Chapter 4 Company lawChapter 4 Company law

1 1 Corporate personality

2 2 Conditions of company

3 3 Company formation

4 4 Corporate capital

5 5 Corporate governance

6 6 Financial and accounting affairs

7 7 Corporate merger and division

8 8 Corporate dissolution and liquidation

1 Corporate personality

1.1 Separate existence

1.1.1 Legal person

IllustrationIllustration: B cannot enforce the property of the company: B cannot enforce the property of the company

A and B entered into a rice sales contract, by which A should deliver 50 tons of grade 1 rice to B, and in return B should pay a price of RMB 100000 to A. B made the payment and A used such money to register a company with C and D. However A failed to deliver the specified rice, thus the contract was cancelled on the basis of fraud on the part of A. A was ordered to return the foregoing money to B. The problem is such money was invested in the company. Can B enforce the property of the company? No, B cannot do so. The company enjoys separate personality, and the company rather than A owns such property. B can only enforce the property of A. If A has no other property, B may request to enforce A’s shares rather than the property in the company. Such practice is designed to secure the separate and perpetual existence of company.

Illustration:Illustration: Salomon v Salomon & Co Ltd(1897)Salomon v Salomon & Co Ltd(1897)

a.20000 ￡ 1 sharesb. Corporate assets as security for ￡ 10000 loanc.cash: ￡ 9000=￡ 39000

Sells business for ￡ 39000

Salomon

The Company

Other creditors

No security

Loan: ￡ 8000

• Liquidation: remaining assets ￡ 6000

• Salomon took all the remaining assets.

• What shall the unsecured creditors do?

• House of Lords: No more obligation to pay.

Illustration:Illustration: Macaura V Northern Assurance Co Ltd(1925Macaura V Northern Assurance Co Ltd(1925 ））Macaura and nominees owned all shares. Owed no debt to others. Macaura insured corporate timber in his name. Timber was destroyed by fire.Can he claim compensation?

House of Lords: No. He wasn’t owner of timber.

Illustration:Illustration: Tunstall v Steigmann (1962)Tunstall v Steigmann (1962)

Mrs Steigmann ran pork shop, leased her next door shop to Mrs Tunstall. She wanted to occupy the shop herself. She could do so if she intended to occupy it herself. Before lawsuit, she incorporated a company, and owned all but 2 shares.

Can she end the lease?

Court of appeal decision: No. It is the company instead of her wanting to occupy the premises.

1.1.2 Shareholder v property owner

Rights of shareholder & property ownerRights of shareholder & property owner

Functions Property owner Shareholder CEO

Possession √ ╳ √

Use √ ╳ Partial

Management √ Partial √

Deriving benefits √ Partial ╳

Security √ ╳ Partial

Transfer √ ╳ √

Indefinite √ √ ╳

Elastics √ √ √

Non-interference on others √ ╳ √

Judgment enforcement √ ╳ ╳

1.1.3 Company v partnership Company v partnershipCompany v partnership

Company Partnership

Basis of formation Articles of association Partnership agreement

Basis of relationship Property Personal trust

Legal status Legal person Semi-legal person

Property ownership Company Partners

Management power Corporate organs Partners

Limited liability √ ╳

Scale Big Small

1.2 Limitations on separate corporate existence

1.2.1 Lifting corporate veil: prevent the abuse of

limited liability

1.2.2 Situations of lifting corporate veil (Common law)

(1) Formed for fraudulent purpose IllustrationIllustration: GMC Ltd v Horne (1933) : GMC Ltd v Horne (1933) Mr. Horne, MD of GMC. Non-competition clause in the employment contract. After termination, he solicited GMC’s customer order. In order to avoid liability, he formed a company whose sole purpose was to solicit GMC’s customers. GMC sued him. He claimed that the clause was not binding on the company.Court of appeal: Mr. Horne was laible. Injunction: he and the company.

