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As the mainstay of China's private economy, family-owned enterprises have made remarkable contributions to promoting economic growth and absorbing employment. However, its unique “family enterprise isomorphism” attribute, in the governance structure, shareholding arrangements, intergenerational inheritance and other aspects of the buried many legal pitfalls, seriously restricting the sustainable development of enterprises. This paper analyzes the core dilemma of family-owned enterprises from a legal perspective, and explores the feasible path to build a rule of law, modernized governance system.

First, the core legal dilemmas faced by family-owned enterprises

(a) the deflation of the corporate governance structure and legal risks:

1. “Rule of man” over the “rule of law”: major corporate decision-making is highly dependent on the founder or family core members of personal authority, shareholders' meeting, board of directors, supervisory board (“three”) The shareholders' meeting, board of directors and supervisory board (“three meetings”) are virtually non-existent, violating the mandatory provisions of the Company Law on corporate governance structure, resulting in a lack of procedural propriety and transparency in decision-making.

2. Failure of the supervision mechanism: family members hold key management positions, making it difficult for the internal supervision (supervisory board or supervisors) to exercise their powers independently and effectively; external supervision (e.g., independent directors, external auditing) is difficult to introduce or is a mere formality. This provides a breeding ground for behaviors that harm the interests of the company and its small and medium shareholders, such as connected transactions and misappropriation of company assets, and it is very easy to trigger the provisions of the Company Law on the prohibition of connected transactions that harm the interests of the company and the recourse to the duty of loyalty and diligence of the directors and supervisors.

3. Imbalance of rights and responsibilities of professional managers: high trust barriers between family members and non-family professional managers, insufficient authorization or excessive intervention, resulting in difficulties for managers to display their talents, or unclear rights and responsibilities, which can easily lead to disputes or even litigation in the performance of their duties.

(ii) Rigid shareholding structure and conflict of rights and interests

1. Highly concentrated and closed equity: equity is concentrated in the hands of the founder and a few family members, poor liquidity. Although this guarantees the stability of control, it hinders the introduction of external capital and the implementation of equity incentives, and restricts the development space of the enterprise.

2. Equity dispersion and disputes caused by intergenerational inheritance: with the change of generations, equity is naturally dispersed among family members. In the absence of clear, legal and effective inheritance planning (e.g. wills, gift agreements, special agreements in the articles of association), it is very easy to cause complicated inheritance disputes and shareholder rights litigation due to unfair distribution, identification of heirs and differences in the valuation of equity.

3. Alienation of the exercise of rights: family shareholders often regard the rights of shareholders (such as the right to vote, the right to know) as a tool for the disposal of “family affairs”, ignoring the statutory procedures and requirements under the Company Law, which may harm the interests of the company or other shareholders.

(III) Legal Vacuum and Risks in Intergenerational Inheritance

1. Whether to “pass on to the elders” or “pass on to the wise”? Lack of legal standards: The succession law only addresses the order of property inheritance, and cannot address the issue of candidates for the inheritance of the right to control and operate the enterprise. Subjective designation of the successor is prone to cause internal conflicts within the family, and even lead to corporate division.

2. Lagging or missing inheritance planning: Many founders are reluctant to talk about their afterlife, and have not made careful arrangements in advance through wills, trusts, equity transfer agreements, amendments to the company's articles of incorporation (such as conditions for successors to enter the board of directors, and special voting arrangements) and other legal tools, resulting in a process of inheritance that is full of uncertainty, high costs, and even lawsuits.

3. High tax risk: when transferring major assets such as equity and real estate from one generation to another, if not properly planned, you may face a huge amount of inheritance tax, gift tax or income tax (if transactions are involved), significantly increasing the cost of inheritance.

(iv) Legal bottlenecks in financing expansion

1. Excessive reliance on family credit guarantee: enterprise financing is often guaranteed by the founder or family members who provide personal unlimited joint and several liability guarantee, which deeply binds the family wealth and enterprise risk. Once the enterprise is in trouble, it may trigger the recovery under the Security Property Rights Section of the Civil Code, leading to the collapse of the family wealth.

2. High cost of compliance with the capital market: IPO or introduction of strategic investors requires strict corporate governance, financial transparency and information disclosure standards. The closed governance model, potential connected transactions, and legal defects in the history of the family business (such as inaccurate capital contribution and unclear property rights in the early days) constitute major obstacles and require high compliance and rectification costs.

Second, the family-owned enterprises to break through the legal predicament of the rule of law way out

The core of the predicament is to promote the family-owned enterprises from the “family control” to the “rule of law control” transition to build clear rights and responsibilities, standardized operation, risk control of the modern enterprise system.

(A) Improve the corporate governance structure, build the foundation of the rule of law

1. Make the “three meetings and one layer”, and clarify the boundaries of rights and responsibilities:

Shareholders' meeting: Strictly in accordance with the provisions of the Company Law and the articles of association, to protect the right to know, the right to make proposals, the right to vote of all shareholders (including non-family shareholders). It can be agreed through the articles of association that major family matters (e.g. nomination of successor, disposal of major assets) need to be passed by a higher percentage of votes.

Board of Directors: Introduce a sufficient proportion of truly independent and professional outside directors/independent directors. Define their core functions of strategic decision-making, risk control and supervision of management. Set up specialized committees led by independent directors for auditing, remuneration, nomination, etc., and strengthen the review of connected transactions and executive remuneration.

Supervisory Board: Ensure the independence of its members (especially employee supervisors), and give them full investigative and questioning rights, focusing on supervising the performance of directors and executives as well as the company's finances.

