Abstract
For the lock-up shares acquired during a judicial enforcement proceeding, the transferee is entitled to require the listed company to cooperate with the release procedure for these shares if the relevant commitments and conditions thereon have been met. However, instead of rendering cooperation, the listed company surprisingly submitted a hidden commitment never disclosed before to challenge the release request. It is not operationally sensible for a listed company to conceal from its investors such a commitment including so many additional release conditions that would affect the release of shares already eligible for release. Therefore, the commitment is doubtful as to its authenticity due to the time of its disclosure. Specifically, the commitment remained undisclosed until this dispute arose, i.e., two years after it was made, therefore existing or potential investors had no way of knowing the additional conditions on the shares in dispute. As the commitment had not been disclosed and announced previously as required by China Securities Regulatory Commission’s (CSRC) Administrative Measures for Information Disclosure of Listed Companies, it is not effective against the bona fide transferee who acquired the shares in dispute before the commitment was announced. The transferee, as a party to the judicial enforcement proceeding, can fully rely on the information announced during the enforcement. In addition, the listed company has no power to restrict a shareholder’s right to sell his shares through a shareholders’ general meeting resolution.
Basic Facts
Orient Securities Co., Ltd. (“Orient Securities”) had entered into a pledge repo transaction with non-party Li XX, under which Li pledged to Orient Securities his 58,410,000 shares in Royal Group Co., Ltd. (“Royal Group”). During its enforcement proceeding, the Beijing No. 2 Intermediate People’s Court (the “the enforcing court”) determined that Orient Securities is entitled to be repaid in priority with the 58,410,000 shares pledged by Li. But these shares are subject to a lock-up commitment because Li acquired them in consideration of transfer to Royal Group of his 100% equity interest in Charter Movie & TV Production Group Co., Ltd. (“Charter Movie & TV”). Li undertook not to transfer these shares from 2014 to 2017. In addition, Li also made a commitment on business performance for Charter Movie & TV and undertook not to transfer these shares before the delivery of the commitment.
In January 2018, the enforcing court issued a Notice of Request for Enforcement Assistance to Royal Group, requiring assistance in ascertaining whether the conditions for releasing the above pledged shares from lock-up had already been met. Royal Group replied that the conditions for performing the release procedure for these shares were not met as its audit report for 2017 had not been issued and the business performance of Charter Movie & TV was yet to be audited by an auditor. These shares were finally transferred to Orient Securities in September 2018 as repayment-in-kind after their auction sale fails. Subsequently, the enforcing court issued another Notice of Request for Enforcement Assistance to Royal Group to request assistance in performing the release procedure, but Royal Group failed to do so.
From 2015 to 2018, Royal Group issued a number of reports and statements on the profitability and performance commitment delivery of Charter Movie & TV, which confirmed that the commitment delivery rate from 2014 to 2017 all exceeded 100%. On July 31, 2018, namely the auction sale date of the shares in question, Royal Group released an Indicative Announcement on the Judicial Auction Sale of the Shares of A Shareholder Holding 5% or More Shares in the Company, stating that the enforcing court would hold an auction sale of the shares and that: “the judicial auction sale will not affect our ordinary course of business, and we will track the progress of this auction sale and timely perform our information disclosure obligations in accordance with applicable laws and regulations” without disclosing the lock-up status of the shares nor any unrealized performance commitment. As from March 2020, Wang X, a staff member of Orient Securities, asked Royal Group about the release procedure and the required materials via WeChat. Royal Group’s staff informed Wang of the required materials but failed to attend to the procedure upon receipt of the materials from Orient Securities. Due to failure in communication, Orient Securities filed a lawsuit with the Shanghai Financial Court on December 2, 2020, claiming that: 1. Royal Group should stop harming Orient Securities’ shareholder rights and immediately complete release procedure for the above lock-up shares; 2. Royal Group should pay Orient Securities RMB 50 million as damages for its delay in lock-up release.
Royal Group argued that Plaintiff’s claims should be dismissed because the release conditions had not been met. To support its argument, Royal Group presented a Letter of Self-regulatory Commitment on Lock-up Release (the “Commitment Letter”) dated March 20, 2018, issued by Li to Royal Group, which states that Li voluntarily consented to a number of additional self-regulatory conditions on the lock-up release, such as the payment of individual income tax on the transfer of shares. On August 13, 2020, Royal Group reported the additional release conditions to Shenzhen Stock Exchange. Thereafter, Royal Group adopted resolutions at its board of directors’ meeting and shareholders’ meeting, requiring Orient Securities to pay the tax of RMB 11,110.70 payable by Li as a prerequisite for Royal Group’s cooperation with the release procedure.
