In December of 2021, the Standing Committee of the National People’s Congress of China published the Draft Revision to the Company Law of China (the “Draft Revision”).
The Draft Revision has made significant changes to the current Company Law which was promulgated in 1993, after which being revised for several times with the latest revision in 2018 (the “Current Company Law”). The changes are mainly reflected in the following aspects:
- improvements to capital contribution system;
- relaxing consent requirements for equity transfer;
- optimization of corporate governance;
- imposing more responsibilities on directors, supervisors and senior management; and
- simplification of companies’ exit process.
The Draft Revision, if passed and implemented, would bring profound influence on not only domestic companies but also foreign invested companies as the Foreign Investment Law coming into force in 2020 has already brought the foreign investment regime in line with the Company Law.
In this article, we will highlight some of the noteworthy changes made by the Revision Draft to the Current Company Law, especially those regarding the limited liability companies, which have long been seen as the most common vehicles for foreign investors who engage in businesses in China.
1 – Improvements to Capital Contribution System
1. Equity Interests and Creditors’ Rights are Expressly Accepted to be Used as Capital Contribution
According to the Current Company Law, shareholders may make capital contributions in cash, in kind, or in intellectual property right, land use right, or other non-monetary properties which can be assessed with value and of which the ownerships can be transferred. The Draft Revision, on this basis, expressly adds two more non-monetary properties, namely equity interests and creditors’ rights, which could be used as capital contribution.
Using the equity interests and the creditors’ rights as capital contribution is not prohibited by law at present, but it is not expressly recognized by any law either. The Draft Revision first ever recognize these two kinds of methods for capital contribution at the level of law. The transactions in the forms of equity swap and debt-equity conversion would be given more solid legal basis. On the other hand, it should be noted that the equity interests and the creditors rights being used as the capital contribution shall strictly follow the assessment requirements which are also imposed on the other non-monetary properties.
2. Accelerated Maturity for Shareholders’ Capital Contribution Obligation is Introduced
In principle, China now adopts the subscription registration system for the registered capital, which means that the shareholders may subscribe their respective capital contribution first and then are obliged to pay in full the amount of their subscribed capital contributions within a term agreed by the shareholder(s). The laws in general do not provide for a mandatory deadline for the capital contribution. However, the Draft Revision introduces an accelerated maturity mechanism, under which if a company is unable to pay off any of its indebtedness and it becomes obviously insolvent, the company or its creditors shall be entitled to request the shareholders who have subscribed but not yet made the capital contribution to pay the capital contribution immediately, no matter whether the agreed term of capital contribution of such shareholders has expired or not. Shareholders would then be exposed to the risks of acceleration of their capital contribution responsibilities, where they intend to subscribe capital contribution first and make actual contribution in the future according to a time schedule.
2. Relaxing Consent Requirements for Equity Transfer
According to the Current Company Law, where a shareholder intends to transfer his equity interest to anyone other than the shareholders of the company, he is required, as a prerequisite, to obtain the consent of more than half of the other shareholders (a shareholder shall be deemed to have consented to the transfer if he fails to reply within 30 days after it receives the notice of the said equity transfer, or if he objects to the equity transfer but refuses to purchase the equity interest proposed to be transferred). Only if such prerequisite has been satisfied, the said equity could be transferred while the other shareholders have the right of first refusal on such equity interest. The Draft Revision takes out such prerequisite of obtaining the consent before equity transfer, while keeping the right of first refusal of the other shareholders. In other words, the transferring shareholder before the proposed transfer only needs to notify the other shareholders; and he can transfer the equity even if the other shareholders object but decide not to exercise the right of first refusal.
This mechanism provided by the Draft Revision is relatively simpler, and shareholders have more freedom in carrying out equity transfers in practice. However, a company, especially a limited liability company, is established and maintains on the basis of trust and willingness of corporation of the shareholders. Lack of control over transferring shareholders’ transfer may adversely impact non-transferring shareholders’ interests and the company’s interests. The lawmakers may have considered this side effect. Therefore, the Draft Revision allows shareholders to negotiate and agree upon tailored restrictions (e.g. consent requirements) on proposed equity transfer and to add them in the company’s charter documents with binding effects.
