Foreign Investors In China: The Old New Law Is Still The Law

China non-compete

Leading law publisher Bowne is recommending a law journal article CLB’s own Steve Dickinson wrote at the onset of China’s new company law in a summary entitled New Law Governs Foreign Investors’ LLCs In China. [link no longer exists].

The site very nicely summarizes Steve’s article, Introduction To The New Company Law Of The People’s Republic Of China, from the University of Washington Law School’s Pacific Rim Law & Policy Journal:

Eliminating cookie-cutter charters
. After 13 years of application, China has completely revised the 1993 law on limited liability companies. Attorney Steven Dickinson, an expert in Chinese law, explains that LLCs are the only operational vehicles open to foreigners under China’s foreign-direct-investment statutes. While the old law dictated the provisions of every company’s articles of association, the new statute encourages shareholders to tailor the articles to the company’s size, nature, and distinctive needs. For example, the company is no longer required to distribute profits in proportion to shareholders’ ownership interests. The new law drastically cuts its predecessor’s minimum-capital requirements and discards its different capital requirements for different kinds of businesses. Another change permits a company to have only one shareholder, rather than two or more, although the minimum-capital requirement is higher for a single-shareholder company.

Researching companies is now as easy as pie.
Under the 1993 law, the public and shareholders faced great difficulty in accessing corporate information. To protect creditors, the new law gives the public the right to obtain basic corporate registration information (such as registered capital, type of business, and shareholders’ names) and requires the registration authority to help the public in doing so. In addition, the company must keep—and make available at a shareholder’s request—the articles of association, minutes for meetings of the directors or supervisors, tax returns, and financial reports. Access rights extend to the complete financial records, the author notes, although the company can withhold them to prevent harm to itself (e.g., if the shareholder is a competitor). The new law also introduces liability for shareholders who misuse the company’s independent status as a legal person or their own limited-liability rights so as to hurt the company, its creditors, or other shareholders.

Thwarting management’s half-baked schemes.
The author points out other significant aspects of the new law. Shareholders can now prevent directors’ and officers’ self-interested dealings, a major problem under the old law. A company may invest in another company but may not become jointly liable for all the latter’s debts. The directors or the shareholders, as specified in the articles of association, must approve any investment in another company or guaranty of its debt, up to the maximum specified therein. A majority of disinterested shareholders must approve a guaranty given to a shareholder or the person in control of the company. In addition, the new law prohibits directors and senior managers from misappropriating corporate funds, using their corporate authority to seek business opportunities for themselves without the shareholders’ consent, and accepting commissions on corporate deals. When a violation occurs, shareholders owning at least 1% of the shares may force the company to sue and, if it declines, may sue on its behalf (or their own behalf, when they are the victims).

Icing on the cake: tax breaks.
Foreigners’ limited-liability companies can take the form of a wholly foreign-owned entity or a joint venture of the equity or contractual type. The statute and regulations governing each of the three forms give foreigners preferential tax treatment, which survives enactment of the new law. The favorable treatment includes a reduction in the income tax rate from 33% to 15% (plus exemptions for specified periods) and a rebate of taxes paid on reinvested profits. Local authorities can give foreigners extra tax breaks, the author adds. The new law applies to all three organizational forms, since each one’s statute and regulations are silent on day-to-day management, although the new law’s promise of revolutionizing companies is liable to remain unfulfilled. Local authorities can mechanically implement some of its changes (e.g., reducing capital requirements and permitting single-shareholder companies), but the author fears that China’s feeble judicial system and bureaucracy—inexperienced at contending with complicated corporate law issues—cannot implement the more dramatic ones. I will note that preferential tax treatment of foreign entities in China is being phased out.

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