Viewpoint | An analysis of the (III) of shareholders' preemptive rights

The the People's Republic of China Companies Act of (I) (hereinafter referred to as the "current Companies Act")

Article 24: A limited liability company shall be established with the capital contribution of not less than 50 shareholders.

The the People's Republic of China Companies Act of (II) (as amended in 2023) (the "Companies Act (as amended in 2023)")

Article 42: A limited liability company shall be established with the capital contribution of not less than 50 shareholders.

Article 90 stipulates that after the death of a natural person shareholder, his legal heir may inherit the qualification of a shareholder, unless otherwise provided for in the articles of association.

(IV) Provisions of the Supreme People's Court of (III) on Several Issues concerning the Application of the the People's Republic of China Company Law (2020 Amendment) (hereinafter referred to as "Interpretation IV of the Company Law")

Article 16 stipulates that when the natural person shareholders of a limited liability company change due to inheritance, if other shareholders claim to exercise the right of preemption in accordance with the provisions of paragraph 3 of Article 71 of the Company Law, the people's court shall not support it, unless otherwise provided in the articles of association or otherwise agreed by all shareholders.

Article 20 stipulates that if the transferring shareholder of a limited liability company does not agree to the transfer of shares after other shareholders claim priority purchase, the people's court shall not support the claim of priority purchase by other shareholders, unless otherwise provided for in the articles of association or otherwise agreed by all shareholders. If other shareholders claim that it is reasonable for the transferring shareholders to compensate for their losses, the people's court shall support it.

Article 21 stipulates that if a shareholder of a limited liability company transfers his equity to a person other than the shareholder, fails to seek the opinions of other shareholders on the equity transfer, or damages the preemptive right of other shareholders by means of fraud or malicious collusion, and other shareholders claim to purchase the transferred equity in accordance with the same conditions, the people's court shall support it, however, other shareholders do not claim within 30 days from the date when they know or should know the same conditions for the exercise of the right of first refusal, or more than one year from the date of registration of the change of equity.

If the other shareholders specified in the preceding paragraph only make requests for confirmation of the equity transfer contract and the validity of the equity change, and do not at the same time advocate the purchase of the transferred equity in accordance with the same conditions, the people's court shall not support it, but other shareholders are unable to exercise the right of first refusal for their own reasons, except for those who request damages.

If an equity transferee other than a shareholder cannot achieve the purpose of the contract due to the exercise of the right of first refusal by the shareholder, it may request the transferring shareholder to bear the corresponding civil liability in accordance with the law.

Minutes of the (IV) National Conference on Civil and Commercial Trials of Courts (Law [2019] No. 254)

Article 9 stipulates that in trial practice, some people's courts have misunderstood the provisions of Article 21 of the judicial interpretation (IV) the Company Law, and often find that the equity transfer contract is invalid on the grounds of protecting the preemptive rights of other shareholders. An accurate understanding of this provision requires attention not only to the protection of the right of first refusal of other shareholders, but also to the protection of the legitimate rights and interests of equity transferees other than shareholders, and to correctly determine the validity of equity transfer contracts concluded between shareholders of a limited liability company and equity transferees other than shareholders. On the one hand, other shareholders shall have the right of first refusal in accordance with the law and shall support their claims if they claim to purchase the shares on the same terms as stipulated in the equity transfer contract, unless the circumstances set out in paragraph 1 of the article arise. On the other hand, in order to protect the legitimate rights and interests of equity transferees other than shareholders, the equity transfer contract shall be deemed valid if there are no other reasons affecting the validity of the contract. If other shareholders exercise the right of first refusal, although the request of the transferee of the equity other than the shareholder to continue to perform the equity transfer contract cannot be supported, it does not affect its contractual request to the transferring shareholder to bear the corresponding liability for breach of contract.

In the event of a change in the shareholders of a (I) limited liability company as a result of succession, do other shareholders have the right to exercise their preemptive rights?

