Academic

Chinese corporate law: where's the beef? (3)

By Gordon Smith, Christine, Hurt, Vic Fleischer, Fred Tung, Lisa Fairfax, David Zaring

To continue from yesterday's post on problems with bringing securities-related lawsuits: In addition to the standing and cause-of-action problems, there are other obstacles peculiar to China and its political situation: specifically, the government's fear and distrust of large groups, especially organized ones, that are not under state control. (All social organizations, for example, must be approved by and registered with the state; even fishing clubs and associations for the study of antique furniture have been disbanded for failure to get official recognition.) Securities litigation, of course, is often possible only if the claims of small shareholders can be aggregated through the class action or some other form of group litigation. While Chinese civil procedure does not provide for class actions in the American sense (where non-participants without notice can be bound by the result), it does provide for various forms of group litigation. But the system makes it difficult for plaintiffs in securities litigation to use these forms.

First, one of the criteria for the professional assessment of Chinese judges is the number of cases they handle. Thus, they have every incentive not to aggregate claims, but rather to disaggregate them. Securities plaintiffs coming to court as one group have on occasion been instructed to split up into several smaller groups - based not on any common characteristics, but simply on numbers.

Second, the system of court fees also contributes to the incentive to split up cases. Court fees are a progressively declining multiple of the amount in controversy: the percentage charged for lower amounts is smaller than the percentage charged for higher amounts. Thus, a court earns more hearing 10 claims of $X than hearing one claim of $10X.

Third, there are two recent rules explicitly aimed at putting the lid on group litigation - probably aimed at social discontent, not securities lawsuits, but nevertheless putting a crimp in the latter. The first rule, issued in the name of the All-China Lawyers Association [PDF here], requires lawyers handling any case involving ten or more plaintiffs to report to the local government for instructions and imposes various other burdens on representation. The second rule, issued in 2006, relaxes the previous (spottily enforced) ban on contingency fees, but keeps it for specific types of cases, including - you guessed it - lawsuits involving multiple plaintiffs (which normally means 10 or more).

Finally, there are special rules governing holders of shares listed on stock exchanges outside the PRC mainland, such as Hong Kong and New York. The China Securities Regulatory Commission requires Chinese companies listing outside of China to include in their articles of association a provision stating that all disputes between holders of non-mainland-listed shares and the company or its high-level management shall be resolved through arbitration. Interestingly, this may well have been intended as a shareholder-friendly measure, on the theory often held in Chinese officialdom that you should require people to do what you think is good for them. We don't see such arbitration clauses in the certificates of incorporation or bylaws of American public companies, and (perhaps because nobody wants to be a test case) it's not at all clear that a federal court would accept such a clause as valid grounds for dismissal of a claim arising out of federal securities law. (My information may be out of date or just wrong; I'm interested in this question, so please add a comment if you know something to the contrary.) But there is little doubt it would be effective in China. Interestingly, this arbitration clause does appear in Article 181 of the Articles of Association of PetroChina, a Chinese company listed (among other places) on the New York Stock Exchange. Do investors generally know it's there? Did the SEC? Does anyone care?

Bottom line: don't look to the Chinese legal system to protect your interests as a small shareholder. (The story is a bit better for holders of significant minority stakes.) There are, of course, other institutions out there that might do the job: for example, equity markets, banks, various gatekeepers, and the financial press. In China I don't think they do the job very well. But that's exactly the paper I'm working on now, and it's a lot more than can be contained in a blog entry.

Full post as published by Conglomerate on February 12, 2008 (boomark / email).