Clear direction over corporate control

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

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.

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.