(2) If it can be characterized as enemy in time of war

IllustrationIllustration: Daimler Ltd v Continental Tyre & Rubber Co Ltd : Daimler Ltd v Continental Tyre & Rubber Co Ltd

(1916)(1916) Continental Tyre Co registered in UK, sued Daimler for recovering debt. German owned all but one shares of Continental Tyre Co.House of Lords: Continental Tyre Co could not sue on the debt.

(3) Economic unit: groups of companies

IllustrationIllustration: DHN Ltd v London Borough of TH (1976): DHN Ltd v London Borough of TH (1976)DHN had two wholly owned subsidiaries. Bronze is one, whose only asset was the premises where DHN carried on business. The second owned vehicles used by DHN. Local authority compulsorily purchased Bronze’s premises, leading to the closure of DHN’s Business. DHN claimed for damages. Local authority argued the matter had nothing to do with DHN.

Court of appeal: Bronze and DHN could be treated as one economic enterprise.

(4) Other situations at court’s discretion

IllustrationIllustration: Goodwin v Birmingham City FC(1980): Goodwin v Birmingham City FC(1980) Mr. Goodwin, manager of Birmingham City Football Club, five-year contract. He used his company to supply the services to the Club. The Club sacked him in year 3. He found a better job soon. His company sued the Club for full damages.

Court decision: His company was only entitled to nominal damages. He and the company could be regarded as same person.

2 Conditions of company

2.1 Shareholder requirement

Requirements of shareholderRequirements of shareholder

CLS LLC

Minimum 5 (except for SOEs restructure) 2

Maximum ╳ 50

Official organ legal person ╳ ╳

State functionary ╳ ╳

Domicile in China 1/2 promoters domiciled in China ╳

2.2 Minimal capital contribution

Corporate capitalizationCorporate capitalization

Types of company Minimal capital (RMB) Non-cash Paid up

LLC

Manufacture 500000 √ √

Commodity wholesale 500000 √ √

Commodity retail 300000 √ √

Scientific & technical development, consulting

or service 100000 √ √

Special industry Separate regulations √ √

CLS

Total 10 million √ √

Promoter’s subscription ≥35% √ √

Public offering ≥25% ╳ √

Listed company 50 million √

2.3 Articles of association

Articles of associationArticles of association

LLC CLS

Mandatory items

Name and domicile √ √

Business scope √ √

Method of creation √

Registered capital √ √

Total shares and par value √

Shareholder’s name √

Promoter’s name and corresponding shares √

Shareholder’s rights and obligations √ √

Capital contribution and each shareholder’s amount √

Conditions of transferring capital contribution √

Corporate organs √ √

Legal representative √ √

Profits distribution √

Conditions of liquidation & dissolution √ √

Methods of notice and announcements √

Other items deemed necessary by shareholders √ √

Formulation Shareholders Promoters

Amendment: 2/3 majority votes √ √

Registration with AICs √ √

2.5 Necessary conditions for production and operation

2.4 Organizational requirement

3 Company formation

Company formationCompany formation

LLC CLS

Methods Promotion √ √

Public offering ╳ √

Capital contribution

Cash √ √

Kind √ √

╳(non-promoter)

Industrial property & non-patent technology

√ √

╳(non-promoter)

Land use rights √√

╳(non-promoter)

Government approval ╳

√ √(special company)

Registration with AICs √ √

3.1 Methods of formation

3.2 Capital contribution IllustrationIllustration: Shareholders liable to creditors for insufficient Shareholders liable to creditors for insufficient capital contribution capital contribution

