Provisions on Some Issues Regarding Application of the PRC Company Law (III)

Issuing Body: Supreme People's Court
Issuing Date: January 27, 2011
Effective Date: February 16, 2011

Acting for the third time to fill gaps in the Company Law of the People's Republic of China (Company Law) since it took effect on January 1, 2006, the Supreme People's Court (SPC) has issued an interpretation of that law addressing issues related to the establishment of companies, capital contributions, and shareholder rights. The court issued the Provisions on Some Issues Regarding Application of the PRC Company Law (III) (Company Law Application Provisions III) on January 27, 2011. The rules apply to both domestic and foreign-invested companies.

While a large number of company dispute cases have been resolved under the general umbrella of the Company Law in the past five years, its provisions have in practice often proved to be too simple and too general for courts to use in their rulings and application of the law. As a result, some local courts have reportedly formulated their own trial guidelines, which has inevitably caused conflicts and confusion as different courts in different regions adopted different practices.

The SPC has been trying to clarify the legal issues involved in the trial of company disputes—and, more broadly, to consolidate and streamline trial practices in China—since shortly after the Company Law took effect in 2006. The court's previous interpretations of the law were released in April 2006 and May 2008. China Law Update summarized the latter set of SPC provisions, which applied to dissolution and liquidation cases, in our August 2008 issue.

Key points of the Company Law Application Provisions III are summarized below.

Company Establishment

Although the Company Law contains specific provisions regarding the liability of shareholders, it remains silent on the liability of the company's founder (the person or entity that establishes a company) arising in or from the process of establishing a company.

Where a founder enters into a contract with a third party in the founder's own name for the purpose of establishing a company, if that third party claims the founder should be liable under the contract, the people's court should support such a claim.

Where such a contract, related to establishment of the company and signed by the founder in his own name, is later acknowledged by the company, or the company has actually enjoyed the contractual rights or performed the contractual obligations after the company was established, if the third party claims the company should undertake liability under the contract, the people's court should support such a claim.

Where a founder enters into a contract with a third party in the name of the company that is being established, if the third party later claims, after the company is established, that the company should be liable under the contract, the people's court should support such claim.

Where there is evidence, after a company is established, to prove the founder signed a contract during the establishment process with a third party in the name of the company, but the contract actually served the founder's interests, if the company claims it should not undertake contractual liability, the people's court should support such a claim, provided that the third party acted in good faith when it entered into the contract.

Capital Contribution

The Company Law Application Provisions III also address the common matter of disputes involving the capital contribution of non-monetary properties.

Where a contributor of capital makes a capital contribution in the form of any non-monetary property that is not evaluated according to law, if the company, any other shareholder, or any creditor of the company claims that the contributor of non-monetary capital has failed to fulfill the capital contribution obligation, the people's court should authorize a legally qualified evaluation institution to evaluate the property. If the value determined through evaluation is significantly lower than the value of the capital contribution established in the company's articles of association, the court will determine that the capital contributor has failed to fully perform its obligation according to law.

Where a contributor of capital makes a capital contribution with non-monetary property (such as real estate, land use rights, or intellectual property rights) that requires title registration, if the property has been delivered to the company for use but the formalities of title transfer have not been completed, the court should order the contributor of capital to transfer title within a specified reasonable period; if the capital contributor transfers the title within the aforesaid period, the court should determine that it has fulfilled its capital contribution obligation.

Where a contributor of capital makes a capital contribution with a property and has transferred title but has not actually delivered it to the company for use, if the company or any shareholder claims the capital contributor should deliver the property to the company and should not enjoy the corresponding shareholders' rights prior to actual delivery, the people's court should support such a claim.

Confirmation of Shareholding Rights

The Company Law Application Provisions III provide specific guidelines for disputes related to shareholding rights that arise during, after, or as a result of an equity transfer transaction.

In an equity transfer transaction, the law requires deregistration of the original shareholder's name and registration of the new shareholder's name with local authorities so the public has a way of knowing the company's shareholding structure. If, however, the required change of registration of shareholders' names has not yet been completed at the company registration authority and the original shareholder transfers, pledges, or otherwise disposes of the equity still registered under his name to a third party; and then the transferee shareholder (from the equity transfer transaction) makes a claim seeking to have the disposal of equity declared invalid on the grounds that the transferee shareholder enjoys actual rights to the equity, the court may hold that the third party enjoys ownership of the equity interest in the company, only if:

• The third party that received the equity interest was acting in good faith; and
• The equity interest was transferred at a reasonable price; and
• The transferred equity interest has been registered by the third party, in case registration is required by law.

Where the original shareholder causes a loss to the transferee shareholder from the equity transaction due to the disposal of such equity to a third party, the court should support the transferee shareholder's claim asserting that the original shareholder should assume liability for compensation, and that the directors, senior managers, or actual controllers who were at fault in failing to timely file the changed registration should assume corresponding liabilities. If the transferee shareholder was also at fault in the failure to file the registration in a timely manner, the liabilities of the aforesaid directors, senior managers, or actual controllers may be appropriately reduced.

Conclusion

In issuing the Company Law Application Provisions III, the Supreme People's Court has addressed some important ambiguities in China's Company Law, a step that is vitally important to both domestic and foreign-invested companies alike. As such, the court's guidance is welcome.

Given the complexity and difficulty in handling cases involving company law disputes, however, we expect the court to issue more provisions in the near future, in particular involving equity transfers and share pledges. China Law Update will cover developments in these areas.