I. Introduction of the Problem
In October 1996, Zhang Min, together with his good friend Lin Min and Lin Min's younger brother Lin Ming, jointly invested in establishing Damin Limited Liability Company with a registered capital of 500,000 yuan. Zhang Min contributed 100,000 yuan, Lin Min contributed 200,000 yuan, and Lin Ming contributed 200,000 yuan. After one year of company operation, Zhang Min had disagreements with the Lin brothers over profit distribution and corporate decision-making. The Lin brothers used their status as controlling shareholders to make resolutions not to distribute company profits, which escalated the conflict. Zhang Min wanted to exit the company. Zhang Min transferred his shares to a third party; however, due to internal conflicts within the company, it was difficult to find a transferee, and Lin Min and Lin Ming also refused to purchase his shares. Helpless, Zhang Min filed a lawsuit.
This case raises a long-standing issue that has troubled both the practice and theory of corporate law: how can shareholders, especially small and medium-sized shareholders, legally and safely exit a company? We all know that once a company is established, it is very difficult for shareholders to withdraw from the legal capital. Article 36 of the "Company Law" stipulates that after the establishment of a company, its shareholders shall not withdraw their contributions. This is due to the strict regulation of statutory registered capital in civil law systems. Minimum capital, capital immutability, and capital maintenance are the statutory principles for the establishment and operation of companies. However, if there are conflicts within the company, not allowing shareholders to exit would also be an infringement on shareholder rights. The 2006 version of the "Company Law" made some regulations regarding the exit of company shareholders, mainly through three models: one is the internal and external transfer of shareholders' equity; two is that shareholders can request the company to repurchase shares under certain special circumstances; three is that shareholders can request the dissolution of the company under certain conditions. Below, I will elaborate on these points.
II. Models for Shareholders Exiting According to China’s "Company Law"
(a) Model of Equity Transfer
Article 72 of the "Company Law": Internal Transfer - Shareholders of a limited liability company may transfer all or part of their equity among themselves. External Transfer - A shareholder who transfers equity to someone outside the group of shareholders must obtain the consent of more than half of the other shareholders. The transferring shareholder must notify the other shareholders in writing to seek their agreement. If the other shareholders do not respond within 30 days of receiving the written notice, it is considered as agreeing to the transfer. If more than half of the other shareholders disagree with the transfer, the dissenting shareholders must purchase the equity being transferred; if they do not purchase it, it is deemed as agreeing to the transfer. Corporate Charter Autonomy - If the corporate charter has different provisions regarding equity transfer, those provisions shall apply. Regulations on the Transfer of Shares in Joint-Stock Companies: Article 139 - The transfer of shares by shareholders shall be conducted in a securities trading venue established according to law or in another manner prescribed by the State Council. Article 140 - Registered shares may be transferred by endorsement by the shareholder or in any other manner prescribed by laws and administrative regulations, and after the transfer, the company shall record the name or title and address of the transferee in the register of shareholders. Article 141 - The transfer of unregistered shares becomes effective when the shareholder delivers the share certificate to the transferee. These clauses indicate that the best way for shareholders to exit the company is through equity transfer. Due to the personal nature of limited liability companies, shareholders need the consent of other shareholders to transfer their equity externally. On the other hand, joint-stock companies reflect the characteristic of capital aggregation, especially for unregistered shares, demonstrating the feature of “voting with your feet.”
If the method of exiting the company through the transfer of shares does not work for shareholders of a limited liability company, such as in the above case, or if shareholders of registered shares in a joint-stock company want to exit but cannot find takers inside or outside the company, how can they exercise their statutory rights and protect their legitimate interests? The "Company Law" stipulates that the company may repurchase its shares under certain circumstances, allowing shareholders to legally exit the company.
(b) Model of Company Repurchasing Shares
Article 75 of the "Company Law": In the following circumstances, shareholders of a limited liability company who voted against a resolution at the shareholders' meeting may request the company to acquire their equity at a reasonable price:
1. The company has not distributed profits to shareholders for five consecutive years, while the company has been profitable for five consecutive years and meets the conditions for profit distribution stipulated in this law;
2. The company merges, splits, or transfers major assets;
3. The business term specified in the articles of association expires or other dissolution reasons specified in the articles of association occur, and the shareholders' meeting passes a resolution to amend the articles of association to continue the existence of the company.
