The Impact of the IV Judicial Interpretation of the Company Law to Foreign Invested Enterprise

A foreign Company A and a Chinese Company B jointly set up a joint venture Company C, which is a limited liability company. The GM of C was assigned by Company B. Because the finance report showed years of loss, A decided to transfer all its equity to B. Several months later, by a chance, A found the GM had set up another company without notified the shareholders. C purchased raw materials with unreasonable high prices from this company for years. A required C to provide the relevant finance documents for review, but C rejected this request. A filed the dispute to the court.

Before the implementation of the “Provisions of the Supreme People’s Court on Several Issues concerning the Application of the Company Law (IV)” (hereinafter referred to as the “Interpretation IV”), the court would not support A. However, upon the implementation of “Interpretation IV”, A as the original shareholder of C might get a chance to obtain the support of the court. There are 2 preconditions for an original shareholder to implement its right to know. Firstly, the original shareholder shall provide a preliminary evidence to prove its legitimate rights and interests were damaged during the holding period. Secondly, the original shareholder could only request to review or copy the company’s specified documents related to the holding period.

For the shareholders’ right to know, enterprises shall pay attention to another 2 changes: (1) Article 7 and 10 of “Interpretation IV” embody the tendency to respect the independent of a company’s management, which means it allows a company to stipulate specific rules on how to perform the shareholders’ right to know. For example, to avoid the bad effects brought by the implementation of the shareholders’ right to know to a company’s daily operation, a company could prescribe the venue, period, frequency in the period, the name or category of the specific documents (e.g. original accounting voucher) and etc., in the Articles of Association. However, if the Articles of Association has materially deprived the shareholders’ right to know, there is a negative risk. (2) If a foreign investor lacks of professional financial knowledge or is not familiar with Chinese financial system, “Interpretation IV” has stipulated the rules on entrusting a third party to assist a shareholder, which says with the presence of the claimed shareholder, the accountants, lawyers could access to the company’s relevant documents in accordance with laws; or other licensed staffs of a third party could assist the shareholder to access to the company’s relevant documents in accordance with laws, and the licensed staffs shall have the duty of confidentiality in accordance with the code of practice.

In addition to the shareholders’ right to know, “Interpretation IV” has stipulated articles on the effectiveness of the resolution of the shareholders’ meeting, and the resolution of the board of directors.

Firstly, the procedure for making a resolution has a domination influence. Article 5 of “Interpretation IV” adds 4 situations in which the resolution shall be deemed invalid. There are, ①where the resolution is adopted without convening a meeting; ②Where the resolution is adopted at the meeting without voting on it; ③Where the number of attendees showing up at the meeting or the voting rights held by present shareholders do (es) not comply with provisions of the Company Law or the company’s articles of association; ④Where the voting result for the resolution at the meeting does not reach the proportion stipulated by the Company Law or specified in the company’s articles of association. For foreign investors who are located overseas, normally the JV or WOFE would not convene a meeting, then it is recommended to check whether the Articles of Association of the JV or WOFE has stipulated that a resolution could be made in written signed or sealed by all shareholders instead of convening a meeting.

Secondly, in order to maintain the stability of the shareholders’ legal relationship, “Interpretation IV” establishes the court’s discretion of reject. Article 4 of “Interpretation IV” prescribes that a shareholder’s claim to cancel a resolution of the board of shareholders or the general meeting of shareholders or the board of directors of a company shall be upheld by the court, ……However, if the procedure for calling the meeting or the voting method is barely subject to a few minor defects, the court shall not uphold the claim. In view of this, the court might reject the claim if there are a few minor defects related to the procedure.

Thirdly, to correspond with the principle on protecting the bona fide counterparty as stipulated in “General Rules of the Civil Law”, Article 6 of “Interpretation IV” stipulates where the court rules that a resolution of the board of shareholders or the general meeting of shareholders or the board of directors of a company is null and void or canceled, the civil legal relationship formed between the company and a bona fide counterparty according to such resolution shall not be affected. In view of this, if a resolution is null and void or canceled, the shareholders could claim to the liable party for liabilities, but for the bona fide counterparty, the civil legal relationship formed with the company shall not be affected.

In addition, “Interpretation IV” have also prescribed some other articles on the distribution of profits, the litigation system related to the shareholder’s representative and so on. Companies and shareholders would be better to review these articles, and check or amend the relevant articles in the Articles of Association or relevant management rules based on the actual situation.