Shareholders' rights in private and public companies in China: overview
A Q&A guide to shareholders' rights in private and public companies law in China.
The Q&A gives an overview of types of limited companies and shares, general shareholders' rights, general meeting of shareholders (calling a general meeting; voting; shareholders' rights relating to general meetings), shareholders' rights against directors, shareholders' rights against the company's auditors, disclosure of information to shareholders, shareholders' agreements, dividends, financing and share interests, share transfers and exit, material transactions, insolvency and corporate groups.
Types of limited companies and shares
Limited liability companies
There are two types of company in the People's Republic of China (PRC) with limited liability: the limited liability company (LLC) and the company limited by shares (CLS).
Foreign invested enterprises
A foreign invested enterprise (FIE) is an enterprise established in the PRC in accordance with applicable Chinese law, with all or part of its capital (in general no lower than 25%) provided by a foreign investor. Under the current PRC law, foreign investors include foreign enterprises and other economic entities or individuals.
The forms of FIEs are mainly as follows:
Equity joint venture (EJV). These are usually foreign companies, enterprises and other economic entities or individuals forming joint venture enterprises in China with Chinese companies, enterprises or other economic entities. All EJVs are LLCs, whereby each party to the EJV assumes the liability of the EJV up to the limit of the capital subscribed by that party.
Co-operative joint venture (CJV). CJVs are enterprises formed under contract terms in accordance with the Sino-Foreign Co-operative Joint Venture Law. A CJV can choose to be a legal person or a non-legal person. A CJV with the status of a Chinese legal person in accordance with law will be an LLC. The differences between a CJV and an EJV are mainly:
Sharing risks and profit. In a CJV, the co-operative enterprises share risks and profit according to their corporative enterprise contract. In an EJV, the profits, risks and losses of the EJV are shared by the parties to the venture in proportion to their contributions to its registered capital.
In a CJV, the foreign party is allowed to take back its investment by taking depreciation fees. In an EJV, the investment cannot be taken back during the operation.
Wholly foreign owned enterprise (WFOE). A WFOE is an enterprise with capital provided solely by one or more foreign investors. The form of a WFOE is an LLC or, subject to approval from the Ministry of Commerce (MOFCOM) it can have a different form of liability. Where a WFOE is an LLC, the liability of the foreign investor in respect of the enterprise is limited to the extent of the investor's capital contribution. Where a WFOE is established with any other form of liability, the liability of the foreign investor in respect of the enterprise is determined according to Chinese laws and regulations.
Foreign invested company limited by shares (FICLS). In a FICLS, the shareholders' liability to the company is based on the relative number of shares held by each shareholder. An FICLS is the only type of FIE that can be listed directly on a stock exchange in China.
Foreign invested holding company (FIHC). A FIHC refers to companies established in China by sole foreign-funded businesses, or by businesses jointly founded with Chinese investors to engage in direct investment. An FIHC is an LLC authorised to hold equity in other FIEs.
Among the above, the most-commonly used forms by foreign investors are EJVs and WFOEs.
As from 1 March 2014, the minimum capital requirements have been lifted in the revised PRC Company Law. However, where paid-in registered capital and minimum registered capital for limited liability companies are otherwise provided for in other laws, administrative regulations and decisions of the State Council, the relevant provisions will prevail.
Legally, FIEs are also no longer subject to minimum registered capital amounts, and MOFCOM has explicitly removed capital contribution restrictions on FIEs. However, compared with Chinese domestically-funded enterprises, the establishment of an FIE is subject to additional approval from MOFCOM or its local branches. In practice, MOFCOM reviews most foreign invested projects (this pre-approval requirement has been cancelled for FIEs established in the Pilot Free Trade Zones, currently located in Shanghai, Tianjin, Guangdong and Fujian) and local branches of MOFCOM are still likely to continue requiring an FIE's total investment to be commensurate with its planned business. Further, fixed ratios between total investment and registered capital continue to apply. The effect of these continuing requirements is that MOFCOM and its local branches are likely to continue requiring FIEs to have a minimum registered capital. For FIEs, Chinese law sets a ratio between investment by registered capital and foreign loans (jointly, "total investment"). Thin capitalisation is not allowed. If the total investment is not planned well on the basis of projected working capital requirements, the entity will soon be out of funds and require an increase of the registered capital. There are no restrictions on FIEs obtaining loans from Chinese banks. The total investment to registered capital ratio is as follows:
Less than US$3 million: more than 70%.
Between US$3 and US$10 million: more than 50% (or minimum US$2.1 million).
Between US$10 and US$30 million: more than 40% (or minimum US$5 million).
More than US$30 million: more than one-third (or minimum US$12 million).
On 19 January 2015, MOFCOM released a draft Foreign Investment Law (the Draft Law) for public comment, together with an official explanation of it. The Draft Law, if adopted, will fundamentally change the foreign investment regime that has been in place for over three decades in China. The Draft Law aims to combine the previous three major laws on foreign investment (the Sino-Foreign Equity Joint Venture Law, the Sino-Foreign Co-operative Joint Venture Law and the Law on Wholly Foreign-owned Enterprises) (collectively, the Foreign Investment Laws).
