On April 12, 2016, the Supreme People’s Court issued the Provisions of the Supreme People’s Court on Issues Relating to Application of Company Law of the People’s Republic of China (IV) (Draft for Public Comments) (“Provisions”).

The Provisions include 36 clauses covering five parts. Among others, eight clauses relating to the preemptive rights will be discussed hereof.

1. Inapplicable Circumstances for Preemptive Rights

Subject to Article 22 and 23 of the Provisions, unless otherwise provided in articles of association of the company, other shareholders’ claims for preemptive rights under the following circumstances shall not be supported by the court:

a. where a shareholder of a limited liability company is changed for reasons such as inheritance and bequest;
b. where the transfer of shares happens among the shareholders of the company.

These two clauses have specified the circumstances which cannot apply to the preemptive rights regarding the share transfers of the company.

2. Further Procedure for the Execution of Preemptive Rights

Article 71 of the Company Law of People’s Republic of China (the “Company Law”) has regulated the general procedure for the execution of preemptive rights. The Provisions further clarify several ambiguous issues as follows:

a. Definition of Equivalent Conditions

Subject to Article 24 of the Provisions, "Equivalent conditions" specified in Paragraph 3 of Article 71 of the Company Law shall be determined in light of several factors, including but not limited to:

(a) the transfer price of shares;
(b) payment methods; and
(c) payment time limit.

Where a shareholder of a limited liability company transfers his shares to a non-shareholder, and other shareholders claim for the priority to purchase part of the shares, the claim shall not be supported by the court, unless otherwise provided in articles of association of the company.

b. Contents of a Written Notice

Subject to Article 25 of the Provisions, where a shareholder of a limited liability company intends to transfer his shares to a non-shareholder, such shareholder shall give to other shareholders a written notice which shall include the following aspects:

(a) the name of the transferee;
(b) type of shares to be transferred;
(c) quantity of shares to be transferred;
(d) price of shares to be transferred;
(e) time limit and method of the payment; and
(f) other critical information stipulated in the share transfer agreement.

c. Term for Executing Preemptive Rights

Where a shareholder of a limited liability company transfers his shares to a non-shareholder, and has given the aforesaid written notice to other shareholders of the company, other shareholders shall, after receiving the notice, execute their preemptive rights within an execution period specified in the articles of association. Where no provision or no detailed provision on this execution period is specified in the articles of association, it shall be determined as follows:

(a) The execution period specified in the written notice shall prevail; or
(b) Where no period is specified in the written notice, or the period specified in the written notice is less than 30 days commencing from the date of service, the period shall be 30 days.

Where other shareholders fail to execute their preemptive rights within the period mentioned above, or have claimed the preemptive right to purchase shares but fail to meet equivalent conditions specified in the Company Law, the Provisions and other relevant regulations, such shareholders shall be considered as having agreed on the transfer and waived their preemptive rights.

3. The Waiver and Invalidity of the Share Transfer

a. Waiver of Share Transfer

Subject to Article 26 of the Provisions, where a shareholder of a limited liability company transfers his shares to a non-shareholder, and other shareholders claim the preemptive right to purchase the shares, and then this shareholder expressly waives this transfer, the claims of other shareholders will not be supported by the court, unless the relevant parties have concluded a share transfer agreement, or otherwise provided in the articles of association of the company.

Such regulation indicates that the shareholder’s disposition right of property shall be respected.

b. Validity of the Agreement Jeopardizing Preemptive Rights

Subject to Article 27 of the Provisions, where a shareholder of a limited liability company transfers its shares to a non-shareholder and jeopardizes preemptive rights of other shareholders in any of the following circumstances, the claim of other shareholders for confirming the invalidity of the corresponding share transfer agreement shall be supported:

(a) The shareholder fails to follow the procedure specified in the Company Law and other judicial interpretations to reach the share transfer agreement;
(b) After other shareholders have waived their preemptive rights, the shareholder materially changes the equivalent conditions specified in the Company Law and other judicial interpretations to transfer his shares by reducing the share price, and transfers the shares to a non-shareholder; and
(c) By maliciously colluding with a non-shareholder, the shareholder violates the equivalent conditions specified in the Company Law and other judicial interpretations by applying false price etc., which cause other shareholders' waiver of preemptive rights, however, the actual transaction conditions agreed by the shareholder and the non-shareholder are lower than those specified in the written notice.

4. Validity of the Clause of Articles of Association on the Restriction of Share Transfer

Subject to Article 29 of the Provisions, where a clause in the articles of association of a limited liability company excessively restricts shareholders' right of share transfer, which causes the failure of share transfer, and if shareholders request the court to confirm the invalidity of that provision, such claim shall be supported by the court.

Comments:

The Provisions further interpret the application of preemptive rights specified in the Company Law, making relevant regulations more practical and proper for the court hearing.

The Provisions indicate several factors/principles regarding preemptive rights which shall be specified to apply to the legal practice in China. Furthermore, while the regulations of preemptive rights are applied, the following factors shall be considered more comprehensively:

a. Consider both the company’s nature in respect of partnership and the nature of capital combination, and do not overemphasize the former;
b. Keep the balance among the overall interests of the company, the benefit of the transferor, the other shareholders and the creditors;
c. Maintain the efficiency and the safety of the transaction.

On the other hand, certain parts of the Provisions are to be further clarified or discussed.

For instance, under the conditions specified in Section 3(b) hereof, it is not proper to directly confirm the invalidity of the share transfer agreement.

In general, the validity of the contract is determined in conformity with the Contract Law of People’s Republic of China (“the Contract Law”). As long as one contract doesn’t apply to Article 52 of the Contract Law (invalidity of the contract), the judge shall not affirm the invalidity of this contract. Otherwise, when the transferor does not want to execute the share transfer agreement, he/she may choose not to perform the obligation of giving the written notice to avoid the responsibility due to the breach of agreement, which may probably cause huge commercial and morality risks during the process of share transfer.

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Article 71 of the Company Law of People’s Republic of China:

a. The shareholders of a limited liability company may transfer all or part of their shares among themselves.
b. A shareholder proposing to transfer its shares to a non-shareholder shall obtain the consent of more than half of the other shareholders. The shareholder shall inform the other shareholders of the proposed share transfer in writing and seek their consent. Failure to reply within 30 days from receipt of the written notice shall be deemed as consent to the proposed transfer. Where more than half of the other shareholders do not consent to the proposed transfer, the non-consenting shareholders shall purchase such shares, failing of the purchase shall be deemed to have consented to the proposed transfer.
c. Where the shareholders consent to the proposed transfer, the other shareholders shall have preemptive right to acquire such shares on equivalent conditions. Where two or more shareholders intend to exercise their preemptive rights, they shall negotiate and determine the acquisition ratio. Where the negotiation fails, the shareholders shall exercise their preemptive rights based on the ratio of capital contribution at the time of the proposed transfer.
d. Where there are provisions in the articles of association of the company for transfer of shares, such provisions shall prevail.