Several Key Compliance Issues in the Reform of Mixed-Ownership Structure of State-Owned Enterprises

Author: Ma Yunhe

• Background

On June 30, 2020, the 14th Meeting of the Central Commission for Deepening Reform reviewed and approved the “Three-Year Action Plan for State-Owned Enterprise Reform (2020–2022).” The plan clearly outlines the reform’s objectives, timetable, and roadmap. This document serves as a guiding framework for China’s deepening reform of state-owned enterprises in the context of a new stage of development.

At the end of September 2020, the State Council conducted a comprehensive mobilization and deployment for the implementation of the Three-Year Action Plan for State-Owned Enterprise Reform, marking the full launch of this long-awaited three-year reform initiative for state-owned enterprises.

From the end of 2020 to the beginning of 2021, local governments, building on and guided by the national-level plans, successively introduced their own local action plans. These locally tailored action plans primarily focus on the specific characteristics of local state-owned economies and are aimed at overcoming the obstacles and barriers that have been hindering the reform of local state-owned enterprises.

• Basic Operational Procedures for the Mixed-Ownership Reform of State-Owned Enterprises

Referring to the “Operational Guidelines for Mixed-Ownership Reform of Central Enterprises,” state-owned enterprises and their subsidiaries at all levels generally should follow the following basic operational procedures when implementing mixed-ownership reform: feasibility study, formulation of a mixed-ownership reform plan, completion of decision-making and approval procedures, conduct of audit and assessment, introduction of non-public capital investors, and promotion of reforms in enterprise operating mechanisms.

For those implementing mixed-ownership reform through methods such as establishing new enterprises, making outbound investments and mergers & acquisitions, or taking equity stakes in other companies, they must also comply with the relevant procedures for investment management applicable to state-owned enterprises.

• Key Milestones for “Compliance” in State-Owned Enterprise Mixed-Ownership Reform

The primary regulatory frameworks for mixed-ownership reform include the Company Law of the People’s Republic of China, the Law of the People’s Republic of China on State-owned Assets in Enterprises, the Administrative Measures for the Supervision and Management of Trading in State-owned Assets in Enterprises, the Opinions on Promoting the Development of a Mixed-Ownership Economy in State-owned Enterprises, and relevant local regulations. Following the basic operational procedures, we can identify the key compliance milestones, which primarily include:

1. Feasibility Study Phase

(1) Social Stability Risk Analysis and Assessment. In accordance with the “Guiding Opinions on Establishing a Mechanism for Assessing Social Stability Risks Related to Major Matters in State-Owned Enterprise Reform” issued by the State-owned Assets Supervision and Administration Commission of the State Council (Guozifa [2010] No. 157) and other relevant regulations, state-owned shareholders shall conduct thorough analysis and assessment of social stability risks in the course of mixed-ownership reform.

(2) During the feasibility study phase, it is also necessary to analyze, based on industry data, case studies, models, and other relevant materials, the alignment between the market outlook and the company’s industrial layout and development strategy. Furthermore, a comparative analysis and evaluation should be conducted on economic indicators and social benefits. In accordance with applicable laws and regulations, the project’s reasonableness, compliance, and operational feasibility must be substantiated.

Feasibility studies should combine document review with field investigations. If an organization lacks the necessary research capabilities, it should leverage the expertise of third-party entities such as industry experts or professional associations.

2. Partner Selection

When implementing mixed-ownership reform, enterprises should conduct necessary credit investigations on prospective partners. They may entrust qualified financial and legal institutions to carry out comprehensive due diligence on these prospective partners and obtain legally valid investigation reports. For significant and complex financial or legal issues involved in the cooperation plan, enterprises may also commission qualified financial and legal institutions to prepare specialized opinion and analysis reports for decision-making reference. If it is discovered that a partner or its senior executives have a poor credit record or are suspected of engaging in malicious behaviors such as deception, which could cause substantial losses to the cooperation project or state-owned capital, the enterprise should promptly terminate the cooperation. Before terminating the cooperation, it should take practical and effective measures to safeguard the security of state-owned assets.

3. Government Integrity

Enterprises planning to implement mixed-ownership reform and their state-owned shareholders, in their interactions with prospective partners, should adhere to the principle of honesty and good faith and avoid making unnecessary or unauthorized commitments to those prospective partners.

4. Decision Approval

Enterprises shall, in accordance with relevant provisions of laws, regulations, the company’s articles of association, and internal rules and regulations, duly carry out internal decision-making procedures and necessary approval processes, and submit their proposals for approval—depending on management levels—to the municipal, provincial, and State Council’s state-owned assets regulatory authorities. If the assets of an enterprise planning to undergo mixed-ownership reform include allocated land, approval from the natural resources administration authority is also required.

5. Asset cleanup and verification, financial audit, and asset valuation

After the mixed-ownership reform plan is approved, the state-owned shareholders or the state asset management authorities of the enterprises intending to carry out the mixed-ownership reform will organize and conduct asset clearing and verification, financial audits, and asset appraisals to ensure fair valuation. If any management personnel intend to take equity stakes, such personnel should recuse themselves from the process. In general, an economic accountability audit should also be conducted on the enterprise’s legal representative or senior executives upon their departure from office.

6. Public standards

When enterprises implement mixed-ownership reform, they should also ensure internal publicity and open trading. In particular, during the open-trading phase, they should adhere to the principles of openness, impartiality, and fairness, and actively attract various types of social capital to participate. It is worth noting that for cases involving state secrets or insider information of listed companies—due to special circumstances—implementation shall follow relevant national regulations.

7. Protection of Employees’ Legitimate Rights and Interests

For restructuring plans involving employee resettlement, the employee resettlement plan shall be reviewed and approved by the Employee Congress or the General Assembly of Employees. As for economic compensation to employees, such compensation shall be provided in accordance with applicable current legal provisions.

8. Protection of State-owned Asset Rights

Prepare foundational documents such as contracts and articles of association for enterprises undergoing mixed-ownership reform, rationally formulate provisions and clauses, and establish standardized and smooth mechanisms for shareholder cooperation and dispute resolution. Clearly define investor commitments, and develop reasonable development plans, business targets, and performance evaluation mechanisms. Explicitly delineate the rights and obligations of each shareholder, and clearly specify the rights of state-owned shareholders regarding major matters such as personnel appointments, investment decisions, equity changes, use of funds, and profit distribution. At the level of the articles of association or governance documents, establish a negative list that explicitly lists specific activities prohibited in mixed-ownership enterprises.

9. Improve the corporate governance structure

Mixed-ownership enterprises should establish and improve their corporate governance structures, standardize the working rules for the board of directors, the supervisory board, and senior management, and especially develop comprehensive, highly operational deliberation rules for “three major matters”—namely, decision-making on significant issues, appointment and removal of key personnel, investment in major projects, and large-scale financial transactions.   

10. Finally, and most importantly, ensure thorough legal and compliance review. Professional lawyers should issue legal opinions on each stage of the mixed-ownership reform, and the approving authorities should rigorously review the legality and compliance of the reform plan.

Author Introduction:

Ma Yunhe, PhD in Law and practicing lawyer, partner at Liaoning Tongfang Law Firm, and former associate professor at the China National Academy of Criminal Police. Master’s thesis advisor. Also possesses extensive legal experience working in large state-owned enterprises, with dual practical experience in public security and law practice. As a lawyer for nearly 20 years, I have long focused on corporate compliance management, competition and antitrust law, and criminal defense. I can help businesses and entrepreneurs accurately and efficiently identify legal risks, assist companies in effectively establishing corporate compliance systems, and proactively propose tailored solutions to address these risks.