By Hai Huang｜Jessie Chen
One view of Article 127[Endnote 1] of the Company Law of the People's Republic of China is that it provides a basis for issuing different class of shares; however, no specific regulations on that point have actually been issued. On November 30, 2013, the Guiding Opinions on Carrying out the Pilot Program of Preferred Shares (Guo Fa No. [2013]46, the “Guiding Opinions”) was promulgated by the State Council, and a pilot program of preferred shares was officially carried out.
I. Preference Rights
According to the Guiding Opinions, shareholders holding preferred shares (the “Preferred Shareholders”) have the following two primary preference rights:
Preference Rights on Dividends Distribution. Preferred Shareholders shall be entitled to receive dividends, subject to a promissory dividend rate, prior and in preference to any payment of any dividend to shareholders holding ordinary shares (the “Ordinary Shareholders”). The company shall make payment of the preferential dividends to Preferred Shareholders in cash. The company shall not make any payment of any dividend to Ordinary Shareholders prior to the preferential dividends relating to preferred shares are paid in full.
Preference Rights on Distribution of Residual Assets Resulting from Dissolution and Bankruptcy. Upon the occurrence of any liquidation event of the company due to dissolution, bankruptcy or other reasons, the residual assets of the company shall be distributed to Preferred Shareholders for payment of unpaid dividends and liquidation distribution amount as specified in the articles of association, prior to and in preference to any distribution made to Ordinary Shareholders.
II. Limitations on Rights of Preferred Shareholders
According to the Guiding Opinions, there are limitations on the voting rights of Preferred Shareholders: in principle, Preferred Shareholders shall not attend the shareholders’ meetings, nor shall they have voting rights thereat, except for voting on the following matters:
• amendment to the articles of association of the company in connection with preferred shares
• decrease to the registered capital of the company in an amount greater than 10% at a time or in the aggregate
• merger, division, dissolution or conversion of the corporate form of the company
• issuance of preferred shares
• other matters specified in the articles of association
If the preferential dividends shall not be paid by the company for three fiscal years in the aggregate or for two consecutive fiscal years, Preferred Shareholders shall be entitled to attend the shareholders’ meetings and have voting rights.
III. Issuance and Trade of Preferred Shares
According to the Guiding Opinions, only the listed companies approved by the China Securities Regulatory Commission can make public offerings of preferred shares. Other listed companies (including the China-incorporated companies with shares listed offshore) and “unlisted public companies”[Endnote 2] can make non-public offerings of preferred shares. The preferred shares (excluding the redeemed preferred shares and the converted preferred shares) issued by the company shall not exceed 50% of the total number of the ordinary shares of the company, nor shall the funds raised from the issuance of the preferred shares exceed 50% of the net assets value of the company prior to such issuance.
According to the Guiding Opinions, the trade or transfer of the preferred shares shall be conducted at a stock exchange, the National Equities Exchange and Quotations or other securities transaction institutions approved by the State Council. The preferred shares shall be registered and recorded by the China Securities Depository and Clearing Corporation Limited.
IV. Brief Review
Preferred shares are regularly used in many financing transactions outside China. For example, a private equity/venture capital (“PE/VC”) fund would have access to greater economic benefits in the target companies when being issued preferred shares in a typical PE/VC backed financing transaction. As a tool to broaden the financing channels of the Chinese public companies, the new Chinese preferred shares regime is obviously far from facilitating a non-public financing transaction.
However, it is a great step-forward towards the international standards. Being a supplement to the existing ordinary shares regime, for one thing, preferred shares are supposed to provide more financing channels to the listed company and hopefully help the company reduce financing stress; for another, preferred shares could provide favorable investment returns to investors who care more about cash dividends, fixed gains and lower risks.
Some conspicuous differences between the Chinese preferred shares and the preferred shares issued in a typical western PE/VC backed private financing transaction include (i) the general voting powers have been stripped off from the Chinese preferred shares except for some matters material to the Preferred Shareholders’ rights, (ii) only the public companies can issue Chinese preferred shares, and (iii) the amount raised from the Chinese preferred shares is limited.
Mr. Hai Huang is a Beijing-based partner with Global Law Office who specializes in advising both foreign and domestic clients on the cross-border mergers & acquisitions, foreign direct investment, venture capital/private equity investment and equity offering on overseas capital markets. (E-mail: hh@glo.com.cn)
Ms. Jessie Chen is a Beijing-based counsel with Global Law Office who specializes in advising both foreign and domestic clients on the cross-border mergers & acquisitions, foreign direct investment, venture capital/private equity investment and equity offering on overseas capital markets. (E-mail: jessie.chen@glo.com.cn)
Endnote 1: Article 127 of the Company Law of the People's Republic of China: Shares shall be issued in accordance with the principles of fairness and impartiality. Each share of the same class shall be entitled to the same rights. With regard to the shares of the same class that are issued at the same time, the issuing conditions and price for each share shall be the same. Any entity or individual shall pay the same price for each of the shares subscribed for.
Endnote 2: The “unlisted public companies” means the companies limited by shares that are under any of the following circumstances and whose shares are not listed or traded on stock exchanges: (i) issuing or transferring shares to specific targets to produce over 200 shareholders; and (ii) transferring shares publicly to the general public.
