Clear direction over corporate control

By Li Weiming and Maggie Mei, Tiantai Law Firm
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The authors are often asked questions concerning failure to provide minority shareholders with adequate protection due to fragmented equity structures that cause inconsistency between ownership and direction over management activities. Fights for corporate control and imbalanced interests of shareholders are not uncommon. For shareholders, it is particularly important that their companies are incorporated with structures ensuring proper corporate control.

Design of equity structures

corporate control
Li Weiming
Partner
Tiantai Law Firm

It is a common practice in the field of corporate governance to establish an agreement on voting rights by setting the proportions of capital contribution to be made by investors. According to the Company Law, it is critical that equity structures are designed to reflect the following prescribed percentages: (1) 67%: major matters of a company must be approved by shareholders representing two-thirds or more of the voting rights; (2) 51%: any matters other than the major ones that require voting at a meeting of shareholders must be approved with votes representing more than a half of the voting rights; (3) 34%: for companies without a controlling interest, a veto right may be exercised over major matters so that relative control can be exerted over the companies; and (4) 10%: the percentage of stake required to convene interim shareholders’ meetings or meetings of the board of directors, and to file a petition of dissolution against companies so that corporate deadlocks can be broken.

It is also important to avoid fragmented equity structures that may lead to an equality of votes on corporate decisions. In a dispute involving Changshu Kailai Industrial in connection with company dissolution, Kailai has only two individual shareholders, each representing 50% in the company’s equity capital.

corporate control
Maggie Mei
Associate
Tiantai Law Firm

According to the bylaws of Kailai, “a resolution at a general meeting must be approved by shareholder(s) representing more than one-half of the total voting rights”. But it is acknowledged by both shareholders that “more than one-half” means a percentage that is bigger than one-half. In reality, however, Kailai has not been able to implement voting process effectively due to constant disagreement and lack of co-ordination between the two shareholders. As a result, the company has not convened any general meeting in four years, i.e., its general meeting mechanism was a total failure. Eventually, Jiangsu Higher People’s Court issued a ruling ordering the dissolution of Kailai.

For situations with equity structures that are not ideal, we advise clients to gain corporate control by making use of other approaches that concern, for example, appointment of proxy for voting, concerted action agreement, and veto right over special matters. Dividing share capital into shares of A class and B class also helps.

Drafting of bylaws provisions

At an early stage of the incorporation process, shareholders should anticipate possibilities of corporate deadlocks. Drafting bylaws that design the company’s governance structure in a reasonable manner should be an effective means to prevent and resolve corporate deadlocks. To avoid blurred boundaries of powers and authorities, the bylaws should also define various tiers of powers, duties and approval authorities vested in the general meeting, the board of directors and the management.

This should be done in line with the company’s governance structure, and with consideration to mandatory legal provisions and specific matters to be determined. Given the fact that most boards of supervisors are unable to play their essential roles effectively, the bylaws may be drafted to expand powers and duties of the board of supervisors and their members appropriately.

It is also necessary to include a reasonable mechanism for the exercise of shareholder voting rights in the bylaws. They may require any shareholder or director with an interest in a resolution to avoid voting. They may also include mechanisms designed to prevent shareholders or directors from harming the interests of the company and other shareholders by participating in the approval procedure of key matters.

Approaches to breaking corporate deadlocks can also be prescribed in the bylaws. For example, they may stipulate that: (1) the chairman of the board or executive director shall have a casting vote in the event of an equality of votes; (2) total consistency between members of the board and members of the general meeting must be avoided; and (3) in the case of an equality of votes at a meeting of the board of directors, the matter shall be submitted to the general meeting for voting.

Finally, the bylaws may be designed to include a compulsory repurchase arrangement, pursuant to which the controlling shareholder shall accept transfer of shares from member(s) in a disadvantageous position or casting adverse votes at a reasonable price when certain conditions are met. It is also a shareholder exit arrangement that can be used to avoid corporate deadlocks.

Safe custody of seals and licences

To keep better corporate control, companies should especially ensure the safe custody of their common seals as well as original copies of business licences. Specifically, companies should have a well established policy for the custody and use of common seals and business licences, and their bylaws should designate officers for keeping them.

In a dispute involving Suqian Jinyuan Wujin Jiaodian Chemical (Jinyuan) over return of licence, the company’s legal representative in name refused to provide its legal representative in essence with the company’s common seal, resulting in the latter’s failure to carry out any activities on behalf of the company. Since lawsuits involving disputes of this kind must be initiated by companies, shareholders are unable to request licences in their own name. Where there is a conflict between the above-mentioned persons, the latter should be arranged to act as the company’s representative of action.

Given this legal logic, the court finally acknowledged that “W was entitled to file this lawsuit against Z on behalf of Jinyuan despite W’s inability to affix the company’s common seal on the complaint due to reasons not considered in this case”. The ruling helped W succeed in taking back the company’s common seal and licence. More importantly, it acknowledged his capacity as Jinyuan’s legal representative and assisted him to regain control over the company.

Therefore, when relevant shareholders wish to get the common seal and licence of their company, an explicit resolution on appointing a custodian of seal and licence may be passed at a meeting of the board of directors or general meeting, where the person holding the seal and licence for the time being should promptly hand them over to the new custodian. Otherwise, the new custodian appointed in this resolution, or any other person appointed in a resolution of the company’s relevant body, may initiate a lawsuit requesting the return of licence.

Li Weiming is a partner and Maggie Mei is an associate at Tiantai Law Firm

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