Management: Implement a professional manager system and sign an appointment contract with clear rights, responsibilities and benefits through an open and transparent selection and recruitment process. Establish a performance-oriented assessment and incentive mechanism, and at the same time constrain their behavior through legal documents (confidentiality agreement, non-competition agreement).

(2) Formulate and strictly implement the Corporate Governance Guidelines: Combine the Company Law and other laws and regulations with the actual situation of the enterprise to formulate an exhaustive governance rulebook, standardize the decision-making process, information disclosure, and management of connected transactions, and ensure its effective implementation.

(ii) Optimize the design of the shareholding structure to balance control and vitality

1. Implement diversified and dynamic shareholding arrangements:

Share incentive scheme: Attract and retain core non-family talents through the establishment of an employee shareholding platform (limited partnership) or direct grants. Legal texts (e.g., option agreements, restricted stock agreements) need to be carefully designed to clarify the granting conditions, exercise prices, and exit mechanisms.

Introduction of strategic investors: Under the premise of maintaining family control (e.g., through AB share structure, unanimous action agreements, voting proxy), institutional investors that can bring in resources and improve governance are introduced to optimize the shareholding structure. Attention should be paid to the control of legal risks such as betting terms.

2. Establish a clear mechanism for equity flow and exit:

Improve the Articles of Incorporation: pre-specify the right of first refusal for internal transfer of equity, the method of determining the transfer price (e.g., appraisal, formula calculation), and the restrictions on transfer.

Formulate the Shareholders' Agreement: Agree on more detailed shareholders' rights and obligations, equity transfer, exit (e.g., right to drag and drop, right to follow the sale, right to repurchase), dispute resolution mechanism, etc., which are strongly legally binding.

Utilizing family trust: placing family equity into a trust structure, held and managed by professional trustees, realizing the separation and stable inheritance of ownership, control and income rights, and effectively avoiding succession disputes.

(C) Planning in advance for intergenerational inheritance and using legal tools to ensure continuity

1. Starting as early as possible and formulating a systematic inheritance legal program:

Defining the mechanism for selecting and cultivating successors: institutionalizing the selection criteria and cultivation paths to reduce subjective arbitrariness. Qualification conditions for successors to enter the board of directors or management can be set through the articles of association or shareholders' agreement.

Comprehensive use of legal tools: (1) wills/grant agreements: clarify the distribution of equity and other property to avoid uncontrolled equalization due to legal succession. Pay attention to tax planning. (2) Family Charter (non-compulsory but instructive): establish family values, corporate vision, code of conduct for members, principles for selection of successors, guidelines for the relationship between the family and the enterprise, etc., which, although non-statutory, can build consensus, reduce conflicts, and provide a basis for formal legal documents. (3) Family trust: to achieve long-term preservation of wealth, isolation of risk (to avoid heir squandering or marital division), targeted distribution, tax optimization and centralized management of control (executed by the trustee according to the agreement). (4) Shareholding reorganization and charter amendment: Safeguard the smooth transition of control by setting up a special shareholding platform (e.g. limited partnership with GP as the successor), setting up golden shares (special voting shares), and amending the charter to increase the transitional arrangement for the successor, and other legal means.

2. Pay attention to tax compliance and planning: with the assistance of lawyers and tax accountants, assess in advance the various types of tax liabilities involved in succession, and utilize legally permissible tools such as installment gifts, charitable donations, insurance, and trust structures to carry out legal planning and reduce the cost of succession.

(iv) Regulate financing behavior and build a risk firewall

1. Promote the legalization of the main body of financing: as far as possible, the company's own assets and credit for financing (such as the issuance of corporate bonds, asset securitization), and strictly limit family members to provide personal unlimited joint and several guarantees. If guarantees are required, clear limits and counter-guarantee measures should be set and risk assessment should be conducted.

2. Strengthening legal regulation of connected transactions: Strictly enforcing the procedures (approval by the board of directors/shareholders' meeting, avoidance of voting by connected parties) and substantive fairness requirements of the Company Law and judicial interpretations on connected transactions; establishing a list of connected parties and improving the internal declaration, approval (especially independent directors' opinions) and information disclosure system for connected transactions; and refining the operating procedures through internal regulations such as the Measures for the Administration of Connected Transactions. .

3. Legal compliance preparation for docking with the capital market: sort out legal defects in history, property rights, taxation, environmental protection, labor and other aspects in advance and carry out standardization and rectification (e.g., make up for the capital contribution, improve the property rights registration, and solve the problem of social security payment). In accordance with the requirements of the Securities Law and the rules of the Stock Exchange, establish and improve the corporate governance, internal control, financial management and information disclosure system in line with the standards of public companies.

Conclusion

In order to realize the everlasting success of family-owned enterprises, it is necessary to face up to the inherent legal dilemma and get out of the shackles of the traditional thinking of “family world”. Only by actively embracing the spirit of the rule of law, taking the Company Law and other laws and regulations as the cornerstone, perfecting the corporate governance structure, optimizing the design of shareholding, using legal tools to plan the inheritance, regulating the financing behavior, and building up a modern enterprise system with clear property rights, clear rights and responsibilities, scientific governance and standardized management can we effectively control legal risks, stimulate the vitality of the organization, and achieve the harmony and unification of the family's wealth, enterprise value and social responsibility. Unification. This is a profound self-revolution, which requires the vision of entrepreneurs and the support of legal professionals, as well as an increasingly perfect business environment under the rule of law as a solid backing. Only in this way will family businesses be able to go through the cycle and stabilize themselves in the tide of the market economy.