By Maarten Roos, Kathleen Cao
In the final days of 2023 and following many years of draft amendments and deliberations, China published a new Company Law to take effect on 1 July 2024. The law will have a material impact on international investors in China, below we summarize some of the key changes.
Most commentaries of the 2023 Company Law focus on the new registered capital requirements, which indeed are a big change from the current regime. Other key areas include:
- Additional director liabilities, for example with regards to the monitoring of capital contributions, fiduciary duties to the company, and liquidation events, and direct liabilities to third parties for gross negligence or intentional acts.
- Appointment of employee representatives to the board of directors or supervisory board of larger enterprises
- The possibility of no longer appointing a supervisor
Contribution within five years
The 2023 Company Law requires shareholders to contribute registered capital within 5 years. Under current law, there are no time limits for the contribution of registered capital, so this is a big change. Companies already established are permitted to gradually adjust their contribution schedules to within the prescribed 5-year period (Article 266), subject to detailed implementing rules to be issued later.
Also, if a company is unable to pay off its debts when due, then the company or its creditor has the right to demand the company’s shareholder(s) to contribute their subscribed registered capital in full – even if such contribution is not yet due under the company’s articles of association. (Article 54)
Reduction of registered capital
For companies that are unable or unwilling to contribute the subscribed registered capital in full, they should be able to complete a reduction of registered capital. The law introduces a simplified procedure for loss-making companies that reduce their capital to make up for their losses (Article 225), but profit-making companies that want to reduce their registered capital will need to complete the regular process.
Liabilities in case of equity transfer
The law defines liabilities for capital contribution in case of equity transfers. When equity is transferred while registered capital has not been contributed, then:
- If the registered capital is not yet due, then the transferee takes primary responsibility for the capital contribution while the transferor takes on a secondary responsibility (though not joint and several) (Article 88).
- If the registered capital was due at transfer or there was a defect related to the contributed capital, then the transferor and transferee will bear joint and several responsibility (as long as the transferee was aware or should have been aware) (Article 88).
Related director liabilities
A company’s board of directors has the responsibility to monitor and verify capital contributions to the company and if any payment is overdue, it must issue a notice to relevant shareholders. Failing to do so, the responsible directors may be held personally liable to the company for any losses resulting from the delinquent capital contribution (Article 51);
Special rules for joint ventures
If a company has two or more shareholders and one of those shareholders fails to contribute its registered capital in time, then after a grace period such registered capital should be transferred or decreased; and if this is not done within 6 months (and doing so without the non-contributing shareholder will be challenging), the other shareholders become responsible for this contribution (and obtain the apportioned equity interest in the company) (Article 52).
Joint Stock Companies
Most companies with foreign investment are set up as limited liability companies, but setting up as a joint-stock company comes with new benefits. Not only does the new law make it possible for the joint-stock company to have only one shareholder (Article 92), but this type of company can now issue different types and classes of shares in terms of dividends, liquidation proceeds, voting rights, transfer restrictions etc. (Article 144). This may be attractive for companies that intend to raise additional funds with third-party investors.
The 2023 Company Law states that the general manager or any director (not only the Chairman of the Board) can be the company’s legal representative but sets as new condition that the person should be involved in the company’s operations. (Article 10)
Small-scale companies or companies with a relatively small number of shareholders, may decide not to have a supervisor at all provided that all shareholders agree (Article 83). As the supervisor rarely has much of a function in companies owned by a single (foreign) shareholder, this should simplify things.
However, if shareholders do decide on having supervisors, then they should appoint either one supervisor, or a supervisory board with at least three members (Article 76). In Chinese-foreign joint ventures it is not uncommon for each party to appoint one supervisor – so this is no longer permitted.
Another option is to replace the supervisory board by an audit committee made up of (some of) the company’s directors, which would have the same supervisory powers over directors and managers (Article 69). This may become tricky in practice as directors on the audit committee would be required to supervise themselves.
The 2023 Company Law makes it mandatory for companies with at least 300 employees to appoint an employee representative to the board of directors (Article 68) or to the supervisory board (or audit committee in place of a supervisory board) (Article 69). The employee representative is to be elected by the company’s employees.
This is a big change for larger companies and may well motivate companies to set up a supervisory board to at least limit the impact of this rule on the company’s senior decision-making.
Liabilities of directors and managers
Current law already includes fiduciary duties of directors and senior managers, but the 2023 Company Law provides more detail. The duty of loyalty refers to avoiding conflicts of interest and not using authority to seek improper interests, while the duty of care means that directors, supervisors, and senior management shall exercise reasonable care in the best interests of the company in performing his or her duties (Article 180).
In foreign-invested enterprises including many joint ventures, directors are often asked to defer to the shareholder’s will in making decisions. The new rules more clearly establish liabilities on directors and management that prioritize the interests of a shareholders over those of the company.
An even greater change: that directors and senior management may be held directly liable toward third parties in the case of gross negligence or an intentional act. Under current law, third parties can only claim against the company and not against the director or manager directly (Article 191).
(Minority) shareholder protections
Right to information
The 2023 Company Law expands on the rights of (minority) shareholders, giving them the right not only to inspect the company’s accounting books but also accounting vouchers; and shareholders have the right to entrust accounting firms, law firms, and other intermediaries to review the company’s articles of association, shareholder list, shareholders’ meeting minutes, board meeting resolutions, supervisory board meeting resolutions, and financial accounting reports (Article 57).
The new law provides for several circumstances where a shareholder can require the company to buy back its equity at a reasonable price, to be enforced through a lawsuit (Article 89), under the following circumstances:
- If a controlling shareholder abuses its shareholder rights and seriously damages the interests of the company or other shareholders.
- If the company has not distributed profits to shareholders for five consecutive years, but the company has made profits in those years and meets the legal conditions for profit distribution;
- If the company has transferred its main assets; and
- When the specified operational period in the company’s articles of association expires, or when another dissolution reason specified in the articles of association occurs, and the shareholders’ meeting passes a resolution to amend those articles to keep the company in existence.
Composition of the liquidation group
The new law establishes that the liquidation group shall consist of the company’s directors – unless provided otherwise in the company’s articles of associations. This means that shareholders that want to protect their directors from the responsibility of liquidating a company, should adjust those articles (Article 232).
The new law formally introduces a simplified de-registration procedure on the condition that shareholders confirm that the company has settled all debts, and an online public announcement is made for twenty days (Article 240). A key consequence is that the shareholder(s) will remain liable for any company debts towards third parties.
Under the 2023 Company Law, directors are obliged to form a liquidation group within fifteen days after the occurrence of any matter triggering a company's dissolution. Failure to do so can make directors liable for losses caused to either the company or its creditors (Article 232).
The corporate team of R&P China Lawyers supports clients on investment projects, corporate changes and restructuring, and company liquidations. The team also advises clients on corporate governance mechanisms, and is frequently involved in disputes involving shareholders, directors and senior managers. For more information, please contact the authors at [email protected], [email protected] or reach out to your usual contact at R&P.