The Draft Law abolishes the general requirement of government approval for all foreign investments, which currently include pre-approval from MOFCOM and/or the National Development and Reform Commission. In exchange, the Draft Law proposes a negative list (the Catalogue of Special Administrative Measures). Only a business which falls within the negative list will be subject to approval by the foreign investment authority. Foreign investors will be allowed to invest in sectors not included in the negative list without any approval requirements or other restrictions. This system also prohibits local governments from imposing other restrictions outside the negative list on foreign investments.
It remains uncertain when the draft will be submitted to the National People's Congress (the whole process may take up to two years or more). It also remains uncertain what the final form of the law will be after the whole process. However, the overall direction of the Draft Law is commendable, with an overall goal of expanding and opening the domestic market, promoting and regulating foreign investment, protecting the legal rights of foreign investors, and safeguarding national security and social-public interests.
Under Chinese law, only companies organised as a CLS can issue shares. There are two types of shares under the current PRC law: ordinary shares and preferred shares. Listed companies and unlisted public companies (unlisted CLSs with more than 200 shareholders) are allowed to issue preferred shares.
For the main rights of holders of ordinary shares, see Question 5. The holders of preferred shares rank above holders of ordinary shares in payment of dividend and liquidation proceeds, but are restricted in other rights such as participation in the management of the company:
Holders of preferred shares are first entitled to payment of dividends at the agreed rate, prior to any dividend payment to the holders of ordinary shares, and then entitled to participate in the dividend distribution together with the holders of ordinary shares.
Before any distribution of liquidation proceeds can be made to holders of ordinary shares, the holders of preferred shares are entitled to receive the per share liquidation value of their preferred shares and all unpaid accumulated dividends.
Holders of preferred shares can attend the shareholders' general meeting and exercise voting rights on matters which may be directly connected with or have a material influence on their interest, for example:
revision of the articles of association related to preferred shares;
reduction of the registered capital of the company by more than 10% at one time or cumulatively;
merger, division and dissolution of the company or change of corporate form;
issuance of preferred shares; or
other circumstances specified by the articles of association.
The other main types of financial instruments available in the Chinese stock market and bond market include:
Bonds with a warrant.
Middle term note (MTN).
Short-term financing bonds.
The PRC Company Law allows natural persons or legal persons to form a single shareholder limited liability company, therefore the minimum number of shareholders is one. An LLC must be funded and established by no more than 50 shareholders.
To prevent abuse of the corporate structure in a single shareholder company, the PRC Company Law provides for a number of restrictions:
A natural person can only establish one single shareholder limited liability company. A single shareholder limited liability company cannot establish a new single shareholder limited liability company.
Both the company registration and business licence of a single shareholder limited liability company must clearly indicate whether the company is funded by a natural or legal person.
Where the shareholder of a single shareholder limited liability company is unable to prove that the property of the company is independent of the shareholder's own property, the shareholder is jointly and severally liable for the debts of the company.
A CLS must have no less than two and no more than 200 promoters, of whom a majority must be domiciled in China.
General shareholders' rights
The general rights of all shareholders are as follows:
To attend and vote at shareholders' meetings (except for EJVs and CJVs, which do not have shareholders' meetings).
To be entitled to dividend payments.
To review and take copies of the company's articles of association, minutes of shareholders' meetings, board resolutions, resolutions of the supervisory board, and financial accounting report.
To receive a share of the liquidation proceeds.
Pre-emptive rights on a capital increase (in the case of LLCs).
Shareholder rights are provided in the articles of association and sometimes in a shareholders' agreement in which shareholders agree how they will vote on specified matters (shareholders of a FIE must submit a shareholders' agreement together with the articles of association for approval).
In general, shareholders in unlisted companies can limit, modify, suppress or waive their rights by express agreement set out in the articles of association or the shareholders' agreement, as long as such variations do not violate mandatory rules in Chinese law and in practice are acceptable to the local competent authorities. However, it is difficult to limit, modify, suppress or waive listed companies' shareholders' rights.
Variations to the rights attached to preferred shares are provided by special law (see Question 3).
Rights of minority shareholders under PRC Company Law include:
Shareholders' general rights: such as to attend a shareholders' meeting and vote, access to company information and documents, receive dividends and other rights (see Question 5). There is no shareholding requirement to exercise such basic rights.
Rights related to corporate governance: in a CLS, any shareholder that individually (or collectively) holds at least 10% of a company's shares for at least 90 consecutive days can call and preside over a general meeting of shareholders, if the board of directors and supervisors fails to do so. Any shareholder that individually (or collectively) holds at least 3% of a company's shares can raise an interim proposal and submit it to the board of directors in writing, ten days in advance of a general meeting of shareholders.
Litigation rights: any shareholder of an LLC or any shareholder of a CLS who individually or collectively holds at least 1% of the company's shares for at least 180 consecutive days prior to the action can initiate proceedings against directors who violate any law, regulation or the company's bye-laws in the course of their duties and cause loss to the company (see Question 19).
