Pei-Ching Ji and Julian Lai
After a dedicated section on closed companies limited by shares was added to the Company Act, the number of family businesses choosing to set up as closed companies has gradually increased, given their ability to impose share transfer restrictions via the articles of incorporation unlike typical companies limited by shares, which are prohibited to do so under law. In addition, a closed company has greater flexibility in designing its preferred shares compared with a typical company. This article will introduce possible designs and restrictions of preferred shares.
1. The design of preferred shares
Under Article 157, Paragraph 3 of the Company Act, a public company may not issue preferred shares with plural voting rights, veto power over specific resolutions, or relating to the appointment of directors or supervisors. Therefore, family business members usually choose to set up a closed company (or a non-public company) to hold the shares of a public company while taking advantage of the more flexible rules regarding preferred shares.
Under Article 356-7 of the Company Act, a closed company may flexibly design the contents of its preferred shares according to the wishes of its members. For example, family members who do not intend to participate in the management may receive preferred shares with ” restricted or no voting rights, but with priority in the distribution of dividends or bonuses”, or preferred shares with “veto power over specific resolutions” so they can retain the right to a share of the profits of the company without actively participating in its management. As for those who intend to participate in the company’s management, they may receive preferred shares with “plural voting rights” or ” the right to appoint directors or supervisors.”
In addition, as a result of estate and gift tax planning, the first-generation owners of a family business usually arrange in advance to transfer part of their shareholding to the second-generation owners over a number of years. However, when the shareholding of the first-generation owners of the family business is lower than that of the second-generation owners, the first-generation owners of the family may acquire preferred shares with “plural voting rights or veto power” or “the right to appoint directors and supervisors” so that the first generation owners can continue to retain control of the company or the power to veto major resolutions.
2. Restrictions on preferred shares
The Ministry of Economic Affairs (hereinafter, the “MOEA”) stated on January 4, 2019 that “when the holders of preferred shares with veto power over specific matters exercise such veto power, it shall be limited to matters that may be resolved in a shareholders’ meeting; such veto power shall not be exercised over matters that are resolved by a board of directors, such as the appointment, discharge, and compensation of managerial officers (Article 29, Paragraph 1, Subparagraph 3 of the Company Act). Holders of preferred shares also shall not exercise veto power over the ‘results of an election of directors’ in order to maintain the normal operation of the company.” The MOEA also stated on June 8, 2020 that “the issuance of new shares by a closed company is a matter to be resolved by the board of directors. According to the Ministry’s Jing-Shang-10702430970 Circular of January 4, 2019, a shareholder holding preferred shares may not veto a decision to ‘contact a specific individual for capital injection’”
The MOEA also stated in a separate June 8, 2020 circular that “…as to whether it is lawful for Company B to issue preferred shares and stipulate in its articles of incorporation that such the holders of those preferred shares are entitled to exercise on behalf of Company B its shareholder rights with respect to listed Company A, Article 157 of the Company Act stipulates that matters pertaining to the rights and obligations of preferred shares shall be specified in the articles of incorporation, which means the rights and obligations between the issuing company and the holders of its preferred shares shall be specified in the company’s articles of incorporation. The rights and obligations between the holders of preferred shares and a third party, however, are not within the scope of Article 157 of the Company Act regarding preferred shares. Article 202 of the Company Act further provides that a corporate shareholder’s shareholder rights from holding another company’s shares are not expressly specified by law as a matter to be decided by the shareholders; rather, they are the responsibility of the board of directors, and the articles of incorporation may not be amended to delegate such responsibility to specific holder(s) of preferred shares in its stead…If Company B is a closed company, it shall still refer to the above explanation.”
In accordance with the above circulars, a company’s issuance of preferred shares with veto power or other specific rights and obligations shall be limited to the matters that may be resolved by the shareholders. If the company intends to issue other preferred shares with specific rights and obligations, they should be limited to the rights and obligations between the company and the preferred shareholders and shall not include those between the preferred shareholders and a third party. For a company’s shareholder rights in connection with its investment in another company, it is not a matter expressly specified by law to be resolved by the shareholders, thus it is the responsibility of board of directors, and the company may not issue preferred shares that designate specific shareholders to exercise such shareholder rights on behalf of the company.
According to the above explanation, since the issuance of new shares is the exclusive authority of a company’s board of directors under the authorized capital system, the company cannot design preferred shares with veto power over the issuance of new shares by the board of directors. However, it should be noted that this may enable the board of directors to introduce a non-family member third party as a shareholder via capital injection, thereby diluting the shareholdings of the other family members.
This article follows the previous article’s analysis on a closed company’s issues with share transfer restrictions and further introduces the possible applications in the issuance of preferred shares by a closed company, as well as providing an analysis and review of the potential restrictions a closed company may face in issuing preferred shares.
 For the issue of share transfer restrictions of a closed company, please refer to the Firm’s cover article in November 2022 titled The Connections Between the Transfer Restrictions of Close Companies Limited by Shares and the Inheritance, Compulsory Enforcement, and the Distribution of the Marital Property (Taiwan) (last visited on December 9, 2022)
 Although the amendment to Article 157 of the Company Act in 2007 allow a non-public company to also issue in accordance with Article 157, Paragraph 2 of the Company Act preferred shares with plural voting rights, veto power over specific resolutions, or to ensure the election of a certain number of directors, closed companies still enjoy greater flexibility in their use of preferred shares. For example, a closed company’s preferred shares with plural voting rights may also apply to the election of supervisors (Article 356-7, Paragraph 2 of the Company Act), and preferred shares that appoint the supervisor may also be issued (Article 356-7, Paragraph 1, Subparagraph 4 of the Company Act), while those of a non-public company may do neither.
 The Jing-Shang-10702430970 Circular of January 4, 2019 from the MOEA. Although this circular is an MOEA interpretation on the issuance of preferred shares with veto power by a non-public company in accordance with Article 157, Paragraph 1 of the Company Act, the interpretation may also be applied to the issuance of preferred shares by a closed company.
 The Jing-Shang-10902414770 Circular of June 8, 2020 from the MOEA.
 The Jing-Shang-10902414780 Circular of June 8, 2020 from the MOEA.
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