1.1 The Evolution of Corporate Law in China
Corporate law in China was developed as part of efforts to reform the overall business law framework beginning in the late 1970s. Legal reforms were initiated at the start of the gaige kaifang āreform and opening upā period by large business entities in both the state and non-state sectors. Consequently, not only did state-owned businesses benefit from the reforms but so did private enterprises. The ensuing economic reform testified to the need for a standardized national legal framework for business that could guide corporate associations and organizations. It took until 1993 however for this standardized framework to be validated by the National Peopleās Congress, the legislature of China, as the Company Law of 1993.
The promulgation of the Company Law of 1993 facilitated a series of economic reforms that transformed Chinaās economy from a planned to a market-oriented system. The law then underwent a series of amendments and revisions by the National Peopleās Congress in 1999 and 2004, again in 2005, effective on January 1, 2006, and again in December 2013, effective from March 1, 2014. Each revision marked a milestone in the development of Chinese corporate law. The first revision, in 1999, resolved, among other things, the issue of supervision and management of state-owned companies and aimed at promoting growth of high technology by condoning a higher level of recognition of technological contributions to corporationsā registered capital. The second revision, in 2004, among other things, abolished governmental approvals that had previously been necessary for the issuance of above par value stocks. The revision of 2005 provided a basic legal framework by adopting a more balanced approach to modern corporate governance. Revisions of the Company Law in 2013 abolished the minimum registered capital contribution requirement for corporations. Under the newly-revised corporate law, not only was no minimum registered capital required, but the requirement of an initial contribution of registered capital and the proportion of cash in the registered capital contribution, were also abolished.1 The revised Company Law of 2013 replaced the paid-in contributions of registered capital requirement with a registered capital by subscription requirement. Under the new subscription system, shareholders had to agree to their subscribed amount, contribution methods, and contribution timing. The revised law no longer required a paid-in minimum registered capital. The timetable for the contribution, the investment certificate, and the registration of paid-in registered capital at the company registration authority will be discussed further later in this chapter.
1.2 Legal Framework
The current corporate law regime consists of Chinese constitutional law, national laws promulgated by the Chinese National Peopleās Congress, regional and local laws enacted by regional and local legislative authorities, administrative rules and regulations enacted by the Chinese State Council and departmental rules issued by cabinet departments under the State Council.
As the fundamental law of the country, the Constitution of the Peopleās Republic of China and its subsequent amendments, provides the overall governance structure for the regulation of all corporations. Lending legitimacy to the existence and establishment of corporations, the Constitution states that economic ownership exists in a tiered ownership system comprising both public and private elements. Private ownership coexists with public ownership, with public ownership at the core.2 Constitutional law allows for different modes of distribution, giving validity to both publicly and privately-owned economic entities. Constitutionally, private business has a legitimate place in the economic system, with the government taking on the role of protecting the lawful rights and interests of economic individuals and private businesses via encouragement, support and guidance.3
In addition to Chinaās constitutional law, the main body of law that governs corporations in China comprises the Company Law, the Civil Law, the Securities Law, the Bankruptcy Law, and the Commercial Banking Law. If a corporation involves foreign investment interests, it is also subject to laws related to foreign investment (FIE law). These include the Equity Joint Venture Law (EJV Law), the Cooperative Joint Venture Law (CJV Law), and the Wholly Foreign-owned Enterprise Law (WFOE Law).
Administrative rules and regulations are another important part of the governing regime. Administrative rules and regulations are issued by the State Council, with authorized agency departments tasked with exercising regulation and supervising corporations. The departments that issue rules governing corporations are principally the State Administration of Industry and Commerce (SAIC), the State Administration of Foreign Exchange (SAFE), the State Administration of Taxation (SAT), the State Asset Supervision and Administration Commission (SASAC), and the China Securities Regulatory Commission (CSRC).
1.3 Corporations
1.3.1 General Introduction
A corporation is an artificial entity created by law to act within the scope of the law to achieve designated purposes. Being an artificial entity, a corporation can act only through agents. Those agents are officers and managers who are entrusted to act on behalf of the corporation.
A corporation has the capacity to undertake civil actions, and these may include owning property, entering into contracts, and suing or being sued in the name of the corporation. In theory, a corporation may enjoy a perpetual existence. Under the law, a corporation is a legal person with independent business property, and may exercise property rights thereto.
The essence of a corporation is limited liability. As the corporation owns corporate assets, shareholders no longer own those assets or capital once they have been contributed to the corporation. The corporation is liable for its debts with regard to all its assets. Shareholders are liable for corporate debts regarding the shares they own or contributions they have made to the corporation. Corporation agents, namely officers and managers, are not generally liable for the debts of the corporation. This is the core value of corporate limited liability. Company Law, however, does impose certain personal liabilities on shareholders. They may be, especially controlling shareholders, held personally liable for any abuses of their position within the corporation. To find otherwise would be tantamount to condoning an abuse of the limited liability protection of the corporation by giving wrongdoers an unfair advantage over creditors in terms of rights and interests.
