For those familiar with shareholding companies where venture capital (VC) is better established than in Vietnam, the concept of voting preference shares is familiar.

I remember in law school discussing the differences in classes of shares for startups and shareholding companies, and the idea that classes of shares are treated differently from each other. That much is true here in Vietnam, but there are differences.

In California, where I studied law, classes of shares are allowed to vote for changes to their own rights according to class. That means that the A-round shares can only vote to change the rights and obligations of the A-round shares but not the B or C round shares, and vice versa.

That concept remains different from what exists here in Vietnam. While ordinary shares can be divided into classes other than those listed in the law (voting, dividend, and redemption) the rights and obligations of those classes of shares remain dictated by the law and charter.

There is no contemplation of instilling in each class of shares the sole right to amend the rights and obligations of that class. Only through legislation or amendment of the governing documents of the company can a change to the rights and obligations of shares be changed. And then, only the ordinary share rights and obligations can be changed.

This means that voting preference shares, dividend preference shares, and redemption preference shares–though they may be separate classes–are only allowed certain rights and obligations in addition to ordinary shares, and those rights and obligations are fixed by law. They cannot be changed by a vote of the class of preference shares or even by vote of the majority of shareholders in general.

Preference shares, except those prescribed by the charter–are thus severely restricted by the law of Vietnam, and though one might think that voting preference shares would allow for a greater ability to affect the rights and obligations of themselves, you would be wrong.

Voting preference shares are granted with more rights than ordinary shareholders, but are also restricted. Voting preference shares are treated nearly identically to ordinary shares with a few distinct differences.

First, they are granted more than one vote per share. The actual number of votes each share enjoys is governed by the charter of the company of which the shareholder of voting preference shares is an owner. But once that number is defined, only a change of the charter, which must be done by majority, or super-majority, of the shareholders can change it. Voting preference share holders cannot change that number on their own.

Second, voting preference share holders cannot alienate their voting preference rights. That means that, while voting preference shares can be sold by the company to certain individuals (we’ll get to that in a moment) those individuals cannot resale those shares to a third party. It is currently unclear whether those voting preference shares can be converted into ordinary shares and then sold, but according to law, the owner of voting preference shares is left with an asset that he can’t exit.

Otherwise, voting preference shares rights and obligations remain the same as ordinary shareholders.

Now to the tricky part: who can own voting preference shares?

The law dictates that voting preference shares can only be owned by two categories of people: founders and organizations that are approved by the government.

For founders, the voting preference share is limited. After three years from the date of issuance of the enterprise registration certificate, those voting preference shares are automatically converted into ordinary shares, leaving the founders with no more rights than any other ordinary shareholder. This is a major drawback as often, founders–especially of a startup–may remain in control of a company and wish to maintain a greater influence on its decisions than is allowed by an ordinary share voting ratio. It also means that the founders of a startup are time limited if they want to exercise additional rights of voting during funding rounds with VCs, or to anticipate second or third round funding, or event exit.

Once the three years from issuance of the ERC passes, however, the founding shareholders lose their voting preferences. They are left with ordinary shares and any preference shares of other classes which they may own. Only the organizations which are authorized by the government remain.

Now, this part is troubling.

First, only organizations can be authorized to own voting preference shares. That means that individual VCs can’t own voting preference shares, individual shareholders other than the founders can’t own voting preference shares, and non-authorized organizations can’t own preference shares.

Second, how does the government authorize organizations to hold voting preference shares?

One could assume that the government is able to approve such situations when they approve, regulatorily, M&A transactions. But this is not the case. Regulators don’t look at preference shares. They look at foreign ownership ratios, they look at amendments to the charter that are required under law, and they look at market share. Only in the charter of the company is there a requirement for identification of the preference share classes, and that is limited to the total number of each type of shares and the value of each class of shares. There is no requirement for listing the actual shareholders of each class of preference shares.

There is no other mechanism for the government to authorize voting preference shareholders. This creates a major problem as voting preference shares are, in practice, purchased by many foreign investors without specific authorization of the government. Previously–in the 2005 enterprise law–a list of shareholders was required to change the share ownership. That is no longer the case, and the many voting preference shareholders that are individuals or that are organizations who believe they are holding voting preference shares in full right of the law may be in for a surprise.

The enforcement of this right as against other shareholders and the company is limited. This is a tricky requirement and I only found it in the law recently. It’s well disguised, like Army camouflage in the forest, and hard to spot. That means that most companies and business probably aren’t familiar with this requirement. That means that a holder of voting preference shares can enforce his rights through self-help without much protest. But take it to court. . .

Enforcement in the courts, or even arbitration, will run across this requirement and unless the organization holding voting preference shares is authorized to do so by the government, then–in addition to the fact of their shareholding of voting preference shares–any decisions made as a result of their preference shareholding can be declared void.

This is a big problem that has been looming since before the 2005 Enterprise Law, and, so far, has yet to be addressed in the draft Enterprise Law coming up before the National Assembly in the next session. The People’s Supreme Court has yet to address the issue. All that is left is an appeal to the administrative offices of the relevant government organs.

Failing a resolution by law, then one must wonder how to deal with the many instances where individuals, or non-authorized organizations, control voting preference shares.

Perhaps the answer lies in the provision that allows other classes of shares to be defined in the charter of the company. The relevant ministries have yet to issue governing documents concerning the provision of additional classes of shares. As long as that class is provided for in the charter, and that charter is approved during the enterprise registration procedures–or amendments–then the government has approved the class of shares, at least hypothetically.

It’s either define your own class or figure out how the courts will interpret the requirement for government authorization.

Amendment 13 November 2019

While, in general, the rules I discussed in the above article apply, I had not taken into account Decree 78/2015/ND-CP issued by the National Assembly less than a year after the Law on Enterprises 2014 was passed. It does not affect the full scope of my argument, however, there is a mechanism for government approval of foreign ownership of preference shares in private joint-stock companies.

According to Article 52, when the foreign holding percentage changes, the company must register with the DPI the new ownership share. This notification must include a listing of the foreign owners, the number of shares they hold, and the type of shares they hold. This means that for foreign owners of private companies, there could be, in a way, a method for government authorization of voting preference share ownership for foreign shareholders.

However, this method for government authorization does not apply to domestic investors, and only applies when the foreign shareholding percentages are changed. This does not demonstrate a completely fool-proof method for approving voting share ownership, particularly as the business registration office only has a three-day turnaround to approve the change in the business registration information and issue a new license.

The argument remains intact, by and large, and I simply include this amendment to address information new to me. I apologize if there was any confusion because of my lack.