Yixin Company with a registered capital of RMB 3 million was jointly sponsored by Yinxin Company, Xinguang Company and Town Government. According to the capital verification certificate by which they obtained corporate registration with the county AIC, the Town Government invested a value of RMB 1.88 million, Yinxin invested RMB 420000, and Xinguang invested RMB 700000. Three years after incorporation the auditor’s report made by the accounting firm found that its shareholder’s actual investment was merely RMB 700000 in total. In the second year after incorporation Yixin owed Huaguang Company RMB 159000 due to contractual dispute. On 11 may 2000 the court ordered Yixin to pay the principal plus interests RMB 210306 to the creditor. However Yixin had stopped business operation and was unable to make the payment. Can the creditor request Yixin’s shareholders to make such repayment? Yes. Pursuant to the SPC judicial interpretation of No.4 in 1994 the three shareholders are liable to the creditors to the extent of their unpaid capital. In this case their unpaid capital is up to RMB 2.3 million, which is sufficient to repay the debt of Xinguang Company.

Illustration:Illustration: Accounting firm liable for issuing false capital Accounting firm liable for issuing false capital verification certificate verification certificate In November 1992 Deyang Accounting Firm issued capital verification certificate with a registered capital of RMB 810000 for its client, Dongfang Company. Such certificate expressly states that if there is anything untrue, this firm is liable to the extent of the amount of this certification. However Dongfang did not make any actual capital contribution. Later on Dongfang owed the Taiyuan Nanjiao Chemical Plant prices of goods. In its lawsuit against Dongfang, Deyang Accounting Firm was added as co-defendant. Upon request by Sichuan High People’s Court, the SPC specially answered in the form of reply No.56 in 1996. By such reply Deyang Accounting Firm was ordered liable to the extent of its certification, if there was any insufficiency unable to pay by the Dongfang.

3.3 Approval

3.4 Registration

3.4.1 Application

3.4.2 Consequence

4 Corporate capital

4.1 OverviewOverview of corporate capital systemsOverview of corporate capital systems

Statutory capital

Authorized capital

Compromise capital

China

Jurisdiction Civil law Common law Civil law Mainland Capital amount stated √ √ √ √

Post registration contribution ╳ √ √ ╳Prior capital contribution √ √ √ √

Installment payment ╳ √ √ ╳Authorized issue of shares ╳ √ √ ╳

Time period restriction × √Paid up capital = registered capital √ × × √

4.2 Transfer LLC: freely transferable among the shareholders To outsiders: consent of 1/2 of the shareholders  

CLS stocks are freely transferable, stock exchange

4.3 Capital increase and reduction

Requirements of capital increase and reductionRequirements of capital increase and reduction

Capital increase Capital reduction

LLC CLS LLC CLS

Resolution of shareholder’s meeting

2/3 majority

1/2 majority

2/3 majority

1/2 majority

Amending articles of association √ √ √ √

Registration with AICs √ √ √ √

Balance sheet & assets list √ √

Notice to creditors √ √

Debt payment or appropriate assurance

√ √

No less than minimal capital √ √

5 Corporate governance CLS structureCLS structure

Shareholder’s meeting

BOD BOS

Manager

Departmental managers

LLC structureLLC structure

Shareholder’s meeting

BODExecutive director

BOSSupervisor

Manager

Departmental managers

5.1 Shareholder’s meeting

5.1.1 Powers and functions

Powers and functions of the shareholder’s meeting Powers and functions of the shareholder’s meeting

CLS LLC

Scope Special resolution

Scope Special resolution

Determining operational guidelines and investment plans √ √

Electing and replacing directors, and their remuneration √ √

Electing and replacing supervisors representing shareholders, and their remuneration

√ √

Approving BOD reports √ √

Approving BOS reports √ √

Approving annual financial budget and final accounting plans

√ √ √

Approving profit distribution plans and plans to cover losses

√ √

Capital increase or reduction √

Resolutions on bonds issuance √ √ √ √

Resolutions on transferring capital contribution to outsiders

√ √

Resolutions on merger, division, dissolution and liquidation

√ √ √ √

Resolutions on change of corporate form

Amending the articles of association

5.1.2 Types of shareholder’s meeting

Regular and interim shareholder’s meeting

Causes of interim shareholder’s meetingCauses of interim shareholder’s meeting

CLS LLC

The number of directors falls below legal limit or 2/3 of the requirement of articles of association

