A draft amendment (the “Second Draft Amendment”) to the Company Law of the People’s Republic of China (“Company Law”) was submitted to the Standing Committee of the National People’s Congress for second review in February 2023. The Second Draft Amendment includes a number of significant changes to existing Company Law that will impact corporates practice when adopted.
This article will focus on the main changes proposed in the Draft Second Amendment with respect to shareholder liability for capital contribution, director responsibilities and corporate governance.
1. Shareholder liability for capital contributions
(1) The obligations of the transferee and transferor during an equity transfer for outstanding or inadequate capital contributions has been clarified
According to Article 88 of the Second Draft Amendment, if any shareholder transfers its equity interest that includes capital contributions that have subscribed to but not fully paid:
(a) in the case that the subscription payment period has not yet expired, the transferee should be liable to pay such unpaid capital contribution. However, if the transferee fails to pay such capital contribution in full within the subscription payment period, the transferor shall assume supplemental liability to contribute the unpaid capital which is due. Supplemental liability is not defined in the Second Draft Amendment. It is generally viewed as liability that would only apply if the primary responsible party has insufficient capability to satisfy the obligation. In such case the party with supplemental liability would be liable for the shortfall. It is not joint and several liability.
(b) in the case that the subscription payment period for the transferor has expired when the equity is transferred and the transferee knows or should have known of the situation, such transferee should bear joint and several liability with the transferor for the unpaid capital contribution.
(c) in the case that the capital contribution is made in-kind through a non-monetary property contribution by the transferor and the actual value of such non-monetary property capital contribution is obviously lower than the amount subscribed, and the transferee knows or should have known of the situation, such the transferee should bear joint and several liability with the transferor for the shortfall in the capital contribution.
(2) Acceleration of the payment obligation for subscribed capital contributions
Article 53 of the Second Draft Amendment states that when the company is unable to pay off its due debts, either the company or the creditors holding the due debt shall have the right to require the shareholders to fully contribute the subscribed capital at that time, even though the subscription payment period has not yet expired. This is a significant change to the Company Law which protects the interests of the creditors of companies.
2. liabilities of directors
(1) Compensation liability
The Second Draft Amendment (Article 190) providers a director shall be personally liable for the damages caused to others by his/her intentional or gross negligence in the performance of his/her duties.
In addition, a director may be personally liable to compensate the company if:
(a) the director of a company limited by shares violates the Company Law by allowing the company to provide financial support to others for the acquisition of its shares (except for the implementation of employee incentive scheme), which causes losses to the company (Article 163 of the Second Draft Amendment);
(b) the company distributes profits to shareholders before making up the company’s losses and contributing to statutory reserves, which causes losses to the company (Article 207 of the Second Draft Amendment); or
(c) the company reduces its registered capital in violation of the Company Law which causes losses to the company (Article 222 of the Second Draft Amendment).
(2) Joint and several liability
Moreover, a director may bear joint and several liability with the violating shareholder to compensate the company if:
(a) the actual value of the non-monetary property used for a capital contribution is obviously lower than the subscribed capital contribution amount, which causes losses to the company (Article 52 of the Second Draft Amendment);
(b) the shareholder withdraws its capital contribution amount, which causes losses to the company (Article 57 of the Second Draft Amendment); and
(c) the controlling shareholders or the actual controllers of the company instruct the directors to engage in acts that harm the interest of the company or shareholders (Article 191 of the Second Draft Amendment).
(3) Directors liability insurance
The Second Draft Amendment recognizes directors’ liability insurance in the Company Law for the first time (Article 192). A company may purchase the directors’ liability insurance for the compensation of liabilities incurred during the tenure of directors. In such case, the board of directors shall report to the shareholders the insured amount, coverage and premium rate of liability insurance.
3. Corporate governance
(1) Establishment of audit committee
The Second Draft Amendment providers that an audit committee may be set up under the board of directors instead of appointing a supervisor or setting up a board of supervisors. The audit committee shall exercise the functions and powers of the board of supervisors as stipulated in the company’s articles of association.
(2) Cancellation of compulsory requirement for appointing a supervisor(s)
The Company Law requires that at least one supervisors shall be appointed by the shareholder(s) of the company. According to the Second Draft Amendment (Article 83), with unanimous consent of all shareholders, a limited liability company with a relatively smaller scale may opt not to appoint any supervisor. However, the Company Law and the Second Draft Amendment are silent about the criteria of “relatively smaller scale”. In practice, it might be decided by the registration authority on basis of the number of employees, revenue, gross value of assets etc. of the company. The elimination of the supervisor role has been under discussion for some time.
(3) Employee’s representatives in the board of directors
Kindly note that the Second Draft Amendment requires a limited liability company that has 300 or more employees to have an employees’ representative on its board of directors, unless the company has a board of supervisors with an employees’ representative. The employees’ representative will be a member of the board of directors and will be selected by the employees.
The foregoing highlights some of the potential major changes on the aforementioned topics (not an exhaustive list) under the Second Draft Amendment that may impact the PRC subsidiaries of foreign investors. Some of these changes are quite significant. It is expected that the final version will be promulgated soon after the second review by the NPC Standing Committee, probably in this year. We will continue to follow the major developments of the Company Law. If you have any enquiries regarding the corporate governance issues, please feel free to contact us.
