China Soon to Allow Limited Liability Partnerships

China is currently reviewing the draft of the revised Partnership Enterprise Law, marking the first round of revisions since the law was promulgated in 1997 and covering new rules on doing business in China in the form of partnership. Currently, Hong Kong companies are prohibited from establishing independently-run operations and must team up with mainland partners in certain business sectors (especially key industries). Hence, Hong Kong companies should take note of these imminent changes.

According to Zhu Shaoping, director of the National People's Congress financial and economic committee bills office, the present round of revisions submitted for deliberation primarily contains changes in the following areas: two new forms of partnership, namely limited partnership (LP) and limited liability partnership (LLP) are introduced, and legal persons can take part in partnerships.

According to Zhu, the existing Partnership Enterprise Law was formulated at a time when the planned economy was shifting gear to the market economy and partnership was only narrowly defined as general partnership. As time changes, the old law can no longer cope with the current needs for building an innovative nation and promoting private investment. One of the major considerations for revising the Partnership Enterprise Law is to introduce LP as a new enterprise form, paving the way for attracting venture capital and promoting the input of technology and innovation.

An LP is a form of enterprise that allows partners assuming limited liability to join on the basis of one or more partners assuming unlimited liability.

This type of partnership has several advantages. First, as a partnership enterprise, no corporate income tax has to be paid and the investors concerned will not be subject to double taxation. Second, investment risk can be reduced as some of the investors and investing institutions concerned may assume limited liability. For those partners who assume unlimited liability, this type of partnership offers the capital enlargement effect as they may raise a massive amount of capital based on a relatively small sum backed by good reputation. In other words, it offers the benefits of low operating cost and high efficiency.

LP is an internationally adopted form of enterprise especially suited to investment in the form of venture capital. Partners with limited liability are usually the major venture capital contributors. They only assume limited liability for their share of capital and are not involved in the management and operation of the venture capital funds. Meanwhile, general partners are responsible for managing the venture capital. They are entrusted with the management of the partnership enterprise because of their higher management capability. They may make a smaller capital contribution but assume unlimited liability. The parties concerned enter into an agreement which clearly sets out the contractual rights and obligations of the respective parties. As a form of enterprise, LP offers various advantages over limited company for venture capital investments, including the operation scale of the capital, the level of professionalism in investing, and the cost of management.

In fact, the issue of LP was discussed during the legislative process of the existing Partnership Enterprise Law. In the year following the formulation of the Partnership Enterprise Law, a group spearheaded by the chairman of China Democratic National Construction Association Cheng Siwei tabled a proposal at the CPPCC (Chinese People's Political Consultative Conference) annual meeting to promote venture capital with full force.

Subsequently, some local authorities experimented with venture capital investment in the form of LP but limited progress was made because LP was not covered in the law.

According to Zhu, more than 250 venture capital firms are currently operating in China involving over Rmb50 billion worth of venture capital funds. These funds are being invested in 3,000-4,000 projects where the investment amount accounts for about one-third of the total capitalisation. The relatively low ratio is attributable to the absence of free flow of capital into and out of China.

Although the introduction of LP is the right move, law professor Gan Peizhong of Peking University who participated in drafting the existing Partnership Enterprise Law cautioned that, "LP also involves high risks because partners with limited liability are not involved in management and they have to take into consideration the credentials and trustworthiness of their partners with unlimited liability, as well as supervision and control over them".

"Legal persons participating in partnerships is an issue that warrants prudence," said Gan. This is because legal person shareholders cannot exert control over partners with unlimited liability, and in-between there is also the presence of the management staff of the legal person. Hence, in many countries and regions the law will require the consent of all or the majority of shareholders for admitting legal person partners.

While the existing Partnership Enterprise Law consists of 78 articles under nine chapters, the revised draft law adds 26 new articles, deletes two articles and combines four articles to form 11 chapters with a total of 100 articles. Major revisions include:

1. The draft contains a new chapter on "Special Provisions on Limited Partnership" which sets out the rights and obligations of the partners with limited liability, how the affairs of the limited partnership are to be managed, as well as special rules governing limited partnership as opposed to general partnership.

2. The draft also contains a new chapter on "Special Provisions on Limited Liability Partnership" which covers the definition of limited liability partnership, the responsibilities of professional services providers, and the professional risk fund etc.

3. The draft provides for the participation of legal persons in partnerships. Wholly state-owned enterprises and listed companies should participate in partnerships via their subsidiaries or other holding companies.