A Statutory Business Judgment Rule For China's Company Law: Theoretical And Comparative Considerations

• Author: Kevin M. Hubacher
• Pages: 3-58

2020] BUSINESS JUDGMENT RULE FOR CHINA’S COMPANY LAW 3

A STATUTORY BUSINESS JUDGMENT RULE FOR CHINA’S

COMPANY LAW: THEORETICAL AND COMPARATIVE

CONSIDERATIONS

Kevin M. Hubacher

Abstract

The conversion of China’s planned economy t o a socialist market

economy cleared the way for the emergence of enterprises in the sense

of the Coasean theory of the firm. A centralized decision-maker

coordinates the allocation of resources and the firm’s activities. He is

vested with authority and responsible to the firm’s owners. The

tension between authority and responsibility is balanced by the

business judgment rule, a concept first established by U.S. Delaware

courts. China has no statutory business judgment rule, and neither the

English-speaking scholars nor the Chinese courts have yet

established a uniform understanding of it. This paper proposes that

China’s Company Law for joint stock limited companies has all the

prerequisites needed for an adoption of the business judgment rule: It

not only separates ownership and management but also grants a

certain amount of authority to the companies’ directors and

supervisors, who a re re quired to perform their duties in due care,

under good faith and in a loyal manner. This paper, after having

assessed the feasibility of a legal transplant of the business judgment

rule, t hus argues that China’s Company Law should recognize the

value of authority granted to the board of directors and the board of

supervisors and implement a due process based ex post review of

business decisions.

I. INTRODUCTION

In December 1978, the Third Plenary Session of the 11th Central

Committee of the Communist Party of China heralded a big change by deciding

to open up the People’s Republic of China (“China”).1 In 2018, China was the

world’s second largest economy measured by gross domestic product at current

U.S. dollars.2 On the way, China abandoned planned economy and turned

towards market driven economy, labelled as “socialist economic system” or

1 James V. Feinerman, Economic and Legal Reform in China, 1978-91, 40 PROBS. COMMUNISM 62, 63

(1991); Yue-man Yeung, China’s Openness and Reform at 30: Retrospect and Prospect, 9 CHINA REV.

(SPECIAL ISSUE) 157, 157–58 (2009); Lin Justin Yifu & Shen Zhongkai, Reform and development strategy, in

CHINA’S 40 YEARS OF REFORM AND DEVELOPMENT 117, 117–20 (Ross Garnaut et al. eds., 2018).

2 THE WORLD BANK GROUP, GDP (current US$) | Data (2020), https://data.worldbank.org/indicator/NY

.GDP.MKTP.CD?end=2018&most_recent_value_desc=true&start=1960 (last visited Feb. 10, 2020).

4 TSINGHUA CHINA LAW REVIEW [Vol. 13:1

“socialist market economy” (see art. 6, para. 1 and art. 15, para. 1

Constitution 3). 4 Hence, market mechanisms (the price mechanism in

particular) became more and more important for the allocation and coordination

of labor, capital and resources.5

The term “market” describes a concept where goods and services are

exchanged on the basis of individual transactions or, put differently, on the basis

of contractual relationships. 6 As Ronald H. Coase elucidated in his

distinguished article The Nature of the Firm, the application of the price

mechanism entails costs. Firms are established because they can reduce

production costs by integrating certain transactions.7 According to Stephen M.

Bainbridge, the decisive element of the Coasean model of the firm is the

centralized decision-making. The decision-maker is vested with authority,

directs the utilization of inputs and thereby reduces the (coordination) costs

inherent in team production.8 The reason why the coordination of team

activities requires authority lies in the fact that team members do not have

identical interests and/or identical information.9 Authority thus increases the

efficiency of group coordination (i.e., decision-making) and information

processing.10 A centralized decision-maker with unlimited authority, however,

is not responsible to anyone; there is no need for the centralized decision-maker

to consider the interests of any other member.11 This calls for corrective

measures, i.e., for a system which holds decision-makers responsible (or

accountable) for their actions. 12 Authority and responsibility are thus

antithetical; an increase in authority implies a decrease in responsibility.13

Maximum responsibility leads to a shift of the decision-making power from the

3 XIANFA (1988) (China) [hereinafter Constitution].

4 Wu Qianlan, The Making of a Market Economy in China: Transformation of Government Regulation

of Market Development, 13 EUR. L. J. 750, 754 (2007); JÁNOS KORNAI, FROM SOCIALISM TO CAPITALISM 47–

60 (2008); Ding Xiaoqing, The Socialist Market Economy: China and the World, 73 SCIENCE & SOCIETY 235,

passim (Apr. 2009).

5 For an explanation of economic planning, see Wallace Peterson, Planning and the Market Economy, 3

J ECON ISSUES 126, 126–27 (1969).

