Brief Introduction to the Case

Defendant A Company was established on April 5, 1990. In May 2004, Company A was restructured from a state-owned enterprise into a limited liability company. Song, an employee of Company A, contributed 20000 yuan to become a natural person shareholder of Company A. Article 14 of Chapter 3 "Registered Capital and Shares" of Company A's Articles of Association The equity of the company shall not be sold or transferred to any group or individual outside the company. After one year of the company's restructuring, it may be gifted, transferred, or inherited within the company with the approval of the board of directors. The death or retirement of the shareholder shall be approved by the board of directors before inheritance, transfer, or acquisition by the enterprise. If the shareholder resigns, transfers or is dismissed, or terminates the labor contract, the shareholder shall retain the shares and the shares held shall be acquired by the enterprise, Article 66 of Chapter 13 "Other Matters Deemed Necessary by Shareholders" stipulates that "This Articles of Association shall be jointly recognized by all shareholders and shall come into effect from the date of establishment of the company". The articles of association of the company have been signed and approved by all shareholders of Company A. On June 3, 2006, Song proposed to terminate his labor contract with Company A and applied to withdraw his 20000 yuan stake in the company. On August 28, 2006, with the consent of the legal representative of Company A, Song received a withdrawal payment of 20000 yuan. On January 8, 2007, Company A held its 2006 annual shareholders' meeting, with 107 shareholders expected to attend and 104 actual shareholders present, representing 93% of the company's total shares. The meeting approved the application for withdrawal of shares by three shareholders, Song, Wang, and Hang, and resolved that "their shares shall be temporarily purchased and kept by the company and shall not participate in dividend distribution". Later Song requested confirmation of his shareholder status as A Company in accordance with the law, citing that A Company's repurchase behavior violated legal provisions, failed to comply with legal procedures, and that shareholders were not allowed to withdraw their capital in accordance with the Company Law.

Song proposed that the procedure for Company A to withdraw its shares is illegal. Although the Company Law does not prohibit the company from repurchasing shareholder shares, the withdrawal and repurchase behavior must comply with the legislative purposes of the Company Law and the conditions and procedures stipulated in the Company Law, namely the three situations stipulated in Article 74 of the Company Law. In this case, the withdrawal behavior between the plaintiff and the defendant is only completed by the signature of the chairman, and there is no agreement reached with the company, The defendant took back Song's shares in June 2006, and until the lawsuit in this case, Song's shares had not been transferred or cancelled in accordance with the law. In the industrial and commercial registration information, Song was still registered as a shareholder of Company A. 2. The defendant's forced withdrawal of Song's shares constitutes the company's withdrawal of capital contributions and violates the prohibitive provisions of the Company Law. The company's repurchase of Song's shares essentially reduces the company's assets and shares, infringes on the company's property rights, and constitutes the withdrawal of company funds; 3. The provision in Company A's articles of association regarding the retention of shares by individuals violates the provisions of the Company Law on shareholder rights. Labor relations and shareholder investment relations are two different legal relationships. The provision in the articles of association that the termination of labor relations requires the return of equity violates the prohibitive provisions of the company law and does not fall within the scope of company autonomy.

Company A's defense proposes that the repurchase of Song's equity by Company A does not violate the prohibitive provisions of the Company Law, and there is no illegal act in the procedure. In this case, Song applied for a withdrawal of shares, and Company A agreed to the withdrawal, which was approved by the shareholders' meeting of the company. The repurchase procedure has no illegality; The repurchase behavior of Company A has not caused a decrease in the registered capital of the company, and does not constitute a withdrawal of capital contributions; The provisions of Company A's articles of association regarding the repurchase of company equity shall not violate the prohibitive provisions of the Company Law, nor shall there be any reason for the invalidity of the contract as stipulated in Article 52 of the Contract Law, and shall be deemed valid; The fact that Song does not qualify as a shareholder of Company A has been confirmed by effective legal documents. Request to dismiss Song's lawsuit request.

 

Court Determination and Judgment Results

The court held that, after hearing the application reasons of Mr. Song and the defense opinions of the defendant A Company, the focus of the case was as follows: 1. Whether the provisions of the Articles of Association of Company A on "people leaving shares" violated the prohibitive provisions of the Company Law of the Company Law of the People's Republic of China (hereinafter referred to as the Company Law), and whether the Articles of Association were valid; 2. Does Company A's repurchase of Song's equity violate the relevant provisions of the Company Law, and does Company A constitute a withdrawal of capital contribution.

