metadata: authors: 0: author: Lichtenstein, Natalie G.
1: author: DEC
count: China
docna: 0: docna: Enterprise reform in China : the evolving
            legal framework
docty: Policy Research Working Paper
subtopic: Social Policy,Legal Products,Judicial System Reform,Urban Housing and Land Settlements,Urban Governance and Management,Urban Housing,Financial Regulation & Supervision,Competition Policy,Corporate Law,Legal Reform,Financial Law,Legislation,Municipal Management and Reform,Regulatory Regimes,Competitiveness and Competition Policy,Law Finance and Growth,Financial Sector Policy
teratopic: Infrastructure Economics and Finance
abstracts: cdata!: Enterprise reform in China since 1979
            has been supported by accelerated reform of China's
            legal framework. In the transition to a "socialist
            market economy", state enterprises will operate
            independently of the government, may no longer be fully
            owned or controlled by the state, and will deal with the
            state and other legal entities through market based
            transactions. The number of collective (township and
            village) enterprises has grown rapidly, and in recent years
            so has the number of private enterprises. This level of
            economic change requires a commensurate level of legal
            change. The author describes the legal framework needed for
            enterprise reform in the world's most populous country.
            First, it is essential to define the enterprise and its
            rights and obligations. To define and broaden the autonomy
            of enterprises, enterprise law and regulations must be
            reformed. For state and collective enterprises, a goal of
            legal reform is also to effect the separation of ownership
            and management. To create a legal environment in which all
            enterprises - including state enterprises -participate as
            independent actors, reform is also needed in the following
            areas. Bankruptcy and competition law, to promote fair
            effective competition among autonomous enterprises and to
            ensure the continued protection of the public interest even
            without direct state management of enterprises. Financial
            laws, including securities laws and regulations, so
            enterprise financing can take place in a market driven
            system rather than through a planning mechanism. Laws
            governing land use, mortgage financing, and pension and
            social security systems, to separate employee housing and
            pension and social security systems from enterprise
            obligation and henceforth to provide housing pensions, and
            social security through alternative means. Contract law, to
            protect the legal rights of enterprises and allow economic
            transactions between parties to replace administrative
            controls, and to ensure that the court system and dispute
            resolution processes function credibly and reliably, thereby
            making all other reforms enforceable. To make these reforms
            meaningful, property rights must also be better defined.
            China's civil code currently offers only a limited
            definition of the rights of ownership and of an
            enterprise's rights to sell, transfer, or otherwise
            dispose of property. The author catalogs these pieces of the
            legal framework, suggesting where further reform is needed
            to support enterprise reform; focuses on the reform of state
            enterprises but also discusses the reform of nonstate
            enterprises; and touches only lightly on the role of foreign
            investment but does address the developing framework of
            patent, trademark, and copyright laws,
geo_reg_key: 517198,119225,517191
repnme: repnme: Enterprise reform in China : the evolving
            legal framework
display_title: Enterprise reform in China : the
            evolving legal framework
listing_relative_url: /research/1993/09/698852/enterprise-reform-china-evolving-legal-framework
topicv3: Company and Corporate Law m1326084 847,Insolvency and Debtor-Creditor Law
            m1326733 846,Competition Policy m1326982 406,Competition Law m1327469 1031,Land and Housing m1327648 817
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Infrastructure Economics and Finance
origu: UNKNOWN
no_of_pages: 46
model_extractions: ## Tastnand Manmo Adjust.nent

# WPS 1198

is the first in a series of staff publications intended to place in a market-dniven system rather than through a planning mechanism.

- This paper- a product of the Legal Department is the first in a series of staff publications intended to provide information and analysis of legal issues relevant to development. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Malini Rangarajan, room MC6-367, extension 81710 (September 1993, 39 pages).

Enterprise reform in China since 1979 has been supported by accelerated reform of China's legal framework. In the transition to a "socialist market economy," state enterprises will operate independently of the government, may no longer be fully owned or controlled by the state, avid will deal with the state and other legal entities through market-based transactions. The number of collective (township and village) enterprises has grown rapidly, and in recent years so has the number of private enterprises.

e Laws governing _land use, mortgagefinancing, and pension and social security systems,_ to separate employee housing znd pension and social security systems from enterpAise obligations and henceforth to provide housing, pensions, and social security through altemative m!ans.

_Lontract C law,_ to protect the legal rights of enterprises and allow economic transactions between paries to replace administrative controls, and to ensure that the _court system and dispute resolution processes_ function credibly and reliably, thereby making all other reforms enforceable.

Th.is level of economic change requires a commensurate level of legal change. Lichtenstein describes the legal framework needed for enterprise reform in the world's most populous country.

First, it is essential to define the enterprise and its rights and obligations. To define and broaden the autonomy of enterprises, _enterprise law and company law and regulations_ must be reformed. For state and collective enterprises, a goal of legal reform is also to effect the separation of ownership and management. To create a - legal environment in which all enterprises - including state enterprises panicipate as independent economic actors, reformn is also needed in the following areas: To make these reforms meaningful, _property rights_ must also be better defined. China's civil code currently offers only a limited definition of the rights of ownership and of an enterprise's rights to sell, transfer, or otherwise dispose of property.

Lichtenstein catalogs these pieces of the legal framnework, suggesting where further reform is needed to support enterprise _reform._ She focuses on the reform of state Lnterprises but also discussus the reforn of nonstate enterprises. She touches only lightly on the role of foreign investment but does not address the developing framework of patent, trademark, and copyright laws.

_Bankruptcy and competition law,_ to promote fair, effective competition among autonomous enterprises and to ensure the continiued protection of the public interest even without direct state management of enterprises.

_* Financial laws, including securities luws and regulations,_ so enterprise financing can take IThe Policy Research Working Paper Series disseminates the findings of work under way in the Bank. An objective of the series is to get these findings out quickly, even if presentations are less than fully polished. The findings, interpretations, and conclusions in these papers do not necessarily represent offikial Bank policy.

Produced by the Policy Research D;ssemination Center
# **ENTERPRISE REFORM IN CHINA:**

# **THE EVOLVING LEGAL FRAMEWORK**

Natalie G. Lichtenstein Legal Department The World Bank
Preface This is the first in a series of staff publications by the World Bank's Legal Department which are intended to provide information and analysis of legal issues relevant to the Bank's development mandate. While the publication of these papers will constitute a resource for the staff of the Bank and the borrowing countries concerned, it could obviously have wider benefits and serve to enhance public awareness of the linkage between legal reform and development in general and the relevance of such reform to private sector development in particular.

Natalie Lichtenstein's paper describes the legal framework for enterprise reform in the world's most populous country. It provides an overview of the legal reforms introduced to date and of the areas where further reforms are needed to help China in its impressive economic and social devel)pment. As the Banl's lawyer most familiar with the Chinese legal system and language, Ms. Lichtenstein is particularly qualified to address these subjects. Outside scholars of Chinese law have reviewed this paper and found it to be a concise overview of the legal framework which is both comprehcnsive and accurate. It provides a model to be followed by the other papers contemplated in this series.

