Validity of shareholders’ agreements and articles of association

By Yang Chaonan, ETR Law Firm

Shareholders’ agreements and the articles of association are in a specific sequence along the timeline of the establishment and operation of a company. Before a company is incorporated, the shareholders conclude the agreement and commence on the establishment of the company based on this, while the articles are signed and filed with the registration authority when the company is being established, setting out guidelines for the operation of the company and the behaviours of related parties.

Yang Chaonan ETR Law Firm shareholders agreements
Yang Chaonan
ETR Law Firm

Noteworthy is that although the articles are signed later, they do not necessarily supersede the agreement in validity, and it is inappropriate to deem that the incorporation of the company ends the validity of the agreement. Regarding issues neither performed nor included in the articles, the agreement shall be construed to remain in force to the signing parties and serve as a legal basis for the resolution of relating disputes.

In terms of the range of validity, as per the Company Law, the articles bind the company, shareholders, directors, supervisors and senior officers, but the agreement is a voluntary contract between and among the shareholders, and follows the principle of privity, which means it is only effective among the signing parties.

Searching by keywords “articles of association”, the author has retrieved 41 judgements pertaining to the articles from cases concluded by the Guangdong High People’s Court in 2018, with 20% being attributable to disputes arising out of differences between the agreement and the articles.

There are three types of disputes. The first and the most common, accounting for 50%, is that the agreement conflicts with the articles on the same issue. The second, which represents 37%, is that some issues are covered in the agreement but not in the articles. The question at stake is whether the provisions of the agreement can be applied alongside the articles when the company is already incorporated and the articles have taken effect. In practice, the validity of the agreement shall be analysed case by case. The third type is that the articles have provided for specific issues, which the agreement has not. This type is relatively insignificant, accounting for only 13% of cases.

The author observes that, in these cases, when the agreement conflicts with the articles, provided that the agreement is legally binding, the first step is to see whether the signing parties have agreed upon how to deal with the difference, e.g., whether there is a clause stating that “this agreement shall prevail in the case of a conflict between this agreement and any other documents”. Such an agreement, if any, will be followed. Otherwise, the resolutions of the three types of disputes are as follows.

Where the agreement conflicts with the articles on the same issue, if the shareholders involved have signed the articles, then the articles shall be deemed as the genuine declaration of intent, and bind the shareholders. The articles have the effect of changing the provisions of the agreement.

However, if the shareholders have raised explicit objection to the articles when passing them, and the dispute relates to the changes to shareholders’ important rights or obligations – such as the time limit of the contribution of capital, the amount of contribution capital, or the distribution of profits – then the changes embodied in the articles are void and the agreement should be followed.

In a case where there is an issue covered in the agreement but not in the articles, considering that the validity of the agreement does not end with the establishment of the company, the shareholders still need to comply with it, and the observant party has the right to demand performance of obligation from other shareholders. The court will not support claims that the performance shall be rescinded because the underlying obligation is not stated in the articles in the case that the obligation has already been fulfilled.

If the articles have provided for specific issues that the agreement has not, the preceding rules apply, which means the majority shareholders shall not abuse their dominance in prejudice of the rights and interests of minority shareholders. The articles undoubtedly bind upon and shall be complied with by the shareholders.

To prevent any potential disputes arising in connection with the differences between the agreement and the articles, investors are recommended to keep the following tips in mind when concluding the agreement and preparing the articles.

First, make every effort to keep the agreement consistent with the articles, or take advantage of a special provision or miscellaneous clause in case of any conflict between them, e.g., a clause stating: “This agreement shall prevail in the case of a conflict between the agreement and the articles of association.”

Second, to avoid any disputes in a situation where specific provisions only exist in the articles but not in the agreement, it is recommended that all of the shareholders who have participated in the conclusion of the agreement are required to sign the articles to make it a genuine declaration of intent of the shareholders, so that the articles are effective and valid beyond question.

Third, take advantage of the clause of “unanimous consent of all shareholders”. To provide that any resolution addressing the rights and interests of shareholders “shall be subject to unanimous consent of all shareholders” when formulating the articles will, on one hand, make both the articles and agreement genuine declarations of intent of the shareholders, and solve any potential disputes, while on the other hand it will keep the balance of interests among shareholders, in particular, protecting the interest of the minority shareholders.

Yang Chaonan is an associate at ETR Law Firm. Qin Guoxin, a paralegal at ETR, also contributed to this article.

Yang Chaonan ETR Law Firm shareholders agreements

ETR Law Firm
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