Research Paper Number

49/2009

Document Type

Article

Publication Date

2009

Keywords

China; company law; corporate governance; derivative actions; enforcement

Abstract

This paper concerns one of the thorniest aspects in company law: the derivative action. As an exception to the rule in Foss v. Harbottle, individual shareholders can, acting on behalf of a company, sue the company’s director if a wrong is done to the company. Private shareholders’ action has been a major landscape in corporate governance in the US, but not in the UK. (Armour et al, 2007) Recently, the law on derivative action has experienced significant changes with the codification adopted in many jurisdictions. It is doubtful as to whether derivative actions are a useful mechanism to enhance investor protection. Chinese companies have been widely conceived as having a blockholder model, in which the state as the controlling shareholder should in theory possess the incentives to constrain the opportunistic behavior of managers. Nonetheless, the state, as loosely defined as “people as a whole”, has failed to exercise any effective monitoring role. The introduction of the statutory derivative action in 2005 is a significant experiment to establish an investor-friendly legal regime. However, during the transplantation of western law into China, there are several fundamental problems that need to be properly dealt with so as to allow the derivative action to function effectively. The paper begins by examining the role of derivative actions in China, then reviews Chinese derivative action system with respect to substantive law and enforcement, and discusses the inadequacies of the present system such as costly litigation expenses and ambiguous procedures. Finally, a discussion for further reforms will inevitably include comparative references to other legal systems. The Chinese case has illustrated a paradigm shift of governance towards the role of private actors.

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