Exit rights: any shareholder holding more than 10% of the voting rights of all shareholders can ask a court to dissolve the company, if the operation and management of the company suffers serious difficulties which will lead to significant losses to the shareholder's interests, and there is no other way to solve it.
Institutional investors in China mainly include securities investment funds, the National Social Security Fund, Qualified Foreign Institutional Investors (QFII), securities companies, and insurance companies.
Although most institutional investors are not active and prefer to "vote-by-foot" in the current Chinese capital market, an increasing number of institutional investors participate in corporate governance, and are becoming more influential. In general, institutional investors influence the company's actions through the following:
Exercising voting rights actively, for example vetoing a proposal which may harm the interests of the company.
Making a shareholder proposal, for example nominating a person to be a director.
Informal influence through private communication with the board and management team.
Co-operating with other institutional investors.
The actual effects of such measures are decided on a case by case basis. Some of them are quite successful, for example Penghua Fund co-operated with Yale Endowment Fund to nominate a director candidate for GREE Electric Appliance Inc. in 2012.
General meeting of shareholders
Calling a general meeting
It is up to the articles of association of an LLC to stipulate the frequency of shareholders' meetings. In practice most LLCs will hold a shareholders' meeting at least once a year. A CLS must have an annual shareholders' general meeting according to the PRC Company Law, but the timing is not stipulated by law.
For simplicity, unless otherwise specified, the term shareholders' meeting in this article means both a shareholders' meeting for an LLC and a shareholders' general meeting for a CLS.
The shareholders' meeting must decide on the following matters:
Decide the company's business strategy and investment plans.
Elect and remove directors and supervisors who are not representatives of employees.
Decide the remuneration of directors and supervisors.
Review and approve the reports of the board of directors.
Review and approve the reports of the supervisory board or the supervisor.
Review and approve the annual financial budget and financial accounting plans of the company.
Review and approve the profit distribution plans or loss recovery plans of the company.
Pass resolutions on any increase or reduction of the registered capital of the company.
Pass resolutions on the issuance of corporate bonds.
Pass resolutions on any company merger, division, dissolution, liquidation, or change of the corporate form.
Any amendment to the articles of association.
Exercise any other powers given to the shareholders' meeting by the articles of association.
The following additional rights are given to shareholders:
The provision of security by the company for a shareholder or the de facto controller of the company must be approved by a resolution of the shareholders' meeting.
In a listed company if the company, within one year, purchases or sells major assets, or provides guarantees to third parties, and the transactional value exceeds 30% of the company's total assets, the transaction must be approved by a two-thirds majority of the voting rights of the shareholders present in the meeting (PRC Company Law).
If the company's articles of association permit, the shareholders' meeting can be held by telecommunication means. The PRC Company Law is silent on the general requirements applicable to conducting a shareholders' meeting by telecommunication. It can be safely presumed that holding the shareholders' meeting is legal provided that the statutory requirement relating to running of the meeting and adoption of resolutions are adhered to (see Question 10) and relevant rules specified in the articles of association are followed.
Under the PRC Company Law, an LLC is allowed to hold a shareholders' meeting in writing, if the resolution(s) to be passed at the meeting is approved by the unanimous written consent of all the shareholders.
For a CLS, the shareholders must be informed of the time and place of a general meeting and the matters to be considered at it at least 20 days in advance, and for an interim general meeting at least 15 days in advance. Holders of bearer shares are notified by a public announcement including the above mentioned items at least 30 days in advance.
For an LLC, unless the articles of association require otherwise, the shareholders must be informed of the time and place of the meeting 15 days in advance.
There is no statutory quorum for holding general meetings in a CLS and a shareholders' meeting in an LLC.
In a CLS, resolutions must be adopted by an affirmative vote of shareholders representing a majority of the voting rights of shareholders present. If a resolution proposes any of the following, it must be adopted by shareholders representing two-thirds or more of the voting rights of shareholders present:
A modification of the articles of association.
An increase or decrease of the registered capital.
A proposed combination, division, dissolution or transformation of the company.
In an LLC, any resolution made regarding a vital interest of the company must be passed by shareholders representing at least two-thirds of the voting rights, for example:
Any revision to the company's articles of association.
An increase or reduction of its registered capital.
Any combination, division, dissolution, or transformation of the company.
Voting can be conducted as follows:
Poll vote. In an LLC, the shareholders will exercise voting rights in proportion to their capital contribution unless otherwise specified in the company's articles of association. In a CLS, shareholders attending a shareholders' general meeting will have one vote for each share that they hold. Therefore, in reality, voting by a "show of hands" can be arranged in the articles of association of an LLC.
Proxy voting. The PRC Company Law allows a shareholder to appoint a proxy to attend a general meeting. The proxy will exercise the voting rights within the scope of his authorisation.
Weighted voting. The concept of weighted voting rights is not regulated in Chinese law. In an LLC, the voting rights can be decided in the articles of association. In a CLS, each share will have one vote at a general meeting.
