Professional Interpretation

Abstract: The shareholders shall exercise the right to claim surplus distribution under the conditions that the subjects are the company’s shareholders; the company has profits to be distributed and a profit distribution scheme has been made by the resolution of the Board of Shareholders, etc. When the shareholders exercise their rights to claim surplus distribution in the practice, various unexpected situations may occur, and the dispute resolution team of Beijing DOCVIT Law Firm will analyze the situations of defective capital contribution in such exercise, no resolution of the Board of Shareholders, loss of shareholder status, etc. in combination with relevant cases. 

The dispute over surplus distribution is the dispute over the shareholders’ rights of sharing profits, and it means the right that the shareholder requests the company to distribute profits to them according to the Company Law; however, most companies will specify the prepositive procedures for the shareholders’ rights of sharing profits in the Articles of Association, therefore, this requires that the exercise of rights to claim surplus and profit distribution by the shareholders needs to meet certain conditions, and not all shareholders can exercise them in any case. Now, the dispute resolution team of Beijing DOCVIT Law Firm will analyze the focus of the corporate surplus distribution dispute in combination with communiqu cases and relevant cases heard by the Supreme People’s Court. 

I. Basic points of corporate surplus distribution 

(I) Conditions for shareholders’ claim of surplus distribution 

The right to claim corporate surplus distribution is the right to claim dividend distribution, and it is a kind of shareholders’ self-benefit rights and means a right that shareholders request the company to distribute dividends to them according to their shareholding proportions or the Articles of Association and that is entitled by shareholders based on their shareholder status according to law. The shareholders shall claim surplus distribution under the following several conditions: 1. The subject is the company’s shareholders; 2. The company has surplus to be distributed; 3. A profit distribution scheme has been made by a legal and effective resolution of the Board of Shareholders. 

(II) Basic situation of the company’s after-tax profit distribution 

As stipulated in Article 166 of the Company Law, “After distribution of after-tax profits of the year, the company shall allocate 10% of the profits to be included in the company’s legal accumulation fund......if such fund is not enough to make up for the losses of the previous year, the profits of that year shall be used to make up for the losses before withdrawing the legal accumulation fund according to the preceding paragraph. After the Company withdraws the legal accumulation fund from the after-tax profits, any legal accumulation fund can be withheld from after-tax profits upon resolutions of the Board of Shareholders or made at the Shareholders’ Meeting. The after-tax profits after the company makes up for the losses and withdraws the accumulation fund shall be distributed by the limited liability company according to Article 34 of the Code; The joint-stock limited company shall distribute such profits according to the shareholding proportions of shareholders, except for those that are not distributed according to the shareholding proportions as stipulated in the Articles of Association......”. According to the code and Article 50 of the General Rules for Enterprise Finance issued by the ministry of finance, the basic process for distribution of the company’s after-tax profits is: 1. Make up for the company’s losses of previous year, 2. Withdraw the legal accumulation fund, 3. Withdraw any accumulation fund upon resolution of the Board of Shareholders, 4. Give a surplus distribution scheme upon resolution of the Board of Shareholders to distribute surplus to shareholders. 

II. Focus of corporate surplus distribution dispute 

(I) The shareholders’ right to claim surplus distribution is not affected by the defective capital contributions, except for those otherwise agreed in the Articles of Association 

According to Article 34 of the Company Law, the shareholders shall participate in profits according to the proportion of the paid-in capital contribution. If any agreement on participation in profits not according to the paid-in capital contribution is made between shareholders, such agreement shall prevail. Therefore, unless otherwise agreed in the Articles of Association, the non-currency contribution does not affect the shareholders’ right to claim profit distribution. In principle, the rights to claim surplus distribution of shareholders with defective capital contribution shall be restricted, but if no formal resolution of the Board of Shareholders restricts the rights of shareholders with defective capital contribution, they can still exercise the rights to claim surplus distribution based on shareholders’ qualifications. However, other shareholders can claim surplus distribution according to the amount of actual capital contribution of the shareholders with defects. 

Therefore, if no other agreement is made in the Articles of Association, the shareholders even with defective capital contribution still have the rights to claim surplus distribution. In the case of dispute over cooperative real estate development contract between ZENG vs Milan Real Estate Company and XU ((2016) ZGFMS No. 363), the court recognizes the rights to claim surplus distribution of shareholders with non-currency capital contribution: 

On March 28, 2007, XU and ZENG went through the name pre-registration approval for Milan Company at Xuzhou Administration of Industry and Commerce, in which, it was proposed to set them as enterprise shareholders with respectively capital contribution of RMB 4,000,000. On April 8, 2007, GE, the person not involved in the case, and XU signed the Agreement of Investment for Buying Shares for Milan Company, agreeing that, after the project was completed, each party would recover cost of RMB 3,000,000. For the remaining profits, XU shared 50%, GE shared 45%, and ZENG shared 5%. On July 11, 2007, Milan Company was registered and established. At that time, the monetary fund was RMB 3,000,000, which was transferred by REN, the person not involved in the case, under the entrustment of ZENG to the account of XU and later returned to REN on July 17, 2007 through Milan Company. Both parties acknowledged that such money was repaid with Milan Company’s proceeds from housing sales, but ZENG said that he paid such money to Milan Company again. Later, a dispute arose between both parties, and ZENG sent a notice of contract cancellation with Milan Company and XU on August 19, 2012, and XU replied on August 22, 2012 that he did not develop the project of Meilan Garden together with ZENG. Later, ZENG brought litigation to the people’s court, and requested to judge as below: I. Confirm the legal relations of cooperative development of real estate between both parties; II. Milan Company and ZENG shall pay the profit of surplus of the cooperative real estate development project, i.e., RMB 13,991,400; III. The litigation expenses of this Case shall be borne by Milan Company and XU. 

