Possible Applications of the New Squeeze-Out Rules in Two Transaction Types

Specifically, Article 219 provides that a parent company may merge with its 90%-owned subsidiary without a resolution of the shareholders’ meeting of the subsidiary, while the subsidiary company must notify its other shareholders, who are entitled to request that the company purchase their equity interests or shares at a “fair price,” and such a merger must instead be approved by the company’s board of directors.

Possible applications in two transaction types include: the two-step merger structure to effect privatization in public transactions, and the use of Article 219 to enhance contractual drag-along rights in private transactions.

1. Two-Step Merger in Public Transactions

Article 219 may be leveraged to facilitate privatization through a two-step merger structure:

• Step one: increasing ownership to 90% and delisting. The acquirer first increases its ownership stake in target to 90% or more, typically via a tender offer, open-market purchases, or negotiated transfers.  At this stage, the acquirer has gained control of the target, and then may direct the company to delist voluntarily, or follow a forced delisting under applicable stock exchange rules.

   

• Step two: short-form merger. Following step one, the acquirer may initiate a merger with the target relying on Article 219, only subject to board approval of the target.  Out-going minority shareholders would receive cash consideration at a fair price for their equity, thereby being “squeezed out” under the Article 219 statutory mechanism.

2. Enhanced Drag-Along Rights in Private Transactions

Another potential application of Article 219 is in enhancing the effectiveness of contractual drag-along rights in private company transactions.  Contractual drag-along provisions in shareholders’ agreements are commonly adopted by investors as a tool for facilitating investor exits, particularly when structuring trade sale exits.  For strategic buyers, who often seek complete control and 100% ownership of the target, drag-along provisions improve deal certainty, as they require minority shareholders to participate in a sale transaction once the requisite majority approval is obtained.

Having said that, even well-drafted drag-along provisions may not fully eliminate the risk of holdouts or refusal of sale by certain dragged minority owners.  Article 219 provides a statutory complement to these contractual rights.  Through the exercise of drag-along provisions, if the selling shareholders are able to tender 90% or more of the equity to the buyer, the buyer could then utilize the statutory short-form merger procedure under Article 219 to complete acquisition of the remaining equities.

For majority selling shareholders, Article 219 can materially enhance the viability of trade sale exit strategies by reducing the risk of residual minority owners complicating the deal; and for strategic buyers, it offers a clearer route to achieving full ownership of the target.  Therefore, Article 219 caters to aligning contractual rights with statutory mechanism to deliver greater transaction certainty.

Key Considerations in Applying the Squeeze-Out Rules

For the first time, the 2023 Amended PRC Company Law introduces the statutory squeeze-out rules.  That said, these rules remain largely conceptual at this stage and will need to be tested in practice.  Moreover, each sale transaction will present its own unique factors and circumstances in assessing whether the specific transaction executed on the basis of Article 219 is appropriate.  Set out below are several preliminary and high-level key considerations that companies and investors should take into account when evaluating potential use of the squeeze-out mechanism.

1. Determining the “Fair Price”

The determination of a “fair price” lies at the heart of compliance with Article 219 and will be critical to the validity and enforceability of a squeeze-out transaction.  Although the 2023 Amended PRC Company Law provides no provision for what constitutes a fair price under Article 219, reference formula and approach of pricing the equity in sale may be drawn from existing China domestic regulatory practice and comparative international practice:

• Tender offer price. Under the Measures for the Administration of the Takeover of Listed Companies (2025 Amendment, effective on March 27, 2025), Article 35 requires that the tender offer price for a listed company generally not be lower than (i) the highest price paid by the acquirer for shares of the same class during the six months prior to the announcement of the offer, or (ii) the average price of the daily weighted average trading prices for the 30 trading days preceding the announcement.

   

• Audit and valuation reports. Chinese courts and regulators, particularly in state-owned asset transactions, often place substantial weight on auditors’ reports and third-party valuation reports.

   

• Special committee or independent director review. U.S. practice often relies on the independent special committee of the board to negotiate with buyer in conflict-of-interest transactions.  While PRC law and the practice in China do not normally use such concept of special committees, independent directors could serve a similar function.

2. Board Approval and Fiduciary Duties

Although Article 219 eliminates the need for shareholder approval, board approval remains a mandatory requirement. This elevates the importance of directors’ compliance with fiduciary duties in transactions executed under Article 219 squeeze-out rules.

Article 180 of the 2023 Amended PRC Company Law provides that directors owe duties of loyalty and diligence to the company.  Directors, on the one hand must avoid conflicts of interest, may not exploit their position for improper gain, and on the other hand must exercise reasonable care to act in the company’s best interests.  The foregoing fiduciary duties shall also apply to the company’s controlling shareholder or actual controller who, although not formally serving as a director, in fact carries out the company’s affairs.

Article 125 of the 2023 Amended PRC Company Law further provides that directors may be personally liable for board resolutions that violate laws, regulations, the articles of association, or shareholder resolutions, unless their objections are expressly recorded in the meeting minutes of the board meeting.  Accordingly, directors who will be voting on the squeeze-out transaction must be mindful of, and carefully consider, the following:

• Conflict of interests and duty of loyalty.  Conflicts of interest may arise in board resolution of a squeeze-out transaction where director(s) appointed by or affiliated with the controlling shareholder votes on the matter.  The board’s actions could be subject to challenge, particularly where the sale proceeds are distributed according to a liquidation waterfall that leaves minority holders of ordinary shares with little or no value or disproportionately favors certain preferred shareholders.  Conflicted directors should normally abstain from voting.

• Independent directors and advisors. It remains to be seen whether independent directors will become a solution in China practice that akin to the U.S. practice of special committees.  Nonetheless, involving independent directors and relying on third-party financial or appraisal advisors to validate valuation and process can help directors mitigate risk of fiduciary violations.

   

• Fair price and fair dealing. Article 219 is intended to promote and facilitate transactions, but it also establishes a critical safeguard rule that minority shareholders subjected to a forced sale must be afforded the right to receive a fair price.  In practice, this likely means that even after a squeeze-out transaction is completed, directors and the surviving company may still face litigation from dissenting shareholders challenging either the transaction price or the transaction process.

   

For comparison, Delaware courts apply the “entire fairness” standard, scrutinizing both the substantive fairness of the consideration and the procedural fairness of the board’s decision-making process (see leading cases such as Trados[1],Nine Systems[2]).  While the PRC laws and judicial practice do not necessarily follow suit of Delaware’s “entire fairness” approach, PRC courts may err on the side of caution by adopting a thorough standard of review in such disputes.