Regarding the first focus issue, firstly, Article 14 of Company A's Articles of Association stipulates that, The equity of the company shall not be sold or transferred to any group or individual outside the company. After one year of the company's restructuring, it may be gifted, transferred, or inherited within the company with the approval of the board of directors. The death or retirement of the shareholder shall be approved by the board of directors before inheritance, transfer, or acquisition by the enterprise. If the shareholder resigns, transfers or is dismissed, or terminates the labor contract, the shareholder shall retain the shares, and the shares held shall be acquired by the enterprise in accordance with the Company Law The second paragraph of Article 25 stipulates that shareholders shall sign and affix their seals to the articles of association of a limited liability company. The articles of association of a limited liability company are normative documents that are unanimously agreed upon by all shareholders upon the establishment of the company and are binding on the company and all shareholders. The act of Song signing the articles of association shall be deemed as his recognition and consent to the aforementioned provisions, and the articles of association shall be binding on both Company A and Song. Secondly, based on the closed nature and human cooperation of limited liability companies, the company's articles of association make certain restrictive provisions on the transfer of equity by shareholders, which is a manifestation of company autonomy. In this case, when Company A underwent enterprise restructuring, the reason why Song became a shareholder of Company A was because Song had a labor contract relationship with Company A. If Song did not establish a labor relationship with Company A, there was no possibility that Song would become a shareholder of Company A. Similarly, the articles of association of Company A use whether or not it has a labor contract relationship with the company as the basis for obtaining shareholder status, and then make provisions on "personnel transfer and stock retention", which is in line with the characteristics of the closed nature and human cooperation of a limited liability company, and also reflects the principle of company autonomy, and does not violate the prohibitive provisions of the Company Law. Thirdly, Article 14 of Company A's articles of association regarding equity transfer is a restrictive provision rather than a prohibited provision for shareholders to transfer equity. Song's right to transfer equity in accordance with the law was not prohibited by the company's articles of association, and there is no infringement of Song's equity transfer rights in Company A's articles of association. In summary, the court found that the articles of association of Company A do not violate the prohibitive provisions of the Company Law.

As for the second focus issue, the dissenting shareholder's Cause of action for repurchase as stipulated in Article 74 of the Company Law has legal conditions to exercise, That is, only in three situations: "the company has not distributed profits to shareholders for five consecutive years, and the company has been profitable for that five consecutive years and meets the conditions for profit distribution stipulated in this Law; the company merges, splits, or transfers its main assets; the business term specified in the company's articles of association expires or other reasons for dissolution specified in the articles of association occur, and the shareholders' meeting passes a resolution to modify the articles of association to ensure the company's survival, Opposing shareholders have the right to request the company to repurchase their equity, corresponding to whether the company should fulfill the legal obligation to repurchase the dissenting shareholders' equity. And this case belongs to whether Company A has the right to repurchase the equity of Song based on the provisions of the company's articles of association and the agreement with Song, which corresponds to whether Company A has the right to repurchase the equity of Song. The nature of the two is different, and Article 74 of the Company Law cannot apply to this case. In this case, Song filed an application for the termination of his labor contract with Company A on June 3, 2006, and wrote the "Withdrawal Application" in writing on the same day, stating that "I request a full withdrawal of my shares, and the year-end profit and loss are not related to me". The "Withdrawal Application" should be considered as his true intention. On August 28, 2006, Company A refunded its full share capital of 20000 yuan and held a shareholders' meeting on January 8, 2007 to review and approve the withdrawal applications of three shareholders, including Mr. Song. Based on Mr. Song's withdrawal application, Company A repurchased Mr. Song's equity in accordance with the provisions of the company's articles of association, and the procedures were not improper. In addition, the withdrawal of capital contribution stipulated in the Company Law specifically refers to the behavior of shareholders of a company to withdraw their capital contribution to the company. The company cannot constitute the subject of the withdrawal of capital contribution, and Song's application reason cannot be established.

Therefore, the court rejected the plaintiff Song's request to confirm his shareholder qualification as defendant A company in accordance with the law.

After the first instance verdict, Song appealed. The Intermediate people's court rejected Song's appeal and upheld the original judgment. After the final judgment was pronounced, Song still refused and applied to the High people's court for retrial. The High people's court also rejected Song's application for retrial.

 

Legal Analysis

1、 Legal situation of the company's repurchase of equity

The Company Law of China stipulates the following provisions for companies to repurchase shares:

Article 74 of the Company Law stipulates that if a limited liability company falls under any of the following circumstances, shareholders who vote against the resolution of the shareholders' meeting may request the company to acquire its equity at a reasonable price: (1) the company has not distributed profits to shareholders for five consecutive years, and the company has been continuously profitable for the past five years and meets the conditions for profit distribution as stipulated in this Law; （2） Merger, division, or transfer of major assets of a company; （3） If the business term specified in the company's articles of association expires or other dissolution reasons specified in the articles of association occur, and the shareholders' meeting passes a resolution to modify the articles of association to enable the company to survive.

Article 142 of the Company Law stipulates that a joint stock limited company shall not acquire its own shares. However, except for one of the following situations: (1) reducing the registered capital of the company; （2） Merger with other companies holding shares in the company; （3） Reward shares to employees of the company; （4） Shareholders request the company to acquire their shares due to objections to the company's merger or division resolution made at the shareholders' meeting.

