6.3.2 Suggestions to improve the oppression remedy in China

After examining the new company law and the relevant articles in a comparative perspective, I have come to the conclusion that the infrastructure of the oppression remedy has been set out in the new company law, but more deliberate changes or improvements need to be made before the remedy can really function in China. In this context, I will recount the findings in Chapter 5 briefly and explain every point in the later part.

As explained, remedies of the same essence as the oppression/unfair prejudice remedy can be found in Article 20 and Article 153 in the Company Law 2006. Article 20 deals with conduct of majority shareholders and Article 153 is about direct suit against conduct of directors. This research places more emphasis on Article 20.

Article 20 is laid down in the chapter of general principles in very vague words. The sole form of relief is compensation. In my opinion, it therefore fails to be an effective remedy for aggrieved minority shareholders to rely on if we also take the Chinese legal culture and tradition into account.1 I thus recommend prescribing a new version of the remedy outside the chapter of general principles, which contains elements such as standards for interpreting the general words, a list of rebuttable presumptions, exit relief as well as valuation principles.

In order to maintain the broad scope of the remedy, situations which may constitute oppression or unfair prejudice cannot be pre-described in the statutes. As in the UK and US, Article 20 is also a standard-based remedy, and does not specify the specific contents of the duties owed by shareholders, only requiring the shareholders not to abuse their rights. Considering the Chinese legal culture which I have specified in Section 5.4.3.2.1, a standard to interpret the general wording such as `abuse of rights', `oppressive', or `unfairly prejudicial' can not only help shareholders to assess their actions, but also help the court to make consistent and sound judgments. But if the standards are not well balanced, they would jeopardize entrepreneurship and long-term economie growth. I therefore recommend that developments in the UK and US which reflect decades of legal experience and a good understanding of corporate practice should be taken into account, and the standards can first be set in the interpretations given by the SPC.

Despite the different wording in s.14.30 of the RMBCA and s. 994 of the UK Companies Act, the interpretation standards converge owing to the similar rationales of these two remedies. Both jurisdictions approve the standards of enhanced fiduciary duties for majority shareholders and reasonable expectations of minority shareholders.

In the UK, with Ebrahimi case, the utmost good faith as partners was endorsed in close companies.2 In the US, cases in Massachusetts take the lead in exploring shareholders' fiduciary duties in close corporations and they are constantly referred to or cited by other jurisdictions. They pioneer in "developing an effective cause of action for minority shareholders who have been denied their fair share of benefits in close corporations."3

At first, the court provided strong protection to minority shareholders in close corporations by introducing a partnership-like fiduciary duty, but the notion of this enhanced fiduciary duty itself was troubled by problems in application, for instance what the level should be of enhanced fiduciary duties, exactly like partnership duties or would somewhat lower also be acceptable. Such questions caused uncertainty and uneasiness to majority shareholders. The majority shareholders argued as well that to strike down legitimate actions which were in conformity with legal provisions by applying partnership-based standards could pose obstacles to effective business management in a company. The Massachusetts court therefore relaxed the enhanced duties in its subsequent cases by introducing a two-step test. Firstly, the court allowed a majority shareholder to rely on a legitimate business purpose to justify his actions.4 After a purpose was advanced, the court had to give its decision on whether a legitimate business purpose had been demonstrated.5 The second step was to require the minority shareholders to show that the desired goals could have been achieved by a less harmful action. Recently, the court showed an inclination towards the standard of `defeat of reasonable expectations'.6

The idea of employing "defeat of reasonable expectations" as a standard to determine oppressive conduct was originated by British judges.7 The starting point to establish reasonable expectations are the terms in the articles of association and shareholder agreements, with the belief of honouring fairness in commercial relations and contracts. "Keeping promises and honouring agreements is probably the most important element of commercial fairness"8 and, in any case, a company is an association of persons formed with legal advice and formality. Terms in the articles of association or shareholder agreements should therefore be respected and they are the initial sources to trace shareholders' expectations.9

People can look beyond the written terras only when the concept of fairness prevents a strict enforcement of the agreed terras or in using rules in a manner which equity would regard as contrary to good faith.10 The underlying reason is that the parties' full understanding and bargaining are often not set out in writing in close companies. When non-written bargains can be construed or reflected through the participants' actions or through other means, legitimate expectations of minority shareholders override the literai provisions in charters, articles of association or agreements.

Finally, fairness empowers the court not only to look beyond an agreement for legitimate expectations but also to abandon the agreement, making an analogy to hardship in contract law.

The standard of reasonable expectations is recognized and adopted by many states in the US as well. The New York court has pioneered in developing the contours of oppression by the notion of defeat of reasonable expectations.

Massachusetts and other states which apply fiduciary duty to address shareholder oppression now oftentimes also use the defeat of reasonable expectations.11 In both jurisdictions, the list of expectations held by the minority shareholders overlap: entitlement to employment, dividends, and a voice in management.

Stemming from the predominating role of fairness in common law, judges and court abandoned their previous hesitation in interfering in certain corporate issues and made up their minds to solve the oppression problem in close companies. Whatever the interpretation standard is, the questions are in essence: how far the protection can go or is allowed to go by the courts so as to strike a balance between equitable considerations and corporate principles, and how to strike a balance between court discretion and legal certainty.

Since oppressive behaviour is predominantly displayed by majority shareholders, the first response is to restrict the conduct of majority shareholders. So, as a corollary measure, courts started exploring the standard to examine the conduct of the majority shareholders. After identifying similarities between a close company and a partnership, courts introduced partnership-like fiduciary duties for close companies. But the standard of enhanced fiduciary duty is easier to utter than to apply, as explained above. Besides, not every state endorses this approach. There is a range from partnership-like fiduciary duties to corporate-standard fiduciary duties. The Massachusetts courts stand on one side by advancing partnership-like fiduciary duties, whereas the Delaware courts stand on the other end, i.e., "all (disputes in) corporations are to be governed by corporate, not partnership, principles".12 There are also states standing in between. Massachusetts courts add burdens to the majority while Delaware makes them feel much assured. In general, cases judged by majority rule are hailed by judges and scholars mainly because of their sympathy with the plight of minority shareholders in a close corporation.

Later, the courts shifted their attention from majority shareholders to minority shareholders. Frustration of expectations of minority shareholders started to serve as an effective parameter to assess the behaviour of majority shareholders. The court does not need to struggle between choices of different levels of fiduciary duty and the business judgement rule. Majority shareholders will also have a better idea of what to observe so as not to breach their duties since they are in a better position to know the unwritten promises or the agreements based on which they and the minority shareholders came together. Reasonable expectations thus offer "a clearer and more specific" focus for all the relevant parties.13 Nowadays, it is considered the best guide in defining oppression, and is being increasingly used by courts.

This development shows us that these two interpretation standards are correlative because both of them stem from the same purpose and stress the concept of faimess. If certain majority conduct defeats the minority's reasonable expectations, it more often than not breaches fiduciary duties as well. The two interpretations are not contradictory but are sufficiently similar with respect to purposes and effects.14

The pre-condition to apply reasonable expectations is that the entity is a close corporation or quasi partnership, which means that there is a close relationship among shareholders, and the basis for cooperation is sharing the management of the business rather than merely making a passive investment.15 If stated by elements, a close corporation/quasi partnership should be: (i) an association formed or continued on the basis of a personal relationship involving mutual confidence; (ii) an agreement, or understanding that all or some (for there may be `sleeping' members) of the shareholders will participate in the conduct of the business; (iii) restrictions on the transfer of the members' interests in the company.16

Even within a quasi partnership or a close company, not every expectation is supposed to be enforceable, so the court uses the word legitimate or reasonable to define the expectations. Legitimate/reasonable expectations are those which have been agreed by the parties, and mutual understanding can be deduced from written documents or from the parties' actions.17 "Privately held expectations which are not made known to the other participants are not `reasonable'. Only expectations embodied in understandings, express or implied, among the participants should be recognized by the court."18

Moreover, expectations aroused at the beginring of the business constitute the foundation of bargaining and the basis on which subsequent conduct and expectations can be appraised. The notion of the entire history of the business association also sees to it that expectations developed during the course of the business are also respected.19

Last but not the least, the concept of legitimate expectations should be objectively reviewed based on the facts of specific cases.20 Judges should not go too far by substituting their own subjective judgements for the legitimate expectations of the parties. An overly solicitous application based on their personal standards of fairness affects a principled resolution of the case.

As commonly understood, the situations that may trigger the oppression remedy cannot be enumerated in legislation. The current Article 20 adopts the same approach as in the UK and US, namely using general words to curb the acts of shareholders. For this reason, I have attached great importance to the exploration of the interpretation standards for the general words. Nevertheless, taking into account the legal culture and tradition in China, additional measures are needed to help the remedy to function efficiently.

China is a civil law country without the tradition of case law. Judges are accustomed to strict compliance with legislative texts, and reluctant to make judicial interpretations. Furthermore, their interpretations are not legally binding as those of the Supreme Court are. The legal tradition, intertwined with several other drawbacks, such as a less developed jurisdiction in the area of corporate law and more than 200,000 judges spread among commercially unevenly developed areas across this huge country, thus requires additional assisting measures to promote a uniform application of the remedy throughout China.

