China makes welcome amendments to its Company Law

Highlight of Key Amendments

After four rounds of review and public consultation in the past five years, the PRC National People’s Congress formally approved the sixth amendment to the Company Law of the People’s Republic of China on December 29, 2023. This newly amended Company Law (New Company Law) will come into effect on July 1, 2024 with a universal impact on all companies in the PRC, including foreign invested enterprises.

The New Company Law now has a total of fifteen chapters and 266 articles, including 112 articles newly added or revised per the sixth amendment, covering substantial changes in areas such as corporate governance, capital contribution, management responsibilities, corporate information disclosure, corporate bonds, corporate litigation, and registrations. This alert is to highlight and summarize some key changes in the New Company Law, with a view to provide some high-level guidance to foreign investors and their subsidiaries in the PRC.

 

1. 5-year Maximum Capital Contribution Period for Limited Liability Companies

The New Company Law has introduced a 5-year maximum capital contribution time limit that applies to all limited liability companies, with a view to enforce actual capital contributions and to protect the interests of creditors.¹ In particular, the registered capital of a limited liability company subscribed by its shareholders must now be contributed in full within five years from the date of the company’s incorporation.

For existing limited liability companies who do not comply with the new 5-year requirement, the New Company Law generally requires that such companies should gradually adjust their capital contribution schedule to comply with the 5-year requirement. However, it is unclear if there will be a special grace period for existing companies, or if the 5-year maximum time limit for existing companies will start from the effective date of the New Company Law. This remains to be clarified in the implementation rules to be released by the State Council.

The New Company Law also grants the company registration authority the power to examine the amount and period of capital contribution of a limited liability company. If the company registration authority believes that the registered capital of a limited liability company is abnormal, or the agreed capital contribution schedule is in violation of the New Company Law, the company registration authority may require the company to make adjustments. Based on our experience, the company registration authority is likely to issue an implementation measure to require existing companies to conduct self-examination and adjust excessively high registered capital and capital contribution periods exceeding five years within a certain period of time after the New Company Law takes effect.

 

2. Enhanced Rights and Obligations against Outstanding Capital Contribution

The New Company Law adopts several new rules surrounding rights and obligations against outstanding capital contribution to ensure full capital contribution by shareholders and protection of company and creditors’ interest. These rules are applicable to both limited liability companies and joint stock limited companies.

Acceleration Rights of Company and Creditor

Under the current Company Law and PRC Bankruptcy law, only when a company becomes insolvent, may the administrator appointed by the court demand the shareholders of the company to accelerate the contribution of any outstanding capital.

The New Company Law now provides a company and its creditors the right to accelerate the shareholders’ obligation to make capital contribution if the company is unable to pay off its debts when they fall due. Under such circumstances, the company or the creditor will be entitled to demand the shareholders’ immediate payment of the outstanding capital prior to scheduled contributions provided under the articles of association of the company.

Shareholders’ Joint Liability for Outstanding Capital Contribution

If, at the time of the incorporation of a company, a shareholder fails to pay the capital contribution in accordance with the articles of association of the company, or if the actual value of the in-kind capital contribution is significantly lower than the amount of the capital contribution subscribed to, the other shareholders at the time of the incorporation of the company will be jointly and severally liable for the shortfall in capital contribution.

Directors’ Responsibility for Outstanding Capital Contribution

After the incorporation of a company, the board of directors shall verify the capital contributions of the shareholders. If the board finds that a shareholder has not paid up the capital contributions stipulated in the articles of association in full and on time, the board shall require the company to issue a written demand letter calling for the payment of the capital contributions. If a director fails to fulfill such verification and demand responsibilities in a timely manner, and thereby causes losses to the company, the director will be held liable to compensate the company for such losses.

Forfeiture of Shareholders’ Equity Interests

If a company issues a demand letter to its shareholder for payment of outstanding capital contribution, the shareholder will have a minimum sixty-day grace period to fulfil its capital contribution obligations. If the shareholder fails to fulfill such obligations within the grace period, the company may, by resolution of the board of directors, forfeit the shareholder’ equity interests corresponding to the outstanding capital contribution.