Ibrahim F.I. Shihata Vice President and General Counsel The World Bank
# CONTENTS

|I.|INTR|ODUCTION ..........................................................<br>1|
|---|---|---|
|II.|DEFI|NING THE ENTERPRISE AND ITS LEGAL RIGHTS AND OBLIGATIONS**..........3**|
||A.|STATE ENTERPRISE AUTONOMY..<br>3|
||B.|STATE ENTERPRISE GOVERNANCE..<br>6|
||C.|NON-STATE FNTERPRISES..<br>.<br>8|
|||1.<br>Collective<br>Entarprises..<br>.....<br>.<br>.8|
|||2.<br>Private Enterprises.<br>.<br>.<br>9|
||D.|STRUCTURING<br>ENTERPRISES<br>AS COMPANIES<br>.<br>.<br>.11|
|||1.<br>Current State of Legislation<br>...<br>11|
|||2.<br>Types of Companies<br>.<br>.<br>.13|
|III.|A COM|PETITIVE ENVIRONMFNT<br>.............................................<br>17|
||A.|BANKRUPTCY<br>LAW ..................................................<br>17|
||B.|COMPETITION<br>LAW .................................................<br>18|
|IV.|FINA|NCIAL LAWS ........................................................<br>21|
|V.|REMO|VING THE SOCIAL BURDENS OF THE ENTERPRISE .........................<br>23|
||A.|HOUSING:<br>LAND USE AND MORTGAGE LAW<br>..<br>23|
||B.|SOCIAL WELFARE RIGHTS ...........................................<br>24|
|VI.|PROT|ECTING<br>THE LEGAL RIGHTS OF THE ENTERPRISE ........................<br>26|
||A.|CONTRACT LAW<br>...................<br>26|
||B.|COURTS AND DISPUTE RESOLUTION PROCESSES<br>.<br>.<br>27|
||C.|LEGAL INSTITUTIONS .............................................<br>28|
|VII.|CONCL|USIONS .....................<br>,,,,,,,,........<br>29|
|Annex|1 (T|able of Legislation) ..............................................<br>30|
|Annex|2 (B|asic Forms of Shareholding<br>Enterprise) ............................<br>36|

The author wishes to acknowledge the helpful comments made on previous versions by William Alford, James Feinerman, Susan Finder, Peter Fox, Peter Harrold, Sherif Hassan, Tariq Hassan and Nena Manley.
# ENTERPRISE REFORM IN CHINA;

# THE EVOLVING LEGAL FRAMEWORX

# I. INTRODUCTION

1. Enterprise reform in China since 1979 has been supported by an accelerating evolution in accompanying reform of the legal framework. State enterprises are in a transition to a "socialist market economy", in which they will operate independently of the government and may no longer be fully owned or controlled by the state, and will deal with both the state and other legal entities through market-based transactions. Collective enterprises have grown rapidly, in the form of township and village enterprises; in more recent years, private enterprises have also developed in increasing numbers. Thus, the legal framework iecessary for enterprise reform is comprehensive as the economic reform of enterprises requirea changes in many areas of economic behiavior.

2. Defining the enterprise and its rights and obligations is at the core of the legal framework i:or enterprise reform through reforms of enterprise law and :ompanv law and reaulaticns necessary to define and broaden enterprise autonomy. For state and collective enterprises, the legal reforms also seek to effect the separation of ownership and management. These core reforms must be accompanied by other reforms which aLe needed to create a legal environment in which all enterprises, including state enterprises, participate as independent economic actors.

(a) development of a competitive environment through reforms in bankruptcy and competitior. law, promoting fair and effective competition among autonomous enterprises and ensuring thot the public interest continues to be protected even without direct state management of en.terprises; (b) reforms in financial laws, such as securities law and securities regulation, r ,cessary for enterprise finincing to take place through a market-driven system rather than through a planning mechanism; (c) separating employee housing and pension and social security systems from the obligations of the enterprise, with reforms in the laws aoverninq land use. mortgaae financing, and rension and social security systems necessary **t.j** ensure alternative means of providing housing, pensions and social security; and (d) protecting the legal rights of the enterprise through reforms in the
2 laws on contracts to allow economic transactions between parties to replace adminintrative controls and to ensuro that the court svstem and dispute resolution Processes function credibly and reliably, making all of these other reforms enforceable.

For all these legal reforms to be fully meaningful, s~.eater definition of property rights will also be needed. Currently, the Civil Code offers only a limited definition of the rights of ownership and of the property rights (disposition, transfer, sale) of enterprises.

3.

3. In most if nct all of these areas, the legal framework is beginning to emerge, as legislation is enacted (if not perfect). This paper attempts to catalogue these pieces of the legal framework, and to sut'est where further developments are required to support full-fledged enterprise reform. While this paper focusses primarily on state enterprise reform, the reform of non-state enterprises is also discussed. The role of foreign investment in enterprise reform, while important, is considered here only briefly, since much has been written elsewhere on China's foreign investment legislation. Similarly, intellectual property laws are not addressed, although the developing framework of patent, trademark and copyright laws will have some impact on enterprise development.
3

# II. DEFINING THE ENTERPRISE AND ITS **_LEGAL_ RIGHTS** AND OBLIGAT N5S

4. The laws relating to enterprise formation and operation and companies have been developed slowly over the reform period. Several importAnt areas have been addressed in increasingly detailed fashion: operational autonomy and governance (including internal enterprise management) for state enterprises, the rise of collect.ve and private enterprises and, in parallel, adoption of corporate form. State, collective and private enterprises are discussed separately in this section, because the current legal framework **has** different legal rules for enterprises urder these differer4<sup>t categcries</sup><sup>**cf**ownership.</sup> However, full-fledged enterprise reform would lead to a consolidation of the legal rules, applied equally to enterprises regardless of ownership.

# **A.** STATE ENTERPRISE AUTONOMY

5. Early in the reform process, in 1983, provisional rules were enacted governing the rights and duties of state industrial enterprises, and providing for a limited sphere of autonomy for their operation. Under the 1983 State Industrial Enterprise Provisional Rules, state enterprises were first obliged to ensure that the planned tasks set down by the supervisory unit were fulfilled; only then were they allowed to determine their supplemental production, and within the scope of state regulations, select and purchase goods, sell products, determine prices, utilize enterpris, funds and determine wages and bonuses for workers. The supervisory unit approved the enterprise's annual production plan, technical transformation program, investment budget and product orientation. State Council regulations promulgated in 1984 provided some additional flexibility, permitting enterprises to retain seventy per cent of depreciation funds and dispose freely of some other enterprise funds, produce and sell a broader range of products, set prices within twenty per cent of state prices and exercise greater decision-making in hiring and promotion of workers.

6. Further legal specification of state enterprise operating rights came with the enactment of the 1988 State Industrial Enterprise Law. The enterprise's right, under the Law, to hold, use and legally dispose of assets the state authorizes it to manage does not differ from the Provisional Rules, nor for that matter from the relevant provisions of the Civil Code General Princip.es enact'd in 1986. As under the Provisional Rules, the enterprise may lease out or "transfer for compensation" its fixed assets, but governmental department approval is required where these assets are neither idle nor excess. Several new
4 enterprise rights **_are_** explicitly included in the Law, such **as the right to plan** production of goods or provision of services needed by society, the right to use **its foreign** exchar.ge portion, the right to invest in cther enterprises and the -ight to issue bonds. Other rights are similar to those under the Provisional Rules, although generally more clearly and sometimes more broadly stated, such as the rights to market its goods choose suppliers, st price, and utilize its capital.

