An alarming number of companies – many listed – became mired in debt and were even pushed to the edge of bankruptcy in recent years due to the illegal provision of external security. To tighten control over listed companies providing external security, the China Securities Regulatory Commission (CSRC), together with the Ministry of Public Security, the State‑owned Assets Supervision and Administration Commission (SASAC) and the China Banking and Insurance Regulatory Commission (CBIRC) on 26 November issued the draft for comments of the Regulatory Guidelines for Listed Companies No. 8 – Regulatory Requirements for Capital Transaction and External Security.
External security for this article refers to when companies provide security for other companies with their own credit or specific assets. In other words, it excludes any provision of security for the company’s own debt.
Improving the approval process for external security and establishing accountability. Consistent with the Circular on Regulating the External Security Provided by Listed Companies (circular No. 120) issued by the CSRC and the China Banking Regulatory Commission, article 7 of the guidelines sets high standards for listed companies’ internal review and accountability systems.
The respective authority of the shareholders’ general meeting and the board of directors for examining and approving external security should be expressly set out under the articles of association. In cases of non-compliant guarantee security provision, companies should be able to trace the exact person responsible, so as to prevent such incidents from the source.
External security to be considered by the shareholders’ general meeting should be first considered by the board of directors. According to article 9 of the guidelines, if the external security is subject to a resolution of the board of directors, it needs only be considered by the board of directors; if the external security is subject to a resolution of the shareholders’ general meeting, it must first be approved by the board of directors before being submitted to shareholders for consideration.
The article is also consistent with the provisions of circular No. 120. Listed companies should pay heed to whether they need “double approval” when providing external security. In addition, the provisions make it mandatory for certain types of external security to be considered by the shareholders’ general meeting, to which listed companies should pay special attention.
The voting requirements in article 9 of the guidelines in respect of consideration by the shareholders’ general meeting on security for affiliates are consistent with those in article 16 of the Company Law. However, regarding consideration by the board of directors, the guidelines clearly differ from those in the Company Law.
Article 111 of the Company Law provides that a board resolution can be approved by a simple majority of directors. The guidelines require approval by at least two-thirds of directors at the meeting – though they do not expressly require all directors to attend. It seems clear that the legislative intent of the guidelines is to make the requirements for the consideration of security more strict. Whether this provision can regulate the procedure of the board of directors more strictly remains to be tested in practice.
Announcement and restrictions
In addition to requiring that the external security by listed companies should be publicly disclosed, article 12 of the guidelines specifies the contents such disclosures should contain, including the resolutions of the board or general meeting, the total amount of external security provided by the listed company and its controlled subsidiaries, and the total amount of security provided by the parent to those units.
Listed companies should make disclosure in strict accordance with the prescribed content, instead of making disclosure a mere formality. For the restrictions on external security, the guidelines do not adopt the restrictions on the objects of external security by listed companies and their financial indicators provided in the Circular on Regulating the Capital Transactions Between Listed Companies and Affiliates and Some Issues Concerning External Security by Listed Companies (Circular No. 16).
Whether the debtor is required to provide counter-security for the external security by listed companies has been much debated. The Civil Code requires that counter-security “may” rather than “must” be provided. In practice, there is no penalty for failure to provide counter-security. Compared with Circular No. 16, which requires everyone to provide counter-security, the guidelines limit the scope of persons who should provide counter-security to the controlling shareholders, actual controllers and affiliates of listed companies, which moderately lightens the obligations of the listed companies.
Security by controlled subsidiaries
Compared with article 9 of the Interpretation of the Supreme People’s Court on the Application of the Security System in the Civil Code, article 15 of the guidelines directly deems the security provided by the controlled subsidiaries of listed companies to persons outside the scope of consolidated statements as being security provided by the listed companies themselves. In future, listed companies should not only disclose the relevant resolutions of their controlled subsidiaries, but also make their own effective resolutions and disclose accordingly, and perform stricter consideration and announcement procedures.
Rectification and disposal
Compared with Circular No. 16, the guidelines do not impose strict requirements on time given to rectify illegal security or the disclosure of the rectification results. They do, however, add the disposal authority of state-owned assets supervision and administration authorities and public security authorities concerning illegal security and further boost the scope and strength of disposal, reflecting the determination of legislators to dispose of illegal security.
To sum up, the guidelines reaffirm and refine the requirements of listed companies when providing external security, and include the rectification of illegal security into the list of work to be continually promoted. As such, they demonstrate the resolve of the relevant departments to regulate the provision of external security by listed companies.
Over time, we can expect that listed companies will gradually enter the benign development stage of standardised security to ensure better realisation of the interests of minority shareholders and creditors.
Yao Xiaomin is a partner and Wang Yumo is an associate at Lantai Partners
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