Since its implementation on 1 July 1994, the Company Law has played a crucial role in China’s reform and opening up, effectively achieving the legislative goal of encouraging investment. To date, more than 40 million companies have been established, and nearly 10,000 public companies are listed on the Shanghai, Shenzhen and Beijing stock exchanges, as well as on the National Equities Exchange and Quotations.
Many companies with strong advantages in technology, management and scale have entered the Fortune 500, and numerous companies have stood out in niche sectors through domestic and international mergers and acquisitions. These achievements are significant for a country like China, which has a relatively weak market and industrial base.
Senior Partner
Kangda Law Firm
China’s market economy experiment, conducted under such weak conditions for just 30 years, reveals a stark contrast to the nearly 500 years of market economic development in Western countries. Currently, there are phenomena of disordered development and rampant growth, with many companies still at a low level of organisation, scale and modernisation, and issues with corporate executives abusing legal rights are common.
Legislators need to acknowledge and address these problems, providing legislative guidance to market participants. Here are some signals that the revised Company Law is sending to the market economy:
Encouraging competitive and well-governed companies. The recent economic downturn tests companies’ core competitiveness and corporate governance. From the perspective of the Company Law, companies that fail first typically lack core competitiveness; over-expand, leading to excessive legal risks; or have ineffective or seriously flawed governance functions.
These flaws include poor decision-making by the shareholders’ meeting/board of directors at critical times, improper execution of decisions by the management team, lack of error correction mechanisms, shareholder disputes causing deadlock, or major legal violations.
The sustained stock price and market value growth of Midea Group in the past five years, contrasted with the collapse of Evergrande Group, aptly illustrates that “good corporate governance is essential for a company’s success”.
Encouraging positive relationships between companies, shareholders and DSOs. The revision reinforces the obligations and responsibilities of shareholders, particularly controlling shareholders and actual controllers. Specific changes include: article 23 introduces “the horizontal corporate personality denial system” in addition to the existing “vertical corporate personality denial system”; article 47 clarifies that shareholders of all companies are obliged to pay their subscribed capital in full within five years; article 54 raises the threshold for accelerated capital contributions from company insolvent to company unable to pay due debts; article 89 allows other shareholders to demand the company repurchase their shares if the controlling shareholder of a limited liability company severely abuses rights and harms the company or shareholders; article 180 introduces the “shadow director/officer” system; article 192 imposes joint liability on controlling shareholders directing directors, supervisors and officers (DSOs) to act against the company’s or shareholders’ interests; article 57 expands shareholders’ right to information to include accounting vouchers and wholly owned subsidiaries; and article 189 introduces the “dual derivative suits” system for shareholders.
The revision also sets higher standards for the performance of DSOs, enforcing their duties of loyalty and diligence, and liabilities for failing to meet these duties. For instance: article 51 stipulates the duty to inspect and supervise shareholders’ capital contributions; article 53 imposes joint liability for shareholders’ withdrawal of capital contributions; article 191 specifies liability for damages caused to third parties due to intentional or gross negligence; and article 232 designates directors as liquidators.
In the current external environment, achieving corporate success requires mutual selection between shareholders and professional managers. Trustworthy, responsible and accountable shareholders will choose directors and officers with strong professional knowledge, skills and work ethic, and vice versa.
Encouraging investors to be well prepared before starting a new business. In a mature market economy, entrepreneurship requires thorough preparation. Besides having ideas, funds and talent, entrepreneurs need to understand the Company Law, the behavioural norms and requirements for establishing and operating a company, and the legal consequences if the company fails to establish.
Clarifying practical confusions in the Company Law. The revision also addresses practical confusions in the current Company Law, such as whether unlisted joint-stock companies can restrict share transfers, whether they must establish a board of directors, and whether shareholding restrictions apply to DSOs of unlisted joint-stock companies.
Although the revision does not use the classification standards of private company (company with restricted share transfer) and public company, it adopts similar system designs for non-listed joint-stock companies as those for limited liability companies, such as allowing share transfer restrictions and not requiring a board of directors. This alleviates practical concerns and marks a significant step towards a more reasonable company classification standard.
To better achieve the legislative goal of encouraging investment under the Company Law, the author has two recommendations: (1) other laws, such as the Labour Law, Tax Law and supporting administrative regulations should be harmonised with the Company Law to create a favourable business environment; and (2) swiftly enact a Personal Bankruptcy Law. Currently, many individual shareholders in China provide guarantees for company actions (such as loans). The introduction of a Personal Bankruptcy Law would offer protection to these shareholders.
Zhang Li is a senior partner at Kangda Law Firm. She can be contacted by phone at +86 10 5086 7577 and by email at li.zhang@kangdalawyers.com
