What can small shareholders do if their equity in Shenzhen is diluted to 8%?

A scene that happened in Nanshan, Shenzhen

34 year old Li Ming (pseudonym) runs an IoT technology company in Nanshan, Shenzhen. When he started his business, he and his partners each held 50% of the shares. In 2023, the company raised funds to expand its shares. He was absent from the shareholders' meeting due to a business trip, and upon returning, he found that his equity had increased from 50% to 8%. The other party, together with new investors, took away 92% of the voting rights. This is not an isolated case. The number of equity dispute cases in Shenzhen has continued to rise in recent years, with the proportion involving company control increasing year by year. Technology enterprises in Longhua and Futian districts are particularly concentrated.

The first question he asked when he sat down was, "Can the equity be recovered through litigation if it is diluted to single digits?" Behind this question is the common dilemma of small and medium-sized shareholders - when major shareholders use their shareholding advantages to modify the articles of association, increase capital and expand shares, and transfer profits, small shareholders are often in a passive position.

Q: Will the shareholder meeting resolution be effective if a partner increases capital and dilutes equity without authorization?

Answer: Not necessarily. Capital increase is a significant matter that requires approval from shareholders representing more than two-thirds of the voting rights, and must fulfill the obligation of notification. If the convening procedure is illegal, shareholders are not notified, signatures are not genuine, or the capital increase price is clearly unfair, shareholders may request confirmation of the invalidity or revocation of the resolution in accordance with relevant provisions of the Company Law and the Civil Code.

Two time points should be noted: the revocation right starts from the date of knowing or should have known that the resolution was made, and if not exercised within the deadline, it will be extinguished; The request to confirm the invalidity of a resolution, although not subject to the same time limit, requires higher evidentiary standards, requiring proof of malicious collusion and damage to shareholder interests by the other party. The earlier an anomaly is discovered, the more advantageous it is to establish evidence.

Three paths: negotiation, litigation, and equity repurchase

When encountering equity disputes, there are only three ways for the parties involved: negotiation, filing a lawsuit, and equity repurchase.

• Negotiation: The cycle is usually 30 to 60 days, with the lowest cost. But since the other party has already taken action, the space for negotiation is limited, and even if an agreement is signed, there is a risk of non performance afterwards.
• Filing a lawsuit: The first instance trial is limited to 6 months and can be extended according to law; One party appeals, and the second trial will take another three months or so. The judgment has compulsory enforcement power, but there is often a discrepancy between the amount determined by the court and the expectations of the parties.
• Equity repurchase: Both parties need to reach an agreement on the price; If we cannot reach an agreement, we need to initiate an audit evaluation, which often takes more than 90 days. When the company's accounts are opaque, the evaluation price may be lower.

Li Ming's case went through the litigation process, which took 7 months from filing to judgment.

Who shall bear the litigation costs and lawyer fees respectively

The litigation fees shall be cumulatively paid in installments according to the subject matter, and shall be advanced by the plaintiff in advance. After the judgment, the losing party shall generally bear the cost. Lawyer fees belong to the service fees between the client and the law firm. Unless otherwise stipulated by law or agreed upon in the contract, they are usually borne by the client themselves. The rules for these two sums of money are different. Before filing a lawsuit, it is important to calculate clearly and not assume that 'if you win, the other party will pay for everything'.

Q: With only 8% equity in hand, can we sue the major shareholder for abusing shareholder rights?

Answer: Sure. Shareholders who abuse their shareholder rights and cause losses to the company or other shareholders shall be liable for compensation in accordance with the law. A low shareholding ratio does not affect the qualification to sue, but it affects the difficulty of providing evidence and bargaining chips.

Director Shen Jinlong's experience in handling such cases is: Don't just focus on "revoking resolutions" at the beginning, you can also advocate for "major shareholders abusing shareholder rights and maliciously diluting". The focus of evidence for the two requests is different, one is on the program and the other is on the funds. Combining them makes it easier to explain the whole matter clearly.

A referenceable approach to handling cases

In 2021, three shareholders of a technology company in Shenzhen went bankrupt, diluting the founder's 35% stake to 5%. The other party increased capital three times in a year, completely marginalizing the founder. When the founder came knocking on the door, he only had a copy of the shareholder meeting resolution and bank transfer records in his hand. The lawyer did not rush to file a case, but first checked the capital flow of the two capital increases and found that the verification funds for the two capital increases were transferred on the seventh day after they were received. The team filed a lawsuit on the grounds of "abuse of shareholder rights and false capital increase", and also applied for property preservation, freezing the other party's account. Before the court hearing, the court organized mediation, and the founder's shareholding ratio was restored, and the two-year dividend difference was recovered.

The key to this case is not the debate in court, but whether the three things of "where the money came from, where it went, and who is operating it" have been thoroughly investigated.

Discovering dilution of equity, do two things first

• Retrieve the complete set of internal documents of the company from the Market Supervision Administration, including previous amendments to the articles of association, shareholder resolutions, and industrial and commercial change materials for capital increase;
• Organize dividend records and bank statements over the years, verify if there are any abnormal transfers, and check if the capital verification funds have been transferred out in the short term.

After completing these two steps, bring the materials and communicate with the lawyer. The problems that can be solved in one face-to-face meeting are far more than consulting empty handed.

Why is time important

The revocation of the resolution has a deadline, property preservation should be done before the assets are transferred, and evidence collection should be done before the documents are replaced. When the other party completes the transfer of company assets or the business registration change has been implemented, the difficulty of processing will significantly increase.

Guangdong Zhiming Law Firm is located at Room 1802, Building A, Xintian Century Business Center, Shixia North Second Street, Futian District, Shenzhen. The consultation hotline is 0755-25986969. The cases discussed by the director and partners shall be handled by themselves.