August 2023
Jolene Chen and Teresa Huang
Dividend rights play a crucial role within the framework of equity incentive systems. In the event of an equity incentive dispute, parties involved assert all relevant rights in the course of litigation, and the disputes over dividend rights are often involved. However, the disputes over the right to dividends are equally intricate and multifaceted when different types of dividend rights are stipulated, it may result in the application of diverse legal norms, ultimately leading to vastly different outcomes in judicial rulings. This article will analyze such complexities through the examination of the following two case studies.
Employees who possess shareholder qualifications can assert their rights to dividend distribution based on the equity they hold, in accordance with the relevant provisions of the Company Law.
Case 1: Civil Judgment of the Dispute over Surplus Distribution between Duan Honghai and Shu Zhenyu et al. and the Company ((2021) Shanghai 02 Final Civil Judgment 11972)
Focus of dispute: The amount of dividends for the year prior to the employee’s departure.
The agreement between the two parties: The employee held 3.32% of the company’s equity. Upon the effectiveness of the agreement, the employee was entitled to the company’s benefits in proportion to their shareholding. The employee was later registered as a shareholder.
Court judgment: The court supports the company’s claim that after deducting the statutory surplus reserve by 10%, dividends should be paid to the employee in proportion to the proportionate shareholding.
Author’s Commentary:
1. Article 34 of the Company Law provides for the calculation of dividends distribution in limited liability companies, where shareholders are entitled to receive dividends in proportion to their actual capital contributions. However, exceptions may apply when all shareholders agree not to distribute dividends in proportion to their capital contributions or when there is an agreement to prioritize capital contributions over dividend distributions based on capital contributions. Article 166 of the Company Law stipulates the calculation method for dividend distribution in joint stock limited companies; dividends should be distributed in proportion to the shareholders’ ownership of shares, unless the articles of association of the joint stock limited companies stipulate that the dividends shall not be distributed in proportion to the shares held by the shareholders.
2. Article 166 of the Company Law stipulates the sequence for profit distribution in a company. The order is as follows: Payment of taxes; offsetting losses; withdrawal of the statutory surplus reserve; withdrawal of any provident fund; distribution of dividends.
3. The Company Law also provides for the procedure of dividend distribution: If a company intends to distribute dividend, it needs to make a valid resolution regarding the distribution; As per Articles 37 and 46 of the Company Law, the board of directors shall develop the company’s profit distribution plan, which should then be deliberated and approved by the shareholders’ meeting.
In this case, both parties acknowledged that profits should be distributed based on the employee’s ownership of company shares, and that the dispute arose regarding whether the dividend amount should be subject to a deduction of 10% for the creation of the statutory surplus reserve. The court ultimately ruled that it is not a violation of the law for a company to continue withdrawing from the statutory surplus reserve even if the cumulative amount extracted exceeds 50% of the company’s registered capital. Therefore, the court supported the company’s decision to distribute dividends based on the profits after deducting 10% for the creation of the statutory surplus reserve.
Thus, it is evident that the dividend distribution in this case fell under the provisions of the Company Law regarding dividend rights. The reason was clear since the employee possessed the qualifications of a shareholder and asserted their right to share in the dividends based on their share ownership. Therefore, the relevant provisions of the Company Law were applicable.
If the incentive target is not a shareholder, it only receives virtual equity. This can essentially be regarded as a bonus system with an algorithmic framework, which may not fall under the provisions of the Company Law regarding dividend rights.
Case 2: The Civil Judgment of the First Instance in the Dispute between Plaintiff Pan Zhimin and Defendant TeeJoy Biotechnology Co., Ltd. over Other Matters Concerning the Company ((2017) Shanghai 0151 FI Civil Judgment No. 7200)
The agreement between the two parties: The Class B shareholding is not entitled to any other shareholder rights other than the right to shareholders’ dividends.
Court judgment: The essence of this equity incentive model was a financial incentive imposed by the defendant on the plaintiff who served as an employee. Due to the “Class B equity” stipulated in the “Agreement” not being legally recognized as actual shareholder rights, its essence lies in providing financial incentives to employees, and it does not require approval from the shareholders’ meeting. Therefore, the company should not withhold payment of virtual equity benefits to employees on the grounds of lacking shareholder meeting resolution.
Author’s Commentary:
In this case, both parties agreed in the agreement that the Class B equity did not entitle the holder to any other shareholder rights besides dividend rights. Furthermore, the agreement did not mention that the employee became a shareholder of the company as a result of this agreement.
The “Class B equity” stipulated in the agreement essentially represented a distribution agreement between the company’s employees and shareholders regarding the transfer of part of the equity benefits. It is a form of broader compensation system rather than a legally recognized equity under the Company Law, and therefore, the provisions of the Company Law regarding dividend rights do not apply. Employees accepting virtual equity do not acquire the status of shareholders in the company by virtue of the Agreement. Furthermore, their entitlement to these benefits will cease upon their departure from the company.
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