(By You Yunting and Wang Ting) Pursuant to China’s Company Law, any shareholder shall be entitled to inspect and copy the Articles of association, minutes of shareholders’ meetings, resolutions of meetings of the board of directors, resolutions of meetings of the board of supervisors and financial reports of a company in which he or she owns shares. However, if a shareholder operates a business in competition with a company in which he or she owns stocks, then when exercising the shareholder’s right to information, such inspection may result in leaks of confidential business and trade secrets. In today’s post, we will introduce this conflict, and discuss ways in accordance with relevant Chinese laws to balance this conflict of interests while maintaining a shareholder’s right to information and a business’ right to protect its trade secrets.
I. How to Balance the Conflict between a Shareholder’s Right to Information and a Business’ Right to Protect its Confidential Business and Trade Secrets?
As the Company Law provides: “Where the company, for any justifiable reason, considers that the shareholder’s request to inspect accounting records is made for any improper purpose and may impair the legitimate interests of the company, the company may decline the shareholder’s request and shall, within 15 days of the date on which the shareholder submits the written request, issue the shareholder with a written reply, stating its reasons thereof.”
In other words, a company may refuse a shareholder’s request for access to information when it provides a proper reason for doing so. In practice, where a shareholder files a lawsuit after having an information request rejected by a company’s accounting department, the company rejecting such a request will have the burden to show that said request was done for an “improper reason”.
Based on our experience, a much more common case is that, where a shareholder exhibits unfavorable behavior, like destroying accounting records, or has stolen some key technological information from the company, if a company then subsequently denies a shareholder’s inspection request, the courts are likely to support the company.
Can protection of a business secret or trade secret be considered a “reasonable” reason in declining a shareholder’s inspection request? The answer is most certainly “yes”. In litigation, if a company can prove that inspection of accounting records by shareholders could possibly result in exposure of business secrets, the court is more likely to act in the company’s defense and deny any request by the shareholder.
However, we have commonly found that, in order to balance protection of trade secrets and a shareholder’s right to exercise information requests, courts can engage in mediation for the parties. A common solution is where the court appoints a third-party accounting firm based upon agreement by both parties to the dispute, and said third-party inspects the accounting records, following up with a report to the shareholder as to the results of its inspection.
Recently, companies have engaged in other effective relief measures in order to safeguards their interests. Where a shareholder’s right to access information has resulted in the exposure of business and trade secrets, the company may file a request for judicial relief, demanding the shareholder responsible be found liable and compensate any losses suffered by the company accordingly. In accord with the latest draft of the Supreme People’s Court’s interpretation of the Company Law, where a company files a lawsuit and asks for compensation against a shareholder allegedly exercising said shareholder’s right to information results in the exposure of confidential business and trade secrets, as well as subsequent loss, the People’s Court should accept the case. Where the claims filed against a shareholder turn out to be supported by the evidence, then the court should rule in the company’s favor.
II. Can a Company’s Shareholder Inspect Archived Material’s Produced Prior to becoming a Shareholder?
There is no clear stipulation speaking to the above question in China’s Company Law, but some relevant provisions suggest that a shareholder who does not understand a company’s state of operation may exercise his or her right to inspect accounting records accordingly. In order to be entitled to exercise this right, a shareholder need only submit a written request for inspection, stating the specific reasons why the shareholder wishes to inspect accounting records.
According to the latest interpretation of the Company Law by the Supreme People’s Court, “where a plaintiff files a lawsuit to inspect archived company materials prior to, or after becoming a shareholder, the People’s Court shall accept the case.”Essentially, this confirms a shareholder’s ability to inspect materials archived prior to the shareholder gaining this interest.
III. Can a Company’s Shareholder Exercise its Right to Information by Inspecting Source Documents?
Financial and accounting reports are carriers for a company’s information disclosure, as well as summarizing documents. If a shareholder attempts to discover detailed information regarding a company’s financial situation and operating information, an understanding of the accountant’s information revealed in such reports’ source documents is necessary.
In relation to whether a company’s shareholder can inspect an accountant’s source documents, the Company Law unfortunately provides no clear provisions in regard to this question. However, the latest interpretation of the Company Law by the Supreme People’s Court provides: where a shareholder in a Limited Liability Company is entitled to inspect source documents, or journal vouchers, etc., relating to the contents of a company’s accounting reports, the People’s Court shall approve such actions accordingly. Where a company proves that a shareholder’s inspection of source documents, journal vouchers, etc. may impair the interests of the company, the People’s Court shall dismiss such actions.