Is the Clause Valid Where a Company Provides a Guarantee for Share Transfers Between Shareholders?

By Wang Jingcheng, Zhang Derong, Ruan Di (Beijing Yunting Law Firm)

Key Takeaway

When a company provides a guarantee for the transfer of shares between shareholders, does this constitute the withdrawal of capital by the transferring shareholder? In this case, the Supreme Court opined that the invalidity of a contract should be strictly determined according to the principle of legalism. The court rejected the validity of the guarantee clause on the grounds that it benefited the shareholders without aligning with the company's operational performance, contradicting the spirit of corporate law.

Judicial View

If an investor has conducted due diligence and followed formal review procedures through a shareholders' resolution, and the guarantee provided by the company benefits its own operational development without harming the rights of the company and its minority shareholders, the guarantee clause should be considered legal and valid.

Case Summary

  1. On April 26, 2011: Hanlin Company, along with Cao Wubo and Qiang Jingyan, signed an "Investment Agreement" and a "Supplementary Agreement." It was agreed that Qiang Jingyan would invest 30 million yuan in Hanlin Company, holding 0.86% of its shares.

  2. According to the Supplementary Agreement: If Hanlin Company failed to meet its annual performance targets, Qiang Jingyan had the right to require Cao Wubo to repurchase the shares held by Qiang Jingyan in cash. Hanlin Company also agreed to provide joint and several liability guarantees for Cao Wubo's repurchase obligations.

  3. In 2011, Hanlin Company did not meet the agreed performance targets. The company faced numerous lawsuits, its operations significantly declined, and it ultimately failed to go public.

  4. On May 31, 2012, Qiang Jingyan and Cao Wubo signed a "Share Transfer Agreement," transferring Qiang Jingyan's shares in Hanlin Company to Cao Wubo. On April 2, 2014, Qiang Jingyan notified Cao Wubo and Hanlin Company in writing, requesting payment for the share transfer and compensation for the breach of contract, but neither Cao Wubo nor Hanlin Company fulfilled their payment obligations.

  5. Subsequently, Qiang Jingyan filed a lawsuit, requesting that Cao Wubo pay the share transfer amount and overdue payment penalty, and that Hanlin Company be held jointly and severally liable for Cao Wubo's payment. The Sichuan Higher People's Court in the second instance held that the guarantee clause in question allowed Qiang Jingyan to evade transaction risks, seriously damaging the legitimate interests of other shareholders and creditors of Hanlin Company. Therefore, the court ruled that Hanlin Company should not be held liable for the guarantee. Upon appeal, the Supreme Court held that the guarantee clause was valid, and Hanlin Company should be legally liable. The final judgment required Hanlin Company to bear joint and several liability for Cao Wubo's share transfer payment and overdue payment penalty.

Key Points of the Judgment

  1. The agreements in question included Hanlin Company's guarantee and other matters, and both were stamped by Hanlin Company and signed by its legal representative. Qiang Jingyan had reason to believe that Hanlin Company had passed a shareholders' resolution on the investment and guarantee. Additionally, the 30 million yuan was fully invested in Hanlin Company's account, benefiting its operations and development. Even if Hanlin Company had not passed a shareholders' resolution regarding the guarantee, this action benefited the company's operations and did not harm the rights of the company and its minority shareholders, nor did it violate the purpose of Article 16 of the Company Law. Therefore, Hanlin Company should bear the guarantee responsibility, which aligns with the principle of fairness.

Practical Experience Summary

  1. A company providing a guarantee for share transfers between shareholders does not automatically constitute the withdrawal of capital. The validity of the guarantee clause should be judged based on specific legal invalidity scenarios. If the guarantee clause does not involve any of these scenarios, it is generally deemed valid.

  2. When a company provides a guarantee for share transfers between shareholders, to ensure the effectiveness of the guarantee clause, it should follow the legal provisions and the company's articles of association, passing a shareholders' resolution and having it stamped or signed by the legal representative.

  3. Even if the guarantee clause was unilaterally entered into by the company's legal representative without authorization, the validity of the contract should be determined based on the investor's good faith at the time of signing. If the investor claims the guarantee contract is valid, they should bear the burden of proof regarding their good faith. This can be demonstrated by providing evidence that they reviewed the shareholders' resolution, and the voting procedure complied with Article 16 of the Company Law.

  4. Although the mainstream view is that a company's guarantee clause for share transfers between shareholders is valid if it does not involve legally invalid situations, some courts have ruled that such a clause is invalid because it leads to the withdrawal of capital. Investors should be cautious about decision-making procedures and the transferee's ability to pay when signing a share transfer contract and corresponding guarantee clause, to avoid the risk of being deemed to have withdrawn capital.

Relevant Legal Provisions

Civil Code

  • Article 153: Civil legal acts that violate mandatory provisions of laws and administrative regulations are invalid, unless the mandatory provisions do not result in the invalidity of the civil legal acts.

Company Law of the People's Republic of China

  • Article 16: A company providing guarantees for others must follow the provisions of its articles of association and be approved by the board of directors or shareholders' meeting. The company's articles of association may set limits on the total amount of investments or guarantees, which must not be exceeded.

