The PRC's new company law is nice in theory, but might not be so useful in practice. This article runs through the bigger changes, what they might bring and provides pointers for private equity investors. The company here includes both limited liability company and company limited by shares.

The A to Z Guide to Chinese Company Law（Ⅱ）

April 1, 2006
International Financial Law Review

Seung Chong

Open information
Shareholders have always had the right to examine a company's financial and accounting reports, such as the balance sheet, profit and loss statement and the statement of the company's financial condition, and they will continue to have this right. The new Law goes a step further by entitling a shareholder of a limited liability company to examine the company's accounting books by submitting a request with reasons for the disclosure. The right for a shareholder to examine accounting books, business records, vouchers and documents will be beneficial for minority shareholders. It has the potential to be disruptive to a private equity-funded company in the case where middle management or employees have obtained shares and so have the right to inspect accounting records. Accounting books also contain more commercially sensitive information than financial statements, such as pricing information, discounting terms and customer volumes and there is a risk that an employee-shareholder could use this information improperly.

Powers of shareholders
The shareholders of a limited liability company and company limited by shares at general meeting represent the highest body of authority. The new Law gives minority shareholders the right to table resolutions for approval at general meeting. Shareholders holding at least 3% of the company's shares are permitted to propose resolutions to the directors, who are then obliged to notify the other shareholders and to include it in the meeting agenda.

Quorum
In the case of a company limited by shares, half or more of all the directors must be present to hold a board meeting that has a quorum. Resolutions must be passed by half or more of all the directors present at the meeting. No requirements on quorum and voting requirements have been laid down for board meetings of limited liability companies. Shareholder meetings of a limited liability company can be convened by shareholders holding at least 10% of the voting rights, reduced from 25%. This brings limited liability companies into line with companies limited by shares.

Repurchase of shares
The new Law confers on shareholders rights relating to the repurchase of shares or equity. Previously, a company could not repurchase shares except to reduce its registered capital or to merge with a company that holds its shares. These rules continue to apply to companies limited by shares, which can also repurchase shares to grant them to employees as an incentive. Under the new Law, a shareholder in a limited liability company can request the company to repurchase his equity at a reasonable price if he votes against a resolution at a general meeting that relates to any of the following matters: (i) where the company has not distributed profits for five consecutive years and the company has been profitable during that period and meets the conditions for making distributions; (ii) a merger or division of the company; (iii) a transfer by the company of its principal assets; or (iv) the company's term of operations has expired (or other grounds for dissolution as stated in the articles of association have arisen) and the shareholders have resolved at general meeting to extend the term of the company. If no agreement is reached within 60 days of the shareholders meeting at which the resolution was passed, the shareholder can initiate proceedings in the People's court within a further period of 30 days. This provision means that a shareholder can be bought out from a company if the company carries out an asset sale of its business. In the case of a company limited by shares, a shareholder can request a repurchase of shares if he opposes a resolution to approve the merger or division of the company. A repurchase of shares or equity would involve a reduction in capital. The new Law introduces a procedure for the reduction in capital.

Shares
Another first for the new Law is the contemplation that different classes of shares might be permitted. These will be subject to new rules expected to be promulgated.

Transfers of shares and equity
The concern to investors is whether shares and equity can be freely transferred. Private equity investors will be keen to know what statutory rights apply to prevent or pre-empt transfers of shares and equity. The new Law contains a provision regulating transfers of equity in a limited liability company that amplifies the previous provision. A shareholder wishing to transfer equity to a non-shareholder must obtain the consent of a majority of the other shareholders. If they do not respond within 30 days, they are deemed to have consented. If a majority of the shareholders do not consent, those who withheld consent must purchase the equity to be transferred. If an objecting shareholder fails to complete the purchase, he will be deemed to have consented to the transfer. The other shareholders will also have a right of pre-emption over the equity to be transferred. Where more than one shareholder exercises his right of pre-emption, the shareholders can discuss how to allocate the equity between themselves. If they cannot agree, the equity will be allocated pro rata to their existing equity interests. These rules do not apply to transfers between existing shareholders. In practice, the articles of association should spell out clearly how rights of pre-emption should work. There are no similar restrictions for a company limited by shares.

The three-year restriction against the transfer of promoter shares has been reduced to one year. This is an important amendment for private equity investors that often invest in companies where the PRC management and investors hold promoter shares, as the amendment will add liquidity to the private equity market.

