In today’s global corporate world, many conglomerates have complex and layered shareholding structures with multiple entities in various jurisdictions. Each entity must function as part of a cohesive whole within the larger global group, but will still be governed by company laws or other laws of its respective local jurisdiction. In international M&A deals, parties sometimes approach the corporate governance of a foreign entity (and correspondingly, negotiations of shareholders agreements, joint venture agreements and other matters) by using principles and concepts that they are familiar with in their domestic jurisdiction.
These cultural differences can cause misunderstandings, complicate negotiations, and create friction during post-completion integration. In this article, we briefly compare some key differences between PRC companies and common law companies.
Types of Companies
In common law jurisdictions, companies commonly seen in the corporate world are either private companies limited by shares or public companies limited by shares. Companies can also take other less common forms such as: (a) private unlimited companies with a share capital; (b) public unlimited companies with a share capital; or (c) companies limited by guarantee without a share capital. The distinctions between the above types of common law companies are briefly as follows:
- A private company can only have a limited number of shareholders and cannot raise capital from the public. A public company can have an unlimited number of shareholders, can raise capital from the public, and is subject to closer regulatory scrutiny.
- In a limited company, shareholders are generally only liable to the extent of their investment in the company. In an unlimited company, shareholders are personally liable for the company’s debts without limit.
- In a company limited by shares, the liability of shareholders is limited to the shares they subscribed for. In a company limited by guarantee, the liability of shareholders is limited to the amount they guaranteed as set out in the company’s constitution.
In the PRC, there are only two types of companies: limited liability companies (有限责任公司) (PRC LLC) and joint stock companies (股份有限公司). Generally, PRC LLCs are similar to common law private companies limited by shares, and PRC joint stock companies are similar to common law public companies limited by shares.
In common law jurisdictions, a company basically has full powers, capacity, rights and privileges to undertake any business, activity or transaction. Whilst such powers may be limited in the company’s constitution, it is not mandatory for a company to have an objects clause in its constitution limiting such powers, and it is common for companies nowadays to not have such an objects clause in its constitution. In the past, a company’s powers had to be set out in its constitution, and drafters creatively sought to circumvent this restriction and facilitate the company’s business freedom by exhaustively setting out in its constitution every imaginable power a company would want to have, in so doing effectively countervailing the purpose of such restriction.
In the PRC, however, a company is required to have a business scope at the time of incorporation, which needs to be approved by the relevant authorities and stated on its business license. The company may only carry out business within the prescribed scope.
In common law jurisdictions, a company has “shares”. A common law company may issue its share capital at different prices (particularly if it is in a jurisdiction that has abolished “par value”) and attach different rights to different classes of its shares. For example, at the time of incorporation, a company may issue 1 ordinary share at the price of $1 to its sole first shareholder, who will then have 100% of the voting rights of the company. Subsequently, the company may introduce a new second shareholder by issuing 1 ordinary share that ranks equally as the first shareholder’s 1 ordinary share at the price of $1 million, at which point the second shareholder will have 50% of the voting rights despite contributing substantially more capital than the first shareholder. The company may then introduce another third shareholder and issue him 1 preference share, which, as preference shares typically do, entitles the third shareholder to a fixed dividend and priority claim in the event of bankruptcy, but no voting rights.
In the PRC, the concept of “registered capital” is applicable. The starting position for a PRC LLC is that voting rights are determined by respective registered capital contributions, although this can be varied in the company’s constitution. The founding members of a PRC LLC will decide the amount of registered capital the PRC LLC shall have upon its incorporation, the portion they each subscribe for and how and when they will each contribute their subscribed registered capital. As a default position, a member’s voting rights is determined based on his percentage contribution to the registered capital of the PRC LLC. For example, if a PRC LLC has a total registered capital of RMB100, of which a member subscribes for RMB51, then the member has 51% of the voting rights of the PRC LLC.
In the PRC, every company must have a “legal representative”, who is the principal representative of the company with legal power to represent and bind the company. Conceptually, a legal representative is the representative, not the agent, of the company, so he may act on behalf of the company without a separate authorization from the company. If a legal representative is acting outside of his power, his conduct may bind the company, provided that the counter party is acting bona fide and there is apparent authority. The legal representative of a company shall be the chairman of the board of directors, executive director or manager of the company.
In common law jurisdictions, there is no equivalent concept of a “legal representative”. In Hong Kong and Singapore, there is a concept of an “authorized representative” for foreign companies, but such representative’s role is essentially restricted to administrative matters and accepting service of process or notice on behalf of such company. Notably, as directors in common law companies act collectively, no single director (even a managing director) prima facie has the individual power to represent and bind a common law company the same way a “legal representative” of a PRC company is able to represent and bind a PRC company.
