The sixth and latest revision of the Company Law was adopted by the Standing Committee of the 14th National People's Congress on December 29 after four readings, one more than the usual three readings, and will take effect on July 1, 2024.1 The latest revision is considered to be the most comprehensive since the Company Law was first enacted in 1993. Compared to the current 2018 edition which consists of 218 articles in 13 chapters, the revised Company Law comprises 266 articles across 15 chapters. 228 articles were newly added or revised, among which some 110 articles were substantively revised, particularly with respect to the company capital system, shareholder rights and responsibilities, governance structure, company registration system, and corporate social responsibility.
The main changes are summarized below:
I. Company Capital System
1. Capital contribution
The revised law sets a five-year time limit for capital contributions to the registered capital of limited liability companies and outlines the consequences for shareholders who fail to meet such obligations, motivated in part by an effort to prevent the adverse consequences of undercapitalized companies overextending themselves and jeopardizing the economy.
In a reversal of the trend to increasingly relax capital contribution requirements since the 2005 revision, including implementation of the capital contribution subscription regime since 2013 in which shareholders were allowed to make capital contributions over a period of 20 years or even longer, the revised Company Law requires that all capital contributions subscribed to by all shareholders of a limited liability company be fully paid up within five years from the date of establishment (Article 47).
The change is seen as a response to delays and even avoidance in making capital contributions by shareholders (some companies and their shareholders are alleged to have intentionally inflated the amount of registered capital in their business licenses to gain an unfair competitive advantage in competitive bidding processes).
To address legacy issues, the revised Company Law allows existing companies to gradually adjust the schedule for full contribution of registered capital to come into alignment with the revised law (Article 266). This revision is one of the biggest changes in the revised Company Law and is likely to have significant impact on many companies, including foreign-invested companies or enterprises ("FIEs").
Shareholders who fail to perform their capital contribution obligations after written notice by the board of directors will forfeit any equity for which they have not made their full subscribed for capital contribution (Articles 51-52) and the forfeited equity shall be transferred or canceled once the company's registered capital is reduced.
The revision also added a clause to require expedited capital contribution when the company is unable to pay its debts when due (Article 54).
Shareholders who fail to deliver, or fail to deliver when due, monetary or non-monetary property as a capital contribution may be subject to a fine ranging from RMB 50,000 to 200,000; and up from 5% to 15% of the amount of the delinquent capital contribution in serious cases (Article 252).
2.Capital decrease
Article 225 allows companies to reduce their registered capital to make up for losses through a simplified capital reduction process (the term "simplified capital reduction" was used in the first draft of the revision but was dropped in the final version). Simplified capital reduction, often referred to as "pro forma capital reduction", would decrease registered capital only on the surface. Unlike "substantive capital reduction" which would reduce company assets and compromise the company's capacity to pay its debts, a simplified capital reduction need not be notified to creditors but would only require a public announcement in a newspaper or the National Enterprise Credit Information Publicity System (the official company registration platform), provided that the reduced capital may not be distributed to shareholders or waive shareholders' obligation to contribute capital.
As capital contributions will now be required to be made within five years, many companies whose shareholders may have trouble making payment in full may comply by reducing their registered capital. Yet it remains unclear whether the simplified capital reduction process will apply to this scenario, or if the companies will need to go through a normal capital reduction process that involves notifying creditors.
3. Profit distribution
Article 212 sets the statutory minimum time length for profit distribution: profit distributions shall be made within six months after authorization by shareholder resolution, replacing requirements currently set in judicial interpretations.
II. Shareholder Rights and Responsibilities
1. Share transfer
The revised law relaxes the requirements for establishing joint stock companies. In particular, Article 160 removes the bar to founders transferring their shares during the first year after establishment unless otherwise provided in law. Note that this does not affect the lock-up period for founder shares once a joint stock company completes an initial public offering and its shares are publicly traded on a stock market.
Restrictions on share transfers to non-shareholders are also relaxed. Under the current law, shareholders are required to obtain the consent of more than half of the company's other shareholders to transfer their equity interests to non-shareholders which means that other shareholders could always block an external transfer even if they chose not to exercise their right of first refusal. This requirement placed an onerous burden on the transferring shareholder and has been widely viewed as a restrictive measure unfriendly to business. Article 84 removes the requirement for shareholder consent. A shareholder may transfer its shares to a non-shareholder following written notice to other shareholders. Any shareholder who fails to respond within 30 days after receipt of written notice is deemed to have waived its right of first refusal.
2.Right of redemption for dissenting shareholders
To protect the interests of minority shareholders and prevent controlling shareholders from abusing their power, Article 89 allows minority dissenting shareholders to require that the company redeem their shares at a reasonable price upon the occurrence of any of the following circumstances: (i) the company has been profitable in each of the past five consecutive years and was able to distribute profits to its shareholders, but failed to do so during such period; (ii) the company engages in a merger, division or transfer of its assets; (iii) the shareholders meeting adopts resolutions allowing the company to continue to exist even though the operating period of the company has expired or the company should have been dissolved according to the articles of association; and (iv) the controlling shareholder(s) has abused its power to seriously damage the interests of the company and its minority shareholders.
If the company fails to reach a redemption agreement with dissenting shareholders within 60 days, the dissenting shareholders may file suit for damages under Article 89.