7. Nonetheless, it is important to note that most -f the rights are subject to 'regulations by the State Council" and, in practice, enterprise enjoyment of these rights has ni.t necessarily followed their legal definition. From a legal perspective, if enterprise rights have not been exercised to the fullest, some of the cause may lie in the vagueness with whi-h they have been granted. Qualifying each right with reference to separate regulations means, ag a legal matter, that the enterprise lacks the certainty as well as the ilarity that is necessary for any economic player to play its role fully. S. The legal vagueness surrounding enterprise rights has been substantially alleviated with the most recent regulations, the Regulations on Transforming the Management Mechanisms of State-Owned Industrial Enterprises. The main thrust of the 1992 Regulations was to strengthen and broaden the operating autonomy of state enterprises by specifying fourteen managemient rights which would henceforth be exercised by the enterprises themselves rather than the government departments concerned. Those manaSoment rights are:

- (a) production and management decision-making powers;

- (b) the right to decide prices of products and services;

- (c) the right to sell products;

- (d) the right to purchase goods and materials;

- (e) import and export rights;

- (f) the right to make investment decisions;

- (g) the right to determine application of reserve funds;

- (h) the right to dispose of assets;

- (i) the right to operate joint ventures or undertake mergers;

- (j) the right to hire workers;

- (k) the right to determine personnel management;

- (1) the right to determine distribution of wages and bonuses;

- (m) the right to decide the organization of internal units; and

- (n) the right to refuse proration (demand for resources from government departments).

These rights are described in greater detail than under the Law, though the scope
**5**

of autonomy is still qualified in certain respects. For **example, the rt.ht to** decide prices does not apply to individual products whose price. are controlled by the price departments of the State Council, nor to prices of the means of production included in the lists issued by those departments and their local counterparte, nor to those products and labor services whose prices are governed by law. Prices for processing, maintenance, technical assistance and other labor services are decided by the enterprise themsel,'es. Thi illustrates the improvement over the vaguer provision in the Enterprise Law, since at least **the** particular scope and limits of prices subject to state regulation **are spelled** out. Moreover, tnere are no limits on service prices, except **as** stated in particular laws.

9. Similarly, the import and export rights extended to an enterprise include the right to select foreign trade agencies from any nart of the country to undertake import and export business, to utilize freely fo-eign exchange earnings (in compliance with foreign exchange control provisions), t.o undertake projects and provide services abroad and to import equipment, goods and materials foz enterprise use (in compliance with import regulations). However, the Regulations still reserve the right to engage directly in import-export activities for enterprises that have favorable conditions and approval by the relevant government departments; in practice, national and local state trading corporations continue to play a role.

10. The same kind of broad definition of rights with limited exceptions, clearly spelled out, applies to most of the other rights as well. As a result, the 1992 Regulations can be viewed as giving needed content to the ubiquitous phrase in the 1988 Law, "in accordance with state regulations". These Regulations demonstrate a reasonable attempt to balance the need for clarity and certainty to bring enterprise autonomy fully into play with the current policy decision to retain government control of parts of the economy and certain economic decisions. Moreover, more detailed local provisions implementing the Regulations are being drafted in jurisdictions such as Shanghai. It remains to be seen in practice whether the actual devolution of authority from the state to the entorprises will follow the legal provisions providing for it.

11. The importance of the new operating mechanism is evidenced by the 1993 amendments to the Constitution, which better reflect the economic structure of the country and the coming socialist market economy. All references to staterun enterprises are changed throughout to state-owned enterprises, and wording more consistent with the new operating mechanisms is used to describe their relationship to the state. More generally, the amendments make minor adjustments in wording to add reform and the socialist market economy to the economic
6 principles referred to in the Constitution, a,.- corr6st **ref3rences to such** economic forms as rural people's com.munes which are r.o longer relevant. These changes can be seen to reflect a consensas at the highest level for the transformation to a socialist market economy. Moreovf ,, **the** fact that the leadership considers it necessary to change the country's basic legal instrument in order to provide a firm base for the refor.ns reflects, a heightened -crncern for the use of legal instruments to effect reform.

# B. STATE ENTERPRISE OOVLRNANCE

12. Under the 1983 Rules, the dec.sions of an enterprise could **not** conflict with those of the supervisory -nit, and while the enterprise could raise suggestions, the supervisory unit's final decision was binding. The 1988 Law appears to have been inr.ended to remedy that situation, by providing that Relevant government departments (and social groups) shall not violate enterprises' legal autonomny. They shall not request tupport from enterprises in terms of manpower or material and financial resources. They shall not request an enterprise to set up a certain organ or determine the size of its staff.

If a relevant government department violates these restrictions, the enterprise has the option to request compliance, and then to petition the next higher level government organ to adjudicate. If the enterprise is dissatisfied with that organ's ruling, it may appeal to the people's court. It would be interesting to know whether these provisions have ever been tested in arbitration or litigation.

13. The 1992 Regulations also addressed the evolving relationship between the government and the enterprise, in three main ways: (a) First, the Regulations include a chapter on enterprise responsibility for profit and loss, which details certain standards to be met (restraining and supervising distribution, limits or tained wages as enterprise wage reserve fund, profit delivery prerequisites for cash awards to managers and employees, to name a few). This chapter gives some meaning to the oft-s.ated "responsibility for profit and loss" while introducing some administrative mechanisms to protect against losses {which the state, as owner of state enterprises, has every right to do).

(b) Second, the role of the government under the transformation of management rights is desc:ribed in a separate chapter, which specifies the
**7**

functions of government departments in exercising ownership righta **lx** the enterprises, in strengtlhening macroeconomic regulation, in developing a **market** system and in providing social services to enterprises. This now **role** for government differs markedly from the kind of control exercised by the government supervisory department in the planning model, and will require substantial rostructuring and rb'orientiv.g in the transition.

(c) Finally, if the government infringes on the legal autonomy of an enterprise, it would be held legally liab!e. Indeed, the Administrative Lit,gation Law now offers a mechanism for enterprises to seek remedies for **government** infringement.

This kind of distinction between the governmen6 as owner and the government as regulator, separated from the enterprise management, **ib** exactly **the** kind of structure that has been the focus of previous policy discussions con state enterprise reform. While the precise formulation of each provision may merit further review, the structure and drafting of the Regulations does represent a meaningful step forward in state enterprise legal reform.

14. As for internal enterprise management, the autonomy of enterprise managers has been a focus of the reform program and has been strengthened under the legislation. Under tho 1983 Rulei the factory director was designated the legal representative and the leading administrator of the firm, but operating under Party Committee leadership. With the introduction of the 1986 Factory Director Rules, the factory director not only is the legal representative of the enterprise but also has the central leadership and overall responsibility for production, operation and management. The factory director is encouraged to seek advice on a number of specified issues from an advisory group, thc management committee, composed cf the factory director, deputy directors, chief engineer, chief accountant, secretary of the party committee, trade union presider:t, secretary of the communist youth league and workers' representatives. Tha managemant committee lacks any legal decision making power, as evidenced by the provision that, when matters discussed by the management comnittee require approval by government authorities or review by the workers' congress, the factory director makes the appropriate report or resolution. Where the factory director and the management committee (acting by a majority) differ on the important matters, the right of final decision rests with the factory director.

15. While the 1986 Factory Director Rules have yet to be updated to conform fully to the 1988 Law, the 1988 Law does enhance the role of the factory director in several ways. First, the Law provides that the factory director is legally responsible for the enterprise's operations in all areas and enjoys legal
8 protection in the exercise of the director's powers, within the scope of autonomy granted to the enterprise. Furthermore, the factory director is no longer under the Party Committee's leadership; rather, the Law provides that the Party Committee supports the director in discharging his or her authority according to law. This seems to offer more autonomy to the factory director than the 1986 Rules, although it is unlikely that the situation will have changed everywhere in practice. The Law, like the Rules, establishes a management committee, but, unlike the Rules, it does not require Party participation. The Law also provides fr .Afferent methods of factory director appointment and different responsibility. The 1992 Regulations do not address this aspect.

