Amendments to the Company Law of the People's Republic of China (the “New Company Law”) were passed on December 29, 2023, and will come into effect on July 1, 2024.
The New Company Law consists of 15 chapters and 260 articles, with substantial additions and modifications of around 70 articles compared to the current Company Law, which comprises 13 chapters and 218 articles. The main revisions are categorized into: (1) Capital Contributions, (2) Corporate Governance Structure, (3) Mandatory Quorum Requirements, and (4) Transition and Redistribution of Responsibilities within Shareholders' Meetings and the Board of Directors.
As a preliminary note, the topics discussed herein do not cover all the changes the New Company Law will bring along. This article focuses on major updates of significant importance to foreign investors and companies.
A. Capital Contribution (Articles 47, 48, 50 and 54)
The New Company Law has amended the capital contribution provisions, specifying that:
- The registered capital of a limited liability company must be paid within the timeframe specified in the articles of association, not exceeding five years from the establishment of the company. For companies established after July 1, 2024, the New Company Law applies, with a maximum payment period of five years. For companies established before July 1, 2024, the contribution period should gradually align with the New Company Law's requirements;
- Shareholders failing to meet capital contribution obligations are not only required to fulfill their contributions but also liable to compensate the company for resulting losses; and
- If a shareholder fails to make actual capital contributions or contributes non-monetary property with a value lower than subscribed, other shareholders at establishment share joint and several liability for the shortfall.
As we understand by the wording of the New Company Law, the State Council will, by the end of 2024, publish detailed implementation measures and likely more guidance regarding the unclear provisions in the Company Law, such as the terms “gradually adjust” and “clearly abnormal”. For more clarity on how existing companies will have to comply with the new rules, we will have to wait for these measures to be released. Nevertheless, foreign-invested companies may already want to reassess their capital contribution timeline and the contributions made so far, and specifically whether they would be able to contribute their outstanding contributions within 5 years from 1 July 2024; eventually, if it is the case, they may take into consideration reducing the registered capital in measure correspondent to the part of it which has not yet been injected in order to not incur in the consequences provided by the law.
Against the backdrop of the gradual tightening of shareholder subscribed capital in the New Company Law, companies should reasonably assess and forecast future business conditions and set appropriate subscribed capital amounts. It is advisable for a company to conduct thorough due diligence on the actual contributions made by shareholders during the company's establishment. In addition, a company should obtain a legally valid assessment report for non-monetary contributions and establish agreements outlining the responsibilities and obligations of shareholders who fail to make timely and sufficient contributions or provide accurate information.
B. Corporate Governance Structure (Articles 23, 68, 69, 71, 83, and 133)
The New Company Law has made several significant changes to corporate governance provisions, which include:
- Employee Representatives & Audit Committee
For companies with over 300 employees or a board of directors with at least three members, it is compulsory to have at least one employee director, unless they already have employee supervisors. Further, we have seen an important development of the audit committee under the New Company Law, where limited liability companies shall establish an audit committee under their articles of association, comprising directors from the board. This committee assumes the functions and powers of the board of supervisors as outlined in the New Company Law, in cases where no separate board of supervisors or directors are established. Employee representatives serving as board members may also be members of the audit committee. It is advisable for companies to carefully consider the role and functions of employee representatives and assess the most convenient structure with least interference of employee representatives within the company's decision-making mechanism. Furthermore, companies that have difficulties finding suitable candidates for the position of supervisor and appointed individuals who were external service providers or not based in China might want to consider alternatives, such as an audit committee in place of the current supervisors. - Number of Supervisors A company could previously be exempted from the requirement of having a supervisory board only if it was a limited liability company with a small-scale of its business operations, in which case it could have one or two supervisors to exercise the powers of the supervisory board. The New Company Law has now provided for more exemptions where such small-scale limited liability companies may elect to have one supervisor without establishing a board, or if unanimously agreed by the shareholders, even no supervisor at all. This will potentially impact certain types of companies, such as Sino-foreign companies (i.e., at least one Chinese shareholder and one foreign shareholder), where each party normally gets to appoint at least one supervisor. Additional modifications and amendments will be required to reflect such updates in their constitutional documents.
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Compensation for Dismissed Directors
The New Company Law stipulates that if a shareholder meeting
unreasonably removes a director before their term expires, the
director may request compensation from the company. In practice,
shareholders normally believe that they have the authority to
arbitrarily remove the directors nominated by them without cause to
properly reflect their shareholder rights. The new provision,
however, diverges from the long-standing perception held by foreign
shareholders.