3.Different classes of shares for joint stock companies
Article 144 makes clear that a joint stock company may issue different classes of shares with rights attached thereto different from those of ordinary shares, including (i) preferred shares (or shares with subordinate rights) with respect to distribution of profits and residual assets; (ii) shares with voting rights different from those of ordinary shares; (iii) shares with transfer restrictions (similar to restricted shares in Western countries); and (iv) other types of shares as may be permitted by the State Council from time to time.
Shares in the same class shall still have the same rights.
4.Enhanced "piercing the corporate veil" doctrine
The revision continues to uphold the doctrine of "piercing the corporate veil" by stipulating that if a shareholder abuses the company's independent legal person status to evade debts and seriously damage the interests of creditors, the independent legal person (limited liability) status of the company will be disregarded, and such shareholder will be jointly and severally liable for the company debts.
In this regard, Article 23 expands the doctrine to cover not only the shareholder itself, but also other entities controlled by such shareholder if they are used to engage in the above conduct: if a shareholder uses two or more companies under its control to carry out the acts specified in the preceding paragraph, each company shall bear joint and several liability for the debts of the company.
Moreover, in any company with only one shareholder, if the shareholder cannot prove that the company's property is independent from that of the shareholder, the shareholder under Article 23 bears joint and several liability for the company's debts.
III. Company Governance Structure
1. Organization structure
1) Legal representative: Replacing the requirement that the role of legal representative be served by the chairman, or executive or managing director, Article 10 allows the role of legal representative to be served by any director or manager authorized to represent the company to execute its corporate affairs.
2) Audit committee: For the first time, the revision allows a company to establish an audit committee in the board of directors to exercise the functions and powers of the board of supervisors, in which case a board of supervisors or sole supervisor will no longer be required (Article 69). A small company may dispense with the role of supervisor upon unanimous approval by all shareholders (Article 83).
3) Employee representative: Article 68 requires that a limited liability company with 300 or more employees include employee representatives on the board of directors unless the board of supervisors has been established and includes employee representatives. This essentially means that companies with 300 or more employees must include an employee representative on their board of supervisors if they do not want such employee representative to sit on the board of directors.
4) Removal of directors: Under the revision, a director may be removed by shareholder resolution (Article 71). A director may also resign by written notice to the company (Article 70). If the director (manager) who serves concurrently as legal representative resigns, he/she shall be deemed to have resigned simultaneously as legal representative and a new legal representative shall be designated within 30 days (Article 10).
2. Management responsibilities
The revised law enhances the rights and responsibilities of management. It introduces additional flexibility in company management structures and expands the liability of directors, supervisors and senior management for failure to perform their duties. Supervisors in many circumstances are subject to additional restrictions or prohibitions with respect to exercising due diligence.
1) Related-party transactions: Directors, supervisors and senior officers engaging in related-party transactions, pursuing business opportunities from the company, or engaging in similar business without proper reporting may bear personal liability (Articles 182 to 189).
2) Shareholder and director liability: Shareholders and responsible directors, supervisors and senior officers shall be held liable for compensation for any losses caused to the company:
a. the company distributes profits to shareholders in violation of the Company Law (Article 211); or
b. if the company reduces its registered capital in violation of the Company Law (Article 226).
3) Directors liability insurance: The revision newly introduces a directors liability insurance system to reduce risk arising from the discharge of directors' duties. A company may (but is not required), during the term of office of a director, purchase liability insurance for the compensation liability to be borne by the director in performing his or her duties to the company (Article 193). If a director is removed prior to the expiration of term of office without justifiable reason, the director may request compensation by the company (Article 71).
4) Duty of diligence: A controlling shareholder or actual controller who is not a director but actually executes the affairs of the company and functions as a de facto director shall bear the obligation of loyalty to the company and the duty to exercise due diligence (Article 180).
IV. Company Registration System
1. Public disclosure
Under Article 40, companies are required to make public the following company information on the National Enterprise Credit Information Publicity System and ensure that the information is true, accurate and complete:
(i) the amount of capital contribution subscribed for and paid up by shareholders, and the methods and dates of capital contributions;
(ii) amendments to the equity of shareholders;
(iii) the approval, modification or cancellation of administrative licenses.
A company which has not incurred any debt or has paid off all of its debts may be deregistered under summary procedure or simplified deregistration procedure upon an undertaking of all shareholders following a 20-day public announcement on the National Enterprise Credit Information Publicity System (Article 240).
3.Forced deregistration
The revised law will allow the company registrar to implement compulsory deregistration of a company which fails to apply for deregistration with the company registrar within three years after revocation of its business license (Article 241). This new procedure importantly will allow formal exit for those FIEs whose business licenses have been revoked but have been unable to deregister for any of various reasons, e.g., failure to open a business for more than six months without justifiable reasons after the business license is obtained.
V. Corporate social responsibility
Article 20 newly provides that the State encourages companies to participate in public welfare activities and publish their social responsibility reports.
Conclusion
The revised Company Law encompasses multiple changes, including with respect to capital contributions, shareholder rights and governance structure, that may have major implications for all companies including FIEs, both wholly-owned and joint ventures. These changes reflect an effort to streamline company governance, enhance shareholder rights, and provide more flexibility in management structure while also ensuring compliance and accountability. The revisions generally appear to balance the need for regulatory oversight with the flexibility required for more efficient and effective business operations. FIEs as well as domestically-invested companies will need to review their articles of association and may need to take action to come into compliance with the new requirements of the Company Law.
Footnotes
1 http://www.npc.gov.cn/npc/c2/c30834/202312/t20231229_433999.html
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