Study On Legal Protection Of Preferred Stockholders' Rights

Common stockholders' rights are the unity of voting rights and property rights,which can be split down and recombined through contracts to form up class stocks carrying different rights and risks from common stocks.Preferred stock is the most important category of class stocks,which is a form of stock rights relative to common stocks.Holders of such stocks usually enjoy priority over common stockholders to gain dividends and surplus assets at the time of liquidation.They could also obtain the ability to quit the investment by way of contracting in advance for redemption rights and conversion rights,while the rights to vote and other rights of the preferred stockholders are subject to some restrictions.Preferred stock is a kind of stock promulgated by company law,and the rights and preferences thereof are agreed by the parties in the contract,thus the preferred stock is the products of both law and contact.The differences between common stock and preferred stock with regard to the contents and sources of rights cause constant conflicts during the realization of their respective rights,presenting various kinds of conflicts of interests.Common stock and preferred stock acquire their gain from the same asset pool formed by the distributable profits of the company.In order to obtain the financial preferences,preferred stockholders give up the decision-making power of the major events in the normal course of business,and the common stockholders own the power to appoint directors and the decision-making power of major events.As residual claimant of the company,common stockholders are largely incentivized to maximize their own interests.Thus the essence of the legal protection of preferred stockholders is to protect their legitimate rights and interests through the ex ante regulation of the law and the ex post judicial adjudication confronting the conflict of interest with the ordinary shareholders.By researching the preferred stock mechanism of foreign countries,especially the United States,we could find that the US adopt a path of differentiating regulation with regard to protection of preferred stockholders' rights,ex ante and ex post regulation.Ex ante regulation means the use of both advocating and mandatory provisions-advocating provisions would utilize default clauses or menu clauses to guide the parties to achieve efficient behaviors,while mandatory provisions means that the parties shall not be agreed to exclude the provisions,thus leaving rooms for state intervention to suppress negative externalities caused by excessive private self-government.Ex post regulation,on the other hand,relies on the re-balance of the interests of the parties-the court would determine and protect the rights of preferred shareholders through contract interpretation and the application of the fiduciary duty in company law.This dissertation intends to sort out the specific solutions and the actual effect of each path through in-depth analysis and interpretation of the above regulatory path,and explore the possible protection path of the preferred stockholders in view of the current practice of China.This dissertation contains six chapters.The introduction gives some detailed description of the topic background,research trend at home and abroad,significance,ideas and methods of the research,as well as the innovations and disadvantages of the dissertation.The first chapter describes the basic theory of preferred stock.Preferred stock is one of the main patterns of differentiated allocation of the financial rights of equity,containing both the characteristics of debt and equity.However,the preferred stock presents a strong equity character from the angle of legal nature.The emergence of preferred stock is to meet the diversified financing needs and differentiated investment preferences.The reality of shareholder heterogeneity drives the practice of diversified shareholder right setting,and according to the company contract theory,the relationship between company participants is deemed to be contractual.Thus the shareholders of the company and the investors have the flexibility to agree on the different rights and preferences of their holdings.Preferred stocks have the advantage in optimizing corporate governance and controlling the cost of corporate finance.Different types of companies could utilize the flexible nature of preferred stock to meet their different financing needs.The rights and preferences of preferred stocks includes a variety of different types,such as dividend priority,liquidation priority,redemption right and put right,voting right and conversion right.The financing company and investors can make flexible provisions according to their different needs.The second chapter examines the necessity of preferred stockholders' rights protection.The differences between common stock and preferred stock with regard to the contents and sources of rights cause constant conflicts during the realization of their respective rights,presenting various kinds of conflicts of interests.The price of preferred's priority is actually borne by common stockholders.As at any point in time,the distribution of the company's wealth is a zero-sum competition,regardless of the size of the company cake and the company's development status,any distribution should be deemed the interests division between the common and the preferred.Therefore,in terms of the preferred's rights and preferences,there exists direct conflicts of interests between the common and the preferred.Such conflicts of interests fall within the level of conflict between different types of participants in the corporate capital structure,but the conflict is rendering more complicated by the involvement of the board of directors.The control of the board of directors will determine the direction of the company's decision-making and the different results of interests competing.Conflict embodied in the entire life cycle of company,from the company's daily operations,sale of assets,mergers and acquisitions to liquidation and reorganization.The performance,reason,degree of profit and loss all differs in each stage.The fourth section of this chapter will illustrate and analyze the actual case of different trigger points of interest competition in the US,in order to further demonstrate the complexity of the conflicts of interests between the preferred and the common,and the importance of defining and protecting the preferred stockholders'rights.Chapter three,four and five respectively describe and discuss the different paths of rights protection of preferred stockholders.Chapter three focuses on the protection and regulation of the rights of the preferred shareholders in closed companies.Preferred stock issuance in closed company is achieved through private placement,during which financing companies and investors can form a one-on-one benign negotiation,thus,based on the principle of corporate autonomy,there is no need to impose too many mandatory terms and conditions.The use of preferred stocks in closed companies mainly lies in the field of private equity financing for start-ups.In view of this practice,the American Venture Capital Association(NVCA),as an