# C. NON-STATE ENTERPRISES

# 1. Collective Enterprises

16. Collective enterprises had been protected under the Constitution for decades, and provisions for their registration as legal persons had existed even before the General Principles of the Civil Code and the Enterprise Legal Person Registration Regulations. It was not until 1990, however, that the legal framework for the structure and governance of collective enterprises gained definition under the Regulations for Rural Collective Enterprises. These were followed in 1991 by the Regulations for Urban Collective Enterprises. These Regulations provide for the establishment, registration, management and operation and termination of rural collective enterprises (those run by township and village peasants' collectives) and urban collectives (those run by mass labor collectives in urban areas). Both sets of Regulations attempt to clarify the legal ownership rights and autonomy of collective enterprises, providing that the enterprises are legal persons which enjoy protection under the law.

17. The Urban Collective Enterprise Regulations provide somewhat more clearly for ownership rights to be exercised by the workers assembly, which selects the enterprise management, as well as for managemer- functions and relationship with government. The Rural Collective Enterprises Regulations are briefer (45 articles, rather than 70 articles) and are less clearly drafted. For example, these Regulations speak of the property of the enterprise being owned by the entire peasants' collective, with the proprietary rights exercised by the peasants' congress or collective economic organization representing all peasants. Again, confusion is introduced by the subsequent references to the rights and obligations of the owner of the enterprise, such as determining the enterprise's orientation, business line, manager (or method of selecting the manger) and distribution of after-tax profit. One would assume that references to the owner must mean the collective which exercises proprietary rights, but there is no clear connection between the provisions.
9 18. In any event, the provisions on the **separation of management are clear,** specifv_ng the qualifications and rights of **enterprise managers, as are the** provisions specifying the autonomy of the **enterprise in operation, such as** setting prices for non-controlled goods, hiring employees, entering into economic contracts and undertaking external trade. Moreover, **the collective nature of the** rural collective enterprise is preserved in several ways. For one, collective enterprises may attract investment from other investors "so long **as the nature** of the enterprise does not change." In addition, the Regulation. specify that at least **60%** of the after-tax profit snould be retained by the enterprise, whether for reinvestment, technological transformation **or bonuses, while the** balance should be used for agricultural infrastructure and renewal and development of other enterprises.

19. These Regulations take the legal framework **for collective enterprises** one step forward, by giving some contours to their legal status, rights and obligations. In light of the new operating mechanisms **recently introduced for** state enterprises, though, it may be opportune to revise the legal framework for collective enterprises to enjoy the same scope of operational autonomy **as** now offered to state enterprises. Pt the same time, **it would be helpful to** consolidate legal framework for all collective **enterprises, whether or** not **they** meet current definitions of urban and rural.

# **2.** Private Enterprises

20. Unlike collective enterprises which have **been part of the economy** since the beginning of the People's Republic, private enterprises were dismantled in the 1950s and only re-emerged during the reform period of the 1980s. Individuals were permitted to establish enterprises, which became known as individual households (getihu) under the 1982 Constitution and the Civil Code. Under various regulations the number of employees working in such **households or** other private entities was limited at times to 7, but in practice private enterprises with many more employees sprang up. It was not until 1988 that the Constitution was amended to permit private enterprises to be established and enjoy legal protection from the state. Shortly thereafter, the Private Enterprise Regulations and related tax provisions and implementing measures were ,enacted to provide a more comprehensive legal framework for private enterprises.

21. The Regulations gave structure to a defined **category of private** enterprises, namely those which are profit seeking economic organizations employing 8 or more persons whose property is privately owned. Private enterprises can be organLzed in one of three forms: sole proprietorship, partnership and limited liability company. The forms differ in **number of** owners,
10

**their liability** and their legal status. sole **proprietorships have only one owner** who **bears** unlimited liability for the obligations of **the enterprise; partnerships have** two or more owners under a written agreement, **each of whom assumes joint and** unlimited liability for the obligations of the enterprise. **Limited liability** companies have two to thirty owners (an exception for **a higher number can be** requested), each of whose liability is limited to his or her investment. The Regulations specifically provide that private enterprises in **the form of limited** liability companies are legal persons; for sole **proprietorships and partnerships, only the** legal representative of the enterprise is specified.

22. The Regulations do not limit the **size or capital of enterprises but rather limit** the types of individuals who may establish them. **These individuals** must **fall** in the following categories: rural **residents, unemployed individudla** ir cities and townships, operators of individual **and commercial households,** employees who have resigned or been discharged and others leaving or retiring from their positions, as further defined in the implementing **measures. The** business lines available for private enterprise are limited, however, to seven basic trades: industry; construction; communications and **transport; commerce; food and** beverage; service and repair; and -ecrhnological **consultancy.**

**23.** Certain other restrictions on private **enterprise can be seen as** manifestations of the desire to control the potential for excess. For example, the salary of the director of a private enterprise is stipulated not to exceed ten times the average staff wages. The enterprise is required to retain at least 50% of after-tax profit in the production development fund. Further retention of profits in lieu of distribution to individual owr.ers is encouraged by the exemption from the 40% tax on after-tax profit distributable to owners for additional amounts retained in the production development fund. Social concerns are noticeable in the requirement of an 8-hour day and prohibition of child labor, a level of detailed management that is not **specified for state and** collective enterprises. Enforcement of the regulations **is** also addressed: first, by specifying the State Administration for Industry and Commerce to administer the Regulations, and second, by providing the **private owner with the** right to request administrative reconsideration and to go to court if dissatisfied.

24. Private enterprises are also granted rights and **obligations similar** to those of collective enterprises. Among other things, they **can operate** autonomously, recruit workers, enter into contracts (including mandatory labor contracts), work out prices and apply for patents and trademarks. **If** a private enterprise is "bankrupt," it is required to liquidate its assets and pay its obligations. These rights must be balanced against the limitations noted above,
11

**in assessing the** scope for autonomy in operations **offered .)y the legal framework. Fuller enterprise** reform would lead to reduction or **reinoval of these limitations; so far,** the policies supporting the development **of private enterprises have** fluctuated in the period since the Regulations were enacted.

# **D.** STRUCTURING ENTERPRISES AS COMPANIES

# 1. **Current State of Legislation**

**25.** companv law. One important area in which **the legal framework for** enterprises **has** been lacking is in the establishment of organizational forms. Throughout the reform period, enterprises have almost **interchangeably called** themselves companies and enterprises. State enterprises, at least, were given a basic definition in the 1988 Enterprise Law, but **the term "company" had no lagal definition** in Chinese law. Indeed, at one stage **(1985), there were separate registration** requirements **for** companies (including **capitalization requirements) even** though there was no separate legal status for companies. **Subsequently, the** 1988 Enterprise Legal Person Registration Regulations repealed **previous** rules and combined the registration requirements for all enterprise legal persons.

26. One limited exception to the lack of company **law noted was the** introduction in 1990 of the limited liability company form for private enterprises, although the provisions of the Private Enterprise Regulations for such companies do not address much of the corporate legal framework normally found in company law. Moreover, there is a process of "chartering" enterprises in which specific powers and duties are set out in a **charter issued by the** supervisory department, and the charter is required for registration as an enterprise legal person. However, these charters frequently do not clarify the legal powers and corporate structure of the enterprise to the **same extent that** even the current shareholdirig legislation would provide.

