Below is an overview on the background and the implications of the Provisions.
- Damages caused by Related-Party Transactions
In practice, some major shareholders, actual controllers or the management of companies, by taking advantage of their related party relationship and controlling status, may force the company to enter into transactions with themselves or other related parties. These actions may negatively impact the legitimate benefits of the company, the minority shareholders, or of creditors because they often aim at diverting company funds or transfer profits.
The current laws already prohibit such actions and impose liability for compensation on those who have taken such actions. Article 21 of the PRC Company Law stipulates that no controlling shareholder, actual controller, director, supervisor or senior officer of a company may damage the interests of the company by taking advantage of his/its affiliated relationship. Any person who causes any loss to a company by violating the preceding paragraph shall be liable for compensation. Article 84 of the PRC General Rules of the Civil Law also states that the controlling investor, actual controller, directors, supervisors and senior officers of a profit-making legal person shall not damage the interests of the legal person by making use of its related-party relationship, and shall be held liable for compensation, if they do cause any damage to the legal person by taking advantage of such related-party relationship.
Based on the principle that any transaction between related parties shall be made on arm’s length’s principle, the Provisions have further clarified that, if the related party transaction infringes the legitimate benefits of the company, the relevant parties shall not be exempted from any liabilities even if legal procedures to approve a related party transaction have been implemented, i.e. approval by the shareholders’ meeting or the Board of Directors, fulfilment of the duty for disclosure, etc.
According to PRC law, in case of unfair related party transaction, a company shall be entitled to claim for compensation for any damages incurred by it. In addition, the Provisions confirm that any shareholder(s) of a limited liability company or any shareholder(s) of a company limited by shares holding 1% or more of the shares for 180 consecutive days or more (i.e. any shareholder(s) satisfying the conditions set forth in Section 1 of Article 151 of the PRC Company Law) shall be entitled to bring a derivative action in his/their own name(s), provided that:
(1) any related party transaction infringes the company’s interests and the company did not initiate a lawsuit; or
(2) the contract for the related party transaction is deemed to be invalid or rescindable and the company did not initiate a lawsuit against the counterparty of such contract.
- Removal of Directors without Cause
Directors have a duty of care to manage to the best of their ability. They must perform their duties in good faith with the care that an ordinarily prudent person in such position would exercise under similar circumstances and in a manner the directors reasonably believe to be in the best interests of the company. Directors also owe a duty of loyalty and a duty of disclosure to the company and the shareholders. In the current PRC Company Law, Articles 146, 147, 148, 150 stipulate the duties of directors and in particular Article 146 has listed certain circumstances under which a director with misconduct shall be dismissed by the company. However, the law has not dealt with the circumstance where a director did not commit any misconduct.
Since directors are appointed by the shareholder, the general opinion in legal practice is that the shareholder can also remove directors during the directorship at any time and without any reason. Article 3 of the Provisions now confirms this. A company shall be entitled to remove a director before the expiry of his/her term of office through effective decisions made by the shareholders’ meeting or the general meeting of shareholders.
However, removal without cause shall not infringe the legal rights of the directors and a company shall not unfairly remove directors for no cause. For the purpose of protection of the legitimate rights of directors, the Provisions state that, if there is any dispute in terms of the indemnification for the removal, such director shall be entitled to bring a lawsuit to claim for reasonable indemnification. Courts shall determine whether the grant of severance compensation is reasonable and how much would be the reasonable amount for indemnification, by comprehensively considering the factors of the reason for removal, the remaining tenure, the renumeration of directors, etc. In essence by the above stipulations, the Provisions implicitly confirm the general principle that corporate positions are independent from contractual agreement, such as employment contracts or service contracts and that the termination of the former does not automatically result in termination of the latter.
- Time Limit for Profit Distribution to Shareholders
Shareholders are entitled to receive profit distribution. According to Articles 14 and 15 of the Provisions of the Supreme People's Court on Several Issues Concerning the Application of the Company Law of the People's Republic of China (IV), effective on 1 September 2017, where a shareholder of a company requesting the distribution of its profits provides an effective resolution that is adopted at the shareholders' meeting or the general meeting of shareholders and specifies the distribution plan in detail, the People's Court shall make a ruling on favor of the shareholder that the company shall distribute its profits in accordance with the specific distribution plan specified in the resolution. Without such an effective resolution, the claim by the shareholder for profit distribution will normally not be sustained by the court, unless the failure of profit distribution is attributable to any shareholder’s abuse of shareholders' rights and results in losses suffered by other shareholders.
Now the Provisions have additionally clarified the time limit for such profit distribution in dispute. Upon a shareholders’ resolution for profit distribution, the following applies:
(1) If the resolution specifies the time limit, the time limit in the resolution shall apply;
(2) If the resolution does not specify the time limit, but the Articles of Association do, the time limit in the Articles of Association shall apply;
(3) If neither the resolution nor the Articles of Association have set forth a time limit, or if there is such time limit but the time limit exceeds one year, the one-year time limit shall apply, i.e. the profits distribution shall be completed within one year after the resolution was passed.
If the time limit set forth in the resolution exceeds that in the Articles of Association, such resolution violates the Articles of Association pursuant to Section 2 of Article 22 of the PRC Company Law. As a result, the shareholders shall be entitled to claim at the court to revoke the resolution in relation to the time limit. Such resolution can be partially revoked without affecting the validity of its remaining parts. However, if the time limit is closely connected with the remaining resolution, it cannot be revoked independently and will be subject to the court’s decision by evaluation of the facts case by case.
- Dispute Settlement between Shareholders of Limited Liability Companies
Where shareholders have major disagreements resulting in the failure of sustaining the normal business of the company, often a deadlock situation occurs. In such situation, if there is any solution to avoid dissolution of the company, such solution will be normally favored. However, in practice, it is often difficult to find a proper solution and for those shareholders who do not intend to continue with the current business it is difficult to withdraw from the company.
Under the current PRC law, there are some provisions concerning the dispute settlement mechanism among shareholders, not only for limited liability companies but also for companies limited by shares and listed companies.
The Provisions now stipulate the mechanism for settlement of disputes between shareholders of limited liability companies. The Provisions state that if upon negotiation between the parties without violating any mandatory provisions in laws and administrative regulations, the dispute is solved in any of the following ways, the People’s Court shall support this:
(1) the remaining shareholders or any third-parties acquire the shareholdings of the withdrawing shareholders; or
(2) the company repurchases the shares of the withdrawing shareholders; or
(3) the company decreases its registered capital; or
(4) the company is divided and the remaining shareholders and the dissenting shareholders will operate separately in the newly divided companies.
- Application of the Provisions
The Provisions, as judicial interpretation by the SPC, will be binding to courts at each level in China and can be quoted directly by courts in judgment. According to Article 6 of the Provisions, the Provisions shall apply to any case for which the final judgment is pending at the time the Provisions enter into force, but shall not apply to any case for which the final judgment has been made before the effectiveness of the Provisions or for which re-trial through trial supervision procedures is possible.