits, obligations and responsibilities based on the provisions of the articles of association, agreements, as well as business rules and rational judgement.
The principle of reasonable expectation contains two meanings. First, the articles of association or agreement set obligations and responsibilities for shareholders, and such obligations and responsibilities need to be clearly and explicitly expressed; otherwise, shareholders cannot be arbitrarily required to perform additional obligations or assume additional responsibilities. Second, the articles of association or agreement set the rights of shareholders. Such setting should be observed, and shareholders cannot be arbitrarily deprived of their rights.
The principle of proportionality requires that purposes fit means. It is a concept in administrative law, but is broadly adopted in corporate resolution disputes. Resolutions made under the oppression of shareholders are often reflected in the arrangement of the rights and obligations of minority shareholders by the resolution of the majority shareholder, which is disproportionate to the so-called “purpose” to be achieved.
The principles of proportionality and reasonable expectations have close relationships in corporate resolution disputes. When the resolution is against the principle of proportionality, it also means that it is hard for shareholders to achieve their reasonable expectations. Compared with the principle of fairness, the principles of proportionality and reasonable expectation are more applicable means to determine shareholder oppression.
For example, examine the logic of how to determine shareholder oppression in the case of a corporate resolution requiring stakeholders to make early completion of their capital contributions. Under normal circumstances, based on the rules of articles of association, shareholders have reasonable expectations with regard to the time for capital contribution.
However, the law does not forbid a company from amending the contribution time, and the company has the right to ask shareholders to contribute capital in advance according to its business needs. But this does not mean that majority shareholders can abuse voting rights and amend the time to contribute capital at will. It will constitute shareholder oppression if the demand is not based on a reasonable business purpose or the purpose and the means are not in proper proportion.
Fiduciary duty means the duty of loyalty and care based on others’ trust. Given that the majority shareholders have the advantage in voting rights, they can appoint and remove directors, supervisors, and senior executives, and because directors, supervisors, and senior executives usually represent the interests of their appointers, the majority shareholders generally become the actual decision makers in a company’s operational management. Thus, it is reasonable to impose a fiduciary duty on the majority shareholders when exercising voting rights. Moreover, it is common for the majority shareholders of a limited liability company to be directors and chairman of the board.
Since the Company Law does not provide for the fiduciary duty of the majority shareholder, in practice, when it comes to the situation that the majority shareholder violates their fiduciary duty to the detriment of other shareholders or the interests of the company, the court usually applies articles 20.1 and 20.2 of the Company Law to decide a case, and some company resolution disputes even are decided according to articles 47, 48 and 49.
Therefore, if a dispute over a corporate resolution involves shareholder oppression, in addition to article 22 of the Company Law, other legal provisions can also be applied in a comprehensive manner to judge the validity of the resolution.
In the case of a dispute over the existence of shareholder oppression, the plaintiff should first claim that the majority shareholder has abused voting rights, violated fiduciary duties, and that the content of the resolution is unreasonable. The majority shareholder should prove that their actions have a reasonable commercial purpose. If the majority shareholder is unable to provide a reasonable explanation, the court can determine that the behaviour is oppressive, so as to make a judgment on the effectiveness of the company’s resolution.
As a rational investor, we should take into account both prevention and remedy, and make good use of the design of shareholders’ agreements and articles of incorporation to achieve a balance of interests, such as the terms of capital contributions, capital increases, and other important matters. Careful design of provisions can avoid improper modification by majority shareholders. Another example is to ensure a smooth option to exit a company in case of shareholder oppression by setting a reasonable mechanism to govern share repurchases.
Yang Chaonan is a partner and He Jiaxin is an associate at ETR Law Firm
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