Under common law, directors are fiduciaries of, and owe fiduciary duties to, the company. Directors have an overarching duty to act bona fide for the benefit of the company, to exercise powers for their proper purpose, and not to allow any conflict of interest. Though the specifics of directors’ duties may vary in each common law jurisdiction, the general principles remain consistent due to their shared origin. Below are some key propositions of director’s duties commonly seen in common law systems:
- Duty to act bona fide for the benefit of the company: directors must act honestly and in good faith in the interests of the company;
- Duty to exercise power for proper purpose: directors must exercise their powers for the objectives which such powers are conferred;
- Duty to avoid conflict of interests: directors must not place themselves in a position where their own interests or the interests of another conflict with those of the company;
- Duty not to misuse company information, property or money;
- Duty not to misuse director’s position to obtain personal profit; and
- Duty to act with care, skill and diligence: directors shall discharge their duties with a reasonable degree of care, skill and diligence.
The sources of directors’ duties are numerous, being found in statutes, case law and company constitutions, and there is a deep foundation of judicial interpretation and case law dealing with director’s duties. Additional requirements on directors can be found across various statutes (e.g. director duties regarding general meetings, financial reporting, trading while the company is insolvent etc.). The liabilities for breaching directors’ duties may be civil and/or criminal.
Under PRC law, there is a similar concept of directors’ duties, but it is statutory, narrower and more particular in its application. The basis of directors’ duties are encapsulated under Articles 147 and 148 of the PRC Company Law, which are summarized below (additional requirements on directors of listed companies can also be found in relevant securities laws and regulations):
- directors shall abide by laws, administrative regulations and the company constitution, be loyal to the company, and perform their duties with diligence;
- directors shall not accept bribes or other illegal gains or encroach on company property;
- directors shall not:
- misappropriate company funds;
- deposit company funds in accounts under the name of the director or other persons;
- lend company funds to other persons or provide guarantees to other persons using company property in violation of the company constitution, without shareholders’ or board approval;
- enter into contracts or trade with the company, without shareholders’ approval or in violation of the company constitution;
- take advantage of his powers to seek business opportunities belonging to the company, or operate a business similar to that of the company either by himself or for other persons, without shareholders’ approval;
- accept commissions from the company’s transactions with other persons;
- disclose the company’s confidential information without authorization; and
- do other acts that are in violation of their duty of loyalty.
Relationship between Shareholders and the Board of Directors
Under common law, the shareholders and the board of directors are two indispensable but distinct organs of a company; the former is the owner of the company and the latter is the operator of the company. The line between shareholders’ functions and the board’s functions is clear in that:
- the board by default has management powers, and may exercise all the powers, of the company (save for powers reserved for members by statute or under the constitution); and
- shareholders have few statutory rights to participate in the decisions of a company and such rights are typically limited to those that are fundamental and affect shareholders’ own rights (e.g. the right to grant directors power to issue shares, to change the constitution, to dispose of the whole or substantially the whole of the company’s assets).
Under PRC law, the line between shareholders’ functions and the board’s function in companies is less clear. In addition to being the owners of the company, the shareholders are referred to as the “organ of power (权力机构)” of the company. The PRC Company Law provides the minimum statutory powers of the shareholders by listing out 11 powers. Notably, the PRC Company Law also provides 11 powers of the board of directors, some of which overlap, and should be read together with, the powers of the shareholders.  We compare some of the powers in the table below:
A notable exception to the PRC Company Law’s recognition of shareholders as the “organ of power” of a company would be the provision relating to sino-foreign joint venture companies, which stipulates that the board shall “decide all material issues relating to the joint venture company”. This provision effectively takes away the powers of the shareholders meeting in a sino-foreign joint venture company. Note, however, that this provision is to be superseded when the new PRC Foreign Investment Law comes into effect.
In the PRC, every company has an additional organ, that of a “board of supervisors” that oversees the conduct of directors and senior managers and the financial and other affairs of the company. A company is required to have a board of supervisors consisting of at least 3 persons, but it may have just one or two supervisors if the company is a PRC LLC that has few shareholders or is small in scale. A board of supervisors shall have shareholders’ representatives and employees’ representatives. A board of supervisors may call for shareholders’ interim meetings, sit in at board meetings, propose to remove a director or senior manager for misconduct, and may even bring an action against a misbehaving director or senior manager. The composition and procedures of a board of supervisors are set out in the PRC Company Law and are governed by the company’s constitution.
In common law jurisdictions, there is no equivalent concept of a “supervisors”. Listed companies have a loosely similar concept of independent directors, who function as an independent check within the company’s structure, but private companies are not required to have independent directors on their board of directors.
The differences discussed above will take on additional significance following the upcoming implementation of PRC’s new Foreign Investment Law on 1 January 2020, which will require that all foreign-invested companies in China be governed by the PRC Company Law. Whether you are a PRC party doing business overseas, or a foreign party doing business in China, it is important to understand the differences in company law principles and requirements between different jurisdictions, and assess how your internal corporate governance structures, organs and processes need to be set up and implemented in a manner that both complies with different legal requirements and meets your commercial requirements.