Article 94 of the Company Law (revised in 2023) has not amended Article 75 of the current Company Law. According to this article and Article 16 of the Interpretation IV of the Company Law, inheritance is the legal cause of the change of shareholders' qualifications and is not affected by the will of other shareholders, unless the articles of association or all shareholders make special provisions. In practice, there may be several problems in acquiring a company's equity through inheritance.

First, how should the shareholders of a limited liability company exceed a quorum due to equity inheritance?

According to the law, the number of shareholders of a limited liability company should be between one and fifty. In the case of (2017) Heimin Shen No. 451 dispute over the qualification confirmation of 32 shareholders between Daqing shirengou fishery co., ltd. and sun lingqi, the court held that the number of more than 50 people in the company was a problem in the reform of the property right system of shirengou aquaculture farm. sun lingqi and 32 people were both former farm workers and investors of shirengou company. only when they became shareholders of the company can the legitimate rights and interests be protected, therefore, the court finally confirmed its shareholder status, and for the problem of exceeding the quorum, it is recommended to resolve the problem by converting the limited liability company into a limited liability company, equity holding, the establishment of a limited partnership, equity custody or equity trust. Although the case does not involve the inheritance of shareholders, but the number of shareholders exceeds the quorum of the situation to give a certain decision ideas, that is, should be combined with the actual situation of the company and shareholders to confirm the qualifications of shareholders, and through the transformation of the form of the company, the successor to negotiate the transfer of inheritance shares, the establishment of trusts and other ways to make the number of shareholders in line with the law.

Second, if a limited liability company has access requirements for shareholder qualifications, heirs generally cannot inherit shareholder qualifications.

According to the civil judgment (2020) Yue01 Minzong No. 24552 issued by the Intermediate People's Court of Guangzhou City, Guangdong Province, because the partner or shareholder of the tax agent firm should be a person with a specific qualification certificate, the court finally found that the heir did not meet the company The articles of association and the statutory shareholder qualification access requirements, and rejected the heir's claim to enjoy the shareholder qualification. Therefore, if the articles of association of the company have made special provisions or there is a statutory shareholder qualification access requirements, the heir has no right to request confirmation of the qualification of shareholders.

How do (II) other shareholders carry out rights relief?

Shareholders shall exercise their right of first refusal within the statutory or agreed period of time, which I have discussed in the previous article and will not repeat here. Article 21 of the interpretation IV of the Company Law provides two remedies for other shareholders in cases where the transferring shareholder fails to fulfill the obligation of notice, or damages the preemptive right of other shareholders by means of fraud or malicious collusion, one is to exercise the preemptive right of shareholders within a certain period of time, and the other is to request damages from the court.

First of all, the first paragraph of Article 21 of Interpretation IV of the Company Law stipulates that other shareholders shall exercise the right of first refusal within 30 days from the date when they know or should know the same conditions for exercising the right of first refusal, or within one year from the registration of the change of shares. It can be seen that other shareholders can file a lawsuit in the people's court within one year after the transferee shareholder is registered as a new shareholder by industry and commerce at the latest, requesting confirmation that the resolution of the shareholders' meeting is not established, and apply to the company registration authority to cancel the registration that has been processed under the resolution. In practice, in some cases, shareholders request the court to confirm that the "equity transfer contract" signed by the transferring shareholder and the transferee shareholder is invalid. However, according to Article 9 of the minutes of the national court civil and commercial trial work conference, if the equity transfer contract that infringes the preemptive right has no other reasons affecting the validity of the contract, it shall be deemed valid. In addition, according to the third paragraph of Article 21 of the "Interpretation IV of the Company Law", if the purpose of the contract cannot be achieved due to the exercise of the preemptive right by other shareholders, the transferee shareholder may request the transferring shareholder to bear corresponding civil liability in accordance with the law.