Holding
The Shanghai Financial Court issued a first-instance judgment on July 29, 2021, ordering: 1. Royal Group shall cooperate with the release procedure within ten days from the effective date of the judgment; 2. Royal Group shall pay Orient Securities RMB 5 million in damages; 3. Royal Group shall reimburse Orient Securities for the attorney fee of RMB 180,000; 4. The remaining claims of Orient Securities are dismissed. After the first-instance judgment was pronounced, Royal Group filed an appeal according to law. On July 25, 2022, the Shanghai High People’s Court rendered a civil judgment ((2021) Hu Min Zhong No. 514), dismissing the appeal and affirming the original judgment.
Reasoning
The issues of this case are as follows: 1. whether the Commitment Letter issued by Li XX to Royal Group is authentic and binds upon Orient Securities’ request to Royal Group for lock-up release; 2. whether the resolution adopted at Royal Group’s shareholders’ general meeting can restrict Orient Securities’ request for lock-up release; 3. how to determine the damages payable by Royal Group to Orient Securities, if Royal Group failed to cooperate with the release procedure as it should.
The Shanghai Financial Court held in the first instance that:
1. It was not until August 2020 that Royal Group presented the Commitment Letter to Orient Securities and Shenzhen Stock Exchange. In its previous announcements, Royal Group not only did not disclose the Commitment Letter but also explicitly stated that the release conditions had been met. It is not operationally sensible for a listed company to conceal from its investors such a Commitment Letter including so many additional release conditions that would affect the release of shares already eligible for release. Though contacted many times by the enforcing court for the judicial auction sale of the shares in question and by Orient Securities for request for release, Royal Group never disclosed the existence of the Commitment Letter. Therefore, the Commitment Letter is in doubt as to its authenticity.
2. Even if the Commitment Letter was indeed signed on March 20, 2018, it shall be disclosed in accordance with CSRC’s Administrative Measures for Information Disclosure of Listed Companies and the Guidelines for Standardized Operation of Listed Companies on the SME Board of Shenzhen Stock Exchange (revised in 2015) as its inconsistency with the original lock-up commitment had a major effect on the market, investors and Orient Securities. However, it remained undisclosed until October 28, 2020. Therefore, existing or potential investors had no way of knowing the additional conditions on the shares in dispute.
3. As a party to the judicial enforcement proceeding, Orient Securities can fully rely on the information announced during the enforcement. According to the then publicly available information and the auction sale announcement, there should be no commitment letter nor any commitment other than the performance commitment on the shares in question; the performance commitment had been fulfilled. Only on this premise did the reserve price in the judicial auction sale become the price for the repayment-in-kind. If there were a Commitment Letter, it would certainly materially affect the price for the repayment-in-kind. Therefore, to protect Orient Securities’ reliance interest, the Commitment Letter disclosed after the transfer of shares in question as repayment-in-kind is not binding upon Orient Securities.
4. Royal Group has no power to restrict a shareholder’s right to sell his shares through a shareholders’ general meeting resolution. In summary, the Shanghai Financial Court held that Royal Group was at fault in refusing to cooperate with the release procedure, which limited Orient Securities’ freedom and opportunities of trading, and thus ordered Royal Group to cooperate with the release procedure.
5. As for the determination of loss, the stock price of Royal Group followed an inverted V-shaped pattern (first up and then down) from April 2020 to December 2020 when this lawsuit was filed, and a V-shaped pattern (first down and then up) after the lawsuit was filed. Considering said fluctuations during the first-instance trial, it was determined that Royal Group should first pay RMB 5 million in damages and that additional loss might be claimed as appropriate, after the shares in dispute are sold by Orient Securities following Royal Group’s cooperation with the release procedure. To conclude, the Shanghai Financial Court issued a first-instance judgment on July 29, 2021, ordering Royal Group to, among others, cooperate with the release procedure within ten days from the effective date of the judgment, pay Orient Securities RMB 5 million in damages, and reimburse Orient Securities for the attorney fee.
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