5.3.2.1 Withholding of dividends

According to Article 75, when a company fails to pay dividends to shareholders for five consecutive years, and the company makes profits continuously during these five years, and has met the distribution requirements prescribed by company law, a shareholder voting against the non-distribution resolution in the shareholders' meeting may request the company to purchase his shares at a reasonable price. This category cannot be found in appraisal rights in the US.

To invoke relief with this trigger, three conditions must be met: (1) the company has made profits for constructive five years, (2) during these five years, the company makes no distribution although it meets the requirement for dividend distribution; (3) the shareholder votes against the non-distribution resolution. We will examine these three conditions in turn.

This requirement is a restriction on invoking the appraisal remedy. It is reasonable to set restrictions because equity capital bears risk and one should not be entitled to a free exit in a close company just because of poor profits, leaving the creditors to take the loss. But why five years? Why is three years not more appropriate? I do not have the statistica on what per cent of close companies in China can survive for 5 years, but it is a common understanding that the first few years can be difficult for many close companies, or they may even operate at a loss. Shareholders may have to wait for a while before the company can make profits, and waiting to make profits for five consecutive years is not easy. Suppose, for example, that after making profits for two years continuously, the company decides to expand its business in the third year and borrows a considerable amount of money from the bank. Even though the business is still on a healthy track or even prospering, the profits of that year are offset. In this case, the minority shareholders have to wait for another 5 years before they can invoke this remedy.

Generally, there are two regimes regulating the legitimacy of a dividend distribution: 1) the company can distribute dividends when equity surpasses liability, without a necessarily making in that specific year;1 2) the other way is more stringent: the company must have made profits in that year, and the amount of profits must be large enough to satisfy statutory conditions for a distribution. China takes the second route. To be specific, in China, the conditions to be met before a dividend distribution are: a company shall first pay tax, cover the company's loss from the previous year if any, and then allocate ten per cent (10%) of the profit to its statutory reserve fund.2 After all these steps (upon adoption of a resolution by the shareholders' meeting or the general meeting of shareholders, funds may be allocated to the discretionary reserve fund), the remainder of the profit can be distributed to shareholders.3 The requirement of meeting distribution conditions actually raises the threshold of the availability of the appraisal remedy to a higher level in the context of the Chinese company law.

No matter what, 5 years can be a long period for most close companies. It is not easy to make profits for five years continuously, and it is even harder to meet extra requirements for the conditions allowing distributions every year. Furthermore, during these five years, if in any year the company makes a distribution with nominal dividends, this remedy will no longer be available to the shareholders because unlike some jurisdictions, it is extremely difficult for the Chinese court to ignore requirements explicitly laid down in the statute for the pursuit of fairness and reasonableness, nor is it a legal tradition to challenge a resolution approved at the shareholders' meeting, barring illegality.4 Although it is necessary and understandable to set a threshold before shareholders can leave the company because dividends are withheld, too high a threshold may render this remedy unavailable.

Now we come to the last condition, which is a problem as well. One of the powers of the shareholders' meeting provided in Article 38 is to examine and approve the company's profit distribution plans and plans for making up losses. The board is in charge of making proposals for distribution, and the final decision-making power is in the hands of the shareholders' meetings. Pursuant to Article 75, a shareholder must vote against the resolution for no distribution first, and will then be able to ask for appraisal rights. But what if such a motion for a resolution has never been brought up in the shareholders' meeting?

In the case of Tangqiuquan vs. Shuzhou Baolishi Ltd.,5 the plaintiff Tangqiuquan (T) was a minority shareholder who held 40 per cent of the shares, and the defendant was the company formed by T and another shareholder, Jin, who held 60 per cent of the shares. The company was established in 1999. T was in charge of technology control and purchase of raw materials, and Jin in charge of finance and accounting. All the financial reports and accounting books were made and filed by Jin and he refused T's request to examine the documents. Although the shareholders' meeting had the power to examine and approve the annual financial budget plan and final accounts plan of the company,6 no shareholders' meeting had ever been convened and Jin did not reveal any financial information to T. According to T's estimation, the company made profits every year and Jin refused to make any distribution, but he had no evidence to prove that. Finally, T filed a petition, requiring the examination of the accounting books availing himself of Article 34 in the new Company Law, and if the conditions for appraisal set in Article 75 (1) were met, he also asked the company to buy him out at a reasonable price.