Second, according to the second paragraph of Article 21 of the interpretation IV of the Company Law, other shareholders can claim damages from the transferring shareholders in accordance with the law, but it should be noted that the premise for other shareholders to claim damages is that they are unable to exercise the preemptive right and are not for their own reasons, but other shareholders need to fully prove that they are not negligent in exercising their rights, and the transferring shareholders are at fault, and their torts have caused losses to other shareholders, if the transferee and the transferring shareholder collude in bad faith, the transferee may be listed as a joint infringer, and if the subject company is at fault, such as providing false materials to assist in the registration of changes in equity, other shareholders may also be listed as joint infringer.

In addition, Article 20 of the "Interpretation IV of the Company Law" stipulates the "right of estoppel" of the transferring shareholder, that is, the transferring shareholder may choose to give up the transfer of equity after other shareholders claim to exercise the right of first refusal. In this case, other shareholders may require The transferring shareholder compensates for his reasonable losses, and the transferee shareholder may also request the transferring shareholder to bear the corresponding liability for breach of contract.

(I) Heilongjiang Higher People's Court (2017) Hei Minshen No. 451 Civil Judgment

Basic case: the retrial applicant Daqing shirengou fishery co., ltd. (hereinafter referred to as shirengou company) and the respondent sun lingqi and other 32 shareholders qualification confirmation dispute case, refused to accept the civil judgment of Daqing intermediate people's court (2016) hei06 min zong no 2189, and applied to Heilongjiang higher people's court for retrial.

Shirungou Company applied for a retrial, saying that according to the provisions of the Company Law, the number of shareholders of a limited company should not exceed 50, and the court of second instance confirmed that Sun Lingqi and other 32 people were shareholders of Shirungou Company, which seriously violated the provisions of the law and was an error of applicable law, so it applied for a retrial.

The retrial court (Heilongjiang Provincial Higher People's Court) held that according to the facts ascertained in the second instance of the 1. and the self-admission of Shirengou Company, it can be confirmed that 32 people including Sun Lingqi have made capital contributions to Shirengou Company, and 49 shareholders in the company are not 32 investors including Sun Lingqi. The second instance judgment confirms that the shareholder identities of 32 people (investors) including Sun Lingqi are correct in accordance with the provisions of the Company Law. Article 24 of the "Company Law" stipulates that "a limited liability company shall be established by less than 50 shareholders." Shirengou Company advocates that the number of shareholders of the company exceeds 50 if the identity of 32 investors such as Sun Lingqi is confirmed, but this is Shirengou. Problems occurred in the reform of the property rights system of the aquaculture farm. Sun Lingqi and other 32 people are both the original farm employees and the investors of Shirengou Company. And the number of shareholders of the company more than 50 can be solved by converting the limited liability company into a limited liability company, or by means of equity holding, establishment of limited partnership, equity custody or equity trust. Therefore, the court finally ruled to reject the retrial application of daqing shirengou fishery co., ltd.

(II) Yangquan City Intermediate People's Court of Shanxi Province (2021) Jin 03 Min Zhong No. 152 Civil Judgment

Basic case: Defendant Colin Company was established on October 28, 2003 with a registered capital of 3 million yuan and organized as a limited liability company. As of May 18, 2011, Yangmei Group has contributed 1.53 million yuan, accounting for 51% of the total share capital, and is the controlling shareholder. The remaining 49% of the shares are held by more than 60 employees of the company. Xu, as the general manager of the company, contributed 160000 yuan, accounting for 5.33 of the total share capital. Over the past few years, Colin has paid dividends many times, but has not increased its capital. There is only an internal transfer of shares between shareholders. On January 25, 2019, Xu died due to invalid medical treatment. The plaintiff's family repeatedly approached the leaders of Colin Company and a group of controlling shareholders, requesting to inherit Xu's shares or transfer them to other shareholders at a discount. Due to the large gap between the two sides, Sanyuan told the court. After investigation, the plaintiff Zhang Shumei is the wife of Xu Moumou, the plaintiff Xu Jing is the daughter of Xu Moumou, and the plaintiff Xu Minglei is the son of Xu Moumou. All three are the legal heirs of Xu. In addition, there are no other legal first-order heirs alive. It was also found out that in the articles of association of the defendant Colin Company (amended on October 19, 2018), which took effect before Xu's death, there is no provision that the legal heirs of the company's natural person shareholders shall not inherit the qualifications of shareholders after the death of the company.