3 .Optimization of Corporate Governance
- Settings regarding Directors and Board are Adjusted
Firstly, the Draft Revision adjusted the concept of the “executive director”. According to the Current Company Law, small-scale limited liability companies may have one executive director instead of setting up board of directors. The executive director, as provided in the Current Company Law, may concurrently serve as the manager of the company. The Draft Revision stipulates that small-scale limited liability companies may only have a director (such position is not named as “executive director”) or a general manager to take the role of a board of directors. The position of “executive director” in the Draft Revision is exclusively set for joint stock limited companies. The “executive director” in the Draft Revision refers to the director concurrently taking the role of daily management of the company, which is the counterpart of the “non-executive director”.
Secondly, the Draft Revision no longer sets out any specific functions and powers of the board as the Current Company Law does; instead, it only states that the board shall exercise the functions and powers other than those of the shareholders’ meeting granted by the law. Accordingly, the shareholders will have greater discretion in designing and allocating the functions and powers of each level of the corporate governance of the company by articulating them in the charter documents.
- Position of Supervisor is No Longer Mandatorily Required
According to the Current Company Law, the companies must set up a board of supervisor, or at least have one or two supervisors. The Draft Revision proposes that a company may choose to set up an audit committee underneath the board which shall be composed of the directors, responsible for supervising the company’s finances and accounting; if the company choose to do so, it will not be required to set up the position of supervisor.
3. Functions and PoweFrs of General Manager are Adjusted
Like the adjustment made to the functions and powers of board of directors, the Draft Revision does not set forth any specific functions and powers ascribed to general managers, but uses a more general stipulation instead, which only states that the general managers shall exercise the functions and powers in accordance with the articles of association or as authorized by the board of directors.
4. Control over Related Party Transaction is Strengthened
The Draft Revision requires that the following parties shall disclose their interests in the proposed transactions (if any) to the board or shareholders when the transactions are submitted for their deliberation and decisions:
- senior managers;
- close relatives of directors, supervisors and senior managers;
- enterprises controlled directly or indirectly by directors, supervisors and senior managers or their close relatives; and
- the others in related relationship with the directors, the supervisors and the senior managers.
The Draft Revision also requires the relevant directors to excuse themselves from voting process on these transactions. All these requirements are not stipulated in the Current Company Law.
4. Imposing More Responsibilities on Directors, Supervisors and Senior Management
The Draft Revision imposes stringent obligations on directors, supervisors and senior managers in safeguarding the company’s capital. They will be held accountable in the following circumstances:
- shareholders fail to pay the capital contribution in full and on time, or the actual value of the non-monetary property as the capital contribution is significantly lower than the subscribed capital contribution, and the directors, supervisors and senior managers know or should have known such misbehaviors but fail to take necessary measures;
- shareholders illegally withdraw their registered capital after the incorporation of the company, and the directors, supervisors and senior managers know or should have known such misbehaviors but fail to take necessary measures;
In addition, if
- any profit is distributed to shareholders in violation of law; or
- the registered capital of the company is reduced in violation of law,
the responsible directors, supervisors and/or senior managers shall have indemnification liabilities.
The Draft Revision also brings forward that if directors and senior managers in performing his duties have caused any damage to any parties due to his intentional acts or gross negligence shall bear joint and several liability with the company.
As stipulated in the Draft Revision, if controlling shareholder or ultimate controller of a company takes advantage of its influence on the company to instruct any director or senior manager to engage in the acts that harm the interests of the company or the shareholders and causes losses to the company or shareholders, such controlling shareholder or ultimate controller of the company shall bear joint and several liability with the director or the senior manager.
5. Simplification of Companies’ Exit Process
The rules of simple de-registration process for the company with no outstanding debts are set out in the Draft Revision. Compared to the general de-registration process, in the simple de-registration process, the steps such as the establishment of the liquidation committee and the serving of notice to creditors are not required, and the prescribed announcement period is shortened from forty-five days to twenty days.
Please note even if the company is de-registered through the simple de-registration process, the shareholders shall guarantee the de-registered company has no outstanding debt and shall undertake to bear joint and several liability for any debts of company which arise before the de-registration. As a consequence, the shareholders would bear heavier risks under the simple de-registration process.
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The Draft Revision has made a series of substantive changes to the Current Company Law. However, it is still not clear when the revised Company Law would be officially promulgated and to what extent the changes made in the Draft Revision would be reflected in the final version eventually taking effect. No information is available up to now about whether any grace period will be given for the existing companies to adjust according to the revised Company Law after it is promulgated, and what penalty would be if the companies fail to make the adjustments.
We will continue to closely monitor the development and inform you of any progress regarding the revisions to the Company Law.
For further information, please contact:
Simon Li, AnJie law firm