China releases its newly revised Company Law

Changes relating to capitalisation requirements and shareholders’ obligations on capital contributions

The changes summarised in items 1 to 7 in our Previous Article regarding capitalisation requirements and shareholders’ obligations on capital contributions remain the same in the New Company Law, subject to the following additional information worth noting:

• With regard to the five-year time limit on registered capital contributions appliable to LLCs, it remains unclear how the regulator will implement this provision for existing LLCs with a capital contribution timeframe spanning more than five years from such LLCs’ incorporation where the subscribed capital has not been fully contributed yet (Existing LLCs)². According to Article 266 of the New Company Law and a notice released by the State Administration for Market Regulation (SAMR, being the company registration authority in China) on 30 December 2023,
  • Existing LLCs should gradually adjust their capital payment timeframe to be compliant with the New Company Law,
  • A transition period will be afforded to Existing LLCs for them to gradually make such adjustment, and
  • as a next step, the State Council will issue detailed implementation measures and policies taking into account different circumstances of Existing LLCs, and guide them towards a compliant status through means of a capital reduction or a reasonable adjustment of the capital payment timeframe.
• In terms of a capital contribution to a CLS, the New Company Law requires that the founding shareholders must make a full contribution of the share capital subscribed by them in a CLS before the incorporation of such CLS. This is not required under current PRC Company Law.
• Regarding the proportionate capital reduction as proposed in the Third Draft Revision (see item 4 in our Previous Article), the New Company Law ultimately leaves some flexibility for the shareholders of a PRC company (being a LLC or a CLS) to agree in the shareholders’ agreement or articles of association that a capital reduction may be conducted otherwise than in proportion to the shareholders’ shareholding ratios in the company.

In addition, if a shareholder fails to pay its subscribed registered capital on time, the New Company Law adds a new administrative penalty provision that SAMR (including its local counterparts) may order such shareholder to rectify this promptly and may impose fines against such shareholder in an amount ranging from RMB 50,000 to RMB 200,000 (or in the case of a serious breach, at 5% to 15% of the unpaid registered capital of such shareholder). Furthermore, SAMR may also impose fines on those persons in charge of the company’s affairs and other directly responsible persons (potentially the directors of the company) in an amount ranging from RMB 10,000 to RMB 100,000.

Changes relating to the corporate governance

The changes summarised in items 8 to 10 of our Previous Article relating to the corporate governance of a PRC company have been retained in the New Company Law.

Please find below a few additional points in respect of the changes to corporate governance provisions:

• The New Company Law removes the previous limit on the number of directors in a company (including a LLC and a CLS), and instead provides that the board of directors of a company shall have at least three board members but there is no maximum number. For both LLCs and CLSs, if it is of small operational scale or has a small number of shareholders, it can have a single director to fulfill the functions of the board of directors. In addition, the New Company Law requires a company to have at least one employee representative as a director if the company has more than 300 employees and there is no employee representative on its board of supervisors, or if the company is a wholly state-owned enterprise.
• The New Company Law requires that in order to effectively hold a board meeting, more than half of the directors must attend to constitute a quorum. This change raises a question on the validity of the commonly seen quorum provisions in the articles of association of a company, that if a quorum is not present at the first board meeting and a reconvened meeting, then the directors attending the third meeting shall be deemed to constitute a valid quorum. 
• The New Company Law introduces the concepts of “de facto director” and “shadow director”, specifically:
  • De facto director: Directors of a company shall (a) bear the duties of loyalty and diligence to the company, (b) avoid any conflict of personal interests with those of the company, and (c) exert a reasonable duty of care in pursuit of the best interests of the company when performing their duties. The controlling shareholder or actual controller of a company, who actually manages the business affairs of such company, shall also comply with the aforementioned obligations (even if not taking the position of a director of the company);
  • Shadow director: If the controlling shareholder or actual controller of a company directs or instructs a director or senior management personnel of such company to carry out activities that damage the interests of such company or its shareholders, such controlling shareholder or actual controller shall bear joint and several liability with such director and/or senior management personnel for damage caused.
• We mentioned in item 9 of our Previous Article that the board of directors of a PRC company may set up an audit committee in lieu of a supervisor or a board of supervisors. In addition, the New Company Law provides that if a LLC is of a small operational scale or has a small number of shareholders, then upon the unanimous approval of all the shareholders, the LLC does not need to have a supervisor or board of supervisors. Such a rule does not apply to a CLS, which must have at least one supervisor. 
• It is also worth noting that, the Regulations on the Implementation of the Foreign Investment Law, set out a five-year transition period (from 1 January 2020 to 31 December 2024), within which existing foreign-invested enterprises must convert their corporate governance structure to be in line with the requirements under existing PRC Company Law. Given that the existing PRC Company Law will be replaced by the New Company Law on the Effective Date, it remains unclear whether or not those companies which have not completed the transition to the governance position under the current PRC Company Law will be required to comply with the applicable requirements in the New Company Law by the end of the same transition period.

