PRC Supreme People’s Court Published Interpretation V of the Company Law

On 28 April 2019, the PRC Supreme People’s Court (hereafter referred to as “SPC”) published Provisions on Several Issues Relating to the Application of the Company Law of the People's Republic of China (V) (hereafter referred to as “Interpretation V”) (Judicial Interpretation [2019] No.7, click here for the official publication) in relation to disputes of shareholders’ rights, which came into effect on 29 April. With merely six articles, Interpretation V provides substantial protection of shareholders’ rights, especially for minority shareholders.

Background

On the same date (28 April), the representative of SPC’s Commercial Court introduced Interpretation V to the press and expressly indicated that Interpretation V aims to protect shareholders’ rights, especially minority shareholders’. This new legislation is part of the government’s efforts to strengthen China’s business environment. In fact, the trend to better protect shareholders’ rights has been apparent in recent legislations, both procedurally and substantively. In 2017, Provisions of the Supreme People’s Court on Several Issues Relating to Application of the Company Law of the People’s Republic of China (IV) (hereafter referred to as “Interpretation IV”) enhances such protection on shareholders’ information rights, profit distribution right, equity transfer right and provides a more detailed process for shareholders’ derivative actions. In 2018, China Securities Regulatory Commission revised Guidelines on Governance of Listed Companies, which specifically emphasizes that the legitimate rights and interests of minority shareholders should be protected.

Highlights of Interpretation V

1. Related-Party Transaction

Interpretation V further restricts the internal responsibility of related-party transaction. Article 21 of the Company Law of PRC briefly stipulates that the controlling shareholders, actual controlling parties, directors, supervisors and senior management personnel of a company cannot cause damage to the company's interests by related-party transactions. In practice, the management always defend their actions by proving the related-party transactions are decided or conducted under due process. Now under Interpretation V, the due process, including information disclosure or the consent of shareholders’ meeting, for related-party transactions will not be supported by the court as a valid defence. Interpretation V outweighs the substantive fairness in the case of related-party transactions in order that the controlling shareholder, the actual controller, directors, supervisors or senior executives, who manipulate the harmful related-party transactions, shall be liable to compensate for the losses.

Interpretation V also expands the application scope of shareholders’ derivative actions regarding related-party transactions. Before the effectiveness of Interpretation V, the shareholders can only bring a lawsuit against a director, supervisor or senior management personnel when he/she violates the provisions of laws and administrative regulations or the articles of association of the company. Under Interpretation V, shareholders can bring a lawsuit (1) against the controlling shareholder, the actual controller, directors, supervisors or senior executives in the case that related-party transactions cause damages to the company; (2) against the other party in the related-party transactions in the case that related-party transactions’ contracts are invalid or revocable to apply for nullification or cancellation of the aforesaid related-party transactions.

2. Removal of Directors

For the first time under Chinese law the Interpretation V formally introduces the rule that shareholders’ meeting is entitled to remove a director without cause before expiry of his/her term of office, which indicates that the legal nature of  relationship between shareholders and directors under Chinese law is an agency appointment contract. The Interpretation also stipulates that directors who are removed by the shareholders’ meeting may be entitled to indemnity according to laws, administrative regulations, the articles of association of the company or the contract and the reasonable amount of indemnity shall take into account the factors such as the reasons for removal, the rest of his/her term of office and his/her remuneration.

3. Time Limit for Profit Distribution

Under Interpretation V, the profit distribution shall be executed and completed within the following time limit (applied in the following order):

1. the period specified in the resolution which shall not be longer than 1 year;
2. the period specified in the articles of association of the company which shall not be longer than 1 year;
3. within 1 year from the date when the resolution is made.

Setting a time limit for profit distribution is of great significance in practice. Interpretation IV guarantees that if there is a valid resolution of profit distribution, shareholders may file a lawsuit against the company and request it to execute it. Now that Interpretation V further solves the question when it should be executed which will certainly strengthen the actual enforcement of such basic shareholders’ rights.

4. Settlement for Disputes among Shareholders

Interpretation V emphasizes the use of mediation in hearing a case of disputes among shareholders in a limited liability company and that the court shall uphold the ways of settlement agreed by shareholders. Such ways of settlement include (1) the company buys back some shareholders’ equity; (2) some shareholders transfer their equity other shareholders; (3) some shareholders transfer equity to third parties; (4) the company reduces its capital; (5) the company splits into two or more; (6) any other way that can resolve the disputes, resume the normal operation of the company and avoid dissolution of the company.

Before Interpretation V, there were not many regulations of dispute settlement among shareholders, which results in respectively little application scope. Apparently, the new provision in Interpretation V obtains a purpose to protect the normal operation and continuous running of the company, instead of dissolving a company as to solve the disputes among shareholders. For shareholders in a limited liability company, the transfer of equity is strictly restricted. Therefore, this provision provides for more options for shareholders in the case that they intend to exit the company.

Summary

Interpretation V undoubtedly fills up some flaws of the previous legislation and provides with a clearer guideline for practice. Of course, the actual cases could be much more complicated in real cases. The frequent update of legislation of the Company Law also shows the huge demand for a better commercial environment.

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