Corporate groups and strategic alliances: new reform instruments to the Chinese.

• Author: Wei, Yuwa

INTRODUCTION

The advent of corporate groups is the result of corporate development. (1) A corporation can become a shareholder of other corporations by purchasing their shares. (2) By the holding and cross-holding of shares, (3) a number of companies connected together may form a corporate group. (4) The controllers of the group "may plan, instigate and co-ordinate its managerial, operational and financial activities on a group basis, while implementing [these activities] through individual group companies." (5) In doing so, the corporation can enjoy the advantages of maximizing financial returns, limiting commercial risks and expanding markets. However, the practice adds new complexities to the already complicated corporate system, which stems from the fact that the fundamental norms and legal framework of the corporation had been built up prior to the emergence of corporate groups in the early-industrialized countries. As a result, the use of corporate groups inevitably brings certain contradictions and challenges to the well-established corporate notions and practice. (6)

Today, most companies of the corporate world belong to different corporate groups in one way or another. (7) Efforts have been made by different legal systems in favor of developing an effective legal framework to deal with the problems presented by corporate groups. Basically, two strategies have been predominant. The first is to create or build a separate legal regime to regulate the operation of corporate groups. (8) German corporate law falls into this class. (9) The second involves conditionally abandoning traditional principles of corporate law and applying specially designed legal structures for corporate groups, upon the occurrence of certain events. This principle is generally applied by Anglo-American systems. (10)

Since the 1970s, the People's Republic of China has undertaken a great deal of effort to establish a network for enterprise cooperation for the purpose of enhancing the competitive ability of its enterprises. (11) Various trials were carried out, including setting up various enterprise alliances (lian ying), enterprise groups (qi yie ji tuan) and corporate groups (ji tuan gong si). (12) China's 1994 Company Law (13) only addresses the terminology of parent companies and subsidiaries, but has no further provisions specific to corporate groups. (14) The 1986 Civil Code (15) does not contain a definition of corporate group, but only defines an enterprise alliance as 'a joint operation between enterprises or an enterprise and an institution.' (16) Such a joint operation may result in the establishment of a new legal entity or a partnership, or may be simply based on a cooperative contract. (17) With the development of corporate practice, the patchy provisions relating to enterprise alliances in the 1986 Civil Code become less and less relevant. China urgently needs to develop an effective legal framework to guide the practice of corporate groups, because more and more state-owned enterprises are being "corporatized" and most newly established firms take the form of a company.

This article will first examine the theoretical challenges and difficulties brought by corporate groups. Part II of this article will introduce the development of corporate groups and other forms of business alliances in China. Finally, Part III will discuss how the problem of corporate groups has been tackled by other jurisdictions so as to provide some wisdom and inspirations for the Chinese government's legislative and practical efforts in this arena.

1. THE THEORETICAL ISSUES CONCERNING CORPORATE GROUPS

   1. The Abuse of Separate Personality and Limited Liability

      Separate personality and limited liability form the basis for the modern corporation. (18) The vitality and attraction of the corporate structure rest on its predictability to investors. (19) It makes it possible for investors to evaluate their business risks and liabilities. (20) These qualities were foreseen by those founding fathers of modern corporate law. In designing corporate laws, they had the clear view of designing a business form that would protect individual investors through preventing their investment from triggering unlimited personal liability. As the holding of shares of other companies was generally forbidden by laws at that time, the doctrines of separate personality and limited liability were, for a time, thought to be sufficient. (21) However, problems arose when limited liability was needed to extend to holding companies. (22) This then introduced limited liability within limited liabilities. (23)

      Portfolio investment by corporations was generally permitted by the end of nineteenth century, as a means of pooling resources and sharing profits. (24) The conventional concepts of separate personality and limited liability began to apply to holding companies and started to experience crises. (25) Since the purpose of the existence of groups of companies is to achieve an optimal performance of the group as a whole, (26) this goal sometimes necessitates the sacrifice of an individual company's benefits in order to maximize the gains of the whole group.

      For example, to implement a strategy that is good for the group, a parent company may instruct a particular subsidiary to sell raw materials to another subsidiary at a low price and to buy the products manufactured by the first company at a high price. In doing so, the group makes gains at the expense of the interests of outside shareholders and creditors of that particular subsidiary. In such cases, business is fragmented among the component companies of the group, and limited liability and separate personality are used to "protect each fragment of the business from liability for the obligations of all the other fragments." (27) Hence, it becomes evident that the traditional doctrines of corporate separate personality and limited liability are no longer adequate in dealing with corporate groups.

      In relation to corporate governance, corporate groups pose the question of how the directors of the companies of the same group direct their loyalties. How do they comprehend and judge the concept of "for the best interests of the company" when they make their business decisions, especially in a situation where there is a conflict of interest between the group as a whole and the individual companies to which they owe their duty of loyalty? With the increasing domination of corporate groups in the world and the national economies, every corporate system has to give adequate attention to the issues posed by corporate groups, such as remedial mechanisms for outside shareholders (e.g., non-group members) and duties of controlling companies.

   2. The Strategies of Regulating Corporate Groups

      In the conventional sense, corporate groups disturb the balance of power between management and the companies concerned. As a result, the fate of the subsidiary companies is decided by someone other than their direct management and board of directors. This is a problem that every corporate system has to face. Different strategies have developed. While some systems regulate a corporate group as a single entity, others adopt the approach of conditionally disregarding the separate personality of individual companies of the group. While some systems allow greater freedom to the controlling companies, others may have stricter rules relating to the exercise of power by parent companies. (28) The best example of this could be the divergence between German law and the common law.

      Germany was the first country to have a separate legal regime, here in the form of the Aktiengesetz, as a way of regulating groups of companies. (29) The law stipulates strict rules of disclosure. (30) It defines the situations of contractual group relations, de facto group relations and integrated group relations. (31) Once a company falls into the category of group companies, it is regulated by a different and self-inclusive set of rules in terms of liabilities and corporate governance. (32) The rules clarify the responsibility of holding company managers to the subsidiaries, and the liability of a holding company to the debts of the subsidiaries. (33) While a parent company enjoys the freedom of directing its subsidiaries, it has to fully indemnify the subsidiaries' losses caused by its decisions within the next accounting period. (34) In other words, the German law treats a corporate group as a single entity. Hence, it is a logical conclusion that this entity exists to pursue the interests of the group as a whole. Later, German courts also developed a body of leading cases, which has further enhanced the potential of the German law in relation to the regulation of corporate groups. (35)

      In common law jurisdictions, groups of companies are gradually brought under effective control by extensively introducing statutory rules concerning corporate groups. (36) In the early stages, traditional law, based on the doctrine of separate personality and limited liability, was unable to deal effectively with corporate groups. (37) As a result, equity jurisprudence developed the concept of "piercing the corporate veil". "Piercing the corporate veil" refers to the situation where courts disregard the principle of separate personality by treating companies within a group as a single entity. (38) However, the remedy was still inadequate, as it was only available in "rare" and "exceptional" situations. (39) The situation did not improve until a sophisticated doctrine of "control" was generally adopted by the common law jurisdictions. (40) The United States has taken the lead in this process. The concept of "control" typically refers to situations where a company has the power to direct or command the direction of management or policies of another company. It is used to determine the demarcation of selective abandonment of the traditional principle of corporate personality, and the...