Becoming a Minority Shareholder in a Chinese Company – Opportunity or Risk?
Imagine you and your friends jointly purchase a car, but you only contribute 10% of the purchase price. Meaning, you own a part of the car and are entitled to 10% of the rental income. However, unless there is a clear agreement protecting your rights, you have little say in major decisions, such as repairs or selling the car. If the majority owners mismanage or neglect their responsibilities, the value of your share decreases, and you bear the risks arising from their decisions.
Meaning: You have financial interests but little control over management decisions.
Now, apply this example to a corporate context. The Chinese company law underwent major changes. How does that affect the minority shareholders?
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General Decision-Making Rules
Different matters require different voting thresholds:
- Major decisions, such as increasing or reducing registered capital, mergers, divisions, dissolution or amendments to the Articles of Association (AoA), require approval from shareholders holding more than two-thirds of the voting rights. This is usually to ensure that major decisions gain majority support and to avoid excessive influence from minority shareholders over critical company decisions.
- For general matters, resolutions typically require approval from shareholders holding more than 50% of the voting rights, unless the Company’s AoA specifies otherwise. Without specific provisions, the threshold for general decisions is a majority vote.
Majority shareholders typically hold more than 50% of the company’s shares, and sometimes even more than two-thirds, thus exerting decisive influence over the company’s significant decisions. This also means that the voice and right to make suggestions of minority shareholders may be somewhat restricted.
Shareholder Responsibility
According to Article 50 of the Company Law of the People’s Republic of China: “When a limited liability Company is established, if a shareholder fails to make actual payment of capital contributions as stipulated in the Company’s AoA, or if the actual value of non-monetary assets actually contributed falls significantly below the subscribed capital amount, the other shareholders at the time of establishment shall bear joint and several liability with that shareholder within the shortfall in contributions.” While this provision protects the interests of corporate creditors, it could pose risks for minority shareholders by exposing them to responsibilities beyond their own capital contributions.
Thus, we recommend carefully choosing joint venture partners who have sufficient financial capability and the willingness to fulfill their capital contribution obligations. This can effectively avoid legal disputes and financial losses caused by inadequate contributions.
How to Effectively Protect Minority Shareholder Rights
No. 1: Share Forfeiture Mechanism
Shareholders who fail to contribute their full capital may receive written notices from the company. If the issue is not resolved within a grace period, the board of directors may pass a resolution to forfeit the shares corresponding to the unpaid contributions. This means the shareholder would lose their shares due to failure to fulfill their contribution obligations.
It is important to note that the capital call notices and share forfeiture procedures must comply with statutory procedures to avoid invalidation due to procedural errors.
No. 2: Specify Requirements in Contribution Agreements and AoA
Minority shareholders can demand greater voting thresholds in shareholder meeting procedures and voting rules than the legal minimum, thereby gaining more control (Article 65 of the new Company Law). Under the old Company Law, shareholder voting rights were generally determined by their contribution ratio unless otherwise specified in the AoA.
We recommend that JV shareholders include relevant provisions in the AoA or shareholder agreements to ensure compliance with capital contribution obligations and clarify the responsibilities for non-compliance.
No. 3: Expanded Access to Shareholder Information
Previously, shareholders could only access company ledgers. However, under Article 57 of the new Company Law, shareholders now have the right to access and copy the following documents:
- AoA
- Shareholder register
- Shareholder meeting minutes
- Resolutions (board resolutions, supervisory board resolutions)
- Financial reports
- Company ledgers and vouchers
- Key documents of wholly-owned subsidiaries
Shareholders can review these themselves or appoint an accounting or legal firm to do so. This makes it easier for foreign shareholders to supervise Sino-foreign JVs and puts more pressure on controlling shareholders and management, enhancing corporate transparency.
No. 4: Exit Mechanism
If controlling shareholders abuse their rights and severely harm the company or the interests of other shareholders, they have the right to request share buybacks (Article 89, Paragraph 3 of the new Company Law). It is advisable to consult legal experts in advance to work out how “abuse of rights” or “severe harm” are defined according to your personal case.
Professional Advice
In conclusion, becoming a minority shareholder in a Chinese company can present both opportunities and significant risks, especially when control over decisions is limited. While the new Company Law offers some protective measures, careful planning is essential. Minority shareholders should work closely with legal and tax experts to ensure their rights are clearly defined in the AoA and shareholder agreements, particularly regarding contributions and voting rights.
Professional advice is crucial to ensuring compliance, reducing risks, and achieving investment fairness in JVs. Contact us for more information!