The court found that since the establishment of the company, there had been no shareholders' meeting concerning the issue of dividend distribution, no resolution had ever been drafted and, certainly, there was no chance either for the petitioner to vote against such a resolution. Referring to the provisions in Article 75, the court held that only in the case that a shareholders' meeting had been held and the resolution for no distribution had been passed could the dissenting shareholders ask for exit. Since such conditions were not satisfied in this case, in pursuance of Article 64 of Law of Civil Procedure, the court rejected the litigation claims of T.

Here we see that if the board is controlled by the controlling shareholders, or the executive directors are the controlling shareholders, and a motion for no distribution has never been made on which they could vote, minority shareholders have no opportunity to vote against the resolution for no distribution and consequently no chance to avail themselves of the appraisal remedy.

In fact, in China, it is also recognized that the matter of dividend distribution is a management decision of the company; the court should not intervene. In Company Law 1993, the problem of no distributions for a long time was not touched upon. In the UK and US, minority shareholders can ask relief through the oppression remedy/unfair prejudice remedy or an action to compel distribution of dividends. In China, the notion of oppression is newly introduced and its scope is not yet defined. An action to compel distribution is not recognized.

Under pressure to protect minority shareholders, therefore, Company Law 2006 regulates such issues for the first time by way of appraisal rights. I do not claim that triggers of appraisal rights in China have to mirror those in the RMBCA or the ALI Principles. The practical needs and historical background may require China to make its own list of triggers, for example the situation of exit in case of prolongation of operational terms.7 At any rate, the categories of appraisal triggers are not identical across the US. But, as we have seen in Chapter 3, appraisal rights are granted in cases of fundamental corporate changes and the court, in granting such rights, generally does has no need of a case-by-case examination with great judicial discretion. I do not think dividend distributions are fundamental issues in corporate management and stipulating it in Article 75 as the only remedy for no distribution can cause two problems.

First of all, it is not a reasonable and preferable remedy for shareholders who only want dividends but no exit. Secondly, even if 'to exit' is the purpose of litigation, it can hardly be achieved by the appraisal remedy. As we have seen in Chapter 3, appraisal rights are granted in respect of fundamental corporate changes and dissenting shareholders can leave once the transactions has taken place; little court discretion is required. If one stipulates a non-fundamental situation in the approach of requiring little judicial examination, one must set the threshold very high to avoid an easy exit or abuse of the exit opportunities by the minority shareholders. In other words, legislators must lay down strict conditions to stress the seriousness of this situation; try to make the situation carry enough weight as a fundamental issue, like mergers and disposition of major assets. And indeed, we see that the three conditions in Article 75: (1) the company has made profits for constructive five years, (2) during these five years, the company makes no distribution although it meets the requirement for dividends distribution; (3) the shareholder votes against the decision of no distribution; are difficult to meet all at once, and in each condition, there is enough room for the majority to manipulate. Therefore, if the majority shareholders are reasonably careful, the availability of the remedy is low.

So it is still doubtful whether this category is capable of a real function in practice. As I understand it, however, the legislators deem a situation of no distribution as a serious problem in close companies. In this case, I suggest regulating this issue as a presumed situation in the oppression remedy. The threshold can be lowered to three years and if no material distribution is made for three years in a row, it is assumed the parties in control have breached their fiduciary duties, but they are given the opportunity to defend themselves.8 I will explain more about this suggestion in the section on the oppression remedy.