 

 

 

2、 Legitimacy of Limited Liability Company's Repurchase of Equity, Except for Legal Situations

 

In order to effectively protect the legitimate rights and interests of minority shareholders, the Company Law stipulates the Cause of action of minority shareholders for share repurchase. However, there is some controversy in judicial practice regarding whether a limited liability company can exercise its equity repurchase right in accordance with the agreement, except for the legal situation. Some views suggest that limited liability companies shall not repurchase their company's equity in any other circumstances except for the specific circumstances specified in Article 74 of the Company Law. The author believes that the Cause of action for share buyback of shareholders of limited liability companies stipulated in Article 74 of the Company Law refers to the right of dissenting shareholders to require the company to purchase their contributed shares under certain special circumstances stipulated by law. This article is different from Article 142 of the Company Law, which stipulates that a joint stock limited company shall not purchase its own shares. Article 74 of the Company Law stipulates the dissenting shareholders' Cause of action for share repurchase. The Company Law does not explicitly provide prohibitive provisions for the repurchase rights of company shares other than those of dissenting shareholders. Therefore, it is legal and effective for a limited liability company to agree on the repurchase rights of the company's shares without violating legal provisions in advance, and it also conforms to the characteristics of the closure and human cooperation of a limited liability company.

In this case, the court held that the articles of association of Company A stipulated that the company's repurchase of equity was the result of a consensus reached by the shareholders of the company, which was in line with the historical situation of the company's establishment and did not violate any legal prohibitions. Moreover, according to the company's articles of association, Company A held a shareholders' meeting and fulfilled the corresponding repurchase procedures. Therefore, Company A's repurchase of Song's equity is legal and effective.

 

3、 Treatment of limited liability companies after repurchasing equity

In judicial practice, there are two main ways for companies to handle stock buybacks:

（1） Reduce registered capital

After the company repurchases its equity in accordance with legal or agreed circumstances, it may reduce its registered capital through legal procedures. According to Article 177 of the Company Law, when a company needs to reduce its registered capital, it must prepare a balance sheet and an inventory of assets. The company shall notify its creditors within 10 days from the date of making a resolution to reduce its registered capital, and make a public announcement in a newspaper within 30 days. Creditors have the right to demand the company to repay their debts or provide corresponding guarantees within 30 days from the date of receiving the notice, or within 45 days from the date of announcement if they do not receive the notice. According to Article 31 of the Company Registration Regulations, if a company reduces its registered capital, it shall apply for a change of registration 45 days from the date of the announcement, and shall submit relevant proof of the company's announcement of reducing its registered capital in newspapers and an explanation of the company's debt repayment or debt guarantee situation. The reduction of registered capital by the company requires the following procedures: notifying creditors, announcing, paying off debts or providing guarantees (if any), and handling change registration.

（2） Equity transfer

The company can transfer the repurchased equity to other shareholders or third parties outside of shareholders. According to Article 71 of the Company Law, shareholders of a limited liability company may transfer all or part of their equity to each other. The transfer of equity by a shareholder to a person other than a shareholder shall be approved by a majority of the other shareholders. Shareholders shall notify other shareholders in writing of their equity transfer matters to seek their consent. If other shareholders fail to respond within 30 days from the date of receiving the written notice, they shall be deemed to have agreed to the transfer. If more than half of the other shareholders do not agree to the transfer, the dissenting shareholders shall purchase the equity to be transferred; Those who do not purchase shall be deemed to have agreed to the transfer. If the equity is transferred with the consent of the shareholders, other shareholders have the right of first refusal under the same conditions. If two or more shareholders claim to exercise the right of first refusal, their respective purchase proportions shall be determined through negotiation; If negotiation fails, the right of first refusal shall be exercised in accordance with the respective proportions of investment at the time of transfer. If the articles of association provide otherwise for the transfer of equity, such provisions shall prevail. Therefore, the transfer of the repurchased equity by the company must comply with legal provisions and the provisions of the company's articles of association.

4、 Issues that Limited Liability Companies Should Pay Attention to when Exercising Equity Repurchase Rights

（1） Comply with legal provisions and the conditions stipulated in the company's articles of association.

（2） The corresponding legal procedures must be followed, and a shareholders' meeting must be held to confirm the company's exercise of equity repurchase rights.

（3） After the repurchase of equity, the company shall promptly handle the repurchased equity and shall not hold the company's equity for a long time.

Conclusion

In summary, when a limited liability company exercises its equity repurchase right, in addition to the legal situation, it can also agree through shareholder consultation and agree on the company's right to repurchase equity in the company's articles of association. The company's treatment and procedures for equity after repurchasing must comply with legal provisions and the provisions of the articles of association. With the development of the market economy, the number of companies exercising repurchase equity will increase accordingly. To prevent disputes over the company's repurchase of equity, it is recommended that shareholders make clear provisions regarding the company's equity repurchase rights when entering into the company's articles of association.