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Shareholder Derivative Actions in China: Lessons to Be Learned From Shin Kong

Thursday, August 18, 2011

Contributed by Susan Finder, Consultant for Listing Division of Hong Kong Exchanges and Clearing Limited

Behind the glitz of one of Beijing’s upscale shopping mall/real estate projects is the cacophony of a business deal gone sour, resulting in dispute resolution in two jurisdictions, with lessons for the international legal and business communities. In 2006, the Shin Kong Group, one of the Taiwanese family-owned conglomerates, established a joint venture with Hualian Investment, a large Chinese State Owned Enterprise (SOE), which has an affiliate listed on the Shanghai stock exchange. In late 2008, relations between the parties had deteriorated to such an extent that Hualian filed a shareholder derivative suit in Beijing against some of the senior managers of the joint venture (appointed by Shin Kong) and two affiliates of Shin Kong, while separately initiating arbitration in Hong Kong against Shin Kong under the joint venture agreement. This case has several takeaways for counsel advising companies doing business in China:

  • litigation in China in a related dispute can be an option for those with offshore (China) arbitration clauses because of the limited availability of interim relief in China;
  • shareholder derivative actions may be used to protect private as well as public companies; and
  • foreign (including Hong Kong, Macau, and Taiwanese) personnel caught in a dispute may, under Chinese law, find themselves prevented from leaving China.

A Strategy to Deal with the Limited Availability of Interim Relief in China

Parties who have agreed upon arbitration of their China joint venture agreement (or other agreement) outside of mainland China (including Hong Kong) may not be aware that there is no civil procedure by which the assets of the joint venture (or other assets) located in China can be frozen or otherwise protected, pending the outcome of the offshore arbitration, from a joint venture or other business partner that is abusing its authority by dissipating or damaging them. This is in contrast to the procedures available in many major offshore arbitration centers such as Hong Kong, London, Stockholm, and Paris (e.g., the Court of the International Chamber of Commerce). Local procedural law in these locations, which governs the authority of an arbitral tribunal to issue interim relief, often permits an arbitral tribunal to issue orders or an injunction prior to or during an arbitration to ensure that the assets connected to the dispute are preserved until the arbitral award is issued and perhaps enforced. Chapter IV of the current UNCITRAL Model Law on International Commercial Arbitration, for example, which (mainland) China has not adopted, gives a model legislative framework for interim measures and preliminary orders and provides that interim measures issued by an arbitral tribunal shall be recognized as binding and enforceable upon application to a competent court, except under specified circumstances.1 In aid of arbitration proceedings, interim relief in China is limited to two types of orders—asset or evidence protection—and generally does not include injunctions. Under the Arbitration Law2 and other Chinese legislation, a party seeking to protect property or preserve evidence in China makes an application to the arbitration commission in China where the arbitration is being held, not to the arbitral tribunal. The arbitration commission does not rule on the matter but merely acts as a liaison, submitting the party's application to the relevant court.3 Neither arbitration commissions nor arbitration panels themselves in China have the legal authority to order interim relief. Moreover, there is no legislative framework under Chinese law for enforcing an order by an offshore arbitral tribunal issuing interim relief. Although China has acceded to the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention), the New York Convention (and the Arrangement with Hong Kong) is generally considered not to include interim measures of relief. 4 Thus, even if an offshore tribunal grants provisional measures as an interim award, there are substantial doubts concerning whether a Chinese court would be willing to enforce the award. Commentators have not reported a successful case. Given these obstacles to enforcing interim measures, if the business metrics of the dispute permit, parties may consider, as in the case of Shin Kong, undertaking litigation related to but separate from the pending offshore arbitration to preserve onshore assets, i.e., "strategic litigation."

