Key Items of the Articles of Association of a Foreign Invested Company in China

By Lily Gao and Richard Hoffmann, ECOVIS Beijing China

Most foreigners may know that the Articles of Association (“AoAs”) are required to be submitted for Chinese governments to approve when setting up a company in China, but they may probably not know why the AoAs are required, and how the AoAs can protect or guide their business activities in China. This Article will address this issue as well as key items to be incorporated into the AoAs.

1. The Functions of the AoAs

1.1 The AoAs are the legal basis for a company to do business with third parties

The AoAs provide the principles or detailed rules in terms of a company’s management structure, business activities, rights and obligations etc., which provides the basis for a company to do business with investor, creditors or any other third party. Once relevant, Chinese government approves the AoAs. They are binding to the company, investors, directors management team as well as all parties in relation to the company, and the company shall, in accordance with its AoAs as well as other applicable Chinese laws or regulations, enjoy rights or bear relevant liabilities. Any business activity complying with the AoAs will be protected; otherwise Chinese government will punish it.

1.2 The AoAs are very important documents for setting up a company in China

The Company Law of the People’s Republic of China clearly states that the AoAs shall be made before a company can apply to be set up with relevant Chinese governments, who will conduct scrutiny inspection on the terms of the AoAs before giving approval or disapproval. Once disapproved, the proposed company cannot be set up.

1.3 The AoAs form the self governed rules of a company

The investor, in accordance with the Company Law, formulates the AoAs, since the Company Law cannot consider each special requirement of each Company. While each company, based on the Company Law, formulates their own AoAs, which definitely reflects the particularity of the company, moreover provides the code of conduct for the company. In addition, the company itself can solve any violation of the AoAs internally as long as such is not violating the Chinese laws or regulations.

In view of the above mentioned important functions of a company, it is of particular importance for the investor, when formulating the AoAs of the proposed company, to consider carefully and incorporate as many details into the AoAs in order to avoid any different interpretations on same items in future by different party involved.

2. Mandatory Items of the AoAs

The following must be incorporated into the AoAs:

➢ The name and domicile of the company;
➢ Business Scope of the company;
➢ Registered capital of the company;
➢ Names of shareholders;
➢ Forms, amount and date of capital contributions made by shareholders;
➢ The organizations of the company and its formation, their functions and rules of procedure;
➢ Legal representative of the company;
➢ Stipulations concerning the assignment of equity, the ratio of profit distribution and losses to be borne by parties to the joint venture;
➢ Principles governing finance, accounting and auditing;
➢ Labour management;
➢ Dissolution and liquidation;
3. Freely Agreed Items in the AoAs

According to the updated Company Law, the company may decide some matters at its own discretion. Below are some examples:

3.1 Principal on shareholders ’voting at the Shareholders’ meeting

➢ The shareholders shall exercise their voting rights at the shareholders’ meetings on the basis of their respective percentage of the capital contributions unless the articles of association otherwise prescribe it. [Legal Provision]

➢ One vote for one shareholder; or Specific voting right for each shareholder upon agreement, i.e. Shareholder A shall have x % of the voting right; Shareholder B shall have y % of the voting right

3.2 Basis for dividends distribution and/or subscription of the increased capital

➢ Unless otherwise agreed upon by all shareholders, the shareholders shall draw dividends in proportion to their actual contributions and, where a company increases capital, shall have the pre-emptive right to subscribe new share in proportion to their actual contribution. [Legal Provision]

➢ Decide the specific percentage for dividend distribution and/or subscription of the increased capital for each shareholder upon agreement. i.e. Shareholder A shall be entitled to draw x% of the dividends, Shareholder B shall be entitled to draw y% of the dividends… [Free Option]
3.3 The Power of the organizations of the company

➢ The shareholders’ meeting shall exercise the following functions: ….. , Other functions as specified in the articles of association. [Legal Provision]

➢ The board of directors shall be responsible for the shareholders’ meeting and exercise the following functions: ….. , Other functions as specified in the articles of association. [Legal Provision]

➢ The manager shall be responsible for the board of directors and shall exercise the following powers: ……, If the articles of association provide otherwise for the powers of managers, the articles of association shall be followed. [Legal Provision]

➢ Such important issues as the investment to any third party, provision of guarantee to others, engagement of qualified accounting firm for annual audit etc. may be described in the AoAs [Free Option]

3.4 Share Transfer

➢ Where a shareholder intends to transfer his share to any non-shareholder, he shall be subject to the consent of more than half of the other shareholders. The shareholder shall give the other shareholders a written notice about the matters related to the share transfer for their consent. If any of the other shareholders fails to give his reply within 30 days after he receives a written notice, he shall be deemed to have consented to the transfer. If half or more of the other shareholders disagree to the transfer, the shareholders who disagree to the transfer shall purchase the share to be transferred. If they refuse to purchase, they shall be deemed to have consented to such transfer. Under the same conditions, the other shareholders have a pre-emptive right to purchase the share to be transferred upon their consent. If two or more shareholders claim the pre-emptive right, they shall determine their respective purchase percentage through negotiation. If they fail to reach an agreement during the negotiation, they shall exercise the pre-emptive right on the basis of their respective percentage of capital contributions. Where the articles of association stipulate otherwise, such stipulation shall apply. [Legal Provision]

➢ Where a natural person shareholder deceases, his shareholder’s status may be inherited by his legal heir unless other stipulated in the articles of association. [Legal Provision]

➢ Under no circumstance may any shareholder transfer his share to any non-shareholder; [Free Option]

➢ Shareholder may not transfer his shareholder to any non-shareholder during the term of xx years upon the formation of the company; [Free Option]

➢ No approvals from other shareholders are needed when a shareholder intends to transfer any of his shares to any non-shareholder, provided that a prior written notice shall be presented to other shareholders. Where any of the other shareholders exercise his pre-emptive right of purchase thereof, such share shall be transferred to the said shareholder. Two or more of the shareholders exercising the pre-emptive rights of purchase shall negotiate and determine the proportion of the shares to be purchased respectively. Failure such, the shares shall be purchased in proportion to their capital contribution at the time of such transfer. [Free Option]