Written consent. In an LLC, it is possible to pass resolutions by unanimous written consent of all of the shareholders.
Aggregate voting right. In practice, aggregating voting rights by means of a trust or shareholders' agreement is allowed.
The term of specific shareholder approval/resolution does not exist in the PRC Company Law.
For the voting requirements for shareholders' resolutions in an LLC and a CLS, see Question 10.
Shareholder rights relating to general meetings
In a CLS, a shareholder (or shareholders) who holds 10% or more of the company's shares for 90 consecutive days or more can convene and preside over a general meeting on his or their own initiative, if the board of directors and the board of supervisors has failed to fulfil its obligations to convene a general meeting.
In an LLC, if the shareholder meeting is not called, shareholders who represent 10% or more of the voting rights can convene and preside over the meeting on their own initiative.
A shareholder in a CLS or an LLC can ask a court to order a general meeting to be called. A shareholder can also petition a court to suspend or nullify a general meeting if the procedure or content of the meeting violates any law, administrative regulation or the company's articles of association.
In a CLS, any shareholder (or shareholders) who holds 3% or more of the shares of the company can submit a written proposal to the board of directors at least ten days in advance of a general meeting.
A shareholder in a CLS can require information from the board. According to the PRC Company Law, shareholders in a CLS must be notified at least 20 days in advance of a general meeting of the time and place of the meeting and the matters to be considered at it.
Any shareholder can challenge a resolution if the procedures for calling or voting at the meeting violate any law, administrative regulation or the company's articles of association, or if any resolution violates the company's articles of association. The time limit for a challenge is within 60 days of the date on which the resolution is passed.
Shareholders' rights against directors
Normally, a shareholder resolution is required to appoint or remove a director. However, in an EJV, there is no shareholders' meeting and the directors are appointed or removed by the parties to the EJV.
Employee representatives who serve as a director on the board of directors of an LLC established by two or more state-owned enterprises or other LLCs are elected by the employees by voting.
If a resolution of the board of directors violates any law or regulation, the resolution is null and void. Shareholders can request a court to confirm that the resolution is void.
Within 60 days following the date on which the board resolution was passed, shareholders can request a court to revoke the resolution if either:
The calling procedure or the voting method of the board meeting violates any law, regulation or the company's articles of association.
The content of the resolution violates the company's articles of association.
Upon the request of the company, the court can require shareholders to provide a guarantee for their request.
There is no minimum shareholding requirement regarding this issue.
Generally, directors are subject to fiduciary and due diligence duties to the company and cannot damage shareholders' interests. In particular, directors are not allowed to do any of the following in relation to the company:
Damage the company's interests by taking advantage of their associated relationships.
Take any bribe or illegal income by taking advantage of their power.
Embezzle the company's funds or assets.
Deposit the company's funds into an account in their own name or any other person's name.
Without the consent of the shareholders or the board, provide a loan or guarantee to any other person using the company's funds or assets which violates the company's bye-laws.
Enter into a contract or transaction with the company which violates the company's bye-laws or without the consent of the shareholders or the board.
Without the consent of the shareholders or the board, take business opportunities which belong to the company for themselves or any other person by taking advantage of their power, or operate a business that is similar in nature to the company for themselves or any other person.
Personally take commission from transactions between the company and another person.
Disclose confidential information of the company.
Conduct other activities that breach their fiduciary duty to the company.
Damaging shareholders' interests may lead to civil liability for a director. PRC law is almost silent on whether directors' liability, to the company or to the shareholders, can be limited or excluded. The only relevant provision is that a director may be exempted from liability relating to a board resolution that violates laws, regulations, the company's articles of association or shareholders' resolutions, and causes serious loss to the company, if both:
The director proves that he raised an objection to the resolution.
The objection is recorded in the minutes.
Shareholders actions against directors
Any shareholder of an LLC or a shareholder of a CLS who individually or collectively holds at least 1% of the company's shares for at least 180 consecutive days prior to the action can initiate proceedings against directors who violate any law, regulation or company's bye-law in the course of their duty and cause loss to the company.
The shareholder will request the board of supervisors or the supervisor(s) of the company in writing to initiate such an action. The shareholder can initiate the action on behalf of the company in his/her own name if the board of supervisors or the supervisor(s) of the company refuses to initiate the action after receiving the request from the shareholder, fails to initiate the action within 30 days after receiving the request from the shareholder, or there is an emergency.
In addition, if a director(s) damages shareholders' interests and this violates laws, regulations or the company's articles of association, any shareholder can initiate legal action against the director(s).
A director is not allowed to damage the company's interests by taking advantage of an affiliated relationship. If he does, the director is liable for such damage and must compensate the company. The "affiliated relationship" here means a relationship between the director and enterprises directly or indirectly controlled by the director, which may cause a transfer of interest in the company.