Shareholders holding 1/4 votes or more request

Uncovered losses have reached 1/3 of the total share capital

1/3 directors or more proposes

Shareholders holding 10% stocks or more request Supervisors propose

BOD deems necessary

BOS proposes

5.1.3 Convention

5.1.3.1 Convener

Illustration Illustration : Chairman is not the convener of interim: Chairman is not the convener of interim shareholder’s meeting shareholder’s meeting

A Company held BOD meeting on 15 August 1992, which unanimously agreed to hold interim shareholder’s meeting so as to amend the articles of association in December 1992. The company notified the shareholders in the name of Mr. Li, the chairman of the BOD rather than the BOD. On 27 December 1992 the interim shareholder’s meeting was held. After reading the draft amendments of the articles of association, part of the shareholders raised objections. The amendments were eventually adopted by 3/5 affirmative votes. Mr. Zhang as the opposition leader challenged the resolution on two points: (1) the convention of the meeting was illegal since it was notified in the name of the chairman; (2) the 3/5 affirmative votes have not reached the 2/3 majority rule. Thus he requested nullification of the resolution.

5.1.3.2 Notice

Illustration: B Company’s notice period was insufficient Illustration: B Company’s notice period was insufficient

On 23 November 2000, B Company announced on the China Securities News that it would hold the second interim shareholder’s meeting on 22 December 2000. The announcement was made in the name of the BOD and dated as 21 November 2000. On 29 November one shareholder raised an opposition that the notice period was only 29 days (23 November to 22 December) failing to reach the legal requirement, thus requested cancellation of such meeting. Else, he would request the nullification of the resolution. The company defended that (1) the notice period was exactly thirty days if the day of meeting was also included; (2) the announcement was dated as 21 November, thus notice period was more than thirty days. The company was incorrect since the notice period only refers to the net period, and the day of meeting cannot be included.

5.1.4 Voting

CLS: one share one vote,

LLC: proportionate to contributed capital

5.1.5 Minutes

5.2 BOD

5.2.1 Composition

Illustration:Illustration: Sichuan Jinlu’s board structure led to Sichuan Jinlu’s board structure led to endless power struggle endless power struggle

Jinlu Company is known for its unprecedented turnover of BOD chairman between 1998 and 2001. In 1998 its chairman was He Guangchang, who was taken over by Ai Xin in 1999. In 2000 Li Furong relaced Ai Xin and in 2001 it was returned to its original chairman, He Guangchang. Why was the turnover of chairman so frequent? The improper board structure was mainly to blame.

In 1999 when Ai Xin’s company became the biggest shareholder in Jinlu. Its shareholding is 14.64%, which is merely 1% more than the second shareholder. However such 1% is decisive, since Ai Xin’s company obtained overwhelming advantage in the board. Among 11 directors Ai Xin’s company occupied 8 seats, plus Ai Xin himself was the chairman. Under such structure the biggest shareholder may do whatever it wishes. During its chairmanship Ai Xin’s company did not waste such wonderful opportunity, i.e. huge number of private benefits was obtained. In sharp contrast once he loses such post, even if he is still the biggest shareholder, he has no meaningful role to play in corporate decision-making. That is the situation of Ai Xin’s company in 2000 when Ai Xin lost his chairmanship, but his company remained the biggest shareholder. Notwithstanding its biggest shareholding status, under the new management Ai Xin was excluded from corporate decision-making, and even did not what was happening in the company. That is why Ai Xin sold his biggest shareholding in May 2001. Even the biggest shareholder did not have a say, let alone the minority shareholders. Thus optimizing board composition is significant value in corporate governance reform, which can never be overemphasized to upgrade the accountability of listed companies and to enhance the protection of minority shareholders.