Furthermore, the forfeited equity interests shall either be transferred, or cancelled by means of registered capital reduction. If the forfeited equity interests are not transferred or canceled within six months, the other shareholders of the company will be responsible to make up for the outstanding capital contribution based on their respective equity ratio.

Directors and Senior Management’s Joint Liability for Illegal Capital Withdrawal

Other than going through proper capital reduction procedures, shareholders are generally forbidden to withdraw their capital contributions made to a company. In the event of a violation, the shareholders shall be liable to return the withdrawn capital contributions. The directors, supervisors and senior management personnel of the company, to the extent responsible for any such illegal withdrawal, will also be jointly and severally liable for any losses caused to the company. Moreover, the company registration authority may impose a punitive fine against such responsible directors, supervisor and senior management, ranging from RMB30,000 to RMB300,000.

 

3. Reconstruction of Corporate Governance Structure

The New Company Law makes some significant adjustments to the corporate governance rules, which to some extent reconstructs the organizational structure and reallocates governance powers of companies.

Employee Representative as Supervisor or Director

Under the current Company Law, only state-owned companies are required to have employee representatives on their board of directors. Non-state-owned companies may but are not required to have an employee representative on their board of directors.

The New Company Law further extends this employee representative rule to mid-large scale non-state-owned companies. In particular, a company with no less than 300 employees (including both limited liability companies and joint stock limited companies whether state-owned or not, must have at least one employee representative on the board of directors, unless the company has a board of supervisors with employee representative(s) on such board of supervisors. The employee representative must be elected by the company’s employees through the employees’ congress or meetings.

Audit Committee as Alternative to the Board of Supervisors

Under the current Company Law, a company must have a supervisor or a board of supervisors, which has the right to monitor, investigate and supervise the company’s operation in view of protecting the interests of the company. In practice, it is very often observed that such supervisory system is seriously out of place in corporate governance and most supervisors in the non-state-owned space are inactive.

The New Company Law now provides for an audit committee as an alternative to the supervisory system. In particular, the New Company Law allows a company to set up an audit committee under the board of directors that consists of directors, and such audit committee may exercise the powers and authorities of a board of supervisors under the New Company Law. In this alternative, the power of board decisions and the obligation of supervision to a large extent will consolidate in the directors.

In addition, the New Company Law allows the small scale limited liability companies or limited liability companies with a small number of shareholders, with the unanimous consent of all shareholders, not to have a board of supervisors or a supervisor.

Executive Personnel as Legal Representative

The current Company Law allows the chairman, executive director or general manager of a company to act as the company’s legal representative, regardless of whether this person is actually controlling or executing the company’s business operations.

The New Company Law now requires the legal representative to be a director or the general manager that actually execute the business operations of the company. The New Company Law also provides that the resignation of a director or general manager who serves as the legal representative shall be deemed to be a simultaneous resignation from the position of legal representative. If the legal representative resigns, the company shall have a new legal representative appointed within thirty days from the date of the legal representative’s resignation.

 

4. Elaboration and Enforcement of Duties of Loyalty and Diligence

The New Company Law reconfirms the duties of loyalty and diligence of a company’s directors, supervisors and senior management personnel, and further defines such duties as the following:

• directors, supervisors and senior management personnel should take measures to avoid conflicts between their own interests and those of the company, and they should not use their authority to seek improper benefits;
• directors, supervisors and senior management personnel should perform duties in the best interests of the company with the reasonable level of care normally expected of a management personnel.

On top of the above, the New Company Law provides that the controlling shareholders and actual controllers of the company who do not serve as directors of the company but actually execute the affairs of the company also owe duties of loyalty and diligence to the company. The New Company Law also provides that the controlling shareholders and actual controllers of the company who instruct the directors and senior management of the company to engage in acts detrimental to the interests of the company or its shareholders shall be jointly and severally liable for the damages and losses of the company.

 

5. Improvement of Rules on Transfer of Equity Interest

The New Company Law has introduced some improvement on the rules for transfer of equity interests in a limited liability company.