Within 60 days from the date the resolution is passed, if the shareholder and the company cannot reach an agreement on the acquisition of equity, the shareholder may file a lawsuit with the people's court within 90 days from the date the resolution is passed. Article 143 of the "Company Law": A joint-stock company may not repurchase its own shares, except in the following cases:
1. To reduce the registered capital of the company;
2. To merge with another company holding the shares of the company;
3. To reward employees of the company with shares;
4. Shareholders object to the resolution of the shareholders' meeting regarding the merger or split of the company and request the company to repurchase their shares.
The advantage of the model of company repurchasing shares stipulated in the "Company Law" is that eligible limited liability companies can reasonably repurchase their shares. However, the "repurchase conditions" are extremely strict, such as not distributing dividends for five years but still being continuously profitable; the expiration of the business term specified in the articles of association or other dissolution reasons, where the shareholders' meeting resolves to keep the company running, etc., and similar situations exist for joint-stock companies. In fact, in our daily lives, such situations are not common. Common scenarios involve conflicts between shareholders, particularly between small and medium shareholders and major shareholders, such as differences in management approaches, wanting to exit, or wanting to cooperate with others who can get along better. In such cases, the "Company Law" is powerless, thus binding the hands of some shareholders who wish to exit. Clearly, the "Company Law" has not touched upon certain aspects related to shareholder withdrawal.
(c) Model of Company Dissolution
Article 183 of the "Company Law": If the management and operation of a company encounter serious difficulties, continuing its existence would cause significant losses to the shareholders' interests, and if such difficulties cannot be resolved through other means, shareholders holding more than ten percent of the total voting rights of the company may request the people's court to dissolve the company. Interpretation (II) of Several Issues Concerning the Application of the "Company Law" by the Supreme People's Court, Article 1: Shareholders who individually or collectively hold more than ten percent of the total voting rights of the company, may initiate litigation for the dissolution of the company based on the following grounds, provided they comply with Article 183 of the "Company Law":
1. The company has been unable to convene shareholders' meetings or general meetings for more than two years, resulting in serious operational difficulties;
2. During voting, the required statutory or charter-specified ratios cannot be reached, leading to the inability to make valid resolutions at shareholders' meetings or general meetings for more than two years, causing serious operational difficulties;
3. Long-term conflicts among directors that cannot be resolved through shareholders' meetings or general meetings, leading to serious operational difficulties;
4. Situations where serious operational difficulties have arisen and continuing the company's existence would cause significant losses to shareholders' interests.
Shareholders who initiate litigation for dissolution based on claims of damage to their rights to information, profit distribution, or claims that the company is suffering losses, insufficient assets to repay all debts, or that the company's business license has been revoked without liquidation, will not be accepted by the court.
Clearly, the conditions for shareholders to exit through the channel of dissolving the company are extremely stringent. First, procedurally, the shareholder must hold more than ten percent of the shares. Second, the company must face serious operational difficulties. Third, such difficulties cannot be resolved through other means. Only under these circumstances can the company be dissolved and exited. Of course, such situations exist in real life. For example, if the company's operations have fallen into difficulty but the shareholders resolve to invest in a risky project, some shareholders might worry about the risk. In such cases, allowing some shareholders to initiate litigation for dissolution would clearly be detrimental to the company's development. I believe that resolving this through a shareholder exit mechanism would be better.
III. Social Realities of Shareholder Withdrawal
(a) Excessive Business Risks Beyond Certain Shareholders' Expectations
In real life, there are some investors who prefer low-risk investments, but happen to partner with shareholders who prefer high-risk investments. In such cases, the company's high-risk investments may exceed the psychological limits of some investors. Moreover, company operations inherently carry commercial risks—no high risk, no high return. If equity transfer or the company lacks sufficient funds for repurchase or does not meet the legal conditions for repurchase, and initiating litigation for dissolution is unsuitable for such situations, I believe that shareholders who prefer low-risk investments should be allowed to freely exit. This is an extension of shareholder rights themselves.
(b) Death or Divorce of Shareholders
In such cases, the portion of shares may be inherited by the shareholder's heirs. In the event of a shareholder's death, the heirs generally have the right to inherit. If some inheriting shareholders do not wish to continue operating the company, in such cases, as long as it does not adversely affect the company's shareholders or creditors, these shareholders should be allowed to freely exit. If a shareholder divorces, the other party involved in the divorce may require the division of the shareholder's shares, and the shareholder may also request to exit. In such cases, I believe that they should be allowed to exit.
(c) Small Shareholders Being Squeezed by Controlling Shareholders, with Their Rights Not Protected
From the perspective of balancing interests, I believe that legal designs should be made to allow small and medium shareholders to safely exit. For example, in this case, Zhang Min is clearly under the control of major shareholders, making it impossible for him to transfer his shares and exit. Also, the company's repurchase of his shares does not comply with the "Company Law." Initiating litigation for dissolution by Zhang Min does not conform to legal provisions either. In such cases, more practical legal provisions should be designed to allow him to exit. His exit will not adversely affect creditors and will be more beneficial to the company's development.