5.2.2 Powers and functionsBOD’s powers and functions BOD’s powers and functions

CLS LLC

Convening shareholder’s meeting and presenting reports thereto √ √

Implementing resolutions adopted by the shareholder’s meeting √ √

Determining corporate operation plans and investment programs √ √

Preparing annual financial budget plans and final accounting plans √ √

Preparing profit distribution plans and plans to cover losses √ √

Preparing plans for increasing or reducing registered capital √ √

Preparing plans for issuing company bonds √

Drafting plans for corporate merger, division or dissolution √ √

Drafting plan for changing corporate form √

Determining the structure of the internal management √ √

Appointing or removing manager; appointing or removing deputy managers and officer in charge of finance upon manager's nomination; and their remuneration

√ √

Formulating basic corporate management systems √ √

5.2.3 Term of office • Three years ceiling

• Reelection allowed

5.2.4 Convention of BOD meetings

5.2.4.1 Frequency and convener

• CLS: two minimal BOD meetings each year • LLC: no such minimal requirement

5.2.4.2 Notice

• Ten days prior to the scheduled date of meeting

5.2.4.3 Voting

• OPOV

5.2.4.4 Minutes

5.3 BOS 5.3.1 Composition

5.3.2 Powers and functions

Powers and functions of the BOSPowers and functions of the BOS

LLC CLS

Reviewing the financial affairs √ √

Monitoring acts of directors or manager to guard against violation of national laws, administrative regulations or articles of association in performing duties

√ √

Requiring directors or manager to rectify any act harming company interests

√ √

Proposing for interim shareholder’s meeting √ √

Other authorities prescribed by the articles of association √ √

5.4 Manager Manager’s powers and functionsManager’s powers and functions

LLC CLS

Managing production and operation, and implementing BOD resolutions √ √

Implementing annual operation plans and investment programs √ √

Drafting plan for the structure of the internal management √ √

Drafting basic management systems √ √

Formulating detailed corporate rules √ √

Recommending for appointment or removal of vice-managers and financial officer

√ √

Appointing and removing other officers √ √

Other authorities authorized by articles of association and the BOD √ √

5.5 Negative qualification of director, supervisor and manager

Negative qualificationNegative qualification Director Supervisor Manager

Civil servant ╳ ╳ ╳

No competence or with limited competence ╳ ╳ ╳

Criminals of embezzlement, bribery, converting or misappropriating property, sabotage of social economic order within 5 years of completing sentence

╳ ╳ ╳

Criminals deprived of political rights within 5 years of completing sentence

╳ ╳ ╳

Director, factory chief, or manager personally responsible for corporate bankruptcy within 3 years of completing bankruptcy liquidation

╳ ╳ ╳

Legal representative personally responsible for corporate business license revocation within 3 years of revocation

╳ ╳ ╳

In default of significant amount of personal debt ╳ ╳ ╳

Corporate director, manager, or financial officer ╳

5.6 Duties of director, supervisor and manager Types of duties Types of duties

Director Supervisor Manager

Abide by the articles of association √ √ √

Faithfully perform duties and safeguard corporate interests √ √ √

No private gains √ √ √

No bribes, illegal income, or convert company property √ √ √

No misappropriation or loan company funds to others √ √

No deposit of company assets into his own account or other individual's

√ √

No collateral on company assets for debt of shareholder or other individuals

√ √

No competition with the company business √ √

No activity adversely affecting corporate interests √ √

Profits derived from competition or adverse activities belongs to company

√ √

No conflict of interests with the company √ √

Confidentiality duty √ √ √

Liability of compensation due to violating the law or articles of association

√ √ √

6 Financial and accounting affairs

6.1 Overview • LLC and CLS: financial and accounting systems • Each company can only keep one official account book• Corporate assets cannot be deposited in any individual’s personal account

• Financial accounting report: (1) balance sheet; (2) income statement; (3) statement of cash flow; (4) explanation of financial conditions; (5) statement of profit distribution.

