Background Report on the Drafting of

Regulations on Employee Stock Ownership in Hainan Special Economic Zone

By the Drafting Team, CIRD

I. Necessity and Legal Basis for Drafting the Regulations

China's efforts in promoting employee ownership aim at linking individual benefits of employees with the performance of the enterprise so as to build up an effective incentive and binding mechanism for improving the performance of the enterprise over the long run. Employee ownership was initiated in China along with the shareholding-oriented reform of state-owned enterprises and the earliest regulations on employee ownership in China were drafted in the mid-80s by different local governments. These regulations drastically differ from each other and most of them are poorly feasible. In view of that, the State Council started to standardize the employee stock ownership in May 1992 and promulgated relevant decrees. Meanwhile, some provincial or municipal governments also issued local regulations on employee stock ownership, including Shenzhen, Shanghai, Jiangsu and Beijing. So far, the employee stock ownership has been adopted in various localities, covering a considerable number of enterprises and employees. As the largest special economic zone in China, Hainan experimented with the shareholding-oriented reform and employee ownership comparatively earlier. However, the policy and regulations standardizing the practice of employee ownership lags behind in Hainan. In this regard, it is imperative for competent authorities to regulate the practice of employee ownership in Hainan through practical legislation.

The drafting of the Regulations on Employee Stock Ownership in Hainan Special Economic Zone (hereinafter Regulations) was mainly based on the Constitution, Company Law, General Civil Law, Contract Law and other related laws and regulations. In addition, local regulations on employee ownership in about 30 provinces and municipalities including Beijing, Shanghai, Tianjin and Shenzhen were also used as reference. In the course of drafting the Regulations, the team tried their best to incorporate the successful experience of SOE reform in Hainan for the past decade, latest research findings on ESOPs in China and comparable legislation in other countries into the Regulations. The purpose of doing so is to make the Regulations reflect the independent legislation power of Hainan Special Economic Zone by bringing out new features that will have a guiding role for legislation in other parts of China.

II. Drafting Process

Officially entrusted by the Hainan Provincial People Congress and its Standing Committee in February 2000, CIRD started to conduct literature research and organize field survey for drafting the Regulations. CIRD set up a drafting team with the participation of top economists and jurists. For the first stage, the drafting team systematically investigated ESOP regulations in other parts of the country and conducted field survey in places like Beijing and Jiangsu. On the basis of such preliminary work, the first draft of the Regulations was formulated. For the second stage, the draft Regulations were revised for many times based on the consultation with legal experts and economists. Altogether seven seminars were organized in Haikou and Beijing for inviting views and opinions concerning the Regulations from legal experts, attorneys, government officials and company representatives. For the third stage, the controversial points of the Regulations were finalized with the help of legal experts.

III. Basic Thoughts for Drafting the Regulations

On the grounds that a scattered shareholding structure does not bring out the benefits of unified management of employee shares and convenient exercise of voting rights, many companies have created an employee shareholding committee to hold employee shares and exercise various rights on behalf of employee shareholders. Regulations vary from place to place in defining the nature and governing the operations of the employee shareholding committee. The following are the most typical definitions.

1. The employee shareholding committee is defined as an independent social corporate. However, the term of "social corporate" is not recognized as a technical term for legislation. Therefore, such a definition lacks sufficient legal basis.

2. The employee shareholding committee is defined as a social group with independent legal status that shall be registered with the civil affairs authority. However, according to the requirement of "Regulations on the Registration of Social Groups" issued by the State Council that social groups shall have a non-profit nature, the employee shareholding committee can hardly gain approval from the civil affairs authority in registration. So far, such a definition only works well for the State Council-approved pilot enterprises within the system of foreign trade and economic exchanges.

3. The employee shareholding committee is defined as a labor union with independent legal status that shall be registered in its own name with the industrial and commercial administration bureau. Such a practice will face the problem of paying taxes.

4. The employee shareholding committee is defined as an internal unit of the labor union. In this case, the registration is much simplified. However, labor union is a political organization whereas the employee shareholding committee is an entity exercising civil rights of employee shareholders. The two are drastically different from each other in nature and shall not be confused.

The drafting team completed the first draft of the Regulations in May this year. To increase the binding force of employee shareholders, the first draft emphasized the principle that except for shareholding cooperatives and enterprises where employees are relatively few, the rights of employee shareholders shall be indirectly exercised through the employee shareholding committee. Given the practice in most provinces and municipalities, the employee shareholding committee was defined as a social group with independent legal status in the first draft with the emphasis that the employee shareholding committee is a non-profit organization and is subject to strict supervision from competent authorities. According to that definition, as explained earlier, the employee shareholding committee must get approval from the civil affairs authority in registration. However, the Document No. 110 from the Ministry of Civil Affairs entitled "Notice on the Suspension of Registration of Employee Shareholding Committees as Social Groups" gave a flat denial to the first draft and the Hainan Provincial Department of Civil Affairs took a similar stance. This forced us to examine the rights of employee shareholders from another perspective and give up the first draft.

Based on the fact that organizations like the employee shareholding committee in the US and the UK are often defined as trusts independent of the enterprise, the drafting team decided to use the trust system to solve the problem of the legal representation of the rights of employee shareholders. The timing was right as the Trust Law of China was in the process of formulation. With such a new idea, the team redrafted the Regulations.

IV. Contents of the Regulations

The Regulations aim at standardizing the practice of employee ownership, promote enterprise reform and mobilize the initiative of employees in Hainan Special Economic Zone through legislation. Under the above guiding principle, the Regulations consist of eight sections with a total of 74 articles (see the following text of the Regulations for details). Section I explains the principle of the Regulation, definition of employee ownership and scope of application; Section II explains the way how employee ownership is created, eligibility of employee shareholders and financing of employee shares; Section III illustrates the trusteeship contract signed between trustees and employee shareholders; Section IV stipulates the rights and obligations of employee shareholders; Section V stipulates the rights and obligations of trustees; Section VI prescribes the conditions, modes and procedures for transfer and repurchase of employee shares; Section VII clarifies the legal liabilities of relevant parties and settlement of disputes; Section VIII identifies the authority for interpreting the Regulations and the date when the Regulations become effective.