Changes relating to protective provisions on shareholders’ rights

The changes summarised in item 11 of our Previous Article regarding shareholders’ inspection rights have been retained in the New Company Law.

The New Company Law also entitles shareholders to some additional rights, for instance:

• If a controlling shareholder of a LLC abuses its position and materially damages the interests of the LLC or other shareholder(s), then such other shareholder(s) shall have the right to require the LLC to re-purchase their equity interest in the LLC at a reasonable price.
• If a director, supervisor or senior management personnel of a wholly-owned subsidiary of a LLC or a CLS (being the parent company) conducts illegal activities when performing their duties, resulting in losses to such subsidiary and the parent company, then any shareholder of the parent company if it is a LLC, or the shareholder(s) holding (alone or in aggregate) more than 1% of the issued shares of the parent company for at least 180 consecutive days if it is a CLS, has the right to request the board of supervisors or directors of the subsidiary to file a claim against such non-compliant director, supervisor or senior management personnel, or to directly file a claim in its own name.

Other notable changes

• Expanded application of the “piercing the corporate veil” doctrine
  The New Company Law provides that if a shareholder of a company abuses the principles of independent legal personality for corporates and the limited liability of shareholders to circumvent debts, which seriously damages the interests of such company’s creditors, then such shareholder shall bear joint and several liability with the company for the debts owed to the creditors. In addition, if a shareholder conducts the abovementioned activities by using two or more companies under its control, each company involved shall have joint and several liability for the debts of such other companies.
• Clarifications on duty of loyalty and duty of diligence
  The existing PRC Company Law fails to give a clear definition of “duty of loyalty” and “duty of diligence” imposed upon directors, supervisors and senior management personnel of a company. According to the New Company Law, the “duty of loyalty” means to take measures to avoid any conflict between their personal interests and those of the company and not to seek an improper interest by using their powers in the company; and the “duty of diligence” means, when performing duties, to exert such reasonable duty of care commonly taken by management personnel for the purpose of pursuing the best interests of the company. 
• Requirements on company registration
  The New Company Law newly includes an independent chapter dealing with various matters on company registration at the company law level (as opposed to the lower level of legislation under the current practice). We briefly summarise some of the notable provisions as below:
  • A company shall publicly disclose its corporate information through the national enterprise credit information system, which shall include, amongst others, the amount of subscribed and paid-in capital, changes in equity interests held by shareholders in LLCs or shares held by founding shareholders in CLSs, and information on the receipt, change and cancellation of administrative licences or approvals; and
  • If a company fails to disclose such corporate information as required or makes any false disclosure, SAMR may order prompt rectification and impose fines in the amount ranging from RMB 10,000 to RMB 50,000 (or in the case of a serious breach, up to RMB 200,000). Furthermore, SAMR may also impose fines on the in-charge person and other directly responsible person of the company in an amount ranging from RMB 10,000 to RMB 100,000.

Overall, the New Company Law has made some substantial changes to the currently applicable PRC Company Law, and imposed greater responsibilities on the shareholders and senior executives, and notably directors in particular. It has also introduced new rules to improve corporate governance and corporate information disclosure. Some of the new or revised provisions in the New Company Law will require further clarification from the regulator, or will need to be tested in practice when the changes become effective.