This Client Briefing is an excerpt from an article entitled “Provisions and Risk Prevention Suggestions on Concerted Action Agreements” (the “Article”) authored by Yan Song and Zhuochao Sun at JunHe LLP.
I. Controversy in Practice Regarding Concerted Action Agreements
(1) Definition of Concerted Action Agreements
To secure influence over a target company and protect investment interests, there has been an increase in private equity investors signing concerted action agreements with the shareholders of target companies.
Neither the Company Law nor the Securities Law provides a definition of a concerted action agreement. Article 83(1) of the Administrative Measures for the Takeover of Listed Companies (2020 Revision) defines “concerted actions” as “acts or facts where investors, through agreements or other arrangements, collectively increase the number of voting rights they can exercise in a listed company.” A broad definition of a concerted action agreement can mean written agreements signed between investors to collectively increase the number of voting rights that they can exercise in a target company.
(2) Disputes in Practice
From a regulatory perspective, the law does not prohibit or restrict shareholders or directors from acting in concert. A concerted action agreement can be valid and binding if it is duly signed and reflects the genuine intentions of the parties involved.
However, a common issue can arise when one party (referred to here as the “obligor” for simplicity) agrees in the concerted action agreement to align its voting decisions with the other party (referred to here as the “obligee”) but subsequently refuses to vote in accordance with the obligee’s instructions. In such cases, questions arise regarding how the obligee can seek remedies, whether the obligee has the right to enforce “compulsory vote alignment,” and the scope of the obligor’s liability for a breach of contract. These issues are becoming increasingly significant in corporate governance and judicial rulings. This Article draws on judicial precedents to provide practical recommendations for drafting terms and managing risks in concerted action agreements.
II. Judicial Divergence on the Right to Compulsory Vote Alignment
For obligors under concerted action agreements, a breach of an agreement typically requires the obligor to pay liquidated damages or compensate the obligee for the losses, as stipulated in the agreement. This is similar to the liability for a breach of contract in other commercial agreements and is generally uncontroversial in judicial practice.
The real dispute lies in whether the target company can directly alter the voting opinions of the breaching party to reflect those of the obligee (i.e., compulsory vote alignment). Judicial opinions on this issue are divided.
The Jiangxi High People’s Court supported the affirmative view in the (2017) Gan Min Shen No. 367 case. The court held that the target company could directly adjust the breaching party’s voting opinion to align with the obligee’s opinion during vote counting. The negative view is far more common in judicial practice and courts often provide the following reasons for this:
- Concerted action agreements are voluntary and should allow for “withdrawal,” and enforcement is either factually or legally impossible.
- Concerted action agreements only bind the parties to the agreement.
- Concerted action agreements are private contracts among shareholders and are neither incorporated into the target company’s articles of association nor registered with the industrial and commercial authorities. Therefore, they cannot serve as a basis for determining the validity of company resolutions.
Courts that adopt the negative view often argue that the obligor’s breach of the agreement and the target company’s exercise of voting rights in shareholders’ or board meetings are separate matters and should therefore remain independent of one another.
This view was adopted in the following cases:
- Case No. (2018) Zhe 0106 Min Chu 3961, adjudicated by the West Lake District People’s Court in Hangzhou;
- Case No. (2022) Su 02 Min Zhong 7352, adjudicated by the New Wu District People’s Court in Wuxi;
- Case No. (2022) Yue 06 Min Zhong 4650, adjudicated by the Intermediate People’s Court of Foshan, Guangdong Province.
These outcomes appear inconsistent, but a closer examination of whether the target company was a party to the concerted action agreement reveals that the judicial logic is fundamentally similar. In cases supporting the affirmative view, the target company was a party to the concerted action agreement and proactively enforced a compulsory vote alignment (a practice that remains highly contentious but is supported by the authors of the Article). In contrast, in cases adopting the negative view, the concerted action agreements were solely between shareholders, without the target company as a party, rendering them incapable of materially influencing the company’s resolutions.
III. The Nature of Compulsory Vote Alignment and Remedies for Breaches
The unique factual circumstances in separate cases are key factors influencing the courts’ judgments. Determining whether a target company can enforce compulsory vote alignment cannot be generalized; it requires a comprehensive analysis of the specific terms agreed upon by the parties, whether the target company was involved in the agreement, and other factors such as the source, nature, enforceability, and the revocability of the compulsory vote alignment right.
(1) Compulsory vote alignment rights stem from contractual agreements between parties. If the target company was not a party to the concerted action agreement and the agreement does not explicitly grant the target company the right to enforce compulsory vote alignment, such actions would lack a legal basis, making it difficult for the target company to enforce compulsory vote alignment.
Since no laws confer the statutory right of compulsory vote alignment to target companies, such rights must be contractually granted. If the target company is not a party to the concerted action agreement, it cannot enjoy the rights under the agreement due to the principle of privity of contract.
Even if the target company participates in the agreement, the compulsory vote alignment clause must be clear and explicit. Specifically, the agreement should state that in the event of a breach by one party, the target company can alter the breaching party’s voting opinion to align with the agreed terms, providing the basis for enforcing compulsory vote alignment.