• LLC: send report directly to shareholders • CLS: table them at least 20 days before AGM • Listed CLS: announce publicly

6.2 Allocation of funds & profit distribution

6.2.1 Allocation and use of funds

6.2.2 Profit distribution

• No profits, no distribution • Proportionate to their capital contribution or shareholding • Illegal distributed profits must be returned to the company

• Statutory reserve fund: 10 % • Statutory welfare fund: 5-10% • Discretionary reserve fund 

• Statutory reserve fund: cover company losses, expand its production and operation, convert into corporate increased capital • Statutory welfare fund: collective welfare of the workers and staff

7 Corporate merger and division

Conditions and procedures Conditions and procedures

Merger Division

Conditions

Agreement between the parties √

Resolution of shareholder’s meeting √ √

Approval by State Council authorized departments or provincial government

╳(LLC) ╳(LLC)

√(CLS) √(CLS)

Procedures

Balance sheet and assets list √ √

Notice to creditors √ √

Debt payment or appropriate assurance √ √

Registration with AICs √ √

7.1 Classification

A

B

C

Figure:Rebirth mergerFigure:Rebirth mergerA

B

A

Figure:Absorptive mergerFigure:Absorptive merger

A

B

C

Figure: Rebirth divisionFigure: Rebirth division

A

B

C

Figure: Derivative divisionFigure: Derivative division

7.2 Conditions

7.3 Procedures

8 Corporate dissolution and liquidation

8.1 Causes of dissolution

8.2 Corporate liquidation

Two types of dissolution: compulsory and voluntary dissolution Voluntary dissolution: (1) term of operation prescribed by articles of association has

expired, or an event for dissolution prescribed by it has occurred;

(2) shareholder’s meeting has adopted the dissolution resolution;

(3) dissolution is required due to merger or division.

Illustration:Illustration: Why were huge fines on Yi’an Technology event Why were huge fines on Yi’an Technology event frustrated frustrated

CSRC firmly decided to punish the four stock price manipulators. They were imposed a huge fine up to RMB 449 million, and the confiscation of the illegal income of RMB 449 million.However such punishment was unable to enforce. Why? The loophole in the compulsory dissolution system is mainly to blame, since it merely cares the revocation of business license, but takes a blind eye on its liquidation.

Yi’an Technology event is the typical case in point. Why were huge fines unenforceable? The four manipulators cannot be located. One of the manipulator is Jinyi Company obtained registration on 24 October 1997. Jinyi’s business license revoked by AIC on 24 October 1998, but no liquidation was made. It does not only mean it did not repay its creditors, but also its creditors could not succeed in suing it. What’s worse Jinyi continued to carry on business in the subsequent two years in the original place in defiance of the AIC’s revocation. The manipulation of Yi’an Technology’s stock prices occurred exactly during the period after business license revocation. It goes without saying that dissolution without liquidation not only seriously injures the creditors, but also disrupts social economic order.

8.2.1 Liquidation group 8.2.1.1 Formation

8.2.1.2 Powers and functions

(1) identifying corporate assets, and preparing balance sheet and assets lists respectively; (2) notifying creditors through notice or public announcement; (3) handling its ongoing businesses related to liquidation;(4) making full payment of taxes owed; (5) identifying the creditor's rights and debtor's liabilities; (6) disposing of the remaining assets after full payment of company debts; (7) participating in civil actions on behalf of the company.

• Voluntary dissolution: company creates liquidation group• LLC: shareholders; CLS: determined by the shareholder’s meeting

• Compulsory liquidation: relevant department shall organize the shareholders, the relevant authority and related professionals to form liquidation group

8.2.2 Procedures

8.2.2.1 Declaration of creditor's rights

8.2.2 2 Sequence of payment

• Liquidation expenses, wages and employee's labor insurance, taxes and corporate debts • Surplus assets: distribute to the shareholders

8.2.2.3 Cancellation registration