Capital reduction is a key procedure within a company’s capital system. Disproportionate capital reduction, also known as targeted capital reduction, often gives rise to disputes because shareholders’ rights are not exercised in proportion. While previous judicial practice recognised the legitimacy of disproportionate capital reduction, there were differing views on whether such reductions should be subject to an absolute majority or require unanimous shareholder approval.
The new Company Law establishes a regime in which proportional capital reduction is the principle and disproportionate capital reduction is the exception. It also differentiates decision-making requirements based on company type, resolving previous controversies on this issue.
Before the new Company Law
Zuo Yuru
Partner
Zhong Lun Law Firm
Prior to the implementation of the new Company Law, there were two approaches in practice regarding the procedures for disproportionate capital reduction in limited liability companies: approval by a two-thirds majority; and unanimous consent of all shareholders. Judicial opinions were also divided. In Lu Qi v Shanghai Hongyang Shipping Co and Huo Rong (2018), a dispute arose over the validity of a shareholder resolution. The shareholders’ meeting passed a resolution, with more than two-thirds of the voting rights in favour, to reduce the company’s registered capital. The decision cut the contribution of the majority shareholder, Huo, while leaving the minority shareholder, Lu, unaffected.
The Shanghai High People’s Court held that the Company Law requires resolutions on changes to registered capital to be approved by at least a two-thirds majority, precisely embodying the principle that major corporate matters are to be decided by shareholders holding a majority of the capital. Adjusting registered capital inevitably alters individual shareholders’ contributions and ownership ratios. Requiring unanimous consent for such changes, the court noted, would run counter to the purpose of article 43 of the Company Law.
In contrast, in Hua Hong v Shanghai Scarab Electronic Commerce (2018), the shareholders’ meeting of Shanghai Scarab Electronic Commerce passed a targeted capital reduction resolution. The appellate court, Shanghai No. 1 Intermediate People’s Court, held that disproportionate capital reduction would directly alter the shareholding structure established at the company’s inception.
If such a resolution could be passed by merely a two-thirds majority, it would, in effect, allow a majority to change the shareholding arrangement that was originally established by unanimous agreement among the founders. Therefore, unless all shareholders or the articles of association provide otherwise, disproportionate capital reduction should require the unanimous consent of all shareholders.
The above-mentioned two cases represent the two main perspectives and opinions regarding the decision-making requirements for disproportionate capital reduction prior to the new Company Law.
After the new Company Law
Yang Yue
Paralegal
Zhong Lun Law Firm
The new Company Law sets out a capital reduction framework in which proportional reductions are the norm, and non-proportional reductions are the exception. Article 224(3) provides that when a company reduces its registered capital, it must reduce shareholders’ contributions or shareholdings in proportion to their existing stakes unless the law provides otherwise, all shareholders of a limited liability company agree, or the articles of association of a joint-stock company stipulate differently.
According to article 1(2)(7) of the Several Provisions of the Supreme People’s Court on the Retroactivity of the Company Law of the People’s Republic of China, this rule also applies in cases where a company reduced its registered capital before the Company Law came into effect and disputes subsequently arise over the corresponding reduction of shareholders’ contributions or shares. In other words, the article applies retroactively to capital reduction actions taken before the implementation of the new Company Law.
Under the new Company Law, the circumstances in which disproportionate capital reduction applies are divided into two categories: (1) statutory circumstances, that is, where the law provides otherwise; and (2) agreed circumstances, for which the decision-making requirements differ according to company type. For limited liability companies, all shareholders must reach a separate agreement. For joint-stock companies, the articles of association shall provide otherwise.
The scope of “where the law provides otherwise” can be summarised as including: (1) compulsory disproportionate capital reduction arising from shareholder expulsion and shareholder forfeiture regimes; (2) disproportionate capital reduction resulting from dissenting shareholders’ exercise of the right to request share repurchase; and (3) disproportionate capital reduction arising from share acquisition and simplified merger regimes in joint-stock companies.
For limited liability companies, a disproportionate capital reduction requires the unanimous consent of all shareholders. This rule sets the decision-making threshold for such reductions in LLCs.
Because these companies have a more personal element, allowing a two-thirds majority to approve a disproportionate reduction could let majority shareholders exploit the rule at the expense of minority investors – a risk highlighted by the Shanghai No. 1 Intermediate People’s Court in Hua Hong v Shanghai Scarab Electronic Commerce (2018). As for how unanimous consent is expressed, the law imposes no formal limits: It may take the form of a shareholders’ meeting resolution, a shareholder agreement, or provisions in the articles of association.
Joint-stock companies, by contrast, are less personal and more capital-driven, with governance based more firmly on majority rule by capital. For these entities, the new Company Law requires only that the articles of association provide otherwise in order to permit a disproportionate reduction.
Courts have already put this into practice. In Taizhou Huarui Riverside Emerging Industry Venture Capital Fund v Laviana Pharma Corporation (2024), a dispute over a shareholder resolution, the Taizhou Intermediate People’s Court in Jiangsu held that, under the articles of association, Laviana could reduce its registered capital by acquiring a particular shareholder’s equity through agreement.
The court ruled that the shareholders’ meeting resolution authorising this disproportionate reduction was both consistent with the articles and compliant with article 224 of the Company Law.
Zuo Yuru is a partner and Yang Yue is a paralegal at Zhong Lun Law Firm
Zhong Lun Law Firm
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Beijing 100020, China
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E-mail: zuoyuru@zhonglun.com
yangyue11@zhonglun.com
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