A. The impact of the community property system on the stability of company equity
Under Chinese law, pre-marital property owned by married individuals does not automatically belong to them personally. Even if the equity is registered under the name of the individual shareholder himself/herself, it does not mean that the shareholder has unrestricted disposal rights over the equity. The reasons are as follows: (1) Regarding post-marital property, unless there are specific agreements, it will be deemed as jointly owned by the couple, with both parties enjoying a 50% interest; (2) Even if the equity was acquired before marriage, the increase in value of the equity during the marriage (excluding the increase due to natural appreciation) will also be considered as community property. Therefore, in the event of a major shareholder’s divorce, no matter whether the equity was acquired before or after marriage, it may result in the division of the equity in half, leading to a change in the proportion of equity held and even affecting the shareholder’s control over the company.
The division of marital property in a divorce may have a negative impact on company decision- making.
In practice, investors often require the spouse of a controlling shareholder of a company (especially a listed company) to sign a joint action agreement to ensure the stability of the company's equity and voting rights.
However, in rare cases where disputes arise between the spouses, or even in divorce disputes, the non-shareholder party may refuse to comply with the joint action agreement and may even apply to freeze the corresponding equity/stocks in litigation. This can restrict the transferability of the equity/stocks and the dispute over the division of equity may even prevent the major shareholder from exercising all of their voting rights, thereby affecting the stability of corporate governance. At the same time, the dispute over the division of equity can also restrict the property rights of the major shareholder, making it impossible for them to exercise their property rights over the shares through sale or pledge.
B. The dispute over the inheritance of the majority shareholder's estate will further complicate the situation in the event of their death
In the absence of a clear will, the estate of the majority shareholder will be divided among the heirs. In the case of having a spouse, unless there is evidence to prove that the company shares held by the majority shareholder can be recognized as their personal property, these shares will be divided as marital property: first, the spouse will receive 50% of the shares, and the remaining 50% will be inherited by all the heirs. It is worth noting that Chinese company law allows the articles of association to make explicit provisions on whether the heirs are allowed to inherit the company shares in the event of the shareholder's death. If the articles of association do not allow the inheritance of shares, the company shares need to be retained by other shareholders through the exercise of the right of first refusal. In practice, extreme situations often arise: the lack of a will, numerous heirs of the majority shareholder, and inability to reach a consensus among the parties. This will result in the company being unable to make effective decisions and may even affect its operations.
In practice, there are also cases where the majority shareholder divorces in order to bypass restrictions on reducing their shareholding. The China Securities Regulatory Commission has been highly concerned about this phenomenon. In May 2024, a regulatory document issued by the China Securities Regulatory Commission explicitly required that in the case of reducing shareholding through divorce, the transferee of the shares must also comply with the regulations on reducing the shareholding of the controlling shareholder and the actual controller of the listed company.
In summary, under Chinese law, changes in the family status of individual shareholders have a significant impact on the stability of company ownership. Currently, there are more and more cases of disputes over control rights, cases involving the effectiveness of company resolutions, and cases directly related to the divorce of major shareholders reducing their shareholding in China.