27. Notwithstanding the lack of a proper legal framework, shareholding companies (also translated as joint stock companies) have been springing up all over China for about five years now. The only two areas in which the "shareholding experiment" was officially sanctioned were in Shanghai and Shenzhen. Both municipalities also established securities exchanges for the trading of share in these companies in 1990, although shares had been actively traded in the financial markets before the exchanges were established. Yet, it was not until the enactment of the Shenzhen provisional company regulations in March 1992 and the Shanghai provisional company regulations came into effect in June 1992 that there was a legally discernlble and enforceable definition of the rights carried by the shares being traded. Thus, from the point of view of establishing a proper legal definition of rights and duties, the Shanghai and
12 Shenzhen regulations constitute an important part of the legal framework for companies. (The limited liability companies under the Private Enterprise Regulations are not permitted to issue shares to the public.) 28. It is recognized, however, that a national legal framework for companies is also necessary. Not only is it desirable to spread nationwide the benefits of the corporate form (limitation of shareholder liability and enforced separation of the government as owner of shares from the management of the enterprise), but a single set of rules for corporate organization would facilitate interprovincial operations of companies and sales of shares. For instance, a buyer in Liaoning could know whether the president or the chairman of the board of the selling company in Shanghai had to sign a contract before the buyer could rely on it--without having to consult various provincial laws on the subject. Thus, a company law of naticnwide applicability remains an important goal.

29. There is yet no national company law, although a draft company law, revised from last August, was considered by the 30th session of the Standing Committee of the National People's Congress in February 1993. Unlike the August version, which only covered limited liability companies, this version reportedly includes limited liability companies, limited share companies, Chinese branches of foreign companies, joint companies and single-owner companies (an important category for state enterprise reform). So far, it apparently does not cover partnerships or unlimited companies. The revised draft is expected to be approved at the August 1993 session of the Standing Committee.

30. The Shareholding Experiment. While enactment of the company law is hoped for in 1993, in the spring of 1992 several parts of the corporate legal framework were established, which can be thought of as a functional substitute for a company law in the interim. On May 15, 1992, five agencies under the State Council (but not the State Council itself) issued the Measures on Enterprises' Shareholding System Experiment --State Commission for Restructturing the Economic System (SRC), State Planning Commission (SPC), Ministry of Finance (MOF), People's Bank of China (PBC) and the State Council Production Commission (now known as the State Economic and Trade Commission). While the Measures do not themselves set out the provisions of a company law, they permit the establishment of shareholding companies throughout China, and they require that these companies be established as either limited share companies or limited liability companies. Most importantly, the Measures mandate that all shareholding companies follow strictly the provisions of two relevant documents issued by SRC, also on May 15, 1992: the Views on Standards for Limited Share Companies and the Views on Standards for Limited Liability Companies. These two
13 documents, the Limited Share Company Standards and the Limited Liability Company Standards, are in the form of guidance from SRC, but they are structured as if they were laws (which they are not). The measures themselves are unusual, but probably binding; by requiring companies to follow the standards, this gives the Standards legal force.

31. This issuance of directives by several agencies coupled with guiding directives from one agency is not a substitute under Chinese law for the enactment of regulations (by the State Council) or laws (by the National People's Congress or its Standing Committee), under Chinese law. It is essentially a stop-gap measure to provide some legal basis in advance of formal enactment of legislation. However, the two Standards were subsequently supplemented with regulations from various agencies on relevant aspects of shareholding companies, enacted under normal administrative procedures. These reguiations cover financial management (MOF, SRC); accounting (MOF, SRC); registration and management of state assets (State Assets Management Bureau, MOF and State Administraticn for Industry and Commerce); taxation (State Taxation Bureau, SRC); labor and wages (Ministry of Labor, SRC); macro-economic control (SPC, SRC); auditing (State Audit Administration, SRC) and land administration (State Land Administration Bureau, SRC).1 While these regulations apply cnly to the socalled experimental shareholding enterprises. they could eventually form the basis for regulations to apply to all companies, once a nationwide company law is 8nacted.

# 2. Types of Companies

32. Based on the shareholding regulations, it is also clear that China is likely to have several types of companies established under nationwide company law, whether in one or several pieces of legislation. The Measures and the Standards provide for two basic types of companies, limited share companies and limited liability -ompanies. Drait legislation in the past several years has also beer divided into limited share companies and limited liability companies, largely because, as noted below, limited liability companies do not touch upon the notion of public ownership of shares. However, it appears that the company law draft (noted in para. 29 above) is likely to include various types of companies.

33. Both types of shareholding company under the current legislation limit the liability of shareholders to the amount of contribution. Limited ' A list of titles and dates can be found in the list of legislation in Annex 1.
14 liability companies have a limited number of shareholders (2-30), transferability of shares is limited and "stock" is not issued. Limited share companies have equal shares with no limit on the number of shares, "stock" can be issued, with approval, to the public, and shares can be transferred. As currently structared, neither of these corporate forms can be used for a state enterprise with only one shareholder. However, with two shareholders (possibly two state enterprises or government departments), a limited liability company can be formed, and a large state enterprise can, with approval, be a sole incorporator in some types of limited share company. Either form would permit cross-ownership of enterprises, while direct individual employee ownership of shares is only permitted in limited share companies.

34. Within the category of limited share companies, the legislation currently provides for several sub-categories: (a) "incorporator-held", in which funds can only be raised from incorporators and transferred among legal persons; (b) "fixed-channel fund-raising", in which funds can be raised from shares sold to incorporators, other legal persons, and, with approval, to company employees (not exceeding 20%), and can only be traded among those classes, with incorporators holding at least 35% of the shares; and (c) "public fund-raising", in which funds can be raised from the public as well as incorporators, transferability is not restricted, and incorporators hold at least 35% of the shares, the public at least 25%, and employees not more than 10% of publicly-held shares.

There are many more distinctions, which are illustrated in the chart in Annex 2. Whether such complex classifications are needed to achieve particular policy goals at this juncture in the development of shareholding companies in China is another area for further analysis.

35.

35. A full analysis of the provisions of the two Standards and the supplementary regulations is outside the scope of this paper. A preliminary overview of the Standards, however, reveals that much improvement could be introduced by making changes in two fundamental thrusts of the legialation. Firs:, there are numerous references to "relevant government departments" and to the need for approvals by and notices to them. To make the most of the economic opportunities, companies need to make economic decisions with certainty about their legal rights and enough speed not to lose those opportunities. If the legislation requires a company to get approvals from unnamed government departments, the company has no certainty about when it has gotten all the necessary approvals and is always subject to interference from another agency
15 which may decide that it is "relevant". Reducing the number of such approvals to the minimum necessary to protect '-he public interest in sound corporate organization and specifying eithier in the Regulations or in a separate document the relevant agencies would help to ameliorate this pervasive problem.

36. The second major area in which the Standards could be made more "market-friendly" to take full advantage of the benefits of the corporate for.n would be to restate the requirements for companies to "safeguard the interests of the State and the public interest". The corporate model succeeds elsewhere because there is the clarity of a single corporate purpose: to generate profits for the shareholders. If the company is wholly or partially government owned, then the government as the shareholder of the compa -' can provide in **the** company's charter and operation for protection of the public interest if that is its purpose. The public interst is safeguarded by the company's respect of applicable laws and regulations. Similarly, there are requirements for government approvals of company decisions (capital increase, merger, termination, etc.) which limit the ability of shareholding companies to make decisions about their financing, investment and operations. In addition to these two major concerns, there is also considerable scope for improvement in the detailed provisions, with a view towards making the corporate form in China as useful a vehicle for economic development as it has been elsewhere.

37. Neither the Standards nor the regulations offer extensive legal provisions governing two frequently-mentioned vehicles for enterprise combinations, holding companies and enterprise groups. The Limited Liability Company Standards do, for the first time, clarify that the subsidiaries of a holding company are independent companies whose shares are held by the parent whereas branch companies are separating operating entities but not separate legal entities. Beyond that, more regulation of holding companies would be expected to be found either in a company law or in separate legislation.