Unions
The new Law affirms the importance of labour unions but the ambiguity of a union's right to represent non-members remains.

Veil, corporate
PRC law respects the doctrine of corporate personality and the new Law affirms the doctrine. The general rule is that a shareholder is only liable to a company up to the amount of his capital contributions or, if those contributions have not been made, up to the amount of his agreed contributions. However, the new Law has provided that the corporate veil can be pierced in certain instances. For example, if a shareholder abuses his rights as a shareholder and causes loss to the company or other shareholders, he might be liable in damages. Likewise, where a controlling shareholder, de facto controller, director, supervisor or senior officer uses his relationship to damage the interests of the company causing it loss, he might be liable in damages to the company. The clear inunciation of these circumstances needs to be carefully considered by private equity investors, because a piercing of the veil could expose their funds to liability. Intermediate offshore holding companies should be used where possible to insulate liability. Any further piercing of the veil would be determined under the law of the place where the intermediate holding company is incorporated. Transactions that are more likely to give rise to a piercing of the veil include those that are carried on by a company when it is insolvent.

Weighted voting
Weighted voting refers to the threshold required to approve certain matters. Amendments to the articles of association, increases or reductions in registered capital and the merger, division, dissolution or change in the company's form require the approval of shareholders holding at least two-thirds of the voting rights in a limited liability company, or the approval of shareholders representing at least two-thirds of the voting rights present at general meeting. Where a listed company sells or purchases material assets in a single year, or where the value of security given to secure the liabilities of any third party or subsidiary exceeds 30% of the company's assets, a resolution of shareholders representing at least two-thirds of the voting rights present at general meeting is required.

X
This stands for the x-files that contain those provisions that have disappeared. The notorious 50% rule that prevented a company from investing no more than 50% of its net assets in a company (including another company) has been abolished. The rule had always been a constraint when structuring acquisitions as, relative to the target, any acquirer would have had to be double in net asset value post-acquisition. The removal of the rule should therefore facilitate mergers and acquisitions in China. The question remains as to whether foreign-invested enterprises continue to be subject to separate rules made in 2000 that impose the 50% rule. The preferred view is that they should not, because those rules were made pursuant to the old Company Law. Given that the old Company Law has been amended, the 2000 rules should be implicitly repealed to the extent they are inconsistent.

Y
This stands for "Why?" – referring to those provisions that would have been useful if they had been promulgated in the new Law. For example, where a company is being privatized or being acquired there is no mechanism to implement a 100% buyout, because the new Law does not contain provisions whereby the acquirer can compulsorily acquire or squeeze out the dissenting shareholders, or provisions where a scheme of arrangement can be effected.

Zhai Juan (bonds)
The conditions for the issuance of bonds have been removed from the new Law and are now contained in the new Securities Law. The old Company Law did permit convertible bonds to be issued, although these provisions were rarely used.

The new Law raises the sophistication of corporate law in China. The question remains, however, how it will be applied in practice. Although the impact of the new Law might be tempered somewhat by the fact that the laws applicable to foreign-invested enterprises continue to govern where the latter have express provisions on similar points, there is no doubt that its influence will be felt and longer lasting.

Vocabulary

come into force 生效

corporate governance  公司治理

convene  召集，召唤

limited liability company  有限责任公司

company limited by shares  股份有限责任公司

confer upon  授予

proceedings  诉讼程序

security  担保

secure  为……提供担保

detrimental  有害的

parent company  母公司

upstream guarantee  上游担保

absolve  赦免，免责

minutes  会议纪录

minimum registered capital  最低注册资本

cap  上限

statutory common reserve  法定公积金

statutory provident fund  法定公积金

social security  社会保障

pro rata  按比例分配

listed company  上市公司

minority shareholders  少数股股东

majority shareholders  多数股股东

bona fide  真正的

legal representative  法人代表

right of first refusal  优先承购权

paid-in capital  实收资本

subscribe  认购

balance sheet  资产负债表

profit and loss statement  损益表

quorum  有效的法定人数

repurchase  回购

promulgate  颁布，公布，传播

pre－empt  以先买权取得

pre－empt  先买权

de facto  事实上的，实际上的

insolvent  无偿付能力的，无钱偿付债务的

weighted voting  加权投票

repeal  废除，取消，作废

buyout  买下所有权

dissent  持异议，不同意，意见不一致