Smart strategies for breaking a company’s corporate deadlock

By Wang Liangzhen and Ming Lufang, Dacheng Law Offices
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Acorporate deadlock means a stalemate as a result of the shareholders or directors of a company unwilling to compromise with each other over a disagreement or a dispute among themselves, thereby rendering the shareholders’ meeting or the board of directors unable to make effective decisions, so that the company cannot carry out normal operations, and even becomes paralysed.

王良珍 Wang Liangzhen 北京大成律师事务所 高级合伙人 Senior Partner Dacheng Law Offices
Wang Liangzhen
Senior Partner
Dacheng Law Offices

The Company Law does not provide for corporate deadlocks. Instead, it adopts a concept that “the management and operations of a company are in severe difficulty”, which covers, without limitations, corporate deadlocks. A corporate deadlock will create great harm if it is not resolved promptly.

Exercising appraisal rights

The appraisal right of a shareholder, also known as “mandatory equity replacement”, means a shareholder, being a party to a corporate deadlock, requests the company or other shareholders to acquire its stake at a reasonable price, which in turn enables the shareholder to retire from the company for the purpose of resolving the corporate deadlock.

Contemporary English and American courts are most willing to take such an alternative legal remedy, likely to be accepted by both parties, because it can enable a company to continue operating, resolve a corporate deadlock, and protect the rights of minority shareholders.

Common precedents

The Company Law does not precisely provide that shareholders can break a corporate deadlock by way of the exercise of appraisal rights. Instead it provides for a regime similar to “a regime against shareholders’ appraisal rights”, which actually gives a shareholder the right to retire from a company. In judicial practice, there are common precedents in which corporate deadlocks are resolved by means of this concept.

明路芳 Ming Lufang 北京大成律师事务所 律师助理 Paralegal Dacheng Law Offices
Ming Lufang
Paralegal
Dacheng Law Offices

Article 5 of the Supreme People’s Court’s Provisions on Several Issues Concerning the Application of Company Law (II) stipulates that “a People’s Court shall focus on mediation in hearing contentious cases involving the dissolution of companies. The court shall offer support if the parties agree to enable a company to subsist by means of the acquisition of shares by the company or shareholders, or the reduction of capital, without the violation of laws, administrative regulations or mandatory provisions”. In judicial practice, judges are aware of applying this rule to dealing with corporate deadlocks.

Representative actions

Article 151 of the Company Law has established a litigation system for shareholder representatives, under which if a director, a supervisor, a manager or a controlling shareholder of a company has breached the law and the company’s articles of association in the course of discharging their duties, which has caused a loss to the company, and the company is negligent or refuses to claim damages against such person, the shareholders of the company have the right to institute legal proceedings in their own name at a people’s court in the interest of the company. The institution of representative actions by shareholders is an effective form of safeguarding the interests of minority shareholders and eventually maintaining the legitimate rights and interests of the company.

If some corporate deadlocks cannot be resolved within a short period of time, and have severely jeopardised the interests of a company, and if the directors or supervisors of the company are negligent in discharging their duties and powers to safeguard the interests of the company, minority shareholders can file subrogation litigation pursuant to article 151 of the Company Law. This allows more parties to be able to participate in applying for breaking the corporate deadlock, and offers more remedies so as to further improve the remedial mechanism.

Interim receiver regime

In countries like the US, which has a relatively sound corporate system, a receiver system is generally introduced under which a court will appoint an independent receiver during the course of proceedings to manage the business of a company. The receiver’s authority is subject to some restrictions, but the company at least can maintain minimum operations. This remedy gives all parties to a company sufficient buffer time, providing an opportunity for them to attempt to break the deadlock, and also encourages them to resolve their differences as soon as possible to end the management of the company by external people.

The Company Law does not provide for an interim receiver regime, but China can refer to the Bankruptcy Law for a reorganisation and administrator system. In the specific design of the system, attention should be paid to the following issues: first, the power to appoint an interim receiver should be exercised by a court; second, an interim receiver must be eligible, must have no interest in the company concerned and must possess the appropriate expertise and experience; and third, an interim receiver must have a term limit. Once a corporate deadlock fails to be resolved, a court should terminate the receivership and rule to dissolve the company according to the law for protecting the interests of all parties in a timely manner.

Compulsory dissolution

Article 182 of the Company Law gives shareholders the right to request a court to dissolve a company compulsorily after satisfying the following four requirements. First, the company reaches an impasse, in which there are severe difficulties in the management and operations of the company objectively, such as the company’s failure to convene a shareholders’ meeting, or to reach an effective resolution for two consecutive years, a long-term conflict with the chairman of the company which cannot be resolved at a shareholders’ meeting, and other serious problems with the management and operations of the company.

Second, the party that requests compulsory dissolution should be a shareholder holding more than 10% of the voting rights of all shareholders of the company. Since such a request is related to the future and destiny of the company, it is necessary to prevent the abuse of the right of action by individual shareholders. Third, the continuity of an impasse will severely jeopardise the interests of the shareholders. Fourth, the deadlock cannot be solved by other means. So, it is necessary to be extremely cautious in applying for compulsory dissolution of a company.

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