(d) Shareholders Moving Abroad or Relocating Elsewhere, Unable to Participate in the Management and Operation of the Company Due to Economic Conditions or Health Issues
In such cases, I believe that shareholders should be allowed to exit the company.
IV. Relevant Theories on Shareholder Exit
(a) Equitable Theory
A basic principle of corporate law is that shareholders should receive equal treatment, whether they are large or small shareholders. However, reality does not always follow this principle, especially in some closed limited liability companies where shareholders often suppress each other. Even in some stock corporations, as the company develops, the number of shareholders increases, and the rights of some small shareholders may become imbalanced. The principle of majority rule in capital decisions harms many small and medium shareholders. As British scholar Brian R. Cheffins wrote in "Corporate Law: Theory, Structure, and Operation": "When all shareholders are treated equally in corporate form, the rights of some shareholders are infringed. At this point, norms guided solely by equality cannot meet the needs of shareholders." Therefore, granting dissenting shareholders the right to request share buybacks allows minority shareholders to receive fair compensation. The right to request share buybacks balances the interests of large and small shareholders. On one hand, large shareholders can implement their plans, and small shareholders can exit the company and receive compensation. Considering interest balance, various countries have established shareholder withdrawal systems, mainly aiming to help dissenting shareholders sell their shares at a reasonable price, abandon their shareholder identity, and leave companies that contradict their investment expectations.
(b) Expectation Disappointment Theory
Expectation rights come from the "corporate contract theory." Early corporate law scholars believed that companies are combinations of contracts between shareholders and shareholders, shareholders and the company, and the company and the government, mediated by the corporate charter as a contractual carrier. Important documents such as the organizational structure, equity structure, and charter terms of the company are essential contents of this contract. Every shareholder has the right to expect the full and actual performance of this contract. As stated by the judge in the case of Wright v. Orville, Silver & Copper Mining Corporation: "The rights of shareholders include the inviolable requirement for the company to continue its business operations—as it has done in the past."
(c) Arguments Against Withdrawal
Opponents of shareholder withdrawal argue that it leads to a reduction in the company's registered capital, adversely affecting creditors. For instance, if a large number of shareholders rush to exercise their withdrawal rights, the company may only be able to fulfill its obligations by selling assets and harming its operations, thereby destroying certain operational values of the company. Others argue that shareholder withdrawal transfers investment risks to creditors. I believe the opponents' concerns are excessive. Firstly, a company's creditworthiness does not depend on the amount of registered capital, and changes in capital during the company's operation are significant. A company's debt-paying ability does not rely on book net assets but rather on the proportion of book net assets that can be quickly liquidated. Protecting creditors' interests does not solely depend on maintaining capital. Secondly, if there are indeed so many shareholders kindly requesting withdrawal and the company lacks sufficient assets to fulfill its obligations, the dissolution of the company can be a solution. If major shareholders insist on continuing the investment and do not want to dissolve the company, then it is entirely their personal matter to sell the company's quality assets to fulfill the obligation. Legal intervention is unnecessary. If shareholders maliciously request withdrawal, major shareholders can counter-sue some small and medium shareholders, requiring them to bear limited liability for the company, meaning they are responsible for their initial investment. Regarding the claim that shareholder withdrawal transfers risks to creditors, this argument is baseless.
V. Conception of Shareholder Withdrawal
Besides the three modes prescribed by law, first, shareholder withdrawal rights can be exercised through the provisions of the company's articles of association, meaning that during the initial establishment of the company, the methods and prices for shareholder withdrawal, as well as solutions for problems arising from withdrawal, can be stipulated in the articles of association, handing over power to the shareholders themselves. Secondly, considering the behavior and subjective attitudes of withdrawing shareholders, combined with the company's operating status and creditor situation, comprehensive consideration should be given to allow shareholders to withdraw. That is, when designing the withdrawal system, the law can grant operating shareholders certain追溯rights and deadlines. If the withdrawing shareholder is malicious, they should bear damages responsibility. Furthermore, shareholder withdrawal implies a reduction in registered capital, so the law must also consider the procedures for withdrawal, such as public announcement, capital reduction procedures, notifying creditors, and settling the debts and credits of withdrawing shareholders in the company.
Original article source: http://www.lawyer126.com/gongsi/536.htm
Shanghai Lawyer Hu Kaiyun