Recent company law reforms in China have improved investment opportunities - foreign companies should take note

------ By Alex Monro

Foreign companies do not generally hold their breath in expectation when the Chinese government raises the possi-bility of legal reform. Even the Company Law and Securities Law reforms announced at the end of October were not aimed speci.cally at foreign enterprises. But they will make a large difference to foreign companies with operations in China, especially those who are looking to restructure.

The new legislation, which was developed through the State Council's Legislative of.ce and announced on October 27, modi.ed 120 separate articles (and more than 400 provi-sions) of current law. Similar proposals were made several years ago, but dropped. Pushing them through recently was a bold move, but which changes will make a real difference?

"In this case they're all quite earth-shatter-ing," says Peter Corne, legal consultant at Lin-klaters, Shanghai. "It's a change that is really quite revolutionary … It will most affect com-panies limited by shares because they haven't really taken off as an investment vehicle yet. This structure - shareholders meeting, direc-tors meetings and so on - is used all over the world, so this could represent an international-ization of corporate forms in the PRC.”

Problem solver

Previously domestic companies could only in-vest 50 percent of their net assets, but accord-ing to the .rst reform, there is now no such limit. "Elsewhere, you take it for granted that if you had a company and wanted to invest in the shares of another company you could just do it and there would be no limitation on the amount of your existing assets you could invest in another company," says Corne. "In China that hasn't been the case - you've been limited to in-vesting only 50 percent of your net assets in any other company's shares or equity interest, which means that it's very inef.cient for structuring in-vestment through domestic enterprises.”

Since the "Domestic company" bracket in-cludes foreign-invested enterprises (FIEs), the change provides business expansion opportuni-ties for foreign companies too, albeit by proxy. In the past, foreign enterprises had to set up a Chinese holding company, and that required an investment of at least US$30 million. Not every-one has that kind of money just sitting around. But now, says Corne, if you have a small manu-facturing company, your core business still has to remain primary, but when you take a stake or even wholly acquire another manufacturing company, you have better options, as you can now afford better.

"I've got a project whereby a company had bought a second company - a WFOE [wholly foreign-owned enterprise] - and you had anoth-er company in the same group which it didn't wholly own, a much bigger company, where it shared the shareholding with others in China, and they wanted to consolidate the two enter-prises," says Corne. "In this sort of situation, you consider a merger but that doesn't actually suit them because they want the money back that they.ve invested in this small enterprise, so they have to get the bigger enterprise to acquire the smaller one, but the bigger one isn.t big enough to acquire all of it. So it [the company law] solves situations like that."

Another rule lifted by the reforms stipulated that wholly owned domestic enterprises must have at least two shareholders. Corne says this may not be so obviously relevant to foreign investors, since in WFOEs you are already allowed a single shareholder. But if you are investing in a Chinese enterprise through a local entity, then your target counts as a domestic enterprise, so you would need to have another shareholder somewhere. Moreover, shareholder status has become much clearer under the revisions.

"There.s more transparency in terms of shareholder.s responsi-bilities and rights," says Clifford Ng, lawyer at Hong Kong-based Preston Gates Ellis. "The new rules leave much more scope in the articles of association for shareholders to decide how the company should be structured, how voting rights, pro.ts, dividends and so forth should be distributed, and it just gives parties more freedom in forming the company the way they want to," says Ng.

Waiting on change

There are 120 reforms in all, but certain areas have received special attention. As the reforms of the 50 percent asset-offset-ting and plural shareholder rules show, investment structuring through local vehicles has become much easier . share buybacks, formerly outlawed, are now possible. There is now also a basis for employee share options . elsewhere it has already been stan-dard practice to have stock option plans in place for staff.

IPO laws have also been changed to reduce the required lock-up period for shares from three years to one. Pro.t periods have become less important, the number of promoters needed has been reduced and creditors can now go after shareholders more easily, since the corporate veil has been lifted . "insider trading" has received a broader de.nition to make it applicable to the direc-tors, senior management and personnel of shareholders as well as those of the issuer. Fluidity has also been improved by ending the rule that a stock cannot be bought and sold on the same day.

The changes open up a sector that has been waiting to do so for some time . similar proposals were made a few years ago but never got anywhere. "I don.t think it.s slower or faster than any-place else," says Ng. "Hong Kong is basically still living on 1948 law. Laws anywhere are always more reactionary than anticipa-tory." Is there in fact a danger of liberalizing too quickly?

"I wouldn.t think so," says Ng. "The changes are long overdue because the commercial realities of China have outpaced the le-gal framework by such a degree that this is actually just bringing the law closer in to the commercial realities."

But be in no doubt that the changes are fundamental and point in a very healthy direction.

"I think, from our analysis, that it does go a long way in mak-ing it look and feel more like the standard law we're used to see-ing in common law jurisdiction," says Ng.