This article draws on an equity-transfer dispute involving a limited liability company handled by the author to examine two issues: the legal effect of the register of shareholders; and the point at which shareholder status is acquired.
In this case, a company in Shanxi (the “target company”) has the following shareholders and shareholdings: Company A holds 51% and company B holds 47%.
Company A, as transferor, later enters into an equity transfer agreement with the client company as transferee, agreeing to transfer 30% of its equity interest in the target company to the client company for a consideration of several tens of billions of renminbi.
At first instance, an intermediate people’s court upholds company B’s claim and holds the agreement invalid. If that judgment stood, the client company would be unable to acquire the equity interest and face substantial losses.
On appeal, the central issue at second instance was this: Absent an updated entry in the target company’s register of shareholders and completed change registration with the market regulation authority, how should the client company’s shareholder status – and timing of its acquisition – be assessed?
Analysis of applicable law
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Kangda Law Firm
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E-mail: jincheng.huo@kangdalawyers.com
Article 8 of the Minutes of the National Courts’ Civil and Commercial Trial Work Conference provides that: “Where the parties transfer equity in a limited liability company, and the transferee asserts that it has acquired the equity on the ground that its name has been recorded in the register of shareholders, the people’s court shall support such claim in accordance with the law, except for equity transfers that, pursuant to laws or administrative regulations, take effect only upon completion of approval procedures. Where a change-of-equity registration has not been completed with the market regulation authority, it may not be asserted against a bona fide counterparty.”
This provision distinguishes between recording the transferee in the register of shareholders and registering the equity change with the market regulation authority.
This is a typical company law dispute in the post-Company Law landscape. The core issue is a familiar one: when does an equity transferee acquire shareholder status?
Views differ in both theory and practice. Main approaches include: the “contract effectiveness” view (shareholder status is acquired once the contract is formed and becomes effective); the “contract performance” view (shareholder status is acquired after the main closing obligations have been performed); the “register-entry” view (shareholder status is acquired once the transferee is entered in the register of shareholders); and the “registration change” view (shareholder status is acquired after the change of registration with the market regulation authority).
The second-instance hearing in this case developed a full argument around the effect of the register of shareholders. In equity transfers and disputes over shareholder status, entry into the register of shareholders is commonly treated as the basis on which the transferee claims to exercise shareholder rights against the company.
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Kangda Law Firm
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By contrast, where registered items change, the law requires that a change of registration be completed; without registration or change of registration, it may not be asserted against a bona fide counterparty.
The discussion of registration here is mainly to frame the system, rather than to address the principal point contested in this judgment. Against that backdrop, an entry into the register of shareholders can be an important basis for finding that the transferee has acquired the equity and obtained shareholder status.
The Supreme People’s Court (SPC) states, in Understanding and Application of the Minutes of the National Civil and Commercial Trial Work Conference, that the register of shareholders may serve as evidence of shareholder identity and as a basis for shareholders to exercise rights against the company, but it is not the only, or necessary, condition for confirming shareholder identity.
In practice, courts generally read article 56(2) of the revised Company Law (2023 revision) as providing that “shareholders recorded in the register of shareholders may, on the basis of the register, claim to exercise shareholder rights”.
It does not follow that a person is not a shareholder merely because it is not recorded. A missing entry simply means the register cannot be relied on as the basis of the claim; shareholder status and the corresponding rights may still be proved and asserted through other evidence or avenues.
The SPC further notes: “Given that the ultimate purpose of changing the register of shareholders is for the company formally to recognise the fact of the equity transfer … relevant company documents, such as the articles of association and meeting minutes, so long as they can prove that the company recognises the transferee as a new shareholder, may produce corresponding legal effect.”
In other words, legislative developments under the revised Company Law do not change the basic position that the register is sufficient evidence, but not a necessary condition.
In this case, the appellate court cited article 32 of the Company Law (2018 revision), which provides that “a shareholder recorded in the register of shareholders may, on the basis of the register, claim to exercise shareholder rights”. The court emphasised that for a limited liability company, entry in the register of shareholders has constitutive effect as against the company – namely, effectiveness of the transfer agreement does not alone bring about change in shareholder status. In principle, the transferee must be recorded in the register before asserting shareholder rights against the company.
The court added that where internal documents such as company resolutions sufficiently show that the company has recognised the transferee’s shareholder status, they may still serve as an important basis for finding the company has confirmed equity change, even if the register has not been updated in time.
Takeaway
Against the backdrop of the revised Company Law, the second-instance court’s treatment of the register of shareholders offers useful reference. It is also a reminder that companies should establish a register of shareholders and standardise related processes.
To reduce risk and limit evidentiary disputes, once equity change occurs, promptly issue capital contribution certificates, update the articles of association and register of shareholders, and complete change registration and public disclosure as soon as possible.
Huo Jincheng is a senior partner at Kangda Law Firm. He can be reached by phone at+86 139 0128 6634 and by mail at jincheng.huo@kangdalawyers.com
Wang Xuechen is an associate at Kangda Law Firm. She can be reached by phone at +86 186 0104 2117 and by mail at xuechen_wang@kangdalawyers.com