38. Similarly, the enterprise group phenomenon, in which several enterprises are linked in some amorphous and possibly contractual way into an enterprise group, would also benefit from the clarity and scope of legal rules that company law could offer. There is a State Council policy document of 1991 on the formation of large enterprise groups. However, the only formal legal provisions are found in the Provisional Implementing Rules for Enterprise Group Registration, issued by the State Administration for Industry and Commerce (SAIC), SPC, SRC and the Production Office in May 1992. These Rules provide certain basic formation requirements for "state trial enterprise groups". State trial enterprise groups must have a strong core enterprise linked to at least three enterprises in close association through control of assets, and other
16 enterprises in semi-close or loose association, through "ties of assets". The core enterprise should be either a large state enterprise or a company controlled by state-owned shares:

- (a) An enterprise in close association is linked to the core enterprise in one of four ways: (1) the core enterprise has a controlling share of investment in the "close enterprise"; (2) the "close enterprise" is contracted or leased by the core enterprise on a long-term **basis;** (3) the "close enterprise" is a state enterprise approved for management by the core enterprise; or (4) the state asset management department has approved the transfer of the "close enterprise" assets to management of the core enterprise.

- (b) An enterprise in semi-close association should either be an enterprise in which the core enterprise holds a non-controlling share or an enterprise whose shares are wholly owned or controlled by a "close enterprise".

- (c) An enterprise of loose association is not tied to the core enterprise through assets, but either has a stable business relationship with the core enterprise or has part of its shares held by a close or semi-close enterprise.

- (d) A non-productive institution can become a member of an enterprise group.

All enterprises in an enterprise group remain as separate legal entities, and the enterprise group itself acquires legal personality upon registration.

39. While these basic provisions provide a framework for the organization of enterprise groups, they raise numerous questions of definition and interpretation. Moreover, these registration rules do not govern the operations and legal relationships of enterprise groups. By requiring an enterprise group charter to specify such matters as the internal governance processes, the rights and obligations of group members and the entry and exit rules, though, the registration rules do reach beyond registration to move enterprise group regulation towards a more coherent legal basis. Enterprise groups will also need to follow the restrictions in the Standards on crossholding of shares, since a company with mo±d than 10% of its shares owned by another company may not purchase shares in that other company. Consequently, enterprise groups is another area in which enterprise reform would be furthered by filling the regulatory vacuum.
17

# III. A COMPETITIVE ENVIRONMENT

## A. BANKRUPTCY LAW

40. A bankruptcy law applicable to state enterprises **was enacted in 1986** and became effective in 1988. The law is consistent with recent developments in bankruptcy law elsewhere, by providing for rectification and reform of those enterprises which can be saved, recover vitality and continue to operate. Provision is made for both voluntary bankruptcy, applied for by the enterprise, and involuntary bankruptcy, applied for by **itL** creditors. Bankruptcy can be declared when an enterprise "has suffered serious losses and cannot pay **its** debts because of poor management." The procedure requires court action **as** well as government intervention through a liquidation committee appointed by the court from the departments concerned. A separate creditors' meeting is to be organized; secured creditors receive priority over other creditor.. After payment of taxes and workers' salaries, unsecured creditors would be paid off on a prorated basis. Resettlement of workers is to be aided by the labor department and bankruptcy relief paid to workers. Managers would be subject to economic sanctions and criminal sanctions for dereliction of duty.

41. Similar liquidation provisions can be found in the shareholding company directives, although these provide that actual bankruptcy for shareholding companies would be handled by reference to the Bankruptcy Law. Both the liquidation provisions for shareholding companies and the Bankruptcy Law provide for preference for secured creditors, an important contribution of bankruptcy and liquidation to the development of financial lending instruments. As an indication of the importance attached to the factors leading to bankruptcy, the shareholding company legislation prohibits persons who bear the main responsibility for enterprises which were closed down or declared bankrupt from serving as corporate directors or managers for a period of three years.

42. The Civil Procedure Law, as enacted in 1991, does set out a procedur-e for liquidation in bankruptcy of non-state enterprises. Unlike the State Enterprise Bankruptcy Law, though, it does not provide for reorganization and rehabilitation o' non-state enterprises. The Civil Procedure Law explicitly states that state enterprise bankruptcy shall follow the provisions of the State Enterprise Bankruptcy Law. In addition, the Supreme People's Court issued procedures for the handling of bankruptcy cases which form the basis for the cases handed thus far. Both national and local implementing regulations for the Bankruptcy Law are also under preparation.

43. The bankruptcy law is beginning to play a valuable role in providing
18 a set of incentives to managers to improve enterprise performance and in allocating enterprise risks among interested parties. Indeed, application of the bankruptcy law has begun to be ieported publicly, although current limitations on the social safety net for displaced workers and the difficulty of making assessments of profit and loss in market terms are among the factors that make it likely to remain rare. One interesting note is that bankruptcy of collectively owned enterprises has also been reported, pointing up the need to revise the law to apply to all enterprises, not just state industrial enterprises. Revision of the bankruptcy law to incorporate bankruptcy in nonstate enterprises and in particular, shareholding companies, will require some adjustment of the provisions, because the role of the government supervisory department under the law is considerable. For example, a public utility or other nationally important enterprise may stave off bankruptcy if the governxn.nt department provides financial aid or takes measures to pay off the debcs. Furthermore, any creditor-initiated bankruptcy can be discontinued when the governmest department requests consolidation and a reconciliation agreement is reached between the enterprise and its creditors. The enterprise itself can only initiate bankruptcy proceedings with the concurrence of the government department. Were the bankruptcy law to consider these actions as prerogatives of the enterprise owners rather than the "higher competent department," the law would be equally well applied to non-state enterprises as well.

# B. COMPETITION LAW

44. While there is no comprehensive system of competition law in China, there are some legal provisions that refer to the need to ensure fair competition among enterprises and address concerns about monopolistic behavior. The 1980 Regulations on Socialist Competition, though somewhat obscure, provide: Except for products which are under the special management of the departments concerned and units appointed by the State, no one is allowed -o exercise a monopoly on the remaining products or act as the sole operator of a business.

Through the 1983 State Enterprise Rules, the state safeguarded lawful competition among enterprises and prohibited use of inappropriate methods (such as trademark fraud, consumer fraud, price control and bribery) and illegal methods to compete. The 1988 State Enterprise Law did not continue these provisions.

45. However, the Advertising Regulations, enacted in 1987, do continue the prohibition of the 1982 Provisional Advertising Rules on mcnopolizing and unfair competition in advertising are also prohibited. The Advertising
19 Regulations also prohibit publication of advertisements which **"denigrate similar** products", and provide a right of administrative **appeal as well as appeal to the** people's courts for losses to users or consumers or for tortious acts. **Under the** related implementing rules, monopolization in **advertising can subject the** violator to a criticism memorandum, confiscation **of** unlawful **income, a fine of** up to 5,000 yuan or suspension of business for reorganization. **Interestingly,** the Advertising Regulations and implementing rules also provide for consumer protection against deceptive and false advertising, with **the same rights of appeal** and similar administrative penalties. This nascent **connection between** competition law and consumer protection is common in market economies **as well,** where the same regulatory agency is frequently **responsible for enforcement in** both areaa, albeit under separate legislative mandates.

# 46.

46. The only recent enactment which touches on **one of the core areas of** competition law and policy are the merger provisions **of the SRC Standards for** Limited Share Companies. ln one general statement without amplification, the Standards provide that approval of a merger may be withheld **if the authorized** government department considers the merger to violate state laws and regulations and policies prohibiting monopoly and unfair competition. **Without any legal** articulation of state laws and policies prohibiting monopoly and unfair competition, though, such a requirement is largely hortatory, and **as yet there** is no government structure focussed solely on the prohibition and punishment of anti-competitive behavior by enterprises.