Directors of listed PRC companies are not allowed to vote, or vote on behalf of another director, on resolutions of the board of directors that involve an enterprise which has an affiliated relationship with the directors. This can be seen as an extra instrument to protect the interests of minority shareholders in listed companies.
In addition, no company can provide a loan to any of its directors, either directly or through its subsidiaries.
Shareholders have a right to bring an action against directors if they breach these rules (see Question 19).
The remuneration of directors in a CLS is required to be regularly disclosed to shareholders under the PRC Company Law, however the means of disclosure is not specified. In a listed CLS, the remuneration of directors must be included in the company's annual report (see Question 26). In practice, the remuneration of directors may also be disclosed by notice on a meeting of the board of directors.
Shareholder approval in the general meeting is required for directors' remuneration, either in an LLC or CLS.
Shareholders' rights against the company's auditors
To appoint or remove the company's auditors, either a shareholders' resolution or a board of directors' resolution is required. For a listed company, an audit committee must be set-up under the board of directors. The function of the audit committee is to supervise and evaluate the company's external auditors, and guide the company's internal auditors. The audit commission can suggest that the board of directors appoint or remove the company's external auditors.
The company's auditor must have relevant professional competence, comply with professional norms, and be independent, objective, impartial and confidential in his/her work.
An accounting firm that issues a false audit report (with any false record, misleading statement or significant omission) which causes loss to any stakeholder including shareholders can be subject to tort liability. The auditors involved may bear joint and several liability with the accounting firm for paying compensation.
The liability of the accounting firm can be excluded if it does any of the following:
Fails to find an error in the accounting materials, but complies with professional rules and maintains professional prudence.
Fails to find that a certification document provided by a financial institute that it relies on is false, but maintains professional prudence.
Has warned the company of its indication of fraud, and pointed this out in the audit report.
Has carried out the audit in accordance with a capital verification procedure and issued the audit report, but the investor withdrew the capital contribution after registration.
Issues a false report on a capital contribution, but the investor makes up the balance of the capital contribution after registration.
Disclosure of information to shareholders
Shareholders are entitled to inspect and copies of:
The company's articles of association.
Minutes of shareholders' meetings.
Resolutions of the board of directors.
Resolutions of the board of supervisors.
Therefore, the directors have to provide the above information to the shareholders.
Unless otherwise provided in the articles of association, a general meeting agenda must be delivered to all shareholders at least 15 days in advance of the shareholders' meeting for an LLC, or 20 days in advance of the regular general meeting of shareholders for a CLS.
Under PRC securities laws, the directors of a listed company must disclose information which has a material effect on investors' investment decisions through periodic reports, either annually, semi-annually or quarterly. The annual report must include the following information:
Basic information about the company.
Major accounting data and financial indices.
The issuance and changes to the company's shares and bonds, the total amount of the shares and bonds, the total number of shareholders, and shareholding information about the largest ten shareholders.
Information about shareholders who hold more than 5% of the shares, the controlling shareholders, and the de facto controlling party.
The employment status, shareholding changes and remuneration of directors, supervisors, and senior management personnel.
Reports of the board of directors.
Discussions and analysis of the management team.
Significant events and their effect on the company.
The financial and accounting report and the audit report.
Other information required by the China Securities Regulatory Commission (CSRC).
Compared with the annual report, the content of the semi-annual report and quarterly report is relatively brief.
With regard to the following events that can have a material effect on the price of a listed company's securities, an interim report including information on the cause, status and possible effect of the event is required:
Material change of the company's business policy and business scope.
Significant investment activities and an assets acquisition decision by the company.
The company concluding an important contract which may have a material effect on the company's assets, liabilities, rights and interests, and operation results.
Significant debt occurs and the company fails to repay a significant due debt, or incurs liability to pay a large amount of compensation.
The company suffers significant loss or damage.
A significant change to the external business operation conditions.
A change of director, one third of the supervisors or the general manager of the company, or the chairman of the directors and general manager fails to perform their duties.
A relatively significant change of shares held by shareholders holding more than 5% of the company's shares, or control of the controlling party of the company.
A company decision on a registered capital reduction, merger, division, dissolution, or application for bankruptcy, or the company enters a bankruptcy procedure or is ordered to close down in accordance with law.
Significant litigation or arbitration involving the company, or a resolution of the general meeting of shareholders or the board of directors is revoked or declared invalid in accordance with law.
The company is suspected of violating laws and regulations and is investigated by the competent authority or subject to criminal punishment or significant administrative punishment, or the director, supervisor or senior management personnel of the company is suspected of violating laws and regulations and is investigated by the competent authority or subject to coercive measures.
Newly published laws, regulations and industry policies that may have a material effect on the company.
Resolution of the board of directors on the issuance of new shares or other refinancing plans and share incentive plans.
A court prohibits the controlling shareholders from transferring their shares, or shares held by shareholders holding more than 5% of the shares of the company are subject to a pledge, freezing, judicial auction, custody, a trust, or a voting rights restriction.
The main assets are sealed up, distained, frozen, mortgaged or pledged.
The main or whole business comes to a halt.
The company provides a significant guarantee for external parties.
