Shareholders’ agreements in limited liability companies in China

di Giovanni Pisacane

Categories: Business Law
Typology: Articles

Shareholders’ agreements in limited liability companies in China


Shareholders' agreements play a significant role in tailoring important aspects of a company structure to the particular needs of the shareholders. Although shareholders' agreements are widely employed in China, they are not yet regulated in the Company Law of the People's Republic of China and therefore there is no reference in corporate law as to their validity and effectiveness. This analysis will therefore focus on some of the more common aspects disciplined by shareholders’ agreements and their regulation and compatibility under the current legal system of the People’s Republic of China.

Dividends preference

One common aspect generally disciplined by shareholders’ agreements is dividends preference. The PRC New Company Law, effective since the 1st of January 2006, modernized the corporate law system and introduced greater flexibility, and now art. 35 stipulates that in principle the dividends shall be distributed to the shareholders proportionally to their paid in capital contributions however it also specifies that this is a default rule that applies “unless all of the shareholders decide that dividends will not be shared in proportion to their capital contributions or that the subscription for capital contributions on a priority basis will not be handled in proportion to their capital contributions”. This is one of the many examples of the New Company Law granting more freedom to the shareholders of limited liability companies.

Therefore dividend preference clauses, found in shareholders’ agreements between all shareholders, although not expressly provided for, it can find a legitimizing provision in the Company Law.

Shareholder voting agreements

Another aspect commonly contained in shareholders' agreement is shareholders voting agreements.

Shareholder voting agreements are a contract entered into by and between the shareholders, or part of them, of a company that regulate how they may exercise their voting power in a certain way on certain matters. These agreements may lead to groups of shareholders exercising their voting rights as a common unit. Whether the shareholders exercise their voting rights in respect of a particular resolution and how to exercise the right to vote belongs to the shareholders right and as such, is in principle freely waived or relinquished.

According to art. 43 of the Company Law in China, “the shareholders shall exercise their voting rights at the shareholders' meeting on the basis of their respective percentage of capital contributions, unless it is otherwise prescribed by the articles of association”. Therefore, according to this article, the Chinese corporate law allows the shareholders to depart from the default rule however there is a specification that this must be incorporated directly into the articles of association of the company.

These voting agreements are of particular importance for certain resolutions that the law poses higher majority requirements on art. 44 specifies that shareholder resolutions on the following issues have to be adopted at a majority of 2/3 of the voting rights: the increase or reduction of the registered capital, or the merger, division, dissolution or restructuring of the company, must be adopted by shareholders representing at least two-thirds of the voting rights.

As we see it is in principle allowed to depart from this rule, however the law also specifies that the different voting rights must be included in the Articles of Association.

Restrictions on decision making are more stringent in the case of Sino-foreign equity joint ventures, where, according to art. 33 of the PRC Sino-foreign Equity Joint Venture Law Implementing Regulations the following decisions require the unanimous consent of the board of directors present (the quorum for a board meeting shall be two-thirds of the directors): amendment of the articles of association of the joint venture; termination and dissolution of the joint venture; increase or reduction of the registered capital of the joint venture; and merger or division of the joint venture.

It is therefore common to provide for different majorities in shareholders’ agreements, and as, there is no express provision in corporate law, they are not expressly regulated nor are they expressly prohibited.

Therefore, to analyze the validity of voting agreements we must turn the Contract Law, in particular Article 52 of the Contract Law offers a useful interpretation of the issue as it provides for when an agreement is invalid:

Art. 52 Invalidating Circumstances

A contract is invalid in any of the following circumstances:

(i)             One party induces conclusion of the contract through fraud or duress, thereby harming the interests of the state;

(ii)           The parties collude in bad faith, thereby harming the interests of the state, the collective or any third party;

(iii)          The parties intend to conceal an illegal purpose under the guise of a legitimate transaction;

(iv)          The contract harms public interests;

(v)           The contract violates a mandatory provision of any law or administrative regulation.”

Therefore, if the content of Shareholder voting agreements does not violate the mandatory norms or the public order and good morals, or does not constitute an abuse of rights, the agreement should be valid and effective on the basis of the parties’ contractual freedom and therefore should be enforceable. As the Company Law and Sino-Equity Joint Venture Law do not provide that shareholders’ agreements are invalid and due to the non mandatory nature of the voting rules, shareholder voting agreements should be valid and enforceable for both wholly-foreign owned companies and sino-foreign joint ventures. 

Protection of minority shareholders of the company

The New Company Law has introduced minority shareholder protection mechanisms which were not present previously, therefore under the current system shareholder(s) representing more than 3% of the share capital may now present an extempore motion and submit it to the board of directors 10 days prior to the convening of a shareholders’ general meeting.