(2) The nature of concerted action agreements and compulsory vote alignment does not constitute an entrustment relationship. Obligors should not have the right to unilaterally terminate an agreement, especially regarding provisions for compulsory vote alignment.
There is some debate whether the obligation to align votes or enforce compulsory vote alignment constitutes an entrustment relationship under the law, granting the obligor statutory unilateral termination rights under Article 933 of the Civil Code. Some cases suggest that concerted action agreements essentially involve one shareholder entrusting another to exercise their voting rights.
The authors of the Article agree with the view that concerted action agreements or compulsory vote alignment rights are special constraints on shareholders’ voting rights designed to secure control over a target company for specific matters. These rights are fundamentally different from entrustment relationships, as they involve the obligor transferring their voting rights or following the obligee’s decisions. Therefore, obligors under concerted action agreements should not enjoy unilateral termination rights. If an obligor votes contrary to the agreed terms during a shareholder meeting, they breach the agreement and consequently bear liability for breach.
Judicial practice supports this view. For instance, in case (2019) Ji 0791 Min Chu No. 1620, the Zhangjiakou Economic Development District People’s Court in Hebei ruled that the purpose of concerted action agreements is to ensure smooth decision-making, approval, and execution within the target company, requiring shareholders to maintain consistent opinions on matters of corporate governance and management, rather than forming an entrustment relationship.
(3) The Superiority of a Company’s Articles of Association Over Concerted Action Agreements
Concerted action agreements granting compulsory vote alignment rights should not override the effectiveness of a target company’s articles of association. According to Articles 66 and 73 of the Company Law, the methods of discussion and voting procedures for shareholder and board meetings are governed by the company’s articles of association unless otherwise specified by law. The articles of association, as a foundational agreement reflecting the shareholders’ collective intent, holds higher binding authority than agreements between certain shareholders. Therefore, incorporating compulsory vote alignment rights into a company’s articles of association through shareholder resolutions would enhance its enforceability and legitimacy.
(4) Enforcement of Concerted Action Agreements by Target Companies
If a target company is a party to the agreement but refuses to enforce compulsory vote alignment upon a shareholder’s request, the courts are unlikely to compel the target company to enforce compulsory vote alignment, given that this issue pertains to corporate governance. Therefore, the target company’s liability would be confined to damages for a breach of contract.
To address the inadequacy of damages in remedying losses, obligees may seek to annul the resolutions formed based on the obligor’s breach of the agreement. For example, they could request the annulment of a negative resolution opposing capital increases. Given that a concerted action agreement is not an entrustment relationship and, therefore, cannot be revoked arbitrarily, it is suggested that courts consider supporting the concerted action agreement and rejecting the vote of the breaching obligor, thereby annulling the resolution of the shareholders’ meeting. While this does not directly enforce compulsory vote alignment, it may prompt a company to re-vote on the matter, providing the obligor an opportunity to correct their breach. Additionally, it may encourage the company to voluntarily enforce compulsory vote alignment.
IV. Our Recommendations
To ensure the implementation of a concerted action agreement, we recommend that the target company becomes a party to the agreement and the target company’s obligations to secure the exercise of the right of mandatory voting is explicitly stipulated. Even more protective is putting the right of mandatory voting into the target company’s articles of association. When drafting and signing a concerted action agreement, the following key points are recommended:
(1) State in the recitals that the purpose of the concerted action is to ensure smooth decision-making and the execution of corporate actions and to protect the investment interests of the concerted action rights holders;
(2) Clarify in the concerted action agreement that there is no relationship of entrustment or agency between the concerted action rights holders and the obligors, that is, the concerted action obligors must vote according to the rights holders’ opinions, not that the concerted action obligors are entrusted by the rights holders to vote on their behalf;
(3) To prevent the concerted action obligors from unilaterally terminating an agreement or breaching an agreement by exercising the right of arbitrary termination, insert a clause to confirm that the concerted action obligors have no right to unilaterally terminate the agreement without the consent of the concerted action rights holders;
(4) The target company should sign the concerted action agreement as a party. The agreement should stipulate that the target company has the right to conduct mandatory voting by modifying the opinions of the concerted action obligors according to the opinions of the concerted action rights holders if the concerted action obligors breach the contract. If the target company cannot participate in signing the agreement, the parties to the concerted action agreement can stipulate in the agreement that a copy of the agreement shall be sent to the target company, in which it is clearly stipulated that the target company shall exercise the right of mandatory voting according to the concerted action agreement if the concerted action obligors do not comply with the concerted action agreement;
(5) In addition to the mandatory voting clause, a separate liquidated damages clause should be set to specify that the concerted action obligors should pay liquidated damages to the rights holders in the event of a breach of contract. This approach aims to raise the costs associated with breaching the agreement for the obligors, thereby reducing the risk of breach;
(6) Stipulate in the target company’s articles of association that “If shareholders have reached a concerted action agreement in accordance with the law, shareholders and directors shall not violate the concerted action agreement in voting; otherwise, the target company shall conduct mandatory voting on the obligors’ voting opinions according to the opinions of the concerted action rights holders.” Or form a valid company resolution on the signing of the concerted action agreement, so as to facilitate refuting objections related to the validity and scope of application of such agreement in case of dispute.
For further information, please contact:
SONG, Yan, Partner, JunHe
songyan@junhe.com
