China corporate governance report: legal framework

Euromoney guides, June 2009

The legal framework for corporate governance in China has taken shape at a rapid pace through the last decade. In fact, every piece of legislation relevant to corporate governance today has either been passed into law or amended since the turn of the century.

One of the first significant documents came in January 2001 when the China Securities Regulatory Commission launched a Code of Corporate Governance for Listed Companies to go alongside the Securities Law and Company Law as they stood at that time. It covered shareholder rights, shareholder meetings, related party transactions, the behaviour of controlling shareholders, procedures for directors and boards, supervisory boards, performance assessments and incentives, and transparency.

Subsequently, the Companies Law and Securities Law would be amended to enshrine some of these principles in their own right. “The earliest legislation development, if you want to trace it back, was the Company Law issued in 2003,” recalls Ji Zou, a corporate partner at Allen & Overy in Shanghai. “The reason I mention that is because that was the first legislation to lay down the role of the board and the shareholders meetings. It introduced the concept of supervisor and defined the role of management. That was quite significant, because in the past most of the corporations were controlled by the state, so the functions of the board, shareholders meetings and management were not that clear.”

The Company Law was revised again in 2005, taking effect in 2006, with the Securities Law revised at the same time. Much of these changes had to do with corporate governance. For example, the revisions to the Company Law made these changes, among others:

• The role of the chairman. Previously, the chairman of the board of directors was the sole legal representative of a company, a status that could make it difficult to make corporate decisions. “For example, if the chairman failed to convene a board meeting, other directors generally would not dare to do so themselves,” say lawyers Thompson Hine in a practice note from the time. The new law allowed a managing director or manager to serve as the company’s legal representative, and allowed the vice-chairman to convene and preside at a board meeting if the chairman failed to do so.
• The concept of “duty of care” and “fiduciary duties” came into legal form with these revisions, aimed at directors, supervisors and senior management, albeit without definitions.
• Several measures sought to protect minority shareholders’ rights. The law allowed companies to adopt voting methods not based on shareholders’ contributions. For example, it allowed cumulative voting (allowing a shareholder to multiply their votes by the number of directors to be elected) in the election of directors and supervisors. It brought in the right to revoke shareholder and board resolutions, the right to petition for liquidation, the right to sell shares for non-payment of dividends, the right to bring derivative action and the right to inspect a company’s account books and minutes of board and shareholders meetings.
• This law also introduced the concept of piercing the corporate veil – a method of allowing the courts to look behind the principle of limited liability if the shareholders of a company appeared to be abusing the separate legal person status of company, perhaps in order to evade liabilities. This change meant the shareholder would be liable to the creditors. This provision perhaps aroused the greatest interest in the west, since it brought into effect a concept that had long been a feature of the corporate law of capitalist countries. The Yale Law Review wrote at the time: “While this change is welcome, China’s new company law fails to address important questions about the veil-piercing doctrine.” It highlighted ambiguity for creditors who lacked certainty about when they could expect to recover from a bankrupt debtor, and a lack of guidance for shareholders about what constitutes abuses of the corporate form.
• The law also removed strict requirements for listing a company’s securities – companies were from then on no longer required to have equity capital of RMB 50 million, three years of operating history and profit for three consecutive years before being able to list their securities on an exchange.

The Securities Law, too, brought major changes designed to protect shareholders. Coming on the heels of a stock market decline, it was designed to address the poor quality of listed companies, irregularities of securities companies, the protection of investors’ interests, the improvement of issuance system, and the trade and registration of stocks. In particular,