China's Highest Court Arms Investors To Go After Corporate Cheats

Zhou Qiang, President of the Supreme People’s Court, speaks during the third plenary session of the National People’s Congress in the Great Hall of the People in Beijing on March 13. (Greg Baker/AFP/Getty Images)

As anyone who spends time doing business in China knows, corporate governance is a major issue in China. With billions of foreign funds invested in Chinese companies, and many Chinese issuers listed on stock exchanges outside of China, tools that will enable minority shareholders, creditors and others to combat basic abuses in Chinese companies are important to the foreign investment community as well as financial institutions.

China’s highest court, the Supreme People’s Court (SPC), is working on this issue, through its power to issue quasi-legislation, called judicial interpretations. It has recently issued a draft judicial interpretation on corporate governance for public consultation. It supplements the vague language in the Company Law and will:

1. Enable minority shareholders, creditors, senior management, and employees to challenge illegal, unfair, and abusive acts by majority shareholders and to prevent those acts from going into effective.


Forged or defective board resolutions or shareholder resolutions, including resolutions from meetings that never happened, or lacked a quorum, or did not vote on the resolution, or failed to pass by the necessary proportion. These happen regularly, as revealed inlitigation in the Chinese courts, New York Courts, US federal courts, and listing documents for major companies (Minsheng Bank).

2. Give specific grounds for challenging unfair or abusive corporate action.

One of those grounds is abusive related party transactions, particularly among listed companies, which the Chinese securities regulatory authority admitted to be a problem in this OECD report and is again discussed in another OECD report.
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3. Give shareholders more specific guidelines to be able to enforce their rights to access and copy company books and records, including being able to designate someone else to access the records. Accurate information about company action and financial records is often needed for a shareholder to enforce his rights in other ways.

4. Enable shareholders to enforce their right of first refusal. That is the priority right that existing shareholders have to purchase the shareholding of a party intending to transfer all or part of his shareholding to a third party. It’s not unusual for the selling shareholder to engage in various types of strategies (such as misleading the other shareholders) to avoid selling to an existing one. Chinese law on what “sale on the same conditions” was unclear, creating difficulties for plaintiffs and judges. The draft judicial interpretation provides that courts will take a holistic approach to the issue.

5. Give specific guidelines for shareholders to file derivative lawsuits.

Chinese company law has had provisions enable shareholders to file derivative lawsuits for several years, and several academic studies have been done on how effective they are. The existing law is felt to be too vague, and leaves important questions unanswered, such as whether a shareholder in a subsidiary can file a derivative lawsuit against the parent company. This provision, called a double derivative lawsuit, is found in English, Delaware, and other jurisdictions.

Efforts are underway among foreign lawyers to comment on the SPC’s draft. If you or your lawyer is interested in becoming involved in commenting on the draft, please use the comment function to contact the author.

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