Additional income is obtained which may have a material effect on the company's assets, liabilities, rights and interests and operation results, such as a large governmental subsidy.
Change of accounting policies and accounting estimates.
An error in information disclosed previously or the information is not disclosed in accordance with the relevant provisions, or a false record, and an order by the relevant authority to rectify or the board of directors decides to rectify.
Any other event that CSRC requires to be disclosed.
The Corporate Governance Code for Listed Companies (Code) was issued by CSRC on 7 January 2002 and only applies to listed companies. The Code states:
The basic principles of corporate governance of a listed company.
Measures to protect investors.
The behaviour standard for directors, supervisors, general managers and other senior management.
The Code has to be fully implemented by listed PRC companies, which means the directors cannot choose alternative means to achieve good governance with an explanation to shareholders. According to the Code, a listed company is required to disclose information on corporate governance, including the actual corporate governance situation, any gap between the company's corporate governance and the Code, and the reasons for the gap. However it is not related to the "comply or explain approach".
Certain information must be provided to the shareholders automatically without a request (see Question 25). In an LLC, a shareholder is entitled to inspect the accounting records of the company by submitting a written request to the board stating the purposes of the request. If the company has reason to believe that the shareholder has an improper purpose and this can damage the legitimate interests of the company, it can refuse the shareholder's request in writing stating the reasons for the refusal within 15 days of receipt. If the company refuses the shareholder's request, the shareholder can submit it to a court. This rule does not apply to a CLS.
The following provisions are commonly included in a shareholders' agreement:
Capital funding: the form, amount and time of capital contribution made by shareholders.
Shareholders' meeting: the voting power of the shareholders, calling procedure and voting rules.
Board of directors: the number of directors, removal and replacement of directors, and legal representation.
Management organisation: positions and duties of the management team.
Share transfer: share transfer restrictions, right of first refusal/pre-emptive right, tag-along and drag-along.
Accounting and financial report.
Terms and terminations.
The shareholders' agreement is only binding on the shareholders. In general a shareholders agreement is not binding and enforceable against third parties. However, according to the PRC Company Law, if the shareholder is a natural person, a successor can inherit the shareholder's position after the shareholder's death, unless otherwise provided by the company's bye-laws.
Generally, shareholders' agreements are not required to be publicly disclosed. However, certain information related to the company such as the parties' names and their capital contribution are obtainable through public company registration records.
The effectiveness and enforceability of a shareholders' agreement for a FIE is subject to the approval of MOFCOM or its local counterparts.
A company's after-tax profit remaining after it has made up its losses and made allocations to its common reserve can be distributed to the shareholders. A company must allocate 10% of its after-tax profits to the statutory common reserve every year until the aggregate amount of the reserve exceeds 50% of the registered capital.
Profit distribution plans and plans for making up losses of the company are formulated by the board of directors (or the executive director of a relatively small company without a board) and submitted to the shareholders' meeting for consideration and approval.
Shareholders are entitled to dividends in proportion to their paid-in capital contributions, unless all of the shareholders agree otherwise in the articles of association. The concept of preferred shares has recently been officially introduced into Chinese law, and the holders of preferred shares rank above holders of ordinary shares when distributing dividends (see Question 3). The right to a dividend can also be varied in the company's articles of association or shareholders' agreement (see Question 5).
The issue of interim dividends is not dealt with explicitly under Chinese law. In practice, listed companies are allowed to make payment of interim dividends according to the listing rules and the articles of association.
Financing and share interests
Shareholders are entitled to pledge their shares that can be legally transferred and pledged. A pledge of shares is registered with the company registry, but failure to do so will not affect the validity of the share pledge agreement.
In a FIE, approval from the original approval authority for the establishment of the FIE is required to register a pledge over the shares in the FIE.
Chinese law does not explicitly restrict a company from providing financial assistance for the purchase of its shares. However, the provision of financial assistance by a Chinese company for a third party may in practice be limited due to laws and regulations which restrict the company from providing a loan or security to support debt, such as foreign exchange rules and banking regulations.
For instance, cross-border security (provision of security by a Chinese entity to an offshore entity) should be filed for record with the State Administration of Foreign Exchange (SAFE), the Chinese foreign exchange regulatory agency. The debt proceeds under such cross-border security must be used within the ordinary scope of business of the debtor. Without SAFE approval, the debt proceeds must not be remitted into China, whether directly or indirectly and whether by way of debt, equity investment, or other means.
Share transfers and exit
Chinese law restricts the transfer of shares in the following ways:
The transfer of shares to a third party outside the company is subject to a right of first refusal by the other existing shareholders.
Governmental approval: the transfer of an equity interest in a FIE or equity interest belonging to a state-owned asset is subject to the approval of the competent authorities.
Statutory lock-up: the shares of a CLS held by a promoter cannot be transferred for a period of one year from the date of establishment of the company. A director, supervisor or senior officer of a CLS is not allowed to transfer more than 25% of his/her total holding of the company's shares per year while he/she is in the service of the company. Further, for a period of one year from the date on which the company's shares are listed for trading, these persons cannot transfer their shares. When any of these persons leaves the company, he/she cannot transfer his/her shares for a period of six months.