Simplified rule on the right of first refusal

Under the current Company Law, the transfer of equity interest by a shareholder to a person other than a shareholder of the company shall first be approved by a majority of the other shareholders. This requirement has been removed by the New Company Law. A selling shareholder shall now notify the other shareholders in writing of the quantity, price, method of payment and period of time for the intended transfer, and the other shareholders shall have the right of first refusal under the same conditions. The shareholders who fail to respond within thirty days from the date of receipt of the written notice will be deemed to have waived their right of first refusal.

Capital Contribution Liability related to Transferred Equity Interest

In practice, it is common that a shareholder may transfer its equity interest in a limited liability company when the corresponding registered capital has not been fully paid up. The New Company Law lays out some specific rules on the allocation of capital contribution liabilities between the transferor and transferee.

If at the time of the transfer, the outstanding capital contribution has not become due per the capital contribution schedule in the company’s articles of association, the transferee shall be liable for the outstanding capital contribution. If the transferee fails to fulfil its obligation of capital contribution by the due date, the transferor shall remain the secondary obligor to make up for the outstanding capital contribution.

If at the time of the transfer, the outstanding capital contribution is already overdue according to the capital contribution schedule in the company’s articles of association, or the actual in-kind contribution made by the transferor is, in term of value, significantly lower than the subscribed capital amount, the transferor will be liable for the outstanding capital contribution. The transferee will be held jointly and severally liable, unless it is a bona fide transferee, ie who is not aware and should not have become aware of the status of the outstanding (or defective) capital contribution.

 

6. Optimization of Registration and Liquidation Procedures

The New Company Law has a new chapter on company registration, which clarifies the matters and procedures for company establishment, change, deregistration and public announcement, and requires the company registration authority to optimize the registration process and improve registration efficiency and convenience. At the same time, the New Company Law requires companies to ensure that the information disclosed through the National Enterprise Credit Information Disclosure System must be true, accurate, and complete.

Company’s information disclosure obligations and authenticity requirements are also strengthened with corresponding legal responsibilities. These new provisions will help enhance the safety and reliability of transactions and better protect the interests of companies, creditors and the public.

The New Company Law also improves the company liquidation system. In particular, the New Company Law clarifies that directors shall be liquidation obligors and also set out their obligations and responsibilities in liquidation. With reference to the relevant provisions of the Market Entity Registration and Management Regulations, the New Company Law includes a simplified liquidation procedure, which stipulates that if a company has not incurred debts during its existence, or has paid off all debts, as guaranteed by all shareholders, the company may be deregistered through a simplified procedure.

 

This New Company Law is released against the backdrop of China facing a fast changing and competitive international market environment while continuing to promote reform and opening up to shore up foreign and domestic investments. The current Company Law is old and stale as well as clumsy and inadequate for regulating corporate governance and relationships among market participants; its many vague mechanisms are often only successful in protecting the status quo and fall out of place in an economy that continues its significant growth. The main objectives of this New Company Law are to improve capital adequacy of Chinese companies, protect the rights and interests of companies and creditors, optimize corporate governance structures, provide clarity to facilitate and protect equity transactions, improve transparency of information disclosure, and simplify company establishment and liquidation procedures. These welcome amendments will operate to help reduce disputes, facilitate transactions and improve management efficiency. We also anticipate that the State Council, the People’s Court and other relevant Chinese authorities will over time issue new implementation rules, practical guidelines, interpretations and transitional measures before any future amendments to the Company Law. Foreign investors will be well advised to seek counsel advice to ensure their new and existing China subsidiaries should comply with the New Company Law on a transitional and continuing basis.

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¹The current Company Law adopts a liberal registered capital subscription system, which does not require completion of capital contribution within a specific period. In practice, it is normally acceptable to the company registration authority that the registered capital of the company is contributed within the company’s registered term of operation. Consequently, many shareholders would subscribe a huge amount of registered capital, but only make actual contributions when it is needed by the company. As a result, there are many limited liability companies with high registered capital but low paid-in capital, and a large number of disputes and legal actions over shareholders’ failures to fulfil their capital contribution obligations.