In proposed amendments to the Company Law now under review by the Standing Committee of the National People’s Congress, key provisions intend to formally establish the legal status of one-person companies (OPCs) limited by shares.
Since the Liechtenstein Persons and Companies Act pioneered legislation of OPCs nearly a century ago, many countries in the world today recognise their legal status, including the EU, US, UK, Japan and South Korea.
This article summarises the significance of China now formalising legal status of OPCs limited by shares and “established by a natural person or a legal person by way of initiation” under Article 93(2) of the draft amendments to the Company Law, announced in December 2021.
A key aspect of the review allows that when a company limited by shares seeks financing through equity transfer, such transfer will not be subject to other shareholders’ consent or pre-emptive right. Thus, it is conducive to capital flow.
Allowing an entrepreneur to set up an OPC avoids the use of nominee shareholders to meet membership requirements, which facilitates market supervision. When the number of shareholders changes due to equity transfer or equity inheritance, an OPC can be easily converted to a multi-person company limited by shares. Such free transition allows flexible capital movements. Once the company grows larger and stronger, and needs to go public to raise funds, it also simplifies the cumbersome procedures of shareholding reform for IPO.
Putting resources together to build state-owned enterprises (SOEs) larger and stronger, as a national economic lifeline, helps boost social and economic stability. The Company Law confines wholly state-owned companies to limited liability companies, which restrains the pooling of capital and development of companies.
A company limited by shares has an inherent advantage in capital market financing. Its greater transparency of financial and operating conditions is conducive to standardising corporate governance and laying a solid foundation for large-scale development. Globally, many multinational conglomerates have enhanced their scale effect and accelerated capital expansion by setting up wholly owned subsidiaries.
Legislative recognition of OPCs helps vitalise SOEs and preserve and increase the value of state-owned assets, while also sharpening their competitive edge relative to overseas multinational conglomerates.
REFINING LEGISLATIVE LOGIC
The Company Law does not recognise the legal status of OPCs and also excludes the concentration of shares in one person due to share inheritance or transfer as a legal cause for dissolution.
Under the current legal framework, legal status becomes ambiguous for a company limited by shares with shares that are concentrated in one person due to share inheritance or transfer. By establishing the legal status of OPCs, the amendment will solve this problem and achieve strict self-consistency in legislative logic.
RISK CONTROL KEY POINTS
If the amendment is formally adopted, the author foresees an upsurge in the setting up of OPCs. After a wholly owned subsidiary limited by shares is set up, the focus of risk prevention for a legal person as a business entity should be on how to prevent the subsidiary from being denied legal personality, and protect its parent from being held jointly and severally liable. For this, the author suggests the following:
(1) Strict financial system. Financial confusion is the primary criterion to identify the confusion in legal personality. According to current regulations, where the shareholder of a single-member company cannot prove the independence of property, the shareholder shall bear joint and several liability for the company’s debts, posing higher requirements for the burden of proof of the shareholder.
Therefore, an OPC should attach greater importance to the soundness of its financial system to ensure independent accounting and clear accounts, and keep its financial personnel separate where possible, so avoiding financial confusion with the parent company.
If there is no special confidentiality requirement, it is better for an unlisted OPC and its parent to publicly disclose their annual reports filed with the industrial and commercial administration. In case of economic disputes, an independently audited and publicly disclosed annual report would provide important proof of financial independence.
(2) Prudent transactions. The focus of the Company Law on OPCs is to prevent them from abusing the legal personality independence and limited liability system to the detriment of creditors’ interests. From the perspective of protecting creditors, the green light for OPCs will certainly require stricter review standards for related party transactions detrimental to creditors’ interests in judicial practice.
Therefore, when self-transactions occur between an OPC and its parent company, or related party transactions take place between companies under common control, greater prudence should be exercised to ensure compliance and adequate risk control in terms of the necessity, reasonableness and transparency of transactions.
(3) Standard voting procedures. Legal personality independence to some extent depends on the independence of the legal person’s will. Strict distinction should be made between the personal will of an OPC’s shareholder and the will of the OPC.
To transform the shareholder’s personal will to the company’s will in the course of the company’s operation, the shareholder’s deliberation and voting procedures should be regulated. A shareholder of an OPC should adopt resolutions through due process to avoid after-event falsification. Written resolutions should be kept properly. Resolutions on significant matters should be included in filings with the industrial and commercial administration for filing purposes.
The amendment to the Company Law only provides general principles for OPCs. The author proposes that a stipulation on the minimum registered capital of OPCs should also be considered. The current Company Law review abolishes the limit on minimum registered capital of companies limited by shares.
But the author believes that an OPC should be subject to a minimum registered capital requirement to avoid abuse of the regime. This would also help to enhance the capital creditworthiness of such companies, demonstrating their difference and competitive advantage compared with a single-member company limited by liability.
Dong Yun is a partner at Joint-Win Partners. He can be contacted on
+86 134 0215 3172 or by email at email@example.com