Chinese Law Prof Blog

Editor: Donald C. Clarke
George Washington University Law School

Tuesday, November 9, 2010

Thoughts about mandatory versus non-mandatory rules in Chinese corporate law

[A Chinese version of this post is available here.]

I attended an interesting conference in Beijing on Nov. 6th on practical issues in corporate law litigation in China. There were a number of judges there who spoke about the kind of cases they were seeing.

I was asked to talk for three minutes about mandatory versus non-mandatory rules in corporate law. Having only three minutes, like the prospect of being hanged, concentrates the mind. Here’s the general gist of what I had to say.

First, I made the observation – now unoriginal, I think, in US corporate law circles, but I don’t think widely appreciated in China – that mandatory rules may not be all that mandatory and that non-mandatory rules (i.e., default rules that can be varied if people want to do so) may not be all that optional. Bernard Black famously wrote about the former issue several years ago in his article, “Is Corporate Law Trivial?”, 84 Nw. U. L. Rev. 542 (1990), and the latter point has been made more recently by (among others) Yair Listokin, “What Do Corporate Default Rules and Menus Do? An Empirical Examination,” 6 J. Empirical Leg. Stud. 279 (2009) and Brett McDonnell, “Sticky Defaults and Altering Rules in Corporate Law,” 60 SMU L. Rev. 383 (2007).

Mandatory rules can be evaded if you can choose a different organizational form – for example, you choose to organize as a limited partnership in order to avoid things you don’t like about the law applying to corporations – or a different jurisdiction altogether in which to incorporate. Optional rules may not be so optional if it’s costly for some reason to choose something other than the default rule provided by the law (and there has to be some default rule).

Particularly when talking about mandatory rules, it occurred to me that the Chinese participants at the conference might be thinking to themselves, “Well, it may be true in the US that you have a huge menu of organizational forms and jurisdictions of incorporation from which to choose, but what’s that got to do with China? That’s not the reality we face here.” Precisely. Business people in China face a much more restricted set of choices. First, there is only one company law: the national one. There is no jurisdictional competition within China. Second, incorporating abroad creates as many problems as it solves. Among other things, foreign companies are subject to considerable restrictions on what they can do in China. Although Lenovo went this route, incorporating in Hong Kong, not many companies can as a practical matter follow in its footsteps. Finally, China’s laws on business organizations – mainly the Company Law and the Partnership Law – offer much less choice of organizational form to businesses. If you want to list your stock publicly, for example, you must be organized as a joint stock company (gufen youxian gongsi, also translated as “company limited by shares”).

What’s the significance of this? It means that Chinese should be especially careful about borrowing mandatory rules from jurisdictions where extensive choice in fact exists. There is a tendency to think that Delaware or the Model Business Corporation Act must have it right in many respects, and that where something is mandatory in those statutes there should therefore be at least a presumption in favor of making it mandatory in China. But a mandatory rule in Delaware has to be understood in context: it’s mandatory in a world where you don’t have to incorporate in Delaware and where you may not have to be organized as an ordinary corporation. In this sense, then, companies subject to Delaware’s rules have all chosen to be subject to them and we can assume that the rules can’t be too burdensome to those companies.

In China, however, such a mandatory rule would have a much stronger effect. Companies could not easily opt out. Thus, companies for whom the mandatory rule was highly burdensome would have no escape. In other words, importing mandatory rules from jurisdictions where real choice exists is importing something that doesn’t really exist in the country of origin. China will end up with a company law that is much more rigid than the company law of the jurisdictions it is trying to emulate.

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