Arbitration Clauses May Not Preclude Shareholder Derivative Actions

Hualian's shareholder derivative action had several implications. Shin Kong argued that the action was one aspect of the shareholder dispute, and the Chinese courts should not take jurisdiction. However, the Beijing Higher People’s Court rejected this argument, ruling that the intermediate court had jurisdiction because the parties to the two disputes were different and the dispute before the Beijing court was based in tort rather than contract. This ruling is consistent with Chinese judicial policy that jurisdiction should be asserted when possible.5 The shareholder derivative action filed by Hualian was the first known case brought in relation to a joint venture in China. This is an area in which Chinese legal infrastructure has lagged behind market demands. It was not until 2006, after the 2005 amendment of the PRC Company Law,6 that a shareholder (such as Hualian) of a limited liability company (such as a joint venture) could file a derivative action against a director or senior officer of the company on behalf of the company for the harm caused by his or her illegal conduct. The same article also gives a shareholder the right to file suit on behalf of the company against a third party that has caused harm to the company, according to the same procedure. While these Company Law provisions set forth the principles for liability, at the time of Hualian's action both the Civil Procedure Law and the Company Law lacked provisions concerning procedural matters, such as which party should be the plaintiff, which the defendant, and the role of the affected company. Since then, because of the number of corporate disputes that have been brought in the Beijing courts, the Beijing Higher People’s Court issued a "Guiding Opinion"7 on the issue of corporate disputes, stipulating that the shareholder should be the plaintiff, the defendants should be the persons who committed the improper acts and any related parties, and the affected company should be brought in as a third person. Hualian sued in the Beijing court several senior managers of the joint venture (appointed by Shin Kong) and Fu Hui Internet Technology (Shanghai) Ltd., alleging that Wu—the general manager of the joint venture who had been nominated by Shin Kong—and his deputy Gan (appointed by Wu) colluded with Fu Hui to conclude an engineering services contract for which the company lacked qualifications, causing losses to the joint venture. This part of the Shin Kong story has several take-aways for foreign parties to joint ventures in China. First, even if a joint venture contract contains an arbitration clause, there is a risk that a Chinese partner may also file a shareholder derivative action. In such an event, it is likely that the reasoning of the Beijing court would be adopted by other mainland courts (although decided cases lack precedential value). Second, if related-party transactions between the joint venture and an affiliate of the foreign parent are done on conditions unfavourable to the joint venture and relations between the parties sour, there is a risk that the Chinese partner would use the transactions as evidence, either in a shareholder dispute or other action.

Exit Restrictions May Bar a Party from Leaving China

At an early stage in the dispute, some of the senior Taiwanese managers of the joint venture, who were suspected of "economic crimes," were prevented from leaving China. Under regulations hidden from view, parties to civil litigation in China (or their senior management, if the party is a corporate entity) may be restricted from leaving China under certain conditions: (1) the case is unresolved; (2) there is a possibility that the party involved would evade the litigation or performance of an obligation required by law; and (3) if the person went abroad, the court may have difficulty hearing the case or it may be impossible to enforce the judgment. A party to a civil case may apply for a restriction order against another party or a senior manager of a corporate entity, subject to the posting of security, or alternatively, the court can impose such restrictions on its own initiative, resulting in either the seizure of travel documents or a stop order issued by immigration officials. The affected party should be informed by the court. This power is often used (or abused) by Chinese courts. The "tip of the iceberg" is not found in the Civil Procedure Law, but in a single line in two sets of regulations on entry/exit from China applicable separately to foreigners and Chinese citizens (as well as Hong Kong, Macau, and Taiwanese Chinese). These regulations provide that persons belonging to the following category shall not be permitted to leave China: "a person under notice by a people's court to be denied exit for an unsettled civil procedure."8 The bulk of the provisions are found in three further (but little known) regulations issued by the Supreme People’s Court (in one case, with other ministries) in 1987, 2005, and 2010, which set out the conditions for issuing an exit order described above.9 The 2005 regulations mention that the exit restrictions may be lifted if security is posted in the amount of the plaintiff’s claim, but do not mention any type of appeal procedure or hearing by the affected party. According to reports, some courts have instituted a review procedure, but there is no obligation to have one, nor is there an obligation to hear the affected party.


The Shin Kong case illustrates that litigation in China on related grounds can be an option for those with offshore (China) arbitration clauses because of the limited availability of interim relief in China. However, it is costly and time-consuming. Shareholder derivative actions may be used to protect private as well as public companies, and can be used by either foreign or Chinese parties to control abuses by senior personnel (or alternatively, to make allegations of abuses). It is likely that such actions will increase in number. Accordingly, counsel dealing with a trade or investment dispute in China should be aware of the possibility of exit restrictions in civil cases, which have finally received publicity in the professional press. Pressure should be put on the Chinese government to put some legal structure into exit restrictions. 

Susan Finder is a Consultant on the staff of the Listing Division of Hong Kong Exchanges and Clearing Limited (HKEx). This article reflects her own views and not those of HKEx. She is also a CIETAC arbitrator. Previously, she worked for some of the top U.K. and U.S. law firms, focusing on China-related investment, regulatory and dispute resolution matters. Susan is admitted in New York and the District of Columbia. She is fluent in Mandarin and Russian. Disclaimer 

This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy. 

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