Validity determination of listed companies' exceeding authority in major asset transactions

This article is reprinted from: Legal Daily

□ Chen Su (Researcher at the Institute of Law, Chinese Academy of Social Sciences)

Article 78, Paragraph 1 of the “Draft Interpretation of the Supreme People’s Court on Several Issues Concerning the Application of the Company Law of the People’s Republic of China” (hereinafter referred to as the Draft for Comments) states: “When a listed company conducts a major asset transaction without依法经股东会决议通过, if the listed company claims that the transaction has no effect on it, the people’s court shall support such claim, except in cases where the counterparty is in good faith.” This interpretative provision expands upon Article 135 of the Company Law, aiming to clarify the validity of major asset transaction contracts entered into by listed companies without following legal procedures. Since Article 135 of the Company Law pertains to internal governance relations of listed companies, the Draft for Comments’ Article 78, Paragraph 1, assigns external legal effect to this internal authority distribution, raising the need to consider the boundary between organizational law norms and transaction law norms. According to Article 134 of the Company Law, a “listed company” refers to “a joint-stock company whose shares are listed and traded on a stock exchange,” consistent with the concept of listed companies under the Securities Law. In this regard, it is recommended that the Draft for Comments further consider the scope of relevant subjects, including whether to extend the concept of listed companies to their holding or controlling companies.

When interpreting current laws either restrictively or expansively, there is always a tendency to generalize the scope of application, which can cause the relevant legal provisions to detach from or overly encompass certain real-life situations, leading to spillover effects of judicial interpretative rules on economic and social life. Generally, spillover effects caused by restrictive interpretations are easier to control, whereas those caused by expansive interpretations are more difficult to manage, because the direction of change in scope differs: restrictive interpretation narrows the scope inwardly, making spillover effects relatively controllable; expansive interpretation broadens scope outwardly, making spillover effects harder to contain. Therefore, in the process of judicial interpretation of company law, when adopting an expansive interpretation, it is essential to conduct thorough spillover effect assessments in advance to prevent excessive uncertainty in relevant economic and social activities.

Regarding the spillover effects of Article 78 of the Draft for Comments, systematic analysis should be conducted to evaluate their approximate thresholds for economic and social impact. While Article 78 can help maintain the order of governance in listed companies and grant them advantages in transaction law to protect their interests, the benefits gained unilaterally by listed companies may come at the cost of significantly increased transaction costs for their counterparts.

First, it increases the recognition costs for market entities in identifying “listed companies” under Paragraph 3 of Article 78. Market participants find it easy to identify listed companies because they can consult the stock exchange’s listing directory. However, identifying companies controlled or held by listed companies is more difficult, as such companies may be directly or indirectly controlled, may have the same or different main business as the listed company, and vary greatly in size—from large corporations to numerous small firms.

Second, it may increase the recognition costs related to the proportion of transaction assets relative to total assets of listed companies. According to Article 135 of the Company Law, if the transaction assets exceed 30% of the total assets of the listed company, approval by the shareholders’ meeting is required. Due to the information disclosure system for listed companies, the counterparty can easily determine the proportion of transaction assets; however, for companies controlled or held by listed companies that are not subject to such disclosure requirements, the counterparty must incur higher costs to ascertain this proportion.

Third, it may alter the rights and responsibilities structure between listed companies and their transaction counterparts. In asset transactions involving company assets, if losses are caused by abuse of power by controllers or senior management, responsibility can be pursued under organizational law. However, when engaging in asset transactions with listed companies and their controlled or holding companies, regardless of whether the transaction has been approved by the shareholders’ meeting, the listed company can exercise its right to determine whether the transaction is effective based on its profit and loss expectations. If the transaction is favorable to the listed company, it can claim the transaction is effective even without shareholder approval, while the counterparty cannot claim the transaction is invalid or revocable. This institutionalizes a disadvantageous transaction structure for the counterparty.

Fourth, it is necessary to consider the reasonable allocation of transaction risks. If an asset transaction without shareholder approval is unfavorable to the listed company, the company can argue that the transaction has no effect on it, thereby completely avoiding the risk. The counterparty, whose contractual expected benefits cannot be realized, must bear the transaction risk first, and may only seek relief under the director’s liability system for third-party damages, which has a low probability. Such a risk allocation scheme is arguably unreasonable.

While granting listed companies the right to choose the effectiveness of their transactions to maintain securities market order is commendable, the resulting increase in overall market transaction costs warrants careful consideration. Especially in scenarios involving asset transactions with listed companies and their controlled or holding companies, even thorough and professional due diligence by the counterparty may still provide the listed company and its affiliates with a basis to claim that the contract has no effect on them. This can impact transaction freedom and security, making market participants more hesitant when facing transaction opportunities and overly cautious in decision-making. I suggest that even if the basic structure of the relevant provisions is retained for the sake of securities market order, the concept of a listed company should be strictly aligned with the provisions of the Company Law, excluding controlled or holding companies from the scope of application of this article.