Protecting Minority Shareholders

3528 words (14 pages) Essay in Company Law

02/02/18 Company Law Reference this

Last modified: 02/02/18 Author: Law student

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1.0. Introduction

1.1. Reasons for minority Protection

When exploring the issue of protecting minority shareholders, there is a question that eventually arises: why is there are a need for the company law to offer protection to the minority shareholders when all the parties follow the majority rule, or are exercising managerial power? These two practices are totally lawful, however, the reason for protecting minority shareholders stems from the fact that, the two practices are normally oppressive to the minority shareholders .1

In order for companies to compete effectively in the modern business environment, managerial power has increased considerably. In addition, its expansion has been necessitated by the distance of shareholders from the corporate businesses, dispersive share structures, and the need to have managerial expertise within companies. The board of directors, rather than the shareholders, has become the center of power in companies. Therefore, an enhanced monitoring and rectifying mistakes made by the management will be of great help not only to the minority shareholders, but the company as well .2

The mechanical application of the majority rule, which is one the basic cornerstones of modern company law, without any restrictions, can lead to serious consequences that can be detrimental to the needs and aspirations of the shareholders. This is harmful to minority shareholders and also contrary to legal tenet of equality and justice, which can eventually lead to collapsing of the company.3

Problems with Chinese Company Law

William Cary has summarized the following four basic components as the foundations of the American company law which can be of great help to the Chinese Company Law. The American company law is built on four major principles:

corporate personality

majority rule

managerial power

minority protection….4

When these are compared to the Chinese Company Law, there is no difficulty in identifying the difference. First, managerial power is not controlled sufficiently as conspiracy between management and shareholders are the order of the day in Chinese Corporations. On the other hand, majority rule under Chinese Company Law works in absolute terms. The majority shareholders wield immense power in Chinese companies. For instance, a shareholder having a 51% shares in China has power to make bidding decisions regarding all the important issues in the company. 5 Based on this background; there is a need to offer protection to the minority shareholders.

2.0 Overview of Minority Protection in the Chinese Company Law

Regarding the protection of minority shareholders in china, the Company Law of China (hereinafter referred as the “Company Law”), is the most supreme law. It is supported by laws and regulations such as the Securities Law, the Contract Law, the Criminal Law, the GPCL, the administrative regulations enacted by China Securities regulation Commission (the CSRC) and the interpretations of the courts in China. 6

In all these laws and regulations, the Company Law offers the most comprehensive protection to minority shareholders. 7 The Security Law however, deals with some portions of publicly listed companies like legal liability in cases of misrepresentation. The Contract Law tries to offers protection to the shareholders by offering criminal sanctions for serious crimes that can be committed against them. The GPCL’S basic principles such as the bona fide doctrine are beneficial in cases where there is no clear regulation that applies. The CSRC set of laws are mainly guidelines pertaining to supervision of markets or detailed rules of administrative regulations by the State Council. The interpretations of the courts in China are merely legal opinions of Supreme Court on individual and certain legal issues, which are bidding in court trials. 8

These sets of laws and regulations form the legal background for the safeguarding Chinese minority shareholders. However, when examined critically, all these laws can be found to be defective and inefficient in protecting minority shareholders. 9 The Chinese Company Law has tried to come up with a system of safeguarding minority shareholders; however, this has not been successful. On the other hand, the minority shareholders do not have a better means of overseeing the management. In addition, the rule of absolute majority leaves the minority shareholder without any protection from oppression from majority shareholders. Furthermore, there is little remedy if any, that can be obtained from lawsuits. This means that the minority shareholders are oppressed on two fronts; oppression from the management and that of the majority shareholders.10

As we can see, minority shareholders face oppression from two fronts. As such there is a need to design measures for arresting this situation. First, there should be a mechanism that should be put in place to prevent oppression from management and majority shareholders early enough. Secondly, if these actions of protection are not sufficient, then legal measure, such as personal suits and derivative suits, ought to be brought against the majority shareholders as well as the company directors. 11

2.1 Protection offered by the Company Law to Minority Shareholders

In order to understand protection offered to minority shareholders, it is crucial to examine the requirements of the Company Law as they relate to the shareholders in general, and in particular, the minority shareholders.

