Derivative Actions in China: Law and Practice

This paper concerns one of the thorniest aspects in company law: the derivative action. China’s introduction of the statutory derivative action in 2005 has been a significant experiment to establish an investor-friendly legal regime. As an exception to the rule in Foss v. Harbottle, individual shareholders can, acting on behalf of a company, sue the company’s director if a wrong is done to the company. Chinese companies have been widely conceived as having a blockholder model, in which the state as the controlling shareholder should in theory possess the incentives to constrain the opportunistic behaviour of managers. Nonetheless, the state, as loosely defined as “people as a whole”, has failed to exercise any effective monitoring role. The introduction of derivative actions has illustrated a paradigm shift of governance towards the role of minority shareholders. During the transplantation of Western law, Chinese system distinguishes itself from other jurisdictions due to the underlying market and its legal institutions. This paper will attempt to explore Chinese experiment in derivative actions. The rest of the paper structures as follows. It will examine the rule in Foss v. Harbottle and the exceptions to that rule, and next the debate over the role of derivative actions is discussed. Furthermore, a large body of the paper will present a comprehensive picture of the legal framework of derivative actions in China, followed by the judicial application. Finally, a brief conclusion will be made.