Consequently, I think, in addition to the general wording, the adoption of an enumerative list of rebuttable presumptions is a workable model, even though such a proposal has been rejected in the UK. General wording maintains the flexible and broad nature of the remedy, while a list of statuary rebuttable presumptions enhances legal certainty. Moreover, members of the company will have a better idea of what kinds of actions are subject to litigation and thus pay more attention to the relevant areas.

After examining the situation in the UK and US, and together with observations on the judiciary in China, I provisionally recommend the following list:

Legislators can draw indications from cases and surveys of business people in order to best adapt the list, which is enumerative but not exhaustive in nature, to the Chinese situation. The list can be presented first in interpretations by the Supreme Court of the Company Law 2006, as the way to explain `serious difficulties' in Article 183 and, after being tested and proved effective, stipulated in Article 20.

One more strong recommendation based on this comparative research is to add the exit remedy to Article 20. The only form of relief provided at this moment is compensation, but as explained, compensation alone is not adequate for shareholder protection in a close company; at a certain point, a `divorce' is necessary and even more sensible.21 From the final solution in a case judged in China, we can also see that shareholders do not always prefer compensation.22 Moreover, under the oppression remedy and the unfair prejudice remedy the form of relief most frequently granted is a court ordered buyout.

Admittedly, shareholders should always be watchful of potential risks and take preventive measures by themselves, like negotiating exit rights in the articles of association or in shareholder agreements, and they are allowed to do so by law. Nonetheless, not every shareholder has bargaining power and most of all, in the Chinese culture, parties are reluctant to think in advance about a breakdown of relationship as they deem it as a practice showing lack of trust between each other, insulting the integrity or credibility ofthe other party, and indicating an unsuccessful cooperation. Consequently, mandatory exit rights stipulated by law are necessary.

Because the exit remedy is not provided in the currently available relief, there is no research discussing the issue of fair value under Article 20. But the exit remedy is strongly recommended by this comparative research, and if it is adopted in the future, knowledge of valuation issues, such as methods, date, and discount, will be important.

In practice, courts and commentators view the corporate valuation methods in the oppression remedy as similar to those in the appraisal remedy because both of these remedies aim to calculate the value of the corporation and attempt to ensure that the dissenting or dissatisfied shareholders can leave the corporation with the fair value of their shares. Methods used in appraisal proceedings are therefore applicable in the oppression proceedings as well.23 If a shareholder brings an appraisal and an oppression suit at the same time, as in the case of a tainted merger, the court usually first carries out valuation in the appraisal suit and let the petitioner show that he should receive more over and above the fair value assessed in the appraisal suit. Successful petitioners can thus recover more through the oppression remedy than in appraisal proceedings. In an appraisal proceeding, wrongdoings are of no relevance to the calculation of fair value, whereas in the oppression or unfair prejudice remedy, the doctrine is that the corporation should be valued as if the oppressive/unfairly prejudicial conduct has never happened.24 In the valuation process, therefore, the decrease of value due to the impact of the wrongdoing is added back, such as, a decrease resulting from transactions at undervalue, hidden distribution, excessive remuneration, exorbitant management fees, waste of assets, self-dealing, intentional and negligent misrepresentation and so on. Again, as in the appraisal remedy, calculation of the fair value here is not an exact science. There is no right answer.

In my opinion, the valuation date cannot and should not be pre-decided in law. The proper valuation date in one case may not be reasonable in another, just as the choice of the valuation method in every case. There are several options: date on which the oppressive conduct occurred, date on which the conduct became known, date of filing of the lawsuit, date of trial, date of judgment and date of the actual valuation. The presumed date in the US is the petition date, whereas in the UK it is the date on which the valuation order is given. But because both jurisdictions recognize the discretion of the court and the shared principle is fairness for all parties involved, the difference on this issue is actually minor. The essence of the decision in each case is to grasp the advantages and disadvantages of each method,25 combined with the idea of ensuring that the minority receives the due value.

As to discount, in general, a pro rata valuation is widely accepted and applied in the US and in the UK. Three exceptions have, however, been pointed out so far:

The legislative progress in the new company law, especially in the area of shareholder remedies, demands respect if we consider the short history of the legal development in the new China. The introduction of the two exit remedies in Chinese company law is undoubtedly valuable for minority shareholder protection, but the real function of such remedies depends not only on the prescriptive transplant of the remedies, but also on its adaptation to the Chinese company law system, the legal tradition, and the legal environment. With all these concerns in mind, I propose the above modest recommendations for these new remedies in China.