An analysis of rules governing limited liability companies in China : between contracts and regulation

Abstract

CL 2005 has been effective for more than eight years. Its impact on corporations and corporate participants has been a popular topic in the academic world. In response, the rules of CL 2005 in regulating limited liability companies, which have not attracted intensive attention of scholars, have considerable influence on the Chinese business environment and are less subject to government control, will be examined in this thesis. With reference to law and economics analysis which asserts the contractual nature of the firm, this thesis lays the theoretical foundation for evaluating CL 2005: 1) the character and the content of legal rules, and 2) the allocation of authority in decision-making and agency problems indicated by the application of agency theory in the context of close corporations. Based on this analytical framework, the relevant rules on the book and in action will be examined in this thesis.

Specifically, it will be argued in this thesis that overlap between ownership and management is an established norm in allocating authority in limited liability companies and this norm requires that shareholders have discretion in choosing the way of management that is tailored to their own special needs. The way of management has a variety of different forms; accordingly, company law should respect and facilitate the private contracting of shareholders by adopting enabling rules in respect of the corporate governance structure of limited liability companies. Nonetheless, the relevant rules on the books fail to meet the requirement of the established norm, as their mandatory character offers a rigid and inflexible statutory governance structure though inclined to shareholder centralism. Although it is found in the work carried out in this thesis that courts relieve shareholders from such a strict regulation in many cases, it is suggested that the character of the relevant rules be clarified as enabling to reduce the uncertainty around their application in practice.

Under the established pattern of allocation of authority, minority shareholders usually depend on the discretionary performance of majority shareholders, and consequently agency problems between shareholders then arise. After demonstrating the inappropriateness of the appraisal remedy in addressing the agency problems, three liability rules under CL 2005 will be analyzed in this thesis. Contrary to deregulators’ claim on the default character of the rules, it will be argued in this thesis that mandatory liability rules with appropriate content should be provided by company law to constrain the discretion of majority shareholders. The three liability rules are considered to be mandatory and the theoretical scope of restraints imposed by them onto the conducts of majority shareholders seems to be somewhat adequate to address oppression. Nevertheless, it is discovered in this thesis that the adoption of the actual legality test by some courts may condone majority shareholders in a number of oppressive cases; when some courts carry out a substantive examination on the conducts of majority shareholders, there is no consistent principle that guides this examination. Therefore, the constraining effect of the rules on oppression and their mandatory character are weakened by the conservative and inconsistent application in practice by courts. To strengthen the protection of minority shareholders, this thesis will propose detailed suggestions for the formulation of the content of a desired mandatory liability rule and recommendations to apply the rule by courts.