If difficulties arise from the operation and management of the company that may cause losses to the shareholders, shareholders representing 10% of the equity may petition the People’s Court to liquidate the Company.

Art. 75 then contemplates protection mechanisms for the shareholder: in the event the shareholder votes against certain resolutions passed at a shareholders’ meeting, the shareholder may request that the company purchase its equity at a reasonable price. The shareholder may request the repurchase of his equity share if: dividends are not paid out for 5 consecutive years in which the Company is operating at a profit; the company merges, is divided or its main property is transferred, modification of the articles of association to extend the life term of the company. If an agreement on the purchase of the equity share isn’t found the shareholder may petition the competent court within 90 days from the vote. 

Whereas these provisions represent an important step towards protecting minority shareholders these protections are in no way exhaustive, and therefore shareholders’ agreements can still represent a more effective protection, that in limited liability companies, due to lack of access to an open market for equity and therefore given the limited cases in which exit is possible, is a reasonable concern for any minority shareholder. Shareholders’ Agreements can therefore prove effective in providing minority shareholders with greater decision-making power of the company and protection from majority abuse. Due to the lack of specific legislation the specific validity and enforceability of shareholders’ agreement will have to be judged on a case by case basis.

Preemptive right

Art. 72 of the PRC Company Law provides that “Where a shareholder transfers its shares to a person other than a shareholder, the consent of more than half of all other shareholders shall be required. Where the shareholders consent to the share transfer, other shareholders shall have the preemptive right to purchase the shares to be transferred on equal terms and conditions. Where the articles of association stipulate otherwise, such stipulations shall apply”. Therefore, unless otherwise provided in the articles of association, the exercise of the preemptive right consists of the following issues: a) consent of more than half of all other shareholders; b) the article literally refers to half of other shareholders and not refers to the shareholders with more than 50%; c) transferring shareholder and non-shareholder purchaser have reached agreement on the terms and conditions of such transfer; and d) the existing shareholder chooses to exercise its preemptive right based on equal terms and conditions.

In addition to the statutory preemptive right, the PRC Contract Law provides the principle of “Freedom of Contract”, which allows the shareholders to get a different contractual preemptive right to a non-shareholder third party. Such contractual preemptive right shall be exercised pursuant to the specific provisions of the contract and is inferior to the statutory preemptive right. If the shareholder granting contractual preemptive right breaches, it will be difficult for the party entitled to the contractual preemptive right to enforce such right.

The main point not clear in the mentioned article is what should be equal term and conditions. This is still an open issue that in practice can create difficulties in interpretation and implementation of the  preemptive right.

Right of First Refusal

Further according to art. 72 of the Company Law in China, in the event of consent being granted to an equity transfer, the other shareholders shall have a pre-emptive right of purchasing the equity whose transfer they have consented to.

However, a more clear indication of the legislator’s non mandatory approach, the third paragraph of art. 72, that states ‘if the company’s articles of association provide otherwise in respect of equity transfers, such provisions shall prevail’.

Therefore, in light of this par. 3, the shareholders are free to renounce to such rights and therefore one may argue that shareholders’ agreements may contain waivers of such rights.

Naturally shareholders’ agreements that contain rights of first refusal of shareholders shall not be in conflict with the application of the Company Law, as they would simply be redundant, however the shareholders’ agreement can be a useful tool to better provide for price determination methods of the equity in exercising the right of first refusal.  


Due to a lack of awareness and the relatively new freedom granted by the Company Law to re-determine rights and obligations of the shareholders, shareholders’ agreements have been undervalued and the legislator’s approach has been to encourage the incorporation of most provisions in the articles of association, primarily by leaving shareholders’ agreements not regulated and therefore cloaked in uncertainty.  

However where the law does not indicate that such depart from the default rule must be indicated in the articles of association, and taking into consideration the spirit of greater freedom introduced with the New Company Law and the interpretation of shareholders’ agreements under the Contract Law, it is possible to sustain their validity and effectiveness in China on most topics. Shareholders’ agreements guarantee greater flexibility and privacy, compared to articles of association and can undoubtedly better meet the various requirements of the shareholders and provide an encouragement for investment. Therefore, whereas, from the above analysis, the validity, effectiveness and enforceability in China question may be overcome though interpretation, for such a useful and widely employed instrument in corporate law not to be expressly disciplined, is an unacceptable gap in the legislation.  It is now more than ever necessary for the law maker in China to acknowledge the wide use and usefulness of shareholders agreement and offer a guide to investors of limited liability companies.

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