Article 25 of the 2021 Draft Amendment to the Arbitration Law proposed that shareholders could, in their own name, represent the company to assert rights against a counterparty, with the arbitration agreement signed between the company and the counterparty being binding on the shareholder. However, this provision was not included in the 2024 Draft Amendment to the Arbitration Law.
Additionally, article 189 of the Company Law, effective since 2024, stipulates that shareholders pursuing litigation in the company’s interest must file claims “directly with the people’s court”.
As a result, it seems there is no explicit legal basis for derivative arbitration by shareholders in China. While most courts support derivative arbitration – viewing it as shareholders formally exercising the company’s rights by substitution – some courts hold that arbitration agreements do not extend to non-signatory shareholders.
Furthermore, the Company Law explicitly requires derivative actions to be under court jurisdiction, excluding arbitration as a viable option.
Hong Kong pathway
Partner
Han Kun Law Offices
Tel: +86 186 0049 7093
E-mail: long.liu@hankunlaw.com
In common law jurisdictions, debates on supporting or excluding shareholder derivative arbitration are not uncommon.
However, in jurisdictions such as Hong Kong and Singapore, the feasibility of derivative arbitration hinges not on whether the arbitration agreement can extend to shareholders who are non-signatories to the agreement, but on whether shareholders have the standing to act on behalf of the company.
Under common law tradition, the historic precedent in Foss v Harbottle (1843) established that the proper plaintiff in cases of harm to a company is the company itself. Derivative actions aim to mitigate the harsh consequences of this rule for minority shareholders.
In Hong Kong, shareholders seeking to initiate statutory derivative actions on behalf of a company must seek the court’s leave pursuant to the Companies Ordinance. The court considers various factors, including whether the derivative action genuinely serves the company’s interests, and whether procedural requirements such as notifying the company have been fulfilled.
Although Hong Kong law does not explicitly permit shareholder derivative arbitration, courts in practice do not reject the validity of arbitration clauses solely because shareholders are not a signatory to the arbitration agreement between the company and its counterparty.
For instance, in Chu Kong v Lau Wing Yan & Ors (2018), the fourth defendant in the first instance applied to stay the derivative action brought by the plaintiff, arguing that the dispute should be submitted to arbitration under the arbitration clause between the fourth defendant and the company.
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Han Kun Law Offices
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E-mail: chen.kuang@hankunlaw.com
The plaintiff counter-argued that, under current Hong Kong law, he could not commence an arbitration derivatively on the company’s behalf; and that the fourth defendant would eventually challenge his standing, rendering derivative arbitration an unviable option.
However, the Court of Appeal held that, under Hong Kong’s Arbitration Ordinance, if there is an arbitration clause between the parties to the litigation – and there are no circumstances rendering the arbitration agreement invalid or incapable of being performed – the court must stay the proceedings. Therefore, even if the fourth defendant were to challenge the plaintiff’s standing to represent the company in arbitration, such disputes should also be resolved by the arbitral tribunal under the arbitration agreement, and this would not render the arbitration agreement incapable of being performed.
In this case, the court did not refuse to stay the proceedings on the grounds that there was no arbitration clause between the shareholder and the counterparty to the contract signed with the company. However, it also did not touch on the shareholder derivative arbitration itself.
Regarding the standing of shareholders in derivative arbitration and the criteria for determining such standing, Hong Kong law has yet to reach a definitive conclusion.
Singapore’s approach
In contrast, Singapore’s legislation explicitly addresses shareholder derivative arbitration, a choice shaped by historical developments.
In Kiyue Company Limited v Aquagen International Pte Ltd (2003), the respondent company, Aquagen International, resolved not to contest the arbitration claim. Kiyue Company, a minority shareholder, asked for the court’s leave to intervene in the arbitration on behalf of the company.
At the time, section 216A of the Singapore Companies Act only provided that shareholders can seek the court’s leave for derivative litigation. The court held that, in the absence of any reference to arbitration in the statute or any indication that the legislature had contemplated derivative arbitration, it was not in a position to interpret section 216A too broadly. Consequently, the court rejected Kiyue Company’s application.
But the legislature later responded to this interpretive gap, with a 2014 amendment to the Companies Act adding the phrase “or arbitration” to section 216A. Since then, shareholders meeting the conditions under section 216A can seek the court’s leave to initiate or intervene in litigation or arbitration on behalf of the company.
The provision also clarified the standards courts must apply when reviewing such applications.
Implications
From a common law perspective, the core issue in shareholder derivative arbitration lies in assessing whether a shareholder has the standing to act on behalf of the company.
This assessment aims to ensure that shareholders’ exercising of rights genuinely aligns with the company’s interests, rather than constituting an abuse of litigation or arbitration processes.
Singapore’s amended Companies Act has established a clear framework for derivative arbitration, setting out the reviewing criteria and prerequisites for determining standing. This legislative approach avoids the ambiguity of the phrase “in accordance with the law” in above-mentioned article 25 of the draft legislation.
It also avoids the uncertainty caused by the lack of explicit legal authority under Hong Kong law regarding shareholders’ standing in derivative arbitration, despite recognising the validity of arbitration agreements.
Hopefully, such discussions and considerations regarding derivative arbitration by legislators and adjudicators in common law jurisdictions will offer new perspectives for Chinese legislature to further refine its legislation on shareholder derivative arbitration.
Liu Long is a partner at Han Kun Law Offices. He can be contacted by phone at +86 186 0049 7093 and by email at long.liu@hankunlaw.com
Kuang Chen is a paralegal at Han Kun Law Offices. He can be contacted by phone at+86 10 8534 7515 and by email at chen.kuang@hankunlaw.com