Therefore, additional proactive steps should be taken to prevent
potential disagreements with departing directors in this context.
For example,
- Familiarize themselves with and adhere to the provisions regarding the dismissal of directors in the New Company Law to avoid the necessity of compensating dismissed directors without valid reasons; and
- Confirm in writing with the directors that there are no compensation matters or unresolved disputes between the directors and the company.
- Piercing MechanismA key attribute of the limited liability
company is that shareholders are not personally liable for
corporate debts in excess of their investment in the company.
Creditors seeking payment of debts generally can reach only the
corporation's assets, not those of its shareholders. However,
the notion of a piercing mechanism is introduced under the New
Company Law, including:
- Where any shareholder of a company evades the debts by abusing the independent status of controlling person of the company or the limited liability of shareholders and thus seriously damages the interests of any creditor of the company, it shall be jointly and severally liable for the debts of the company; and
- If a company cannot repay its debts, it or the creditors can demand early capital contributions from shareholders who have not met their deadlines yet.
The New Company Law appears to indicate that a creditor may be able to enforce against a company's shareholder, to the extent of its subscribed but unpaid capital, for example, if a company cannot pay a debt in a judgment. In case of any company with only one shareholder, if the shareholder is unable to prove that the property of the company is independent of its own property, it shall be jointly and severally liable for the debt of the company.
C. Mandatory Quorum Requirements (Articles 27, 66 and 73)
The New Company Law made some specific adjustments to the rules of procedures for shareholder meetings and board meetings of foreign-invested companies. These include:
- Shareholders Meetings A resolution made by the shareholders' meeting shall be adopted by the shareholders representing more than half of the voting rights. A resolution made by the shareholders' meeting on modifying the articles of association, increasing, or decreasing the registered capital, as well as merger, division, dissolution, or change of corporate form of the company shall be adopted by the shareholders representing more than two thirds of the voting rights.
- Board Meetings No meeting of the board of directors may be held unless more than half of the directors are present. When the board of directors makes a resolution, it shall require the affirmative votes of more than half of all the directors. For the voting on a resolution of the board of directors, each director shall have one vote.
- Quorum If the number of attendees is insufficient or the number of people agreeing to a resolution does not meet the requirements of the New Company Law or constitutional documents of the company, the resolutions of the shareholder meeting or board meeting are not valid. Given that the New Company Law has clearly defined mandatory quorum requirements, including the statutory meeting attendance and voting mechanisms, some flexibility that companies currently enjoy under the existing Company Law will be challenged. For example, it may become a new issue if a director who is frequently absent, and decision-making delays are caused by failure to meet the statutory number of directors in board meetings. Efficient and stable business operations for foreign-invested companies heavily rely on the successful passage of shareholder and board resolutions. Therefore, companies should re-evaluate the mandatory quorum requirements, especially concerning shareholders' meeting procedures and the board of directors, and revisit their mechanisms for deadlock situations in their articles of association or shareholders agreements, including those clauses providing for shareholders' meeting or board of director meetings to be convened (and the relevant resolutions to be passed) despite half of the equity interest or the directors not being in attendance, will not be effective anymore.
D. Transition and Redistribution of Responsibilities within Shareholders' Meetings and the Board of Directors (Article 59 and 67)
The New Company Law inherits the duties and powers of the original board of shareholders regarding personnel matters, approval rights, and decisions on significant company matters, while excluding decision-making duty and power on operational matters. It reflects the transition from a shareholder-centric governance model to a director-centric governance model under the New Company Law. This shift aims to address numerous issues within the governance framework of foreign-invested companies:
- The power to "decide on the business direction and investment plans of the company" has been transferred from the board of shareholders to the board of directors.
- The power to "review and approve the annual financial budget and financial accounting plan of the company" has been taken away from the board of shareholders.
- The shareholders' meeting, through board of directors' resolution, can authorize new corporate bond issuance.
- The power of “formulating the annual financial budget and financial accounting plan of the company” has been taken away from the board of directors, which means this will no longer be a statutory matter for the board of directors and can be addressed by granting authority to the board of directors or by stipulating designated governance bodies in the company's articles of association.
Going forward, companies should adapt to the transition and redistribution of responsibilities within shareholders' meetings and the board of directors, reflecting these in their constitutional documents; the provisions appear to be vesting more decision-making powers in the board of directors as commonly practiced in other common-law and civil-law jurisdictions.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.