In this Case, within several days after the incorporation of Milan Company, the loan of RMB 3,000,000 was returned by Milan Company with the proceeds from housing sales to REN, in which Milan Company constituted withdrawal of capital. ZENG did not actually perform the investment obligations; XU knew and recognized the fact, but they still agreed equal distribution of deposits on the account of Milan Company and its proceeds from housing sales in the Supplementary Agreement, which complied with the agreement on profit distribution in the Joint Development Agreement signed before, was the true expression of the parties and did not violate the compulsory regulations of laws and administrative regulations. During the cooperation of both parties, XU did not put forward that ZENG shall not enjoy profit distribution if he did not contribute. Now Milan Company and XU claim that ZENG did not contribute and shall not enjoy profit distribution, inconsistent with the agreement of both parties, so it is appropriate that the judgment of second instance does not support the claim. The court rejects the reasons of retrial application by Milan Company and XU that ZENG shall be judged to have no right to claim for profits distribution according to the provision of Articles 22 and 23 of Interpretation of the Supreme People's Court on the Applicable Laws Concerning the Trial of Cases Concerning Contract Disputes over State-Owned Land Use Rights. 

(II) The resolution of the Board of Shareholders which specifies the specific distribution scheme shall be submitted for the shareholder's claim for the profit surplus distribution, except that there is evidence proving that some shareholders distribute, conceal or transfer the surplus in a disguised way 

According to Article 15 of Provisions of the Supreme People's Court on Some Issues about the Application of the Company Law of the People's Republic of China (IV), in the profit surplus distribution disputes, in case there is evidence proving that the company has a surplus and that some shareholders have abused the rights of shareholders by distributing, concealing or transferring the company's profits in a disguised way, although the shareholder claiming for the profit distribution has not submitted the resolutions of the Board of Shareholders or resolutions made at the Shareholders’ Meeting which specifies the specific distribution scheme, the profit surplus distribution can be forced in the lawsuit, and it is not premised on other relief measures, such as share repurchase and subrogation lawsuit. 

In the case of profit surplus distribution disputes between Taiyi Heating Co., Ltd. and LI ((2016) ZGFMZ No. 528), the Supreme Judicial Court supports the profit surplus distribution claim of shareholder(s) not submitting resolution of the Board of Shareholders but other shareholders transfer profits: 

Taiyi Heating Company was established by LI and ZHANG Hailong. In April 2007, ZHANG Hailong signed an equity transfer agreement with Juli Doors Company to transfer the equity of RMB 3,500,000 in Taiyi Heating Company to Juli Doors Company. In May 2007, LI signed an equity transfer agreement with Taiyi Industry and Trade Company and Juli Doors Company to transfer the equity of RMB 6,000,000 in Taiyi Heating Company to Taiyi Industry and Trade Company and the equity of RMB 500,000 to Juli Doors Company. In May of the same year, Taiyi Heating Company amended its Articles of Association to change the shareholders into Taiyi Industry and Trade Company and Juli Doors Company, with the shareholding ratio of Taiyi Industry and Trade Company of 60% and that of Juli Doors Company of 40%, which was registered for change in industrial and commercial administrative department. On September 29, 2009, People's Government of Qingyang decided to conduct an overall acquisition of Taiyi Heating Company. On July 10, 2010, Qingyang Economic Development Investment Co., Ltd. paid the balance of asset transfer of RMB 57,610,000 to Taiyi Heating Company. Later, Juli Doors Company appealed to people's court that: I. Order Taiyi Heating Company to distribute the surplus cash over RMB 70,000,000 and surplus land of 32.7mu to Juli Doors Company according to Article 35 of the Company Law and Article 27 of Articles of Association of Taiyi Heating Company; II. Order LI to bear joint liability for the first item of claims by Juli Doors Company. 

In this Case, first, there are no other business activities after the total assets of Taiyi Heating Company are acquired, and the conclusion of judicial audit entrusted by the court of first instance shows that, the net earning upon liquidation of Taiyi Heating Company is RMB 75,973,413.08, so even after deducting the amount in dispute, Taiyi Heating Company still has a huge distributable profit, with the preconditions of surplus profit distribution; Secondly, LI, as the legal representative of Taiyi Heating Company and its controlling shareholder: Taiyi Industry and Trade Company, without the consent of the other shareholder: Juli Doors Company, transfers the company asset transfer amount over RMB 56,000,000 to the account of Xingsheng Jian’an Company without reasonable reasons, transferring company profits, causing losses to Juli Doors Company, which belongs to abuse of shareholder rights by Taiyi Industry and Trade Company; Thirdly, as for the relief right for shareholder surplus distribution stipulated in the foregoing judicial interpretation, it is not required to take other relief measures, such as share repurchase, company dissolution and subrogation lawsuit as the pre-procedure, and Juli Doors Company has the right to freely choose different relief paths. Therefore, the court of second instance considers that the determination of the first instance judgement that Taiyi Heating Company shall carry out surplus distribution has factual and legal ground. 