industrial association,has developed a set of legal texts commonly used in the field of venture capital,including the full set of terms of the preferred stock contract for both the investment and financing parties to quote in their contract negotiation.The advocating menu clauses would not only remind the parties,but more importantly,also allow the legislators and regulators and other institutions to achieve significant impacts--soft regulation--on the content of the contract without violating the spirit of free contracting,thus facilitating regulators to implement standardization guidance and impact on preferred stock practices.This section will sort out the preferences clauses of the preferred stocks with reference to the NVCA model contract text,todescribe the issues that need to be addressed in the drafting of these clauses,and provide suggestions thereon.In addition,the preferred stock contract is embedded in the company's articles of association,which is regulated by the company law and could be altered by shareholders voting in the way of capital majority rule.The alternation of the articles of association involves lots of issues,including the use of control power over the company,the influence of the decision-making power of the board of directors and the decision-making rule with regard to capital.It is difficult to find an ideal solution in the field of contract,calling for the introduction of the regulation and adjudication method of company law,especially the complementing and rectifying function of fiduciary duty on incomplete contracts.The fourth chapter discusses the protection of the preferred's rights in public companies.The rights of the preferred stockholders contain both preference and restricted rights.If the determination of these rights is completely left to the parties'negotiations,there will be a great space for opportunism in the context of public companies.There are large number of public investors in public companies,most of whom lack of cognitive ability and the ability,experience or judgment required to make a reasonable decision on various investment terms and matters,calling for interventions from the state-level to protect public interest.On the other hand,in the issuance of preferred stocks to the public,the preferred stock contract is unilaterally drafted by the issuer,and small and medium investors can only choose whether to join,but they do not have the ability to negotiate and bargaining f-or the terms and clauses thereof.As a result,in order to protect the interests of investors,the company laws of foreign countries generally made certain mandatory provisions on the rights of preferred stockholders,especially in aspects of the conditions of issuance,the type of preferred stocks,ratio of issuance,issuing target etc.Such mandatory provisions cannot be changed or circumvented through contract negotiations.The purpose of the provisions is to limit the spillover effect resulting from excessive private autonomy,and to maintain public interests from the angle of investor protection.This chapter mainly describes the mandatory provisions on preferred stocks in the company laws of the US,UK,Japan and France,focusing on the special provisions on listed companies and the preferred stockholders thereof.The fifth chapter discusses the protection of preferred's rights by fiduciary duties in company law.The interpretation of contract terms of the preferred stocks and the determination of the rights by way of fiduciary duty belong to the ex post regulatory path for the protection of preferred's rights.The interpretation of contract is a necessary way for judicial judgment of the validity of the contract and the scope of the rights and obligations of the parties.However,there is always controversy over whether fiduciary duties should be applicable to the protection of preferred stockholders.Those who are opposed to the application holds that the priority of the preferred stockholders is contractual,since the contractual rights and obligations are already agreed upon,the parties should definitely obey the contract,and thus there would be no room for the application of fiduciary duties.However,based on the theory of shareholders' equity balance and the reality of incomplete contract,it is necessary for the court to use the rules of fiduciary duties to solve the problem of information asymmetry and agency cost.The purpose of applying fiduciary duties is not to give the preferred those rights that they have abandoned in the process of contract negotiation,but to avoid "opportunistic theft" by common stockholders and board of directors when the preferred have no chance to negotiate for the clauses and terms at all.As a ex post regulatory path,the attitude of court in the judicial practice is at stake for preferred stockholders'protection.So,in the rest of this part,the author will also introduce a number of typical US cases in this field to illustrate the judicial attitude of the US court in dealing with these issues.The last chapter turns the focus back to China to analyze the current practice of preferred stock mechanism in China,and put forward improvement proposals.China's current Company Law does not contain the legal mechanism of preferred stock,and in 2014,the pilot practice on preferred stock started operation.Some problems presented during the pilot practice are worthy of attention.The issuance terms of the preferred stocks of listed companies tend to be rigid,and the clauses of many companies are overly identical,losing necessary flexibility.The fixed return characteristics are diluted and exit channels are blocked.Preferred stocks turn into "common stocks without voting right".The fixed return characteristics of the preferred stocks issued by unlisted public companies have been strengthened,and the exit flexibility increases,making up the shortcomings of the preferred stocks of listed companies.But there is also some problems regarding the increase of potential risks caused by high dividend rate.The demand for usage of preferred stock is very strong in closed companies,but there is no relevant provisions in current Chinese company law,thus emerging a variety of self-adaptive "quasi-preferred stock" contract arrangements to achieve the purpose of priority terms attached to investment.Such contractual arrangements,represented by Value Adjustment Mechanism(VAM)agreements,often encounter conflicts with existing legal systems,and are not legally recognized.On the basis of the above analysis,the author holds that,according to the present situations and problems of domestic practice in China,protection of preferred stockholders should be implemented in accordance with the different levels of risk tolerance and involvement in commercial activities by different investors to give them different degree and types of protection.Different regulatory models should be applied to public company and closed company respectively,and in the field of judicial adjudication,the court's commercial adjudication thinking should be strengthened to overcome the administration thinking in the adjudication process.Courts should treat commercial transactions seriously,in order to preserve the private order rationally selected by private parties.