30 January 2006
1 November 2013
29 July 2013
21 August 2013
10 June 2013
Tougher product liability provisions following the release of long-awaited amendments to consumer rights and interests protection law in China
6 December 2013
China has implemented a number of changes to its once command-based economy to open up its markets to foreign investment and competition since it became a member of the World Trade Organisation four years ago.
The latest move to 'Westernise' itself and improve the legal and business environment for foreign investors came at the start of 2006, when wholesale revisions to the Company Law of the People's Republic of China (PRC) came into force.
These changes included the revision of the regulation of Chinese corporate entities. The most significant of these include changes to registered capital requirements, corporate governance and the increased protection of minority shareholders. The revisions to the Company Law primarily affect the regulation of the two most common forms of domestic enterprise, namely limited-liability companies (LLCs) and companies limited by shares, but they will also have an incremental impact on the way foreign investors do business in China.
Foreign investment in China is restricted by law to a limited number of corporate vehicles known as foreign-invested enterprises (FIEs). FIEs most commonly take the form of wholly foreign-owned enterprises or joint ventures (JVs), of which there are two types, equity and cooperative.
Each type of FIE is subject to its own specific regulatory regime, which in each case contains restrictions on, for example, the minimum investment required from the foreign party, expatriation of profits and, in the case of JVs, the maximum percentage of equity that the foreign party may take.
FIEs are not only required to comply with the Chinese laws and regulations specific to the relevant form of FIE, but are also subject to the Company Law to the extent that there is no clear stipulation in the regulations specific to the type of FIE in question. Furthermore, FIEs themselves are permitted in certain circumstances to acquire interests in domestic PRC companies (such 'reinvestments' being themselves subject to a specific regulatory regime). It is here where the revisions to the Company Law will have the greatest impact upon foreign investors.
The Company Law adopts a 'true capital principle', which differs from the authorised capital provisions commonly seen in the West. This means there is no gap between the registered capital and the capital actually contributed by investors. The revised Company Law lowers the minimum registered capital requirement for both LLCs to Rmb30,000 (£2,100) and for companies limited by shares to Rmb5m (£350,000) and broadens the methods by which registered capital may be contributed.
While the lowering of registered capital requirements may appear spectacular on paper, the amounts stated in the revised Company Law are indicative at best. In practice, authorities often require investors to contribute much higher amounts to registered capital to ensure that a company owns sufficient funds to carry on its intended business. In addition, regulations specific to foreign investment in certain industries may require higher amounts of minimum registered capital.
Where the previous rule said that capital contribution in the form of intangible assets may not exceed 20 per cent of the total registered capital, the revised Company Law stipulates simply that the cash contribution may not be less than 30 per cent of the total registered capital. This means that investors will be allowed to contribute as much as 70 per cent of the total registered capital by such intangible assets as IP rights. Regrettably, the revised Company Law does not state clearly whether shares can be contributed to the registered capital of companies.
Furthermore, in lieu of the previous provisions for the full payment of registered capital at the inception, the revised Company Law allows the registered capital of a company to be contributed in certain cases as much as two years after its establishment. These changes are expected to make it easier, and perhaps cheaper, for foreign parties to invest in, or set up a company in, the PRC.
No more 50 per cent
Prior to the recent revisions, the Company Law provided that, where a company invests in other companies, the aggregate amount of such investment was not allowed to exceed 50 per cent of the net assets of the company. This cap on outward investment has been a significant barrier to many M&A activities, including those driven by foreign investors, as it meant that companies were unable to employ fully all of their assets and thus were seen as ineffective investment vehicles. This limitation has now been completely removed under the revised Company Law, leaving outward investment to the discretion of the shareholders of the company. It is anticipated that this will simplify the M&A market and facilitate acquisitions for smaller companies that need to inject most, if not all, of their assets into a proposed joint venture. Unfortunately, FIEs will not be able to benefit from this relaxation due to a restriction on inter-company investments by FIEs in Tentative Measures on Investments in China by Foreign-Invested Enterprises (effective since 1 September 2000).
The changes to corporate governance include restrictions on the authority of the chairman of the board (who is, under Chinese law, the legal representative of the company) and, at the same time, delegation of more authority to the board of supervisors. This will include the right to call a shareholder meeting and the right to file lawsuits against directors or senior management who are in default.
The revised Company Law also introduces the rules of conflict of interests, where a controlling shareholder, effective controller, director or senior manager of a company incurs personal liability when taking advantage of a relationship with a third party that damages the interests of the company. Directors of listed companies are ineligible to vote on matters in which they have an interest. Notably, the revised Company Law imposes a stricter duty of care on the directors, supervisors and senior management. This will give foreign investors some comfort that senior staff can be held accountable for their actions.
Protection of minority shareholders
For the first time, the revised Company Law enhances shareholder control over the company. Those holding 3 per cent or more of a company's shares may put forward proposals to the board of directors. Shareholders also now have a right to petition the court to revoke resolutions that were made in breach of the law, to sell their shares to the company at reasonable prices and to petition the court to liquidate the company under certain circumstances.
Those holding 10 per cent or more of a company's shares have the right to petition the People's Court to liquidate the company when the company's managerial problems threaten to damage shareholders' interests. A certain percentage of shareholders are also now entitled to bring actions against directors, supervisors and/or senior management for breaches of the law or the company's articles of association. This will be particularly important in the case of an FIE JV where the foreign party is a minority shareholder, which is common where the industry in which the JV is operating is deemed to have been restricted by the Ministry of Commerce.
The revised Company Law also brings in a variety of noteworthy changes. It introduces one-person companies and the principle of 'piercing the corporate veil'; it regulates transactions between affiliated companies, enhances employees' participation in the management of the company and amends the conditions for public listing and bond issue.
However, it is by no means a complete panacea - it contains sufficient contradictions, omissions and ambiguities to cause headaches for lawyers advising clients looking to invest in China. The legal community will therefore be looking to the Chinese government to promulgate further implementing regulations with the aim of clarifying the regulatory procedures. It may be that the full impact of these revisions can be assessed only after such clarification is provided.
Finally, foreign investors should be aware that, in many respects, FIEs and domestically invested companies are subject to different regimes and rules. Article 218 of the revised Company Law states that, where the laws governing foreign investment differ from the provisions of the revised Company Law, the former shall prevail. In other words, the revised Company Law applies to foreign investors and FIEs only in circumstances where legislation on FIEs is silent, and few of the benefits of the revised Company Law will actually flow through to foreign investors and FIEs.
Dale Fischer is a corporate partner and Derek Roth-Biester is a senior associate at the Hong Kong office of Pinsent Masons