47. Effective legal protection of inter-enterprise competition would require legislation to specify the forms of prohibited behavior (monopolistic, anti-competitive or exploitative) and the establishment of legal institutions and procedures to enforce this legislation. Special attention will **be required** for areas in which the state retains a monopoly. A draft "anti-unfair competition law" has had its first reading at the June 1993 session of the Standing Committee of the National People's Congress. It apparently is based on the draft **fair** trade law prepared by the State Administration for Industry and Commerce (SAIC). However, only prohibitions against unfair competition are included in the **law,** and anti-monopoly provisions are expected to be added in a few **years. Other** areas which might be expected to be addressed are cartels (horizontal and vertical), market power, concentration, bid rigging, market dominance, mergers and regional barriers.

# 48.

48. Beyond preparation of a law, enforcement of competition law **also** raises institutional issues. Although criminal penalties are sometimes included along with civil penalties in such legislation, enforcement of competition law is frequently the province of a quasi-independent economic-oriented agency.
20

**Moreover, since** a comprehensive competition law **would include review of** enterprise mergers as well as anti-competitive **behavior, it in** important for economic policy reasons to maintain a relationship between the **eniorcement agency** and the government's economic policy departments. For Cniina, a new agency could be established for this purpose, or a new office could be **added to an existing** agency, such as the SAIC. SAIC (and its local level agencies) already **have many** enterprise related functions, includTng registration **of enterprise and company** establisnment, merger>, terminations and changes of operations, trademark and advertising enforcement and cortract arbitration. There **may be some economies** and efficiencies in locating a competition bureau in this agency.
21

# IV. FINANCIAL LAWS

49. Trading in ccrporate securities, whether bond. **or shares, is** a necessary adjunct to marke; financing of enterprises. **Three aspects of financial** market regulations are ess3ntial to the legal framework **for enterprise financing:** definition of the rights assc"iated with the securities, **regulation of the** securities markets, and provision of rules and procedures **for transactions. The definition of** rights in equity sscurities has been enhanced **by the sharenolding company legislation** described above. Basic provisions for **enterprise bonds were issued in 1987** by the State Council, covering a limited **number of important aspects such as** form of bonds, exclusion **of management rights and transferability.** There is still considerable scope for **definition of other types of financial** instruments, such as dents and commercial **paper of enterprises.** Clarifying the legal framework would support the development of various financing mechanisms for state and non-sta'* enterpri es alike.

50. Regulation of securlijes markets has been the **subject cf renewed** attention, as the country's two seci.rities markets in Shanghai and Shenzhen have attracted considerable activit-y and some concern. A national Securities Management Commission along with a securities regulatory body are being established. Depending on their precise scope of responsibilities and legal functions, this should be a welcome development. Until now, **regulation of** securities markets has not been specifically addressed in national law, although both Shanghai and Shenzhen have enacted regulations governing the issuance and trading of securities in their jurisdictions as well as regulating their securities exchanges. Since companies from other cities may now be listed in Shanghai and Shenzhen, this broadens the application of the regulations. Nonetheless, as regional and national financial markets develop, it will become increasingly desirable to have the same consistent set of rules applied everywhere, to facilitate interprovincial transactions. 'n addition, legal rules and safeguards will be needed for all players in these financial transactions, such as financial institutions, underwriters, dealers, appraisers, accountants and lawyers.

51. Progress towards meeting these needs for regulation of the securities markets is expected in 1993. A "Regulation on the Issuance and Trading of Stock" was issued by the State Council in April 1993, and "Regulations on the Administration of Securities Exchanges" were issued in July 1993. The April 1993 regulations .over issuance of stock by limited share companies and market trading of that stock; paybacks by listed companies; storage, settlement and transfer of stock disclosure of listed company information; investigation and penalties; and dispute settlement. By the and of the year, two other national
22 regulations are expected: regulations on employee **shareholding in companies, ^nd** measures for the administration of public shares (that is, state shares and legal person shares in shareholding conmpanies). A nationwide **securities law is also** being prepared. Its importance is underlined by the fact **that the NPC Standing** Committee **is** responsible for its drafting. This law would be **expected to cover** such areas as the securities regulatory structure, the issuance of shares (including the approval process), transactional rules (role of **brokers, etc.) and** legal prohibitions (self-dealing, insider trading). **The China Securities** Regulatory Commission (CSRC) itself has recently **issued standards and rules on** information disclosure, and has assisted in drafting codes of conduct for securities professionals and CSRC staff.

52. Overall reform of the financial sector will also have benefits for further enterprise reform. The availability of credit at a **reasonable cost, of** deposit facilities for surplus cash and temporary investment, and of facilities for prompt clearance and settlement of payments are essential elements for the development of a market economy. The preparation of a workable legal basis for **the** modern banking system which this will require has just **commenced, and will** involve further development of banking and bank regulation legislation, as well as laws to govern credit transactions and the payments system. Drafting work is underway on central banking and financial institutions laws, as well a national negotiable instruments law.
23

## **V. REMOVING THE SOCIAL BURDENS OF THE ENTERPRISE**

53. Among the social burdens of state enterprises **have been the provision** of employee housing and social welfare benefits; this **is** much less of a problem for collective and private enterprises. Converting **state enterprises into** autonomous non-governmental operating economic entities requires development of alternative means of providing for the housing and **social welfare of their** employees. Removing these functions, and providing **for employees equally** regardless of the ownership structure of their employer, contributes to the "level playing field" among enterprises of different ownership.

# A. HOUSING: LAND USE AND MORTGAGE LAW

54. The development of the laws necessary **for an efficient and** functioning housing market is a prerequisite to replacing enterprise delivery of housing to employees with market-based delivery of housing. **Without clear legal** definitions of property rights and a reliable means to enforce them, it is difficult for enterprises to be compensated appropriately **for the housing stock** currently under their control, for new managers of the housing to allocate it effectively to individuals, and for mortgage lendling to **provide** an **adequate basis** for financing housing construction and sale.

55. A significant first step can be seen as the 1988 amendment of the Constitution to allow leasing of land while maintaining state ownership of urban land and collective ownership of rural land. Soon thereafter, the 1986 Land **Law** was amended, and provides a beginning definition of the land use rights and permits their transfer. National urban land use regulations appeared in 1990. These national urban land use regulations provide, inter alia, for specific maximum terms for land leases of different types, for transfer **of land use rights** for compensation, bidding and auction, for re-transfer o' leases and for pledging of leases. In 1992, these regulations were further supplemented **by provisional** procedures on the administration of allocated leaseholds, which provide in more detail for their transfer, lease and mortgage. In addition, detailed local legislation on the transfer of land use rights for value exists **in** such **places** as Shanghai, Guangdong and Shenzhen, to facilitate the **transfers of** land use rights already taking place. Many other localities are in the process of issuing local legislation on land use, with particular focus on land use rights sold to and held by foreign investors. To support the use of land for housing, laws on tenancy and condominium rights are also necessary.
24 56. Land registration systems, which are crucial for **transfers** of land use rights to be meaningful, have also been developed over the reform period. However, a review of the legal framework points up some of the difficulties in this area. Different rights (such as the rights to buildings, land use and mineral extraction) may be registered under different legislation, by different agencies in different locations. As a result, purchasers of rights may find it difficult to ensure that all rights have been effectively and simultaneously transferred, and mortgage financiers may be reluctant to extend loans without assurances that their interests in all rights have been adequately secured. The state may also be disadvantaged, since the multiplicity of systems limits its ability to ensure that the different agencies permit the transfer of rights in a mutually consistent way, and priced in an efficient manner.

