China Corporate Law -- The Basics of China's Company Law.

III. THE NEW COMPANY LAW'S IMPACT ON FOREIGN INVESTORS

Direct foreign investment in China may be carried out in three forms: a wholly foreign owned entity, an equity joint venture, or a contractual joint venture. [UPDATE NOTE: come 2010, it appears we will be adding limited partnerships to this list] These forms of foreign invested enterprise are typically organized in China as limited liability companies. The statutes and associated regulations provide for specific and unique provisions concerning each of these three forms of foreign investment in China. Where the unique provisions do not apply, the provisions of the New Company Law will control. The foreign invested enterprise statutes and regulations are concerned with approvals and investment percentages, but not with day to day management issues. Accordingly, the fundamental changes introduced by the New Company Law will significantly impact both existing and future foreign invested enterprises in China.

The three foreign invested enterprises laws provide for special treatment of investors in a limited liability company based on the status of the investor. In this case, the status is foreign nationality. Similar status based distinctions formerly existed for domestic enterprises. For example, wholly state owned enterprises and town and village enterprises were governed by their own unique statutes and regulations. A primary goal of the New Company Law is to eliminate such status-based distinctions for domestic enterprises. As a result, all Chinese companies are in principle formed under the provisions of the Company Law, regardless of the status of the investor.

This change in principle is not the case for foreign investment, primarily because China still provides significant tax benefits and other incentives to foreign invested enterprises. It is essential to be able to characterize a limited liability company as a foreign invested enterprise to maintain these special benefits. [UPDATE NOTE: Most of the tax law distinctions and special benefits for foreign companies no longer exist.]

For example, an extremely favorable tax regime provides foreign invested companies with benefits not available to domestic enterprises. This foreign invested enterprises tax regime provides for numerous tax reductions, including the following:

* a reduced fifteen percent tax rate instead of the normal thirty-three percent rate

* exemption from all income tax for certain periods

* rebates of taxes paid upon reinvestment of profits

* exemption from import duty on imports of equipment

In addition, local authorities are authorized to provide additional tax and related incentives to foreign invested enterprises.

This special regime for foreign investors has survived adoption of the New Company Law. These tax and related benefits give foreign invested enterprises a significant business advantage over purely domestic Chinese competitors in the Chinese market, which makes investment in China more attractive for foreign investors. [UPDATE NOTE: Most of these special benefits for foreigners no longer exist]

IV. CONCLUSION

The New Company Law intends to make a revolutionary change in the practice of formation and management of corporations in China. However, a mere change in the law is not sufficient to bring about such change. The change will come only if the principles and procedures embodied in the new law are actually adopted and used by entrepreneurs, attorneys and the courts. There is much that suggests that the process of change will be slow and difficult.

Some elements of the New Company Law will have an immediate impact. These are elements that can be applied automatically by local government officials and that do not require the participation of legal professionals or the courts. There are three such provisions that should have such immediate impact: the reduction in the amount of registered capital, the provision allowing single shareholder limited liability companies, and the provisions that allow for a simplified management structure for limited liability companies with a limited number of shareholders.

It is realistic to presume that these provisions will be implemented within the existing Chinese system. Each of these provisions can be implemented without the commitment of resources and in a way that is entirely automatic. For the reduction in registered capital and single shareholder companies, this is obvious. The changes are uniform and are applicable throughout the system without the need for local officials to make discretionary evaluations. Management structure is similar. Local authorities can devise a check box form that allows the party forming the company to choose one of two options: either a full board or a single director. Once the choice is made, the local authorities can then proceed in a rigid and formalized manner that does not require discretion or judgment.

The other, more dramatic changes introduced by the New Company Law will encounter implementation problems. As with most Chinese laws, the New Company Law was drafted by a group of sophisticated legal professionals at the top levels of government but with little input from the public or lower levels of the bureaucratic structure. These changes require demand from the public, legal professionals for implementation, government officials for registration, and a court system for enforcement. Given the weak judiciary system and a bureaucracy unaccustomed to handling complex corporate law questions, the New Company Law likely will have little impact on closely held limited liability companies in China. Absent public or institutional demand for such sweeping legislation, the only way the legislation may have any impact is through a combination of massive, government-imposed education and vigorous government enforcement. Since neither of these may happen in China, the New Company law likely may fail to have the significant impact the drafters hoped for. [UPDATE NOTE: Steve's predictions have generally come true. The new law has improved corporate governance in China, slowly but surely.]

V. BIBLIOGRAPHY

1. Company Law of the People's Republic of China (promulgated by the Standing Comm. Nat'1 People's Cong., Oct. 27, 2005, effective Jan. 1, 2006) LAWINFOCHINA (last visited Nov. 5, 2006) (P.R.C.) [hereinafter New Company Law].

2. Company Law of the People's Republic of China (promulgated by the Standing Comm. Nat'l People's Cong., Dec. 29, 1993, amended Dec. 25, 1999 and August 28, 2004), translated at www.lawinfochina.com/dispecontent.asp7db= l&id=3656 (last visited Nov. 5, 2006) (P.R.C.) [hereinafter Old Company Law].

3. See the discussion on foreign invested companies, infra Section III.

4. See New Company Law art. 37-57 (giving the provisions for management of limited liability companies).

5. See, e.g., id. art. 42-47, 49-51, 54, 56.

6. Old Company Law art. 33.

7. New Company Law art. 35.

8. See id. art. 38,46, 50.

9. See generally id. art. 26-32.

10. Old Company Law art. 23.

11. New Company Law art. 26.

12. Id. art. 59.

13. Id. art. 58-64.

14. Old Company Law art. 20.

15. New Company Law art. 59.

16. Id.

17. Id.

18. Id. art. 64.

19. Id. art. 6, 7.

20. Id. art.7, 25.

21. Id. art. 23(3).

22. Id. art. 165,166.

23. Id. art. 34, para. 2.

24. Id. art. 20.

25. Id art. 64.

26. Id. art. 16.

27. Id. art. 149.

28. See generally Law of the People's Republic of China on Enterprises Operated Exclusively with Foreign Capital (promulgated by the Standing Comm. Nat'l People's Cong., Apr. 12, 1986, effective Oct. 31, 2000) LAWINFOCHINA (last visited Nov. 7,2006) (P.R.C.).

29. See generally Law of the People's Republic of China on Chinese-Foreign Equity Joint Ventures (promulgated by the Nat'1 People's Cong., Mar. 15, 2001, effective Mar. 15, 2001) LAWINFOCHINA (last visited Nov. 7, 2006) (P.R.C.).

30. See generally Law of the People's Republic of China on Chinese-Foreign Contractual Joint Ventures (promulgated by the Nat'l People's Cong., Oct. 31, 2000, amended Oct. 31, 2000) LAWINFOCHINA (last visited Nov. 7, 2006) (P.R.C.).

31. New Company Law art. 218.

32. See generally Income Tax Law of the People's Republic of China for Enterprises With Foreign Investment and Foreign Enterprises (promulgated by the Nat'l People's Cong., Apr. 9, 1991, effective Jul. 1, 1991) LAWINFOCHINA (last visited Nov. 7, 2006) (P.R.C.).

33. Id. art. 7, 8, 10.

34. New Company Law, art. 26, 59.

35. Id. art. 58-64.

36. Id. art. 61, 62.

37. The transparency of the legislative process in China has been studied and criticized by many legal scholars. For a brief treatment of this issue and the Chinese law-making system generally, see generally, Congressional-Executive Commission on China, Legislative Transparency of China's NPC, http://www.cecc.gov/pages/virtualficad/govnegistransp.php.