Following approval by the Standing Committee of the National People’s Congress on December 29, 2023, the revised Company Law of the People’s Republic of China (the “New Company Law”) is set to take effect on July 1, 2024. This revision marks the most comprehensive and substantial amendment to the Chinese Company Law since its enactment in 1993, nearly 30 years ago. The New Company Law will significantly impact the operations of foreign-invested companies in China. Drawing on our experience serving foreign-invested companies, this article aims to provide an overview of the major issues in the New Company Law for the reference of such companies.
1. Adjustments to the maximum period for subscribed capital contribution by shareholders
The first major change in the new company law is the requirement that the registered capital of a company must be paid by a specified term, and the consequences of failing to fulfill this obligation by the specified date have been strengthened. For limited liability companies, Article 47 of the new company law explicitly establishes a five-year time limit for capital injection, stating “Within five years from the date of incorporation, all shareholders shall fully contribute their subscribed capital in accordance with the provisions of the company’s articles of association”.
For companies established and registered before the implementation of the New Company Law on July 1, 2024, if their capital contributions exceed the five-year time limit, the New Company Law requires them to ‘gradually adjust’ their capital contributions within five years from the establishment of the company. Additional official regulations from China’s authorities will provide further guidance on the implementation of this “gradual adjustment”.
2. Flexible Adjustment to the Supervisor Role
The new Company Law has implemented significant adjustments to the corporate governance structure. It offers foreign-invested companies greater flexibility in selecting their governance model. Specifically, the New Company Law allows limited liability companies to replace the functions of a supervisor with an audit committee composed of directors. In the case of smaller-scale companies or those with fewer shareholders, the governance structure can be further simplified by omitting the establishment of a supervisory board, subject to unanimous consent from all shareholders. Considering the practical situations of foreign-invested companies, the role of a supervisor is often perceived as a mere formality to fulfill registration requirements, without carrying any actual responsibilities. Additionally, foreign-invested companies typically fulfill the condition of having a small number of shareholders. Therefore, it may align more closely with the actual needs of foreign-invested companies to eliminate the mandatory requirement of having a supervisor.
3. Introduce the audit committee
The new Company Law stipulates that limited liability companies can establish an audit committee within the board of directors, exercising the powers of a supervisory board as stipulated in the company’s articles of association. According to the current Company Law, the corporate governance structure is as follows: board of directors and the board of supervisors are established under the shareholders’ meeting, in which the shareholders’ meeting serves as the highest authority in the company, the board of directors acts as the company’s governing body and the board of supervisors functions as the company’s supervisory body. Due to the historical lack of a substantive supervisory role for supervisors, the New Company Law introduces the option to appoint an audit committee to replace the duties of supervisors, without necessarily requiring their complete removal. This represents a beneficial attempt to improve the corporate governance structure. However, as the committee is under the control of the directors, additional regulations are needed to define its scope of authority, and its effectiveness in practice has yet to be further observed.
4. Adjustment of the establishment of single shareholder company
The new company law has adjusted the establishment of single shareholder companies by abolishing the category of single shareholder limited liability companies and incorporating them into the system of limited liability companies and joint-stock companies. The revised company law no longer restricts the establishment of single shareholder limited liability companies; a natural person may establish multiple single shareholder companies, and the creation of single shareholder joint-stock companies is also permitted. These changes provide greater flexibility for foreign-invested companies to conduct investment and business operations, better meeting the needs and requirements of foreign investment.
5． Strengthen the fiduciary duty of directors, supervisors and senior executives
The new Company Law strengthens the diligence obligations of directors, supervisors, and senior managers. Article 180 of the New Company Law defines the meaning of ‘diligence’ for the first time. Directors, supervisors, and senior managers have a duty of diligence to the company. When performing their duties, they should exercise the reasonable care normally expected of managers in the best interests of the company. The New Company Law clearly stipulates that after it takes effect, controlling shareholders and actual controllers of the company who do not serve as directors but actively engage in the company’s affairