Article 1 With respect to the damage to a company's interests by related-party transactions, if the plaintiff company requests the controlling shareholder, actual controller, director, supervisor or senior officer to pay compensation for the losses incurred according to Article 21 of the Company Law and the defendant only makes its defense on the grounds that it has performed the duty of information disclosure, it has obtained the consent of the board of shareholders or the general meeting, or it has completed other procedures required by laws, administrative regulations or articles of association, such defense will not be supported by the people's court.

If the company does not initiate a legal action, the shareholders that meet the conditions specified in Paragraph 1 of Article 151 of the Company Law may initiate a legal action in the people's court in accordance with Paragraphs 2 and 3 of Article 151 of the Company Law.

[Official Interpretation] Damage compensation lability cannot be exempted by performance of statutory procedures in related-party transactions

Regarding the internal liability for compensation in related-party transactions, this article of the Judicial Interpretation clearly states that such liability cannot be exempted by the performance of statutory procedures if a transaction causes damage to the company's interests. In practice, in court trials of disputes involving damage compensation liability in related-party translations, the relevant persons tend to argue that they have performed the legal procedures for their conduct, most importantly by securing a resolution of the shareholders' meeting or the board of directors, and that they have also recused themselves from the voting process as required, etc. However, the key issue with related-party transactions concerns fairness. This article emphasizes that even though a related-party transaction may have passed the relevant procedures, the company can still claim damage compensation liability against the relevant persons if the transaction is in breach of the arm's length principle.

Given that the persons conducting a related-party transaction often control or have significant influences on the decision-making of the company, it will be hard to depend on the company to initiate a claim for damage compensation on its own behalf. Therefore, this article stipulates that shareholders may bring derivative suits in appropriate circumstances, thus giving minority shareholders an effective weapon to hold those responsible for related-party transactions to account and protect the company's and their own interests.

Article 2 If anything in the contract on related-party transactions is invalid or revocable and the company does not initiate a legal action against the counterparty thereto, the shareholders that meet the conditions specified in Paragraph 1 of Article 151 of the Company Law may initiate a legal action in the people's court in accordance with Paragraphs 2 and 3 of Article 151 of the Company Law.

[Official Interpretation] Shareholders may bring derivative suits to request invalidation or revocation of the relevant contracts in related-party transactions

Under current Chinese laws, a company as a party to a contract may directly make a request for the invalidation or revocation of such contract in accordance with the relevant regulations if the contract is invalid, unconscionable or revocable due to other circumstances. But different from normal contracts, related-party transaction contracts are entered into for transactions facilitated by the connected relationship between related parties, who often control or have significant influences on the decision-making of the company. So even if there are circumstances which can render a contract invalid or revocable, it will be hard for the company itself to initiate a claim. Considering this, the Provisions effectively expanded the scope of application of shareholder derivative suits to include disputes concerning invalidation and revocation of related-party transaction contracts. In the absence of an action by the company to revoke a related-party transaction, qualified shareholders may bring a derivative suit in accordance with the law to protect the company's and their own interests.

Article 3 Where a director is removed from his post through an effective resolution made by the board of shareholders or general meeting before expiry of his term of office and he claims that the said removal shall have no legal effect, such claim will not be supported by the people's court.

After a director is removed from his post, if any dispute arises between the company and the director due to compensation and a legal action is therefore initiated, the people's court shall determine whether compensation should be paid, as well as the reasonable amount of compensation, in accordance with laws, administrative regulations and articles of association, or the terms of the contract, and in consideration of such factors as the reasons for removal, the term of office remaining and the director's renumeration.

[Official Interpretation] Companies may remove a director from office at any time but shall pay reasonable compensation

The Provisions clarify the relationship between companies and their directors, specifying that companies may remove a director from office at any time. The Chinese Company Law makes no clear stipulations on such relationship, but only states that the term of office of directors shall be prescribed by the articles of associations and in any case, shall not exceed three years for each term, and that directors may serve consecutive terms if re-elected upon expiration of one term. But in theory and practice regarding the Company Law, a consensus has generally been reached to deem the relationship between companies and their directors as a principal-agent relationship, which becomes contractual under the Contract Law upon the resolution of the shareholders' meeting to appoint a director and the director's acceptance of the appointment. As a principal-agent contract, it can be rescinded freely by either party to the contract, meaning that a company may dismiss a director from office at any time regardless of whether his/her term of office has expired or not, whilst the director may also quit office at any time.

Termination without cause will not prejudice the legitimate rights of directors. To balance the interests between the parties, it is required that companies should pay reasonable compensation to directors in the event of dismissal so that the legitimate rights of directors can be protected, and companies can also be prevented from arbitral dismissal. Therefore, the emphasis of this article is reasonable compensation. According to the Chinese Contract Law, the principal shall compensate the agent for loss if such loss is caused to the agent due to the rescission of contract by the principal for reasons not attributable to the agent. This article provides the corresponding guidance for courts to exercise their discretionary powers in the trial of this type of cases.

Article 4 After a resolution is passed by the board of shareholders or general meeting regarding profit distribution, the company shall distribute the profits within the time limit expressly stated in the resolution. If no time limit is specified in the resolution, the provisions in the articles of association shall prevail. If no time limit is specified in both the resolution and the articles of association, or if the time limit lasts for more than one year, the company shall distribute the profits within one year from the date when the resolution is passed.

If the time limit for profit distribution specified in the resolution exceeds that in the articles of association, shareholders may request the people's court to revoke the provisions regarding the said time limit in the resolution according to Paragraph 2 of Article 22 of the Company Law.

[Official Interpretation] A resolution setting a time limit for profit distribution that exceeds that prescribed in the articles of associations can be partially revoked depending on the situation.

In this Judicial Interpretation, the principle regarding the time limit for profit distribution is stated as follows:
If a distribution plan specifies a time limit, such time limit shall prevail;
If a distribution plan does not specify a time limit, the time limit specified in the articles of association shall apply; or
If there is no time limit specified in both the distribution plan and the articles of association, or the time limit specified exceeds a year, profits shall be distributed within one year upon the date of resolution on the distribution plan.

If the time limit for profit distribution prescribed in a specific distribution plan exceeds that in the articles of association, shareholders would likely want to follow the time limit set in the articles of association. This is a case where the content of a company resolution is in breach of the articles of association, and in such case, the resolution in question can be revoked and shareholders shall have the legal right to sue for revocation of the part of the resolution concerning the time limit. If it is revoked, profits should be distributed according to the relevant provision of the articles of association.

This article also provides that a company resolution can be partially revoked without affecting the validity of its remaining parts. However, if the time limit prescribed is closely tied to the other parts of the resolution, it cannot be revoked alone. Therefore, it will be subject to the decision of the trial court based on the specific situation.

Article 5 When hearing a case involving a major disagreement among the shareholders of a limited liability company, the people's court shall pay attention to mediation. If the dispute is resolved in any of the following ways upon negotiation between the parties concerned without violating any mandatory provisions in laws and administrative regulations, the people's court shall support the said resolution.

1. The company repurchases the shares of some shareholders;
2. Some shareholders transfer their shares to other shareholders;
3. Some shareholders transfer their shares to other parties;
4. The company reduces its registered capital;
5. The company is divided; or
6. Other ways through which the company resolves the dispute and resumes normal operation without being dissolved.

Since LLCs have a distinct membership feature and have more restrictions on the transfer of shares, it's more difficult for their shareholders to exit the company. Although mediation in the ligation process is a feasible option to achieve similar results, mediation of this kind of cases is often more complicated and requires greater expertise. Therefore, it's necessary to have corresponding guidance in judicial interpretations.

The Chinese Company Law does provide certain mechanisms for resolution of shareholder disagreements. For example, Article 74 of the Company Law specifies the right to request share buybacks for shareholders of LLCs, and Item 4 of the first paragraph of Article 142 specifies the same right for shareholders of joint stock limited companies. Article 88 and Article 96 of the Chinese Securities Law both state that in the event that 30% of shares in a listed company is acquired, the right to compulsory sales of the shares of minority shareholders will be protected by law. Article 5 of the Second Judicial Interpretation on the Company Law also states that courts should pay attention to mediation before ordering a dissolution. The abovementioned provisions reflect the efforts to avoid corporate dissolution by judicial actions. But the applicable scope of these provisions is a bit narrow. The Provisions follow up on the previous disagreement resolution mechanism with an expansion of their applicable scope to cover all cases and disputes involving major disagreements among shareholders of LLCs.

Through mediation, shareholders who wish to stay in the company may buy the shares of those who don't, which is similar to the squeeze-out mechanism; or the company may buy back the shares, which is similar to the share buyback mechanism; or a third party outside the company may buy the shares. The disagreeing shareholders can exit the company when their shares are bought or bought back, and the corporate deadlock can be broken so that the normal operation of the company can be maintained. If share transfers cannot be achieved, a capital reduction of the company may be achieved through mediation so that the disagreeing shareholders can “cash out” and exit, while the remaining shareholders can continue to operate the reduced company and the company can also continue to exit; on the other hand, a division of the company will have the disagreeing shareholders who don't wish to stay to “venture out” on their own, and the company will exist in a new form.

Meanwhile, this article also emphasizes that mandatory provisions in laws or regulations shall not be violated. No matter whether the shares are transferred between shareholders, bought back by the company or transferred to a third part outside the company, or no matter whether there is a capital reduction or company division, they have their respective conditions and procedural requirements to meet. Courts should pay attention to guiding the parties to comply with laws, regulations and regulatory rules, as well as the relevant procedures in the course of mediation.