Other restrictions on the transfer of the company's shares can be specified in the company's articles of association.
In an LLC, shareholders are entitled to subscribe for capital contributions on a priority basis in proportion to their paid-in capital contributions.
In a CLS, when new shares are issued, resolutions in respect of the class and amount of new shares issued to existing shareholders are adopted by the shareholders' general meeting.
A minority shareholder of an EJV or a CJV has statutory veto rights on the increase, decrease or transfer of the registered capital.
Although Chinese laws do not provide such statutory veto rights to the minority shareholders of a domestically-funded LLC or CLS, it is not uncommon that a resolution on the increase or decrease of registered capital requires the unanimous approval of all the shareholders.
A company must register the names of its shareholders with the company registry. If the registered particulars change, the procedures for amending the registration must be carried out. Particulars that have not been registered or for which registration amendment procedures have not been carried out are not enforceable against a third party.
An LLC can repurchase an equity interest from a shareholder at the shareholder's request if the shareholder votes against a relevant resolution at a meeting of the shareholders in any of the following events:
The company has not distributed profits to the shareholder for five consecutive years and the company has been profitable during those five years, and the shareholder satisfies the conditions for distribution of profits in accordance with the PRC Company Law.
The company merges, is divided, or transfers its main assets.
The term of operation specified in the company's articles of association expires or other grounds for dissolution as specified in the articles of association arise, and the shareholders' meeting resolves to amend the articles of association to extend the life of the company.
A CLS can only purchase its own shares in the following circumstances:
It is reducing its registered capital.
It is merging with another company that holds shares of the company.
It will grant the shares as an incentive to its staff and workers.
A shareholder who opposes a resolution on the merger or division of the company adopted at a shareholders' general meeting requests that the company purchase his/her shares.
A shareholder can exit from the company through one of the following procedures:
Transfer of its equity interest to another shareholder or a third party outside the company.
Request the company to repurchase its equity interest under certain circumstances specified by law (see Question 38).
Decrease of registered capital.
Shareholders holding a least 10% of all shareholder voting rights can petition a court to dissolve the company if serious difficulties arise in the operation and management of a company and its continued existence would cause a material loss to the interests of the shareholders, and the difficulties cannot be resolved through other means.
Shareholders can require their shares to be purchased back by the company (see Question 38).
The shareholders' meeting of a company has the right to strip the defaulting shareholder of all its shareholder rights if it fails to make any capital contribution or withdraws its entire capital contribution. However, the defaulting shareholder may be able to block the passing of a shareholders' resolution limiting or stripping its rights.
Although in general the selling shareholders and the buyer have discretion over the valuation of the shares, such withdrawals commonly require governmental approval in the context of an FIE or foreign acquisition, which may be difficult if the valuation is not at fair market value. Further, if payment for the shares involves payment into or out of China, it may be subject to foreign exchange control laws and regulations.
In FIEs, shareholders have veto rights over mergers and other material transactions. Such veto rights are commonly provided to shareholders of an LLC or CLS, based on the shareholders' agreement or articles of association.
In an LLC or CLS, a shareholder who objects to a merger or split can demand that the company repurchase its shares. A shareholder of an LLC can also require the company to repurchase his/her shares if he/she opposes the transfer of the main assets of the company.
An LLC can be converted into a CLS and vice versa. A shareholder resolution adopted by shareholders representing at least two-thirds of the voting rights in the LLC, or in a CLS at least two-thirds of the voting rights held by the shareholders in attendance, is required for such a conversion (PRC Company Law).
A change of corporate form of an FIE is subject to the unanimous approval of the board (applicable to an EJV and a CJV) and governmental approval.
Regular shareholders' rights, such as distribution of a return on investment, are significantly restricted if the company is insolvent. The main rights of a shareholder in an insolvent company under Chinese law include:
Application for reorganisation. If creditors apply for the bankruptcy or liquidation of the company and the court accepts the application, before the debtor is declared bankrupt shareholders holding more than one-tenth of the debtor's registered capital can apply to the court for a reorganisation of the company.
Voting on a reorganisation plan. The interests and benefits of the shareholders can be adjusted in a reorganisation plan. Where the draft reorganisation plan involves adjusting the interests and benefits of investors, an investor group must be set up to vote on such matters.
Under the PRC Company Law, the liquidation procedure will commence for a company if the company is dissolved in certain circumstances. The shareholders can cause the dissolution of the company through the following means:
The shareholders' meeting or shareholders' general meeting resolves to dissolve the company.
Petition to court to dissolve the company (see Question 39).
If a party to an EJV or CJV fails to perform its obligations under the joint venture agreement and/or articles of association, making it impossible for the joint venture to continue operation, the other party can opt to dissolve the company, subject to the approval of the competent authorities.
Further, in an EJV or a CJV, liquidation would also be subject to the terms of the joint venture agreement and the unanimous approval of the board of directors.