6 Instead of many Hugh G. J. Aitken, A Note on the Definition of a Free Market, 16 THE CANADIAN

JOURNAL OF ECONOMICS AND POLITICAL SCIENCE 236, 237 (1950).

7 R. H. Coase, The Nature of the Firm, 4 ECONOMICA 386, 390–94 (1937).

8 Stephen M. Bainbridge, Director Primacy: The Means and Ends of Corporate Governance, 97 NW. U.

L. REV. 547, 556–57 (2002) [hereinafter Director Primacy].

9 KENNETH J. ARROW, THE LIMITS OF ORGANIZATION 68–70 (1974).

10 Id. at 69.

11 Michael P. Dooley, Two Models of Corporate Governance, 47 BUS. LAW. 461, 468 (1991); cf. ARROW,

supra note 9, at 65.

12 Id. at 73–76; Dooley, supra note 11, at 468.

13 ARROW, supra note 9, at 77–78; Dooley, supra note 11, at 464; Bainbridge, Director Primacy, supra

note 8, at 573.

2020] BUSINESS JUDGMENT RULE FOR CHINA’S COMPANY LAW 5

centralized decision-maker to the ones to whom he 14 is responsible. 15

Maximum responsibility therefore deprives the firm of its original purpose, i.e.,

the reduction of production costs through an efficient decision-making

process.16 Consequently, the right balance between authority and responsibility

has to be found.17

In many jurisdictions,18 a corporation’s supreme authority is typically

vested in the board of directors or an equivalent centralized corporate

authority.19 It is the corporate law’s task to provide a framework for an efficient

decision-making system.20 For this purpose, the U.S. corporate law developed

the so-called business judgment rule which balances authority and

responsibility.21 The business judgment rule is based on the economic theory

of efficiency, as will be discussed later on,22 and has become a widely

recognized legal institution implemented by numerous jurisdictions.23

China’s economic transformation cleared the way for the emergence of

enterprises in the sense of the Coasean theory of the firm. In order to be

competitive, especially in today’s integrated world economy, Chinese firms

need to incorporate a decision-making process whose efficiency at least

matches its foreign counterparts. The question thus arises whether such a

system is in process and how China’s Company Law24 balances authority and

responsibility. This paper focuses on the statutory business judgment rule yet

unknown to the Company Law.25 Scholars suggest that the business judgment

14 For the sake of readability and simplicity, the masculine form was chosen in the text. Reference is

nevertheless made to members of both genders.

15 ARROW, supra note 9, at 78; Bainbridge, Director Primacy, supra note 8, at 573; see also Huang Hui,

The Statutory Derivative Action in China: Critical Analysis and Recommendations for Reform, 4 BERKELEY

BUS. L. J. 227, 231 (2007).

16 See ARROW, supra note 9, at 78.

17 Id. at 79; Bainbridge, Director Primacy, supra note 8, at 573.

18 See chapters III (United States), VI.B.1 (Switzerland), VI.B.2 (Germany).

19 Cf. Dooley, supra note 11, at 467–68.

20 Stephen M. Bainbridge, The Business Judgment Rule as Abstention Doctrine, 57 VAND. L. REV. 83, 85

(2004) [hereinafter Abstention]; Dooley, supra note 11, at 463; Wayne O. Hanewicz, Director Primacy,

Omnicare, and the Function of Corporate Law, 71 TENN. L. REV. 511, 511 (2003).

21 Bainbridge, Director Primacy, supra note 8, at 602–03.

22 See chapter II.

23 Peter V. Kunz, Business Judgment Rule (BJR): Fluch oder Segen? [Business Judgment Rule (BJR):

Curse or Blessing?], 3 SJZ 274, 274 (2014).

24 Gongsi Fa (公司法) [Company Law] (promulgated by Standing Comm. Nat’l People’s Cong., Oct. 26,

2018, effective Oct. 26, 2018), art. 2, CLI.1.324551(EN), translated by Chinalawinfo Co., Ltd., LTD.,

en.pkulaw.cn [hereinafter Company Law].

25 GU MINKANG, UNDERSTANDING CHINESE COMPANY LAW 196–97 (2d ed. 2010); Sun Hui, The Study

on the Transplantation of Controlling Shareholders’ Fiduciary Duty from U.S. to China, 4 PEKING U.

TRANSNAT’L L. REV. 72, 105 (2016); John D. Osgathorpe, A Critical Survey of the People’s Republic of

China’s New Company Law, 6 IND. INT’L & COMP. L. REV. 493, 504 (1995); Wei Yuwa, A Chinese

Perspective on Corporate Governance, 10 BOND L. REV. 363, 373 (1998) [hereinafter Corporate

Governance].