The Regulations of Several Issues Concerning Application of the Company Law of the People’s Republic of China (IV) (Legal Interpretation IV of the Company Law) taken into action by the Supreme People’s Court on 1 September 2017 provides that if shareholders claim that the company should distribute its profits without providing a related distribution plan or shareholder resolution, the court should reject the claim unless shareholder rights are abused, causing the company unable to distribute its profits and causing damage to other shareholders. In other words, in principle, courts should reject profit distribution claims brought by shareholders without a related shareholder resolution, unless in exceptional circumstances.

We advised on a profit distribution case brought by shareholders against their company in November 2017, two months after the publication of the Legal Interpretation IV of the Company Law. In this case we represented the plaintiff who could not provide a related shareholder resolution and eventually succeeded in meeting the client’s purpose by providing a series of evidence in an organized way.

Brief description of the case

The defendant Shanghai JL Company was incorporated on 18 February 1998 with thirteen shareholders and registered capital of 5 million RMB, of which the plaintiff Jin contributed 14.78% and the largest shareholder Yao contributed 40.84%. Yao was executive director, legal representative, controlling shareholder and actual controller of the defendant Shanghai JL Company.

An accounting firm in Shanghai issued at the defendant’s request the Special Audit Report for the defendant’s company. According to the report, the dividends payable under its financial report dated 31 March 2013 was RMB 13,943,547.27. Therefore, the plaintiff believed that it should receive distributed profits of RMB 2,060,856.29 in proportion to its capital contribution. I brought an action on behalf of the plaintiff Jin by claiming that the defendant Shanghai JL Company should pay to the plaintiff distributed profits of over RMB 2,000,000.

Key issues

The key issues in this case are whether Shanghai JL Company had a shareholder resolution for the profit distribution and whether the profits should be allocated to the plaintiff Jin without such shareholder resolution.

a.Was there a shareholder resolution on the profit distribution?

Subject to the corporate accounting principles, we believe that “payable dividends” mean cash dividends or profits that will be distributed to investors according to profit distribution plan approved by the shareholder meeting or similar authority. The account of “payable dividends” is used to calculate dividends or profits owed by a company to its investors that it has decided or declared will be paid. The closing balance on the credit side of the account reflects cash dividends or profits due but unpaid by the company.

The balance of the “payable dividends” on the credit side of the balance sheet of Shanghai JL Company could not have been over RMB 13,000,000 without a shareholder resolution on the profit distribution. Once the balance was fixed, the debts owed by Shanghai JL Company to its shareholders and their right to claim distribution of profits would change to a general right to the debts governed by debt related regulations under civil law and then the plaintiff had the right to claim his share of distributed profits without the need to provide the shareholder resolution.

b.Without a related shareholder resolution, should the profits be distributed to the plaintiff Jin?

We believe based on the Special Audit Report that the legal representative Yao repeatedly used his positions as controlling shareholder and legal representative and abused his shareholder rights, causing damage to the plaintiff and other shareholders. From October 2006 to July 2-12 he transferred RMB 15,335,299.29 from the defendant’s account to the Company A’s account under his control. From September 2009 to January 2013 he transferred RMB 28,087,000 from the defendant’s account to the Company B’s account under his control (Company B is now named as Company C). From June 2004 to December 2011 he transferred RMB 13,552,687.04 from the defendant’s account to the Company D’s account under his control. From December 2008 to January 2013 he transferred RMB8,500,000 from the defendant’s account to his personal account. Yao invested in the above companies on his own, none of which has shareholding relationship with the defendant. The court should support the plaintiff’s claims according to the Legal Interpretation IV. 

Decision

This case, which relates to the interdisciplinary area between the company law and the science of accounting happened when the Legal Interpretation IV of the Company Law by the Supreme Court was just promulgated. Our side gathered a lot of evidence under Article Fifteen of the Legal Interpretation IV. During the hearings we could see the judge was more and more in favor of the plaintiff and gradually lost confidence in the defendant. This case ended when defendant paid the distributed profits to the plaintiff and the plaintiff withdrew the action.

Further discussion

If shareholders claim that they should be paid part of distributed profits without submitting a detailed profit distribution plan or shareholder resolution and with proof of abuses of shareholder rights that cause their company unable to distribute profits and cause damage to other shareholders, the court can support their claims. In legal practice, upon occurrence of one of the following circumstance, profits can be distributed.

a. Distributing profits among shareholders indirectly by paying to incumbent shareholders or their proxies salaries that are too high considering the company’s size and performance and the salary level in the same industry;

b. Distributing profits among shareholders indirectly by buying services or properties not connected with its business for consumption or use by the shareholders; or

c. Concealing or transferring the company’s properties to avoid profit distribution.

In the first case the controlling shareholder Yao borrowed a large amount of money to his associate companies, which is the circumstance of a shareholder abusing his shareholder rights to distribute profits to himself that meets the profit distribution conditions included in Article 15 of the Legal Interpretation IV of the Company Law.