57.

57. Finally, mortgage lending currently proceeds on a truncated and fragmented legal basis. The General Principles of the Civil Code recognize the pledge of specific property as security for a debt, and creditor's rights in respect of the property. These are only expressed as principles in the Civil Code, however, and detailed rules are not included. Beyond this, there is no national law on secured lending. Under the 1981 Economic Contract Law, Loan Contract Regulations were enacted in 1985, which permit secured interests under loan contracts. Several local jurisdictions, such as Shanghai and Guangdong, have enacted their own mortgage lending provisions. Not only would national legislation have the advantage of standardizing transactions and facilitating the development of interprovincial financial markets, but it would also be an opportunity to improve any imperfections in the local legislation.

# B. SOCIAL WELFARE RIGHTS

58.

58. One area in which legislation has touched upon the social welfare rights of workers in state enterprises is in the introduction of the labor contract system in 1986. At that time, provisional regulations were enacted on worker dismissal, recruitment, and unemployment insurance along with the regulations on the introduction of the labor contract system. Now that major changes are envisaged in this area, such as establishment of new systems and agencies, legislation will be needed to provide a firm legal basis for the reforms. Some analogies for this new legislation may be found in the provisions for labor management in foreign investment enterprises which have been developed both nationally and locally (e.g., the special economic zones) since the advent of joint venture legislation in the early 1980s. The legal framework can also be expected to enhance worker confidence in the system, which is essential to its smooth functioning, and to promote much-needed labor mobility. The importance
25 of this area for enterprise reform **is** presaged by the highly specific projections for workers in the Private Enterprise Regulations noted above. In addition, Regulations on Unemployment Insurance for State Enterprise Employee. **were** enacted in April l99i, which provide for the establishment, management **and operation of** unemployment insurance funds.
26

# **VI.** PROTECTING THE LEGAL RIGHTS OF **THE** ENTERPRISE

# A. CONTRACT LAW

59. The use os contracts to initiate and regulate economic activity instead of administrative directives is an important step in developing the economic responsibility of the enterprise. Thus, when the Economic Contract Law came into force in 1982, it signalled the beginning of a process. The Economic Contract Law and the regulations under it governing various types of contracts (supply and installation, loan contracts, insurance contracts) provided a mechanism to permit enterprises to enter into economic transactions with other legal entities without going through the government bureaus and to enforce their rights in those transactions. While the Law states that contracts between individual business people and legal entities should be governed with reference to the Law, there is no reference to contracts between individuals. For the moment, contracts between individuals are addressed by the General P.ovisions of the Civil Code. (In contrast, contracts with foreign parties are governed by the Foreign Economic Contract Law, as well as any relevant international conventions to which China has acceded.) 60. Both the Economic Contract Law and the Civil Code stipulate the basic principles of contract, essential elements and liability for breach, although the Law (and supplementary regulations) offers a great deal of specific detail and the Civil Code offers only a few provisions. The Law also prohibits enterprises from unilaterally altering or terminating contracts, using coercion against the other party, or soliciting interference from outside. Moreover, because mediation or arbitration need not precede litigation in the case of default, the parties have greater control over dispute resolution.

61. Many of the provisions of the Law reflect the prevalence of mandatory planning at the time of enactment, and may well be suited to revision in light of the significant decrease in mandatory planning and significant increases in guidance planning and market transactions. For example, economic contracts that fulfill mandatory State plans must conform to State-set targets; contracts under guidance plans must take into consideration State targets as well as actual conditions. No specific reference is made to market-based transactions, given their rarity at the time. While these kind of provisions are increasingly irrelevant but harmless, there is a need to revise the continuing requirement that change or cancellation of an economic contract agreed by the parties must still not harm state interests or affect state plans. In addition to broadening the contract law to encompass more non-State economic activity, it would also be
27 opportune to revise the law to provide clear contractual rules on which individuals can rely for contracts among themselves. Indeed, revisions of the Economic Contract Law are currently under preparation and were considered at the June 1993 session of the Standing Committee of the National People's Congress. Approval at the August 1993 session of the Standing Committee is expected.

# B. COURTS AND DISPUTE RESOLUTION PROCESSES

62. To create confidence in the economic rights of enterprises, to ensure the protection of those rights and to continue to provide for protection of the public interest even when government no longer controls enterprise operation, a well-functioning system for resolution of disputes is essential. In keeping with China's legal traditions, there is an emphasis on mediation and arbitration of disputes, but in recent years the court system has developed ae well. The Civil Procedure Law, for example, provides in detail for the litigation of civil cases, but it also includes conciliation and the honoring of arbitration clauses in foreign economic trade, transport and maritime contracts. In the area of contract law, there is a system of contract arbitration and mediation for economic contracts generally whether by the SAIC, the courts or private parties. There are also provisions for arbitration of specific types of contracts, such as economic contracts and technology transfer contracts.

63. Economic chambers were established in the court systems early in the 1980s, however, and there has been a substantial increase in the number of cases coming to them and to courts generally. (The 1993 Report of the Supreme People's Court to the N tural People's Congress, for instance, notes that civil lawsuits have increased by 9.9% each year over the past five years, of which about 50% are divorce cases.) Whether enterprise managers have sufficient confidence in their avenues of legal recourse to exercise their rights and feel obliged to fulfill their obligations is not merely a reflection of the legal framework, of course, but that is an important part. Equally important are public and private perceptions, such as the concern frequently voiced that litigants from outside a jurisdiction are unlikely to get a fair result in litigation with a local entity. Judging these intangibles is likely to prove difficult for those outside of the Chinese scene, but at a minimum one can encourage further development of an efficient court and dispute resolution system in tangible ways. Two such improvaments would be the continued development of a well-trained legal profession and the public availability of the laws that do exist.
28

# C. LEGAL INSTITUTIONS

64. Protecting the legal rights of enterprises will also **require** strengthening legal institutions and changing the roles **of governmental** institutions. The court system referred to in paras. 62-63 above will need continued development, ensuring that court personnel gain **experience and training** in market transaction issues will be necessary. Specialized institutions, much as the SAIC and securities regulatory bodies, will need to develop institutional processes more in line with market orientation than with **administrative controls.** Government agencies are beginning the process of reorienting their functions and roles to reflect the changed role of government in **a market economy. This** pending change can be seen in the 1992 State Enterprise Regulations (para. 13) as well as in the restructuring of several ministries (e.g. textiles) as decided at the 1993 National People's Congress.
29

# **VII. CONCLUSIONS**

65. It is difficult to offer meaningful conclusions **about a body of law** as vast and as changing as the one described in the preceding pages. **The** legal framework for China's economic transition to a market economy **of which enterprise** reform is an important part, is itself in transition. What **is** worth noting **is** the increasing recognition that legal reforms are necessary **to bring economic** reforms fully into play, as wit;nessed not only by the flurry of legislative activity documented here, but also by public pronouncements of Chinese leaders. Most recently, the new Chairman of the Standing Committee **of the National** People's Congress, Mr. Qiao Shi, has been quoted as saying: A market economy requires a sound and comprehensive legal system.... The history of economic development in modern **states has proved that** without sound legal standards or guarantees, the various social and economic activities will have no guidelines, thus inevitably leading to chaos.

66. He also noted the need to draw on foreign experience in formulating economic laws and acknowledged that some current Chinese laws are **unsuited to the** reforms and require revision. If these remarks by a key legislative official are any guide, the next few years should see continued development of the legal framework for enterprise reform -- hopefully addressing the many facets discussed in this paper.

7/27/93