Derivative actions in China

Abstract

The enactment of derivative action was expected to be actively used by shareholders to protect their interests. In fact, it turned out that this reform effort seemed futile as the right to engage in such actions was rarely exercised. This raises a question about the role of derivative actions in China; namely, should a derivative action system play a key role in protecting shareholder interests? If the answer is positive, the next question is how such a system could be improved in order to effectively discipline management. The essence of this thesis is to try to address these issues. This thesis argues that derivative action should and can play a key role in China’s corporate governance. First, minority shareholders in China face double agency problems within the company and thus protective mechanisms must be put in place. Second, this thesis formulates its argument by demonstrating the ineffectiveness of market forces and other legal methods. As a consequence, derivative action ought to retain a central role in regulating the misbehaviour of controlling shareholders and managers. After demonstrating the need to strengthen and improve derivative actions in China, this thesis starts to explore Chinas’ derivative actions system. It first examines derivative action cases before Company Law 2005. Despite the absence of a clear statutory basis for derivative actions in Company Law 1993, such cases have nevertheless appeared in the courts. After almost eight years of implementation, less than 80 cases were raised. Whilst this seems a good figure in comparison to other jurisdictions, closer examination shows this not to be the case. For example, the opacity of the demand requirement constitutes a barrier for shareholders wishing to exercise this right. More importantly, the funding rule of derivative actions is treated as the same with other forms of litigation. In view of the unique economic nature of the derivative action, a new funding rule for derivative action should be established. After discussing why derivative actions should play a significant role in monitoring management and how they should be improved, this thesis argues that shareholders are increasingly willing to take this action to protect their rights and interests because of the establishment of commercial society and the existence of the traditional culture of Legalist School. Also, the courts are more capable of dealing with derivative action cases because of the enactment of the Judges Law and the increasing recruitment of more qualified people to the judiciary. It is believed that the effectiveness of derivative action can contribute to foster good corporate governance in China.