How Would the Share Donation Impacts the Preemptive Right

道可特法视界第1253篇原创文章

Abstract: Article 71 of the Company Law of the People’s Republic of China provides as follows:

“Stock rights of the shareholders in a limited liability company may be transferred among the shareholders in whole or in part.

Where any shareholder proposes transferring his/its stock rights to any person other than the shareholders, any such proposal shall be subject to the consent of a majority of the other shareholders. The relevant shareholder shall give the other shareholders a written notice of the details of the proposed transfer of stock rights and seek their consent. Any of the other shareholders who fails to respond within 30 days upon receipt of the written notice shall be deemed to have consented to the transfer. Where a majority of the other shareholders whose consent is sought disagree with the proposed transfer, the shareholders who disagree with the proposed transfer shall purchase the stock rights to be transferred. In the event that they refuse to purchase the stock rights in question, they shall be deemed to have consented to the transfer.

Under the same conditions, the other shareholders shall have the right of first refusal for the purchase of the stock rights to be transferred upon their consent. Where two or more shareholders exercise such a right of first refusal, they shall determine their respective purchase percentages by negotiation, failing which they shall exercise the right of first refusal in proportion to their respective capital contributions at the time of transfer.

Where there any provisions regarding the transfer of stock rights in the articles of association, such provisions shall prevail.”

In practices, there are two situations for transferring equity. One is transfer with consideration, the other is transfer free of charge. In the case of the transfer with consideration, the above-mentioned article can be easily applied. However, when a shareholder transfers shares free of charge to the parties other than the rest of shareholders of the company, the substantial legal relationship between the assignor and the proposed assignee is donation because the consideration for the shares to be transferred is zero. In the absence of a special agreement in the articles of association, if the provisions of the preceding three paragraphs of the above-mentioned article is applied, it is no doubt that the application will likely cause disputes between the assignor and the proposed assignee, between the assignor and the other shareholders, between the proposed assignee and the other shareholders, or even among other shareholders of the company.

We noted that the contract disputes and company disputes due to the share transfer free of charge are indeed taking place in practices, and the substances of the disputes always focus on the identification of the nature of the behavior of free transfer of shares, whether other shareholders can be excluded from exercising the preemptive right when transferring shares without consideration, and how to define "the same conditions" stipulated in above-mentioned article. It should be also noted that the decisions in final judgments regarding these disputes issued by local courts in different places vary a lot, which are mainly summarized as follows:

1. It is recognized that donation is one of the ways for share transfer, and it cannot prevent the other shareholders of the company from exercising the preemptive right conferred on them by law.

In case Pu Zhong Fa Min Zai Zhong Zi No. 33 (2011), the court held that the share donation contract shall be valid if the other shareholders agreed to give up their preemptive right, and if the other shareholders did not agree and exercise the preemptive right, the exercise of such contract shall become meaningless because the subject matter of the donation will no longer exist. Because it is a donation contract, the recipient may not claim damages to the shareholder who intend to donate the equity.

In case Su 0412 Min Chu No. 7789 (2017), the court decides that share donation is a special form of share transfer. The Company Law and the articles of association of the company shall be applicable to share donation, i.e. the consent of the other shareholders of the company shall be obtained before such share is donated…Sheng donated the shares to other parties other than the rest of shareholders of the company, which resulted in the conflict between the donation rights of assignor and the preemptive rights of other shareholders of the company. The Company Law sets out certain procedural restrictions on the transfer of shares from shareholders to non-shareholders… When Sheng and Dou signed the supplementary clauses for share donation, Sheng, as a shareholder of the company, did not satisfy the procedural requirements stipulated in the above-mentioned legal provisions and the articles of association, so the transfer of shares did not take effect.

Based on the aforesaid judgments, the Intermediate People’s Court in Xuan Cheng, An Hui made further decisions on “the same conditions”:

In case Wan 18 Min Zhong No. 492 (2017), the court of first trial held that the share transfer involved in the case was a free transfer and lacked the basis for ascertaining “the same conditions”. Xu asked for using audit results as a consideration of the transfer between Zhang and Huang, which is more appropriate. Although Zhang and Huang basically consented with Xu's valuation of share which amounts to RMB 3.12 million, they only wanted to acquire those shares for RMB 400,000, and it can be regarded as Zhang and Huang had no intention of buying the shares involved in the case. Therefore, the "Share Transfer Agreement" signed by Xu, Shu and Yang shows the true meaning of the parties, and the content of such Agreement does not violate any mandatory provisions of laws and regulations, thus it is legal and effective. As the second trial court, the Intermediate People’s Court in Xuan Cheng, An Hui further decides that in this case, Xu transferred the shares of the company without any consideration to Shu and Yang, Zhang and Huang as the other shareholders of the company shall reserve the preemptive right to acquire such shares at a fair and reasonable price in accordance with the Company Law. However, after Xu sent out relevant notice to them, neither Zhang nor Huang intended to acquire such shares with paying a fair and reasonable price, therefore, it shall be determined that both Zhang and Huang agreed on the share transfer without consideration by Xu to Shu and Yang.

2. Denying that donation is one of the forms of share transfer under the Company Law, the donation destroys the “purchase and acquire” in the preemptive right. If the shareholder donates the shares to a person other than the other shareholders, the other shareholders can not exercise the preemptive right in accordance with the Company Law.

In case Su 04 Min Chu No. 108 (2017), the court held that in terms of share donation, the Company Law does not provide any regulation regarding the question whether the shareholder shall seek the opinions of other shareholders or not, whether the other shareholders have the preemptive right and how to exercise such preemptive right under  “the same conditions”. In fact, the share donation is different from the share transfer because of its nature of zero consideration, and due to the absence of the consideration in transfer, the other shareholders cannot exercise the preemptive right at “the same conditions”… In a word, the disputed share donation agreement does not fall into the scope of the mandatory requirement of seeking the opinions of other shareholders when transferring shares to parties other than the other shareholders of the company, and the other shareholders will not enjoy the preemptive right under “the same conditions”.

In case Min Min Er (Shang) Chu Zi No. 588 (2015), the court held that the preemptive right is based on transfer with certain consideration, but in this case Chen donated the shares to Yang for free. Therefore, “the same conditions” do not exist for purchasing such shares, and the plaintiff does not enjoy the preemptive right.

In fact, the question in the title of this article is caused by the ambiguity of the legal definition of the words “assignment and transfer”. Therefore, the relevant disputes are caused due to the failure of the parties of the limited liability companies to effectively understand the extensive autonomy rights conferred on them by laws and regulations. In the current practice, most of the shareholders and the company believe that the articles of association are only the standard terms during the establishment and operation of the company, and the huge utility of the articles of association on corporate governance has been therefore ignored. If the shareholders of the limited liability companies may perfectly utilize the fourth paragraph of Article 71 of the Company Law, incorporate detailed representations and relevant restrictions regarding share transfer matters in the articles of association, then it can effectively resist the imbalance of rights and interests between shareholders and prospective assignee which may result from the transfer of shares in different forms.

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