2.3 The exit remedy in a close company in China

Minority shareholders can be protected ex ante and/or ex post by law. Ex ante, minority shareholders may be given enhanced rights in a resolution adopted by cumulative voting, supermajority requirements or other schemes. Ex post, minority shareholders can resort to litigation. They may sue directors for breach of duties, ask for annulment of a resolution or even apply for dissolution of the company. With a view to ex post protection, considering the enclosed nature of a close company, a buyout through the exit remedy can be very efficient to protect minority shareholders in such a situation. There are currently two legislative approaches. One is to grant the minority shareholders exit rights when the business has fundamentally changed. The other is to allow the minorities to be bought out when they are unfairly prejudiced or oppressed by the majority. Both of these practices are quite new to China. Here we will have a brief look at these two exit modes in China. An expanded discussion will follow in Chapter 5.

Before the revised company law 2006, there was no buy-out remedy like the appraisal or oppression/unfair prejudice remedy in China. A shareholder who wanted to exit a close company had two options provided by the company law: either dissolution of the company or transfer of shares with the consent of other shareholders, neither of which is easy to achieve. Such a legislative approach clearly reflected the legislator 's intention to restrict shareholders' exit in order to maintain the viability of the business and to protect the creditors' interests. Admittedly, the exit of shareholders may, to some extent, harm the continuity of a company, especially in terras of the management structure and cash flow. Nevertheless, such a traditional approach cannot strike a balance between different interests groups in that it neglects the attributen of close companies and the interests of minority shareholders. In a close company, when the personal relationships between shareholders turn sour, or the minority shareholders disagree with certain fundamental changes, the cooperative basis is gone. Locking these shareholders in the company is harmful to the interests of the shareholders and harmful to the business as well, which may run the risk of deterioration.

With the new company law 2006, shareholders in close companies are given "appraisal rights" by Article 75. This marks the void-filling efforts in the area of the buyout remedy in China. According to Professor Zhu Ciyun, a member of the new company law revision team: "this is one of the breakthrough points in the new company law and this article was finally approved after many debates and discussions." Article 75 stipulates that shareholders who disagree with certain resolutions during the shareholders' meeting can ask the company to repurchase their stock at a reasonable price:

When such resolutions are adopted by the shareholders' meeting, the opposing shareholders can bring a lawsuit in the court within 90 days of adoption, if shareholders and the company fail to reach agreement on the repurchase of the shares within 60 days of the adoption of such resolutions.

The second mode of the buyout remedy, i.e., granting the minority shareholders the rights to be bought out when their interests are unfairly prejudiced or oppressed, can be found in Section 994 of the UK Company Act and in Article 14.30 (ii) in the RMBCA. In China, we cannot find it in either the dissolution provision or in a separate article specially providing this remedy.1 Article 20 of the PRC Company Law reads: "The shareholders of a company shall abide by laws, administrative regulations and the articles of association of the company, exercise their rights according to law, and shall not abuse their rights to damage the interests of the company or other shareholders (...).The shareholders, who abuse their rights so as to cause losses to the company or other shareholders, shall undertake the liability for compensation." This article, laid down in the chapter of general provisions of the Company Law 2006, imposes fiduciary duties on shareholders towards each other. In this article, no buyout relief, but only compensation is offered; shareholders have no option to leave the company. What the scope of the word "abuse" is, however, remains unclear. This will be explored further in Chapter 5.

In sum, it takes expertise and effort to devise an effective exit remedy through a buyout because legislators must have a clear grasp of the goal of the remedy, the legal environment to accommodate the remedy, features of other comparable remedies, and all the interests concerned to strike a balance. Excessive protection of either party will considerably affect the efficiency of the market.2 In the following two chapters, we will examine how the exit remedy is regulated and applied in the US and UK.