Protecting Shareholders' Rights in Delayed Company Liquidations

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In China, a company often fails to carry out liquidation procedures although its operations may have ceased due to poor management or ineffective cooperation among its shareholders. Alternatively, a company may sometimes remain in operation and choose not to initiate liquidation procedures despite having had its business licence revoked or having been ordered to close down. Under these circumstances, the realization of a company's assets is unknown. As a consequence, creditors are unsure when they will be paid-off and shareholders are prevented from distributing the residual value of their invested capital fairly.

In order to protect the interests of creditors, the PRC Company Law (Company Law) (中华人民共和国公司法)provides that if a company fails to establish a liquidation committee within a certain period of time, a company's creditors may apply to the people's court to appoint appropriate persons to form a liquidation committee and carry out the liquidation. Investors of a foreign investment enterprise (FIE) also have similar rights. However, the rights for shareholders of other types of companies are not as clearly defined in the law. Not surprisingly, disputes between shareholders can easily arise, leading inevitably to litigation.

The Nantong case

A February 2006 decision of the Nantong Intermediate People's Court of Jiangsu Province provides an insight into the types of shareholders' interests that may be involved. In this case, two shareholders of a limited liability company could not reach agreement on the management of the company and decided against further cooperation by ceasing to trade. At the same time, liquidation procedures were not carried out. A year later, when the company failed to submit its annual inspection documents, the local Administration of Industry and Commerce revoked the company's business licence. Subsequently, a minority shareholder (Huang), on suspicion that a majority shareholder (Cai) was unlawfully using the company's property, requested that liquidation procedures be carried out. By relying on her status as a majority shareholder, Cai refused. In response, Huang made an application to the court seeking the appointment of shareholders to form a liquidation committee and to carry out liquidation procedures. Both the court of first instance and the appeal court supported Huang's claim.

Shareholders' interests protected

Although the legal basis for such minority shareholders' rights has not always been clear, in accordance with legal principle (see Article 192 of the old Company Law), the court took the view that where a company has ceased to do business and dissolution is imminent, minority shareholders have the right to commence with company liquidation. The court held that carrying out liquidation procedures is not only a duty but a right of the shareholders. Furthermore, the interests of minority shareholders in obtaining the company's remaining assets must not be impaired.

Even though the court's conclusion is a welcome one, a better developed line of legal reasoning may be used to support the judgement. It could be said that the court did not simply base its decision on the general principles of law derived from the old Company Law but used provisions in the new Company Law as well. Article 184 of the new Company Law provides that if a company fails to carry out liquidation within the time limit, an application can be made to the court to carry it out. Furthermore, analogy may be drawn from the various legal provisions concerning creditors' rights, where in some instances the interests of minority shareholders may be comparable to those of the creditors.

The case is also significant because it highlights the importance of protecting minority shareholders' interests. This position is supported by Article 183 of the new Company Law, which provides that shareholders holding 10% or more of a company's shares have the right to petition the court to dissolve the company when its managerial problems threaten to damage shareholders' interests.

Beijing court's guiding opinions

In 2004, the Beijing High People's Court expressed its view on this problem in the Guiding Opinions on Several Issues Concerning the Trial of Company Dispute Cases (Trial Implementation) (Guiding Opinions). The court opined that shareholders of a limited liability company are entitled to take legal action against other shareholders, if those shareholders have failed to fulfil their duty of carrying out the liquidation of the company's assets where the company is to be dissolved. The Guiding Opinions do not have a direct legally binding effect on lower-level courts in Beijing. However, due to the risk of having their judgement repealed by higher-level courts, these courts are expected to refer to and abide by the Guiding Opinions in practice.

Liquidation of FIEs

The Company Law only provides very general guidelines with respect to company liquidation when compared with the laws governing FIEs, which provide a more complete set of rules regulating liquidation (see Measures Concerning the Liquidation of Foreign Invested Enterprises, issued by the former PRC Ministry of Foreign Trade and Economic Cooperation in 1996). An important point to note under the old and new Company Law is that shareholders have the duty to be in charge of liquidation proceedings. Under FIE laws, such a right and duty is exercised by the board of directors, although investors may have rights in certain circumstances. Pursuant to Article 153 of the new Company Law, if the FIE's board of directors fails to carry out liquidation procedures, resulting in harm to the shareholder's interests, the shareholder may initiate legal proceedings in court.