(III) The shareholders must remain shareholders of the company at the time of lawsuit and during hearing. 

As is known to all, only by enjoying the shareholder qualification according to law can the shareholders enjoy the due rights and interests stipulated in the Company Law, including the right of profit distribution claim. If before the equity transfer by the shareholders, the company has adopted the resolution of the Board of Shareholders to form a profit distribution scheme, and after the equity transfer according to law, it may not enjoy the right of profit distribution claim according to the shareholder's qualification, but the right of dividend claim, in case of litigation, the corresponding claims need to be changed according to law. Therefore, to exercise the right of profit distribution claim, it is necessary to enjoy the shareholder qualification according to law. 

In the case of profit surplus distribution dispute between CUI and Tieli Jianeng Investment Co., Ltd., CHEN ((2017) HMZ No. 491), the court does not support the surplus distribution claim of the plaintiff losing shareholder qualification after equity transfer: 

In March 2010, CHEN and CUI jointly invested RMB 5,000,000 to register and establish Jianeng Company. On July 1, 2013, CUI and CHEN signed an Equity Transfer Agreement agreeing that CUI transferred 59.80% of the equity in Jianeng Company to CHEN at the transfer price of RMB 3,000,000, and handled the equity change registration in the industrial and commercial department. Without the knowledge of CUI, CHEN signed an Equity Transfer Agreement with Zhengzhou Kangling Commercial and Trading Co. Ltd. (hereinafter referred to as Kangling Company) on behalf of Jianeng Company on June 21, 2013, to transfer Jiahua Company to Kangling Company, at the transfer price of RMB 30,000,000. On June 25, 2013, according to the requirements of CHEN, Kangling Company transferred RMB 6,000,000 to the account of Jiahua Company, and CHEN transferred RMB 3,000,000 to CUI for the purchase of 59.80% equity of CUI in Jianeng Company. Kangling Company has fulfilled the payment obligation according to the agreement, and handled the equity change registration in the industrial and commercial department, so Kangling Company owns 100% equity of Jiahua Company.  Upon learning of this situation, CUI, on one hand, criminally accused CHEN of misappropriation of the company's property; on the other hand, civilly prosecuted CHEN, demanding Jianeng Company to compensate for the equity transfer fund of RMB 8,970,000. 

In this Case, the essence of the right attribute of CUI claiming Jianeng Company to compensate for RMB 8,970,000 is the claim for profit surplus distribution. Though on June 21, 2013, when Jianeng Company transferred its equity of Jiahua Company to the person not involved in the case of Kangling Company, CUI had the shareholder qualification of Jianeng Company, and the equity transfer payment of Jiahua Company belonged to the earnings of Jianeng Company before CUI transferred the equity of Jianeng Company, the Equity Transfer Agreement signed by CUI and CHEN does not explicitly stipulate that CUI, the former shareholder, is entitled to claim for the profits of Jianeng Company before the equity transfer, and as the shareholder qualification of CUI is lost with the equity transfer and change registration, the right to claim for profit distribution based on shareholder qualification is also lost, so CUI has had no right to distribute the profits of Jianeng Company based on the shareholder qualification. CUI and Jianeng Company have not formed the debtor-creditor relationship over the company's profits. Although CUI claimed that when he/she transferred the equity of Jianeng Company, CHEN deliberately concealed the important matter of transferring the equity of Jiahua Company at a high price and committed fraud, the legal consequences of fraud in the civil legal relationship may lead to the validity of the civil act between CUI and CHEN in a variable and revocable state, rather than the factual and ground for CUI’s claim for Jianeng Company to pay the surplus profit, and the effective criminal judgment has recovered and returned to Jianeng Company more than RMB 15,000,000 of equity transfer funds embezzled by CHEN from Jianeng Company, so the court does not support CUI’s claim. 

III. Lawyer suggestion 

The dispute resolution team of Beijing DOCVIT Law Firm suggests: According to the provisions of the current Company Law and the judicial interpretation of the Company Law in China, the shareholder shall possess the following preconditions when exercising the right of claim for surplus distribution according to law: First, the shareholder claiming for profit distribution shall enjoy shareholder qualification according to law; Secondly, the after-tax profit of the company still has surplus after covering the deficit and withdrawal of public accumulation funds; Thirdly, the shareholder who claims shall form the profit distribution scheme through resolutions of the Board of Shareholders or resolutions made at the Shareholders’ Meeting. Only by meeting these three conditions can the shareholder enjoy the right of claim for profit distribution, but unless the company or other shareholders violate the law and abuse the right of shareholder, causing that the company does not distribute profits, and causing losses to other shareholders.