2.1.1 The Goal of the Company Law

Article 1 of the Chinese Company Law says that one of its legislative duties is protection of the rights of shareholders.12 The article offers, in accordance with the constitution, to protect the rights and interest of shareholders, companies and their creditors. In this case, the term shareholders refers to people who have a legitimate right and interest in a company and who will be protected by this legislation. In general terms, it means that minority are included in the “shareholders”

2.1.2 The Majority Rule

Item 1 of Article 4 of the Company Law provides a brief description of the rights of shareholders in accordance with the Company Law. The Article States that the shareholders can make decisions based on capital contributed. 14 This Article sets forth several basic rights of company shareholders and is worthy of consideration since it lays down a theoretical framework for understanding the rule of absolute majority. This is because the voting right is based on the “capital they have invested in the company” 15

There is no constraint placed on the right to vote. Given that majority rule is important in a company, it should not be acknowledged if it results in the oppression of the minority shareholders. This should also be applied in cases where the majority shareholders are not doing anything illegal, but their action or conduct is seen as being oppressive in nature to the minority shareholders through the use of their majority powers. The establishment of the absolute majority is also confirmed by Article 43 and 106 of the Company Law16

2.1.3 The Principle of Limited Liability

Article 3 of the company Law provides some protection to shareholders with limited liability. All companies, whether limited by shares or liabilities, are considered legal persons. Shareholders of a company limited by shares can be held liable to the extent of the amount contributed to the company. A limited liability company is responsible for the company debts including its assets. There is a need here to mention something concerning companies that are limited liability as well as those that are limited by shares. These two terminologies are awkward in nature and are commonly used in the officially approved translations of the Company Law. The two most popular alternatives would be “closely held corporations” and “publicly held corporations” respectively. In this analysis the terms are used interchangeably.

When it comes to the limited liability principle, the personal patrimony of shareholders, including minority shareholders is safe from their loss in the corporations. This is a basic tenet of modern corporate law. The Chinese Company Law does not have such provisions as “lifting the corporate veil”, and as such, it would be impossible to hold shareholders personally liable with different mechanisms such as “holding majority shareholders liable for their acts.” Since the minority shareholders are not that likely as the majority shareholders to control the company or abuse the legal personality of the company, it would be the majority shareholders who would benefit more from the lack of “lifting the corporate veil” The corporate veil is lifted in cases where there is abuse of the legal personality of the company. 19

2.1.4. Specific Rights of Shareholders

After the introduction of the general principles of Company Law, it is important to enumerate the specific rights of shareholders as prescribed in the Company Law. These are as follows;

right to attend shareholders meeting and right to take part in voting,

right to access company record and make proposals regarding the operation of the company,

right to request an interim shareholders general meeting,

right to commence court proceeding to require that actions of violation or infringement be stopped where resolutions agreed at a general meeting violate rights of shareholders,

right to request share certificates to be released to shareholders after a company has been registered,

right to purchase newly issued shares,

right to transfer shares according to the law,

right to request the appropriation of profits that remain after a company has made up its losses, and

right to request proportional distribution of properties that remain after paying debts in accordance with the requirements of dissolution 20

3.0. Defects of Minority Shareholders Protection in the Company Law

As we have seen above there are several protections offered to the minority shareholders as well as the specific rights and privileges under the company Law. However, these provisions are not adequate in the sense of the word as they have many loopholes that put the minority shareholders at a disadvantage. Minority shareholders, according to the provisions of the Chinese Company Law, are in precarious situations because of the following reasons 21

First, minority shareholders cannot supervise the management because they have no powers to call for a general meeting of shareholder as well as their inability to raise motions at such meetings. The right to vote can be exercised at the shareholders meeting that have bee convened legally, otherwise, any resolution arising from irregular meetings will not be bidding on the company, the management or any other shareholder. The first step would therefore be to convene a lawful meeting. Article 43 and 104 of the Company Law provide the procedure for convening a closely held company and publicly held one respectively. The articles divide the meetings into regular (closely held companies) and annual (public held companies), and interim meetings. The procedure is that the board of directors is responsible for convening such meetings and which is supposed to be chaired by the board chairman. The power to convene a shareholders meeting therefore lies solely on the hands of the management. There is no way that the minority shareholders can participate in this decision 22

This scenario places the minority shareholders in an awkward position. In a case where the management does something that is harmful to the shareholders or the company, he best option for the minority shareholders is to convene a regular/annual meeting and vote against the action of the directors or remove them from their positions. However, they have no such right and can only request to convene it if they have enough shares to do so (one-fourth for a closely held company or one tenth for a publicly held corporation). Such request can be turned down by the management lawfully. This means, under the Company Law, the minority shareholders have no ability to stop the unlawful actions of the management 23

On the issue of raising motions at the shareholders meeting, the Company Law seems to have failed the minority shareholders again. Article 44 and 104 implies that the matters that are tom be deliberated at shareholders meetings are raised by the board of directors. There is no elaboration on how shareholders can raise issues at such meetings 24. The end result is that the management (or the majority shareholders) has absolute powers to decide on these issues, while the minority shareholders are left without any say in such matters. Article 105 of the Company Law stipulates that an interim shareholders general meeting cannot adopt matters that are not stated in the notice. The content of meetings is decided by management, and minority shareholders cannot raise any matter that is not in the notice. The minority shareholders have no forum to raise their opinions either in the notices or in the meetings 25

