China Company Law Reform

On 29 December 2023, the seventh session of the Standing Committee of the fourteenth National People’s Congress adopted a reformed Company Law of the People’s Republic of China, which will come into effect starting July 2024. The reform is enacted in the context of a broader overhauling of the PRC legal system, which includes inter alia the Civil Code, the Law on Foreign Investment, etc.

The reform is inspired by the necessity to rely on a more structured normative system, appropriate for the current dynamic corporate environment. Some of the thematic areas of the revised Company Law are set out below. The way these rules will be applied in practice will largely depend on the implementing regulations that are likely to be published in the next few months.

Capital contribution system

The new Company Law introduces several additional safeguards in relation to the payment of the registered capital, which are probably aimed at curbing the risk of hiddenly undercapitalised companies, in particular:

• Whilst the old law did not provide for a final term to pay up capital contributions, under the new law, the longest term for the payment of initial capital contributions is now five years. Companies incorporated before 1 July 2024, whose payment terms for contributions exceed five years, will be required to adjust the terms to comply with the five-year deadline, unless otherwise provided by laws, departmental administrative regulations or the State Council.
• In addition, the introduction of an authorized capital system means the company needs not issue all shares at once; rather the board of directors may decide on the issuance of capital according to the company's actual operating conditions and the market.
• Under the new Company Law, the company may request shareholders who have not timely paid capital contributions to comply within a period of not less than 60 days. If contributions are not paid within the deadline, the shareholder may lose rights to the unpaid shares, which may be transferred to other shareholders or cancelled resulting in a reduction of capital. If within six months the shares are not transferred or cancelled, other shareholders may contribute pro rata.

Under the new as under the old law, shareholders may not withdraw capital contributions without effecting a formal capital reduction, which is a rather cumbersome procedure. Under the new law, however, directors, auditors, and senior managers are jointly and severally liable with shareholders who illegally withdraw capital contributions, causing damage to the company.

Corporate governance

The new Company Law tries to ensure the participation of employees in the management of companies. Companies with more than 300 employees must include employees’ representatives in the board of directors unless a board of supervisors – inclusive of employee representatives - has been established in accordance with the law. The aim is to make the deliberation procedure of larger companies more democratic and concerned with the instances of a larger number of stakeholders. We are not sure how this will pan out in practice in a context where the government is trying to promote economic growth.

The new Company Law also emphasises the liability of single-member companies, including those on debt assumption and abuse of limited liability. Even though there are no hard new rules, the level of emphasis clearly suggests that we may see significant new instances of lifting the corporate veil in the PRC in the next few years.

In addition to the above, the potential liability of directors, supervisors and senior management is significantly expanded as it now includes unlawful financial assistance to purchase own shares of joint-stock companies, withdrawal of registered capital, unlawful profit distribution etc.

Shareholders’ rights

Shareholders of limited liability companies may now consult - and make a copy of – accounting vouchers and accounting reports, as well as accounting books, under specific conditions. Procedures that enable the convening of a special shareholder meeting have been modified. The right for shareholders to make temporary proposals strengthens their democratic participation, and improves the corresponding access rights.

In the case a majority shareholder abuses their rights and severely damages the interests of the company at large or other shareholders, the latter have the right to request that the company acquire their shares at a reasonable price. Similarly, shareholders can file derivative actions against the directors, managers, and supervisors of the company’s subsidiaries. These rules strengthen and clarify protection mechanisms that were already present under the old law, promote transparency clarify the mechanisms of internal accountability.

Liability of company officers

The new Company Law adds detailed provisions on the duty of loyalty and diligence of directors, supervisors, and senior executives, clarifying that “loyalty” implies taking measures to avoid conflicts between one's own interests and the interests of the company, and that officers may not use their authority to seek improper benefits. With regards to related-party transactions, the new law adds supervisors to the list of restricted persons, stipulating that directors, supervisors, and senior executives are required to disclose relevant information.

The amended Law increases the potential liability of supervisors by not allowing them to use their position to seek business opportunities belonging to the company for their own personal advantage.

In the event of related party transactions, the seeking of personal business opportunities, and intra-industry competition, affected directors will have to restrain from voting. If the number of unaffected directors on the board is less than three, the matter must be submitted to – and deliberated by – the shareholders.

To strengthen the responsibilities of controlling shareholders and de facto controllers, the amendment adds two important provisions.

1. even if the controlling shareholder or de facto controller does not formally serve as directors, yet are materially engaged in the company's affairs, they will be subject to the same duty of loyalty and diligence as directors, supervisors, and senior executives.
2. if a controlling shareholder or de facto controller instructs a director or senior executive to engage in acts that harm the interests of the company or of other shareholders, the former will be jointly and severally liable with the acting director or senior executive. The provision reflects the system of joint infringement present in the Civil Code, aiming at regulating the behaviour of controlling shareholders and de facto controllers and reducing the risk of harm to the interests of the company and the minority shareholders.

Improvement of the establishment, modification, and cancellation systems

The new law provides for the use of electronic business licenses, as well as electronic communication methods to convene meeting and cast votes. The type of assets that can be used as contribution has also been partly revised, as both equity and debt may now be objects of contribution.

The amended system requires that the company register its modification – most notably if they affect the articles of association – and that failure to register an item may not be used against a bona fide third party.

The resolution to change the legal representative must be countersigned by the newly nominated person. This aims at avoiding situations in which the exiting representative refuses to cooperate, or (yes, it happens) legal representatives are appointed against their will or even their knowledge.

Cancellation is devised as a corrective mechanism against wrongful registration, rather than an administrative penalty. In terms of regulated conducts, the revised norms are more directed towards the registration authority, rather than companies. Their concern seems to be to empower the registration authority to investigate the falsehoods in registration.

This article is for information purposes only and is not, and cannot be intended as, a professional opinion on the topics dealt with. For any further information please contact Hermes Pazzaglini.