1.3.2 Piercing the Corporate Veil
The revised Company Law of 2005 codified ācorporate veil piercingā as legal doctrine. Intended to impose liability upon shareholders, especially controlling shareholders, who are found to have abused their positions, it describes the process of removing the corporate legal personality identity in order to call shareholders or a shareholder of a corporation to account. The doctrine can be applied in circumstances where a shareholder abuses the independent identity of the juridical person of the corporation or their limited liability to evade their liability with respect to a debt payment or where a shareholder co-mingles their personal funds with the assets of the corporation. An example of this might be when the sole shareholder of a company uses its funds and assets as their own. The legal significance of this doctrine is to minimize the absolute effect of limited liability borne by a corporate entity.
Despite its fairly recent codification, the courts had been applying the principle of corporate veil piercing before 2006. The first instance was a 1994 Supreme Court decision in response to an inquiry made by the Guangdong High Court. Its response was that corporate veil piercing was permissible if the actual capital contribution made to a corporation was less than the sum of registered capital of the company. Undercapitalization was thereafter a consideration in applying the doctrine. Interestingly, later revisions of the corporate law did not include the response of the Supreme Peopleās Court of 1994 in its codification that undercapitalization might be considered a factor in cases of corporate veil piercing.
The Company Law of 2005 offered two more provisions regarding the doctrine of corporate veil piercing. Article 20 of the law states that āwhere any shareholders of a corporation evades payment of its debt by abusing the independent identity of juridical person or the shareholderās limited liability, thus seriously damaging the interests of creditors, it shall bear joint liabilities for the debts of the corporation.ā Article 20 focuses on two factors that the courts should consider in deciding to pierce the corporate veil, namely (1) whether the abuse resulted in non-payment of debts, and (2) whether this non-payment caused any actual injury to the creditor. Article 64 of the law provides for a commingling of funds in a sole shareholder limited liability corporation, in that āif the shareholder of a one-person limited liability corporation is not independent from their own property, they shall bear joint liabilities for the debts of the corporation.ā
Currently, in deciding whether or not to pierce the corporate veil, the court applies these two factors. The legal focus of concern remains the protection of creditorsā rights. The doctrine in effect grants the court more discretion in holding shareholders liable for abusing their position. The law does not suggest the presence of fraud is a factor for judicial consideration. Relevant judicial practice suggests that courts tend to follow a narrow reading of the law and limit the application of the doctrine to circumstances that concern the protection of creditorsā interests.
1.4 Types of Corporations
1.4.1 Limited Liability Corporations and Joint Stock Corporations
There are two main types of corporation in China. They are the limited liability company (LLC) and the joint stock limited company (JSC).
A LLC is usually a privately-held, small-scale entity, owned by a limited number of shareholders who enjoy rights in proportion to their capital contributions. They may, however, agree otherwise with respect to their rights regarding management and profit if agreed to by all shareholders and included in the articles of incorporation. They may also make decisions with respect to the structure and management of the company if included in the articles of incorporation. In general, the law lends a greater degree of management and operational freedom to limited liability companies.
A JSC is usually a medium to large scale enterprise. The governance structure is composed of a shareholder meeting, a board of directors, a board of supervisors, and a body of executive management. It has limited liability. It may be established upon the issuance of stocks to incorporators and may issue one part of its stocks to incorporators and the other to investors. In a partial purchase of stocks, incorporators must purchase a required 35 per cent minimum of the total number of the stocks of the corporation. The corporation may decide to issue shares to the public or specified investors for subscription. It may also choose to list shares on the stock exchange to become a public corporation.
In practice, a corporation may change from a LLC to a JSC or vice versa upon satisfying statutory requirements.
1.4.2 Special Types of Corporations in China
The Company Law sets out special categories for corporations. These are single member LLCs, wholly state-owned enterprises (SOEs), and listed corporations.
1.4.3 The Single Member Limited Liability Company (LLCs)
Single member LLCs or wholly state-owned corporations are limited liability corporations. Listed corporations must be established and organized as joint stock corporations.
A revision under the Company Law of 2005 allowed a single member to establish a limited liability company. Under the previous version of the law, a LLC was required to have a minimum of two shareholders. In practice, there were already single member companies before the Company Law of 2005 came into being. Such companies operated and maintained business activities by having a shadow shareholder. Recognition of the validity of a single shareholder company under the Company Law of 2005 saw the national legislature provide a legal basis for the practice of wholly state-owned companies (SOEs) or wholly foreign-owned enterprises (WFOEs).
Specifically, single member LLCs are companies with one shareholder, who may be a natural or a legal person. A natural person may establish only one single member LLC. Such a LLC may not invest to establish a single person LLC. The Company Law of 2005 determined that the minimum registered capital for such companies was a lump sum of RMB 100,000. The Company Law of 2014 abolished both requirements for establishing a single member LLC.4
Upon filing for company registration, a LLC with a single shareholder is required to state that it is solely funded by one natural or legal person as shown on the company business license. A single member LLC may use a simplified style of management. Any shareholder meeting decision is required by law to be made in writing and kept with the company. An audited financial statement at the end of each fiscal year is also required.
By virtue of the legislative validation of single member LLCs, a foreign individual investor may set up a wholly foreign-owned enterprise (WFOE). They are required, however, to comply with all the relevant provisions of the Company Law and the Wholly Foreign-owned Enterprise Law.
1.4.4 Wholly State-Owned Enterprises (WFOE)
A wholly state-owned enterprise is another type of corporation that is specific to China.
A wholly state-owned enterprise (WFOE) is a LLC established through investment by the state. Here, the state refers to agencies authorized by the State Council or local authorities that manage and supervise state-owned assets by acti...