Secondly, minority shareholders operate in a delicate situation because of the rule of absolute majority. Article 38 and 103 grant broad powers to the shareholders general meetings, since they are authoritative in providing directions. The aim of these two articles is to assure the shareholders that they assume a crucial role in running the company. The majority rule is the one that gives powers to the shareholders to exercise their rights at a general meeting 26. In the Company Law of China, the powers of the shareholders to supervise the management are mainly controlled by the majority shareholders. Majority shareholders can express their wishes with through voting, unlike the minority shareholders. Majority shareholders thus have a dominant part to play in the company and the minority shareholders are not protected from the dominion of the majority shareholders. Based on the notion that the majority shareholders can form a majority resolution, the minority shareholders would be in an extremely difficult position if they were seeking to overthrow the resolution or remedies. The fundamental principle in either Article 41(closely held companies) or 106 (publicly held companies), is that shareholders shall vote according to the capital they have invested in the company. One share equals one vote. If you have 90% of the shares in a company, you have 90% of the votes. This rule also applies to the shareholders general meeting, ranging from selecting directors or passing of important issues 27.

Thirdly, in circumstances where the positive resolution mechanisms have failed to protect the minority shareholders, it is quite impossible for to raise personal suits for compensation. In addition, it is also not possible to bring derivative action. In circumstances where the directors or majority shareholders are doing things that are technically legal but which harm the minority shareholders in one way, the minority shareholders can do nothing. Once more, we encounter another situation that specifically works to the disadvantage of the minority shareholders. Article 63 gives the minority shareholders a right to raise direct suits 28. It states that a director or supervisor shall be liable to damages in case where his actions violate the law. However, the manner in which to hold such a director liable is not stipulated. This is merely abstract as any action by a minority shareholder to bring a law suit against directors will mostly be rejected.

On the other hand, minority shareholders have no right to bring a derivative action on behalf of the company. The Company law does not provide for a derivative action and in the event that a shareholder would attempt to bring a law suit on behalf of the company, Item 1of Article 108 in the Civil Procedural Law of Peoples Republic of China would apply. This article requires two conditions are met in such a case: the plaintiff must be a citizen or a legal person with a direct interest in the company. If a derivative action is allowed, then the item that would be considered to have a direct interest inn the case would be the company and not the shareholder 29

4.0 Proposal for Reforms

The Chinese Company Law places ultimate power and authority of the corporation in the hands of the shareholders. The shareholders, ought to be more active and be able to propose resolutions at the general meeting. The Company law should be amended so as to offer minority shareholders more protection from the actions of management and the absolute majority rule. The question whether the proposals by minority shareholder can be added to the agenda can be decided on the basis of who convened the meeting. If the general meeting was convened by minority shareholders, this issue should be dealt with by the convening minority shareholders. In addition, the provision resolutions should be applicable to annual general meetings and also at extraordinary meetings as well 30

Another significant proposal would be to amend the Company Law of China, so that the law should impose a fiduciary duty on majority shareholders towards minority shareholders. China should also attach greater significance to cumulative voting for closely held corporations. In addition, the voting power of majority shareholders should be reduced so as to minimize the abuse of this rule. Civil law traditions tend to impose such restrictions. For instance, the Commercial Code of Italy provides that shareholders with less than 100 shares can only have one vote for every five shares held. Those with more than 100 can have only one vote for every twenty shares held. Article 179 of the Company Law of Taiwan province provides a similar arrangement. Belgium Company Law provides that a single shareholder shall not have more than 20% of the voting power of the corporation, nor shall he have more than 40% of the voting power present at the shareholders general meeting 31

Cumulative voting is essential for the protection of minority shareholders because Chinese Company Law is essentially weak and derivative action and oppression remedy are missing. In addition, it allows minority shareholders to get a fair representation on the board of directors based on the proportion of their holdings. Besides ensuring a balance of power between the minority shareholders, and the majority shareholders and the management, cumulative voting also offers a secure protection of the minority as they are well represented in the board of directors 32

The last but not the least proposal would be to allow classes and series in the Company Law of China. However, their privileges and rights should be set up in the corporate constitution by the shareholders. In this regard, China can borrow several ideas from England whose company Law is akin to that of China. Although these actions are easy to execute, the adaptation of them to the social reality in China remains a big challenge. Improving the welfare of the minority shareholders is not only a shareholders remedy issue, but also an issue of judicial reform, social justice and rule of law 33

5.0. Conclusion

In conclusion, this paper has deliberated on two major tasks. First, the shortcomings of the Chinese Law in the protection of minority shareholders were discussed. Secondly, several measures that were designed to offer shareholders protection were examined as well as the proposals to reform the Company Law of China. The defects identified were mainly the inability of the minority shareholders to deal with the dual oppression of the management and majority shareholders. Secondly was their inability to seek remedial action though lawsuits. The proposal for reform to protect the minority shareholders from managerial power included a proposal to convene a shareholders meeting and propose resolutions. Secondly, the imposition of fiduciary duty of majority shareholders towards minority shareholders was proposed. Thirdly, remedies available to minority shareholders through lawsuits were discussed.


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