Tuesday, January 28, 2014
I was surprised, but pleasantly so, to see that China passed amendments to the Company Law last month that, among other things, completely abolish the minimum capitalization requirement for both limited liability companies (LLCs) (有限责任公司) and companies limited by shares (CLSs) (股份有限公司).
In the original 1993 Company Law, the minimum capitalization for LLCs was from 100,000 to 500,000 yuan, depending on the type of business; this was changed to 30,000 yuan in the 2004 revision. The minimum capitalization for CLSs was a world-beating 10 million yuan in 1993, reduced to 5 million in 204, presumably as a compromise between those who thought it should stay at 10 and those who thought it should be nothing. I say "world-beating" because this number is an extreme outlier globally; the legally required minimum capitalization for a US company of that type incorporated in Delaware is zero, and in Europe tends to range from about 50,000 to 100,000 euros (the EU mandates a minimum of 25,000). (My information on Europe may be outdated; remember that this is just a blog post.)
To go from 5 million to zero in one fell swoop is pretty impressive, especially considering that going to zero represents not just a modification of policy but a complete change in thinking about minimum capitalization. China has long been a slave to the myth that minimum capitalization requirements protect creditors; this doctrine is a staple of company law textbooks. In fact, such requirements simply pointlessly impede corporate formation while doing nothing to protect creditors Anyone contemplating lending to a company wants to know about current assets and liabilities and future earning prospects; the historical number represented by the initial capitalization is irrelevant. (For a thorough takedown of this myth, see Macey & Enriques, Creditors Versus Capital Formation: The Case Against the European Legal Capital Rules.) Initial capitalization is not some kind of savings stashed away in the corporate mattress; it is just a number on the books and may well not represent real cash or other assets in hand. This is the American approach and it doesn't seem to have crippled creditors of American corporations or otherwise stifled economic growth. The European approach is not much different in substance - 50,000 or 100,000 euros is probably not that big an obstacle to corporate formation in most cases - but it's quite different in principle, and it's surprising to see China, which self-identifies as a civil law jurisdiction, utterly abandon this European principle and embrace the American one so whole-heartedly and so suddenly.
One thing policymakers need to think about, though, is what does protect creditors if minimum capital requirements don't. The answer is: the institutions that make it easier for creditors to evaluate the creditworthiness of borrowers before the loan is made, and those that give borrowers an incentive to repay the loan after it is made. The latter institutions aren't just legal; they could include mechanisms for making reputational sanctions meaningful. Thus, the needed complementary reforms include opening up information flows and not (as the government is currently doing) vigorously stanching them, and strengthening the ability of courts to find hidden assets and enforce judgments.
Other revisions to the Company Law passed at the same time are essentially complementary and involve the dismantling of the whole regime that fetishized registered capital. There's a nice memo on the revisions by the firm of Davis Wright Tremaine here.