(The Wholly Foreign Owned Enterprise: Part 2 of 2)
The purpose of this entry today is to complete this brief description about the functioning of the WFOE. In particular today we are going to concentrate on the corporate governance of this investment instrument.
Corporate governance of a WFOE
With regard to the
governance
of an enterprise, it must first be specified that ‘enterprises with foreign capital shall conduct their operation and management in accordance with the approved articles of association and shall be free from any interference (in this sense see art. 11 of the
Law of the People’s Republic of China on Foreign-Capital Enterprises,
(
http://www.lehmanlaw.com/resource-centre/laws-and-regulations/foreign-investment/law-of-the-peoples-republic-of-china-on-wholly-foreign-owned-enterprises-2000.html
)
and its
Implementation Rules
).
http://www.lehmanlaw.com/resource-centre/laws-and-regulations/foreign-investment/detailed-implementing-rules-for-the-law-of-the-peoples-republic-of-china-on-wholly-foreign-owned-enterprises-2001.html
).
With specific regard to the management of a WFOE it is necessary to specify that the law requires the presence of one
Executive Director
or of a
Board of Directors.
The Board of Directors, consisting of at least three persons, is mandatory under the
Company Law
, (available at the following web-site:
http://www.lehmanlaw.com/resource-centre/laws-and-regulations/company/the-company-law-of-the-peoples-republic-of-china.html
) its directors appointed by the shareholder and registered with the competent registration authority. An exception is made for small-scale companies that benefit from a simple decision-making structure. In case there is one investor only, he will appoint all the
directors
and thus he will have a total control of the enterprise.
Under the Company Law, senior managers in a limited liability company are the general manager, deputy manager(s), chief financial officer or any other persons listed as such in the Articles of Association. In China, registration of the general manager usually is mandatory, while the registration of other senior managers is optional.
A director may concurrently hold the post of general manager, and either the chairman of the Board of directors, the Executive director or the general manager may be appointed as the company’s legal representative, a decision which must be confirmed in the company’s Articles of Association. Under PRC law, the legal representative is the official representative of the company and is entitled to act on the company’s behalf, therefore investors should take extra care to make an appointment which is both practical and safe.
The Board of directors must meet at least once a year, with the presence of at least 2/3 of its members for its validity. The
quorum
for the deliberations are set in the Articles of Association and not fixed by law as in the case of the
joint venture
;
WFOE
does not have Chinese partners to be protected by the local government with a specific discipline. In any case the
quorum
can be either a simple majority (ordinary management) or qualified majority. A qualified majority (2/3) is required for decisions concerning reduction or increase of the registered capital, mergers and acquisitions transactions, other changes and amendments to the Articles of Association (reference must be done to the WFOE Implementation Rules).
The Board of directors is also responsible for the preparation of the balance-sheet (1-1/31-12), which should be ready in three months from the beginning of each year, the balance-sheet must be certified by an authorized company within the territory of China.
Directors shall exercise their authority through the “Board of directors”, which in turn is accountable to the shareholder (note that this is different for Chinese-foreign Joint Ventures, where the Board of directors by law is the highest authority of the company). Article 47 of the Company Law differentiates the functions of the Board of Directors as: i)
Statutory functions;
and
ii) Functions stipulated in the Articles of Association.
Under the Company Law, the general manager is to implement Board of directors’ resolutions and is responsible for the company’s business operations. Moreover he shall also engage in activities and have the right to make decisions on matters as provided in the Articles of Association, or as authorized in a resolution of the Board of directors. In practice, to prevent the general manager from obtaining too much control over the company’s operations, and to avoid the pursuit of private gains, it is best to include in the Articles of Association a clear scope of the general manager’s scope authority and the limitations thereto; alternatively or in addition, these may be confirmed in a resolution by the Board of directors. Directors and senior managers shall bear legal obligations of fidelity and diligence to the company; Articles 148, 149 and 151 of the Company Law provides more details on what this entails. Where directors or senior managers fail in their performance or neglect their duties, this may result in civil liabilities.
Noteworthy, if involving third parties, the company can generally be held liable for such losses, but in turn the company can demand compensation from the responsible Director or senior manager. Article 152 of the Company Law also specifies the shareholder’s right to request the supervisor or the Board of Directors to sue a director or senior manager. In case the supervisor or the Board of Directors fails to do so or in case of an emergency, then the shareholder may, on its own behalf, directly file the lawsuit.
The first step to improve the corporate governance of a WFOE is to draft the Articles of Association in a way that properly divides responsibilities and authority between the shareholder, the Board of directors and senior management, and facilitates decision-making within and by the Board of Directors, and between senior managers
.
The amendments to the Company Law in 2006 made the appointment of a supervisor mandatory to all companies in China, including WFOE’s. The supervisor serves as an external controller of the company and mainly supervises the activities of the directors and senior managers to ensure their compliance with relevant PRC laws and the company’s Articles of Association. The supervisor may demand of any director or senior manager that he makes corrections if his act has injured the interests of the company. This is also the reason why by law, a director or senior manager may not concurrently serve as supervisor. It is important to monitor the activities of directors and senior managers, in fact even a perfectly-designed system can be subject to abuse where implementation is not monitored. After years of operations, directors and managers may be so used to one way of doing things that they forget about the checks and balances that the system was designed with. Therefore the investors or shareholders should ensure compliance, or instruct the supervisor to complete this task.
A
wholly foreign owned enterprise
will be dissolved under one of the following circumstances (see Art. 75,
WFOE Implementation Rules
):
1) Expiration of the term of the enterprise; 2) dissolution by the foreign investor due to poorly run operations and heavy losses; 3) inability to continue operations due to heavy losses caused by
force majeure
, such as natural disaster and war; 4) bankruptcy; 5) revocation of the enterprise’s right to run the business due to violation of Chinese laws and regulations or impairment of public interest; or 6) occurrence of other causes for dissolution as stipulated in the articles of association. In the case of points 2, 3 and 4 the
wholly foreign owned enterprise
shall submit on its own an application for dissolution to the examination and approval authority (i.e. the MofCOM). The date of approval will be the date of the dissolution of the enterprise. If the enterprise is dissolved under point 1, 2, 3, or 6, it must, within 15 days of its dissolution, make a public announcement and notify its creditors. Immediately after the dissolution and within 15 days of the announcement, the enterprise must propose the procedures and principles for liquidation and nominate candidates for the liquidation committee. The liquidation committee shall be composed of the legal representative of the enterprise, a representative of its creditors, a representative of its department in charge, and accountants and lawyers registered in China. After the MofCOM has given its approval, the liquidation committee shall conduct liquidation.
It is worthy to note that when a
WFOE
liquidates its assets, Chinese enterprises or other economic organizations have the right of priority to purchase the assets on equal terms. In addition, after the dissolution and the liquidation is completed the WFOE shall apply for cancellation of registration with the SAIC (and return its business license), and other authorities (e.g. tax authority).
– Cristiano Rizzi