  • Article 35: After the company is established, shareholders shall not withdraw their capital contributions.

Court Ruling

The court's statement during the trial:

The Supreme Court in its retrial held that the guarantee clause in the "Supplementary Agreement" was valid, and Hanlin Company should bear the guarantee responsibility. The reasons are as follows:

  1. Qiang Jingyan had exercised due diligence and formal review obligations through the shareholders' resolution regarding Hanlin Company's provision of the guarantee. The "Investment Agreement" stated that "Hanlin Company has passed a shareholders' resolution, and the original shareholders agree to the investment; all parties have followed internal procedures to ensure they have the full rights to sign this agreement; the authorized representatives of each party have been formally authorized." The "Supplementary Agreement" stated, "Party A (Hanlin Company) passed a shareholders' resolution agreeing to this investment." Since the agreements included the investment amount, investment purposes, repurchase conditions, repurchase price, and Hanlin Company's provision of the guarantee, and both agreements were stamped and signed by Hanlin Company and its legal representative, Qiang Jingyan had reason to believe that Hanlin Company had passed a shareholders' resolution covering these matters, and that Cao Wubo had been authorized to sign the guarantee clause on behalf of Hanlin Company. Hanlin Company did not submit any contrary evidence to prove that it had not passed a shareholders' resolution on the guarantee matter during the trial, so Qiang Jingyan had fulfilled the duty of care and formal review obligations regarding the shareholders' resolution. Therefore, the guarantee clause in the "Supplementary Agreement" has legal effect on Hanlin Company.

  2. Qiang Jingyan's investment was fully used for the company's operations, benefiting all shareholders of Hanlin Company, and therefore Hanlin Company should bear the guarantee responsibility. The purpose of Article 16 of the Company Law is to prevent major shareholders from abusing their control to have the company provide guarantees for their personal debts, which could harm the company and its minority shareholders. In this case, although the guarantee clause was signed by Cao Wubo on behalf of Hanlin Company, the 30 million yuan was not used for Cao Wubo's personal investment or consumption, nor was it purely for his personal needs. It was entirely invested in Hanlin Company's account for its operational development, benefiting Hanlin Company’s continued profitability. This is in the interest of both the new shareholder, Qiang Jingyan, and the entire body of shareholders. Even if Hanlin Company had not passed a shareholders' resolution on the guarantee, the guarantee action was beneficial to Hanlin Company’s operations and did not harm the company and its minority shareholders' rights, nor did it violate the purpose of Article 16 of the Company Law. Therefore, holding Hanlin Company responsible for the guarantee aligns with the principle of fairness.

In conclusion, Qiang Jingyan had exercised due diligence regarding Hanlin Company's provision of the guarantee through the shareholders' resolution, and Hanlin Company's guarantee was beneficial to its operational development without harming the company or its minority shareholders. Therefore, the guarantee clause should be considered valid, and Hanlin Company should bear joint and several liability for Cao Wubo's payment of the share transfer and breach penalties.

Case Source: Qiang Jingyan v. Cao Wubo, Supreme People's Court, Case No. (2016) Supreme Court Min Zai 128.

Further Reading

Judicial Rule 1:

When a legal representative provides unauthorized guarantees for others, the validity of the contract depends on whether the creditor was acting in good faith. When the guarantee is for a shareholder or actual controller, the creditor must provide evidence that they reviewed the shareholders' resolution, and that the voting procedure complied with Article 16 of the Company Law.

Case 1: Beijing Third Intermediate People's Court, Sun Yongcun v. Wu Yanjiang, Case No. (2019) Jing 03 Min Zhong 15271

  • The court held that according to Article 16 of the Company Law, when a legal representative provides unauthorized guarantees for others, the validity of the contract depends on whether the creditor was acting in good faith. When the guarantee is for a shareholder or actual controller, the creditor must provide evidence that they reviewed the shareholders' resolution, and that the voting procedure complied with Article 16 of the Company Law.

Case 2: Shanghai First Intermediate People's Court, Zhang Deqiang v. Shanghai Jiali Co., Ltd., Case No. (2019) Hu 01 Min Zhong 2483

  • The court held that in cases where the company's shareholders did not approve the guarantee in accordance with Article 16 of the Company Law, and there is no evidence that the creditor acted in good faith or conducted due diligence, the company should not be liable for the guarantee.

Judicial Rule 2:

The mainstream view is that a company's guarantee clause for share transfers between shareholders is valid if it does not involve legally invalid situations, such as the withdrawal of capital.

Case 3: Zhejiang Higher People's Court, Li Xiaoming v. Hangzhou Jinyi Digital Technology Co., Ltd., Case No. (2019) Zhe Min Zhong 102

  • The court held that the guarantee clause did not constitute the withdrawal of capital and was therefore valid.

Case 4: Guangdong Higher People's Court, Zhang Yonghui v. Zhang Yue, Case No. (2019) Yue Min Zhong 1089

  • The court held that the guarantee clause did not constitute the withdrawal of capital and was therefore valid.






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