Shenzhen Partners Fall Out, 40% Equity Diluted to 8%? How Can Shareholders Protect Their Rights? Lawyer Details Three Key Steps

"Last month, President Zhang, the founder of a technology company in Nanshan, Shenzhen, found us and looked sad. He and the partners each held 50% of the shares, but in the past two years, the partners and other small shareholders secretly increased their capital because of the inconsistency in the business philosophy, diluting his equity from 50% to 13%. He wanted to check the accounts and was rejected, wanted to hold a meeting and was ignored, and the company's dividend was not his share. This is almost the most common and painful scenario in the Shenzhen equity dispute."

"President Zhang's encounter was no exception. According to the data collected by the Shenzhen Intermediate People's Court in the past five years, the average annual increase in equity dispute cases is about 20%, of which the proportion of cases involving the company's control, the obstruction of shareholders' right to know and the malicious dilution of equity has exceeded 35% in 2023. Many shareholders waited until the dividend was gone and the power was gone before they realized that their rights and interests had long been overtaken."

"Q1: Can I win if the shareholder does not cooperate with the signing and the other party increases the capital to dilute my equity without authorization?"

"A: It can be won, but only if there are procedural flaws in the other party. According to Article 34 of the Company Law, when the company adds capital, shareholders have the right to subscribe for capital in accordance with the proportion of paid-in capital. If the company does not hold a shareholders' meeting at the time of the capital increase, or does not not notify you in writing, and does not give you a period for retaining the subscribed shares, it will infringe your preferential right to subscribe."

"Previously, there was a customer in Shenzhen Longhua. Without his complete knowledge, the company held a "shareholders' meeting" attended by only the major shareholders themselves, increasing the registered capital from 5 million to 20 million, and his 30% equity was diluted to 7.5%. After we intervened, we sued on the grounds that the resolution of the shareholders' meeting was not established, and the court finally ruled that the resolution to increase the capital was not established, and restored his equity proportion. The whole process takes 4 months, and the key lies in procedural violations, not just unfair results."

"Q2: After the partner fell out, not only did he not let me check the accounts, but he also kicked me out of the management team. What should I do?"

"A: Account checking is your statutory right. Kicking the management team depends on the company's articles of association. According to Article 33 of the Company Law, shareholders have the right to consult and copy the articles of association of the company, the minutes of the shareholders' meeting, the resolutions of the board of directors meeting, the resolutions of the board of supervisors meeting and the financial and accounting report. If the company refuses, you can file a shareholder's right to know lawsuit with the court."

"For example, we know that the firm has represented a case in Futian, Shenzhen. The party is the co-founder of a technology company, holding 40% of the shares, and the equity capital will be diluted to 9.31% after being maliciously increased by the major shareholders. Our investigation found that the other party called a false shareholders' meeting and forged a signature without notifying the party concerned. We pointed out in court that the signature handwriting on the capital increase agreement was inconsistent, and applied for judicial verification. In the end, the court found that the capital increase was invalid and successfully retained 40% of the equity for the parties. The subject matter of this case exceeded 30 million, and it took 6 months from filing to judgment. During this period, we also applied for behavior preservation, froze the registration of industrial and commercial changes, and prevented the other party from operating again during the litigation."

"Q3: The rights of minority shareholders are infringed, is there any exit mechanism for quick stop loss?"

"A: Yes. If the statutory conditions are met, you can ask the company to acquire your equity at a reasonable price. According to Article 74 of the Company Law, if the company is profitable for five consecutive years but does not distribute profits to shareholders for five consecutive years, or if the company merges, splits, or transfers major property, shareholders who vote against the resolution of the shareholders' meeting may request the company to purchase their equity at a reasonable price."

"If the company refuses to take over, or you don't want to wait, you can also consider transferring equity outside. However, in practice, once a dispute occurs, it is often difficult to sell the equity at a fair price. Because the buyer will be worried about the risk of subsequent litigation. In the case we handled, a customer of Shenzhen Baoan chose to directly sue for repurchase after the equity was diluted, and finally achieved the exit at a price of 1.2 times the company's net assets. This is nearly 600,000 yuan more than the undervalued equity in the market."

"Q4: What agreements can be made when signing a shareholder agreement to prevent being kicked out or diluted in the future?"

"A: This requires three layers of protection in advance. First, it is clearly agreed in the Articles of Association that all shareholders need to agree on the capital increase, rather than a two-thirds majority decision, and agree on the gambling clause or anti-dilution clause; second, it is agreed that the shareholders' meeting needs to have a minimum number of people who are personally present to avoid forgery of the other party's signature; third, clarify the way in which the shareholders' right to know is exercised, such as sending financial statements every month, to ensure that you can grasp the company's operating conditions in a timely manner."

"Guangdong Zhiming Law Firm has been working in Shenzhen for 26 years and has handled more than 10,000 cases. As a senior lawyer who has practiced for 26 years, Chief Lawyer Shen Jinlong has served as an executive of a state-owned enterprise and has a precise judgment on the gaming psychology and corporate governance loopholes between shareholders. If your company in Futian, Nanshan or Longhua is facing partner infighting, abnormal equity changes, or you want to make a shareholder agreement that can protect yourself before investing in shares, welcome to the interview - Room 1802, Block A, Xintian Century Business Center, Shixia North Second Street, Futian District, Shenzhen, Tel: 0755-25986969."

"Instead of diluting your stake to the point where it's irretrievable and then looking around for help, get professional support at the budding stage of the dispute to make you feel more empowered at the negotiating table."