The term companies group under PRC law is defined as all of the following:
An association of enterprise artificial persons, which is lawfully registered in the territory of the PRC.
Composed of parent companies, subsidiaries, share-participating companies and other member enterprises or businesses which are bound by means of capital, with the parent and subsidiary companies as the principal part.
With the articles of association of the group as the common behaviour criteria.
A "companies group" is not recognised as an independent company or other legal entity.
Under Chinese law, a company's controlling shareholder or de facto controller cannot use his/her affiliated relationship to harm the interests of the company. Any losses caused by a violation of this rule must be compensated by the controlling shareholder or de facto controller.
If the controlling shareholder or de facto controller infringes the lawful rights and interests of the company, causing the company to incur a loss, a shareholder(s) of an LLC or CLS who alone or jointly holds at least 1% of the company's shares for at least 180 days in succession has the right to request the supervisory board (or the supervisor(s), for an LLC without a supervisory board) to start legal proceedings in court in respect of the infringement.
If the supervisory board or the supervisor(s) fail to start legal proceedings within 30 days of the date of receipt of the request or, in urgent circumstances where failure to promptly start legal proceedings could cause irreparable harm to the company's interests, the shareholders have the right, in the interests of the company, to directly start proceedings in a court in their own name.
The National People's Congress of China (NPC)
The NPC is responsible for enacting and amending all statutes in China.
Jan Holthuis, Managing Partner
HIL International Lawyers & Advisers
- Qualified Dutch attorney at law admitted to the Amsterdam Bar since 1992.
- Non-practicing solicitor in England and Wales registered at the London Law Society since 2004.
- Registered Arbitrator at the China International Economic Trade Arbitration Commission (CIETAC) since 2014.
- Registered Arbitrator at the Shanghai International Economic and Trade Arbitration Commission (SHAIC)/ Shanghai International Arbitration Centre (SIAC) since 2015.
Areas of practice. Chinese and Dutch foreign direct investment; M&A; trade secret protection; technology transfer; Chinese and Dutch agriculture investment law; biotechnology; renewable energy (solar and wind power).
- Dutch Law Degree, Rotterdam Erasmus University, 1991.
- Certificat d'Etudes Politiques, Paris Institute of Political Sciences (Science Po), 1992.
- Specialist International M&A certificate of Grotius Academy in 2009.
- Guest lecturer on Chinese Agricultural Law at Wageningen University.
- Guest lecturer on Chinese corporate and commercial law at Rotterdam Erasmus University.
- Advisor with respect to a China company restructuring and refinancing of a distressed foreign invested solar company.
- Advisor of a Dutch aircraft manufacturer in its set-up of a sino-foreign airplane manufacturing joint-venture.
- Advisor to a sino-foreign joint venture for the production of wind energy turbines, involving high-tech wind turbine engineering technology transfers.
- Advising a world leading pig breeding and artificial insemination firm with respect to its joint-venture transactions with Chinese listed food conglomerates.
- Advising agriculture and solar high-tech companies on technology transfer arrangements with Chinese state-owned and private companies.
- Advisor of a public-private consortium involving the Chinese and Dutch governments on the legal organisation of a Greenport investment concept to supply sustainable high quality food production to the Shanghai area.
- Advising on the establishment of a sino-foreign joint-venture on animal health products.
Languages. Dutch, English, French, Chinese (basic)
- Dutch Bar Association (NOVA).
- International Bar Association (IBA).
- Non-practicing solicitor registered with the Law Society of England and Wales.
- Member European Union Chamber of Commerce in China.
- General Editor of the Agriculture Global Guide, Thomson Reuters.
- Technology Transfer Agreements with China, 2014, EU SME Centre.
- Chinese Law and Practice on the Agricultural Seed Business in China, 2010, NABSO.
- Law as Instrument: The Process of Direct Investment Authorization in China, 2003, Curzon.
Li Jiao, Senior Associate
HIL International Lawyers & Advisers
Professional qualifications. PRC, admitted to the Bar since 2007
Areas of practice. Chinese investment law; corporate law; contract law; technology transfer.
- Advising a Dutch company specialised in biotech on its Sino-foreign joint venture project with one of the largest biotech equipment producers in China.
- Advising a Dutch wind energy tech company on its Sino-foreign joint venture project with a Chinese state-owned enterprise for manufacturing in China.
- Advising a world leading producer of specialty chemicals on its strategic co-operative programmes with a number of Chinese first-tier salt and chemicals companies.
- Advising a leading tech company in the area of Internet of Things on its co-operation projects with a number of Chinese/world top companies active in providing telecommunications services, equipment, network solutions and software technology.
Languages. Chinese, English
Professional associations/memberships. All China Lawyers Association
Publications. Foreign Acquisitions and Joint Ventures in China, in the Comparative Law Yearbook Of International Business, Volume 32 B: Mergers And Acquisitions In North America, Latin America, Asia And The Pacific – Selected Issues And Jurisdictions, Kluwer Law International.