The court of first instance (the People's Court of the Mining Area of Yangquan City, Shanxi Province) held that: Article 75 of the "Company Law" stipulates that after the death of a natural person shareholder, his legal heir may inherit the shareholder status; however, unless otherwise provided for in the company's articles of association. The third paragraph of Article 32 stipulates that a company shall register the names or names of its shareholders with the company registration authority; if the registration items are changed, the change registration shall be carried out. If the registration is not registered or the registration is changed, it shall not be used against a third party. In this case, the heir, Xu, is a natural person shareholder of the defendant Colin Company, holding 5.33 per cent of the total share capital. Since the defendant Colin's articles of association did not make a special agreement on the inheritance of shares after the death of shareholders, according to the provisions of the company law, the three plaintiffs, as the legal heirs of Xu, have the right to inherit Xu's shares, obtain the shareholder qualification of the defendant Colin, and have the right to require Colin to handle the industrial and commercial change registration for the three plaintiffs. The defendant Colin Company cited the "Opinions on the Pilot Program of Employee Stock Ownership in State-controlled Mixed Ownership Enterprises" and the "Amendment to the Articles of Association of Colin Company", and the claim that "Xu's shares can only be transferred internally and not inherited externally" is lacking. The facts and legal basis are not supported by the court.

Article 26 of the the People's Republic of China Inheritance Law stipulates that, unless there is an agreement, if the estate is divided, half of the jointly owned property acquired by the husband and wife during the existence of the marriage relationship shall be divided into the spouse. The rest is the estate of the decedent. Article 13 stipulates that the share of inheritance of heirs in the same order shall generally be equal. In this case, Xu's 5.33 percent stake in Colin Company belongs to the common property of Xu and Zhang Shumei. Therefore, half of it should be owned by the plaintiff Zhang Shumei, and the remaining half should be inherited by the three plaintiffs equally. The three original claims that Xu's actual shareholding ratio of 9.67 per cent lacked factual basis, and the court did not accept it. The three original claims were based on the "9.67 per cent" of the three-person inheritance ratio, which was not supported by the court due to the lack of factual and legal basis.

The Court of Second Instance (Intermediate People's Court of Yangquan City, Shanxi Province) held that: In this case, Xu Moumou had an equity interest in Colin Company before his death, and the appellants Zhang Shumei, Xu Jing, and Xu Minglei filed a lawsuit in this case as Xu Moumou's immediate family members, requesting to inherit Xu Moumou's shareholder qualification, and his subject qualification complies with the law. Whether his claim can be supported depends mainly on how the provisions of Colin's articles of association are viewed. As the autonomous rules of the company, the articles of association are the most basic and important guidelines for the organization and activities of the company, and are binding on all shareholders. The correct understanding of the articles of the articles of association should be based on the interpretation of the text, taking into account the system of the articles of association, the background of formulation and the implementation of the analysis. Although Colin's articles of association do not expressly state that heirs may not succeed to shareholders after the death of a shareholder, Colin's articles of association expressly state that shareholders may not transfer shares to legal or natural persons other than shareholders, and that retirement and transfer shall transfer all shares within the company. Colin Company is a state-controlled enterprise, the natural person shareholders are all company personnel, Colin Company has a high degree of human nature and closed characteristics, therefore, this case should be found that the articles of association of the company has excluded the inheritance of shareholder qualifications. Regarding Xu's shareholding ratio in Colin, although Colin's articles of association record that Xu accounts for 9.67 of the company's total share capital, but because Colin's shareholders are not only 10 as shown in the articles of association, but as many as more than 60 people, and all of them are employees of the company. Evidence such as 4 receipts submitted by Colin Company, details of company dividends in 2012 and 2013, employee stock ownership table, employee stock ownership details, stock ownership certificate, and stock ownership certificate personally signed by natural person shareholders can form a complete chain of evidence, and Xu Moumou's actual stock ownership ratio can be determined to be 5.33. Excluding the inheritance of shareholder qualifications, Zhang Shumei, Xu Jing, Xu Minglei still have property rights, how to deal with the underlying equity is a corporate governance matter, Colin can negotiate with Zhang Shumei, Xu Jing, Xu Minglei to buy back shares, but also through other legal means to solve the problem. To sum up, the claims of Zhang Shumei, Xu Jing and Xu Minglei in the first instance lack factual and legal basis and should be rejected. The court finally decided to revoke the civil judgment No. 1198 of the People's Court of Yangquan Mining Area (2019) of Shanxi 0303 and Minchu; and rejected the claims of Zhang Shumei, Xu Jing, and Xu Minglei.

(III) Civil Judgment No. 24552 of the Intermediate People's Court of Guangzhou City, Guangdong Province (2020)

Basic case: Ruihai Company was established on November 1, 2000 with a registered capital of 300000 yuan. Zhou is one of the shareholders (investors) of Ruihai Company, contributing 15000 yuan and holding 5% of Ruihai Company. On August 20, 2002, the shareholders of Ruihai Company, including Zhou, signed the "Articles of Association of Limited Liability of Guangzhou Ruihai Tax Agent Firm". There is no relevant agreement in the articles of association on the inheritance of shareholder qualifications or the equity arrangement after the death of shareholders.

Huang Zhigang and Zhou registered their marriage on January 11, 1991. On April 10, 2016, Zhou died. On July 13, 2016, notarized by the Haizhu Notary Office in Guangzhou City, Guangdong Province, Zhou's 5% equity in Ruihai Company was inherited by Huang Zhigang alone. On August 22, 2016, Huang Zhigang entrusted Guangdong Yiheng Law Firm to mail Ruihai Company a "Lawyer's Letter on Request to Purchase Equity in the Company and Pay Equity Price", in which Ruihai Company was required to purchase 5% equity of Ruihai Company under Zhou's name inherited by Huang Zhigang and pay a reasonable equity price. Huang Zhigang filed a lawsuit in the court of first instance because he failed to recover the equity price from Ruihai Company. In the lawsuit, the court of first instance, based on Huang Zhigang's application, entrusted Yeqin Appraisal Company in accordance with the law to evaluate the market value of 5% of the shareholders' equity of Ruihai Company.

The court of first instance (Haizhu District People's Court, Guangzhou City, Guangdong Province) held that the case was a dispute over the acquisition of shares by the company. Huang Zhigang asked Ruihai Company to compensate the equity price of 421966 yuan according to the appraisal price. In fact, he asked Ruihai Company to purchase 5% equity of Ruihai Company under Zhou's name at 421966 yuan. There is no relevant agreement in Ruihai's articles of association for the inheritance of shareholder qualifications or the arrangement of shareholding after the death of a shareholder, and there is no special agreement between Huang Zhigang and Ruihai. The 5% equity of Ruihai Company under Zhou's name belongs to Zhou's estate. The price assessed by Yeqin Appraisal Company on the market value of 5% shareholders' equity of Ruihai Company is only a reference price. The price has not been actually tested by the market and will change due to external factors. Up to now, there is no evidence that anyone is willing to buy at this price, at present, Huang Zhigang requires Ruihai Company to buy back 5% of Ruihai Company's shares under Zhou's name at this price, which is equivalent to forcing Ruihai Company to reduce its capital to acquire shares. There is no relevant legal basis for this, and it also violates the principle of fairness. Moreover, the rights and obligations of shareholders within the company are equal. Forced repurchase may cause damage to the rights and interests of other shareholders, so the court of first instance does not support it. In this case, Huang Zhigang said that he did not have the qualification to be the investor of the tax agent firm, could not be registered as a shareholder of Ruihai Company in essence, and could not exercise the rights of shareholders. In order to protect Huang Zhigang's legitimate rights and interests, Ruihai Company should assist Huang Zhigang to handle the listing and trading procedures of 5% equity of Ruihai Company under Zhou's name in the equity trading department, and the trading price can be determined by referring to the assessed price of 421966 yuan, the disposal of 5% of Ruihai's equity through market bidding is more conducive to protecting the rights and interests of both parties. Since Ruihai Company is not at fault in this case, and there is no breach of contract, the main reason for the dispute is the death of Huang Zhigang's spouse Zhou, Huang Zhigang is unable to exercise the rights of shareholders, so the assessment fee and acceptance fee of this case shall be borne by Huang Zhigang. To sum up, the court of first instance ruled that Ruihai Company shall assist Huang Zhigang to go to the equity trading department to handle the listing and trading procedures of 5% equity of Ruihai Company held by Zhou Mou (the price shall be determined by reference to 421966 yuan) within one month from the effective date of the judgment, and the proceeds from the equity transfer shall belong to Huang Zhigang. And rejected Huang Zhigang's other claims.

The court of second instance (Guangzhou intermediate people's Court of Guangdong Province) held that: on the question of whether Ruihai company should compensate Huang Zhigang for the equity price, first of all, judging from the facts ascertained in this case, Huang Zhigang can no longer enjoy the complete rights of shareholders, nor can he realize his inherited property rights through internal transfer. On the one hand, although Huang Zhigang inherited Zhou's 5% stake in Ruihai Company, he could not register as a shareholder of Ruihai Company because he did not have the qualifications required by the industry to which the company belongs. Article 5 of the regulations on Administrative Registration of tax agents (for trial implementation), which came into effect by the State Administration of Taxation on September 1, 2017, stipulates that if a tax agent firm adopts the form of partnership or limited responsibility system, the following conditions shall be met, unless otherwise stipulated by the State Administration of Taxation: (1) the partners or shareholders shall be tax agents, certified public accountants and lawyers, of which the proportion of tax agents shall be higher than 50%. Huang Zhigang does not have the required professional qualifications, so it objectively does not have the qualifications to become a shareholder of Ruihai Company. On the other hand, the shares inherited by Huang Zhigang cannot be realized through the transfer of the company's internal shareholders. After Huang Zhigang solicited opinions from the shareholders of Ruihai Company on his own, none of the shareholders of Ruihai Company expressed their willingness to purchase. Ruihai Company also solicited opinions from its shareholders, but only two shareholders expressed their willingness to purchase, and the price difference led to failure.

Secondly, Article 74 of the the People's Republic of China Company Law stipulates several situations in which the dissenting shareholders who vote against the resolution of the shareholders' meeting request the company to purchase the shares. Although this case does not conform to the above legal situation of requesting the company to buy back the shares and lacks the internal agreement of the company's articles of association as a ready basis to support Huang Zhigang's claim in this case, the "original" defect of the shares inherited by Huang Zhigang is the reason that cannot be attributed to both parties, it is more in line with the principle of fairness to determine that Ruihai Company is the compensation subject when Huang Zhigang withdraws from the company. Therefore, the final judgment is to revoke the civil judgment No. 569 of the People's Court of Haizhu District, Guangzhou City, Guangdong Province (2018) Yue 0105 Min Chu. And Guangzhou Ruihai Tax Agent Office Co., Ltd. shall compensate Huang Zhigang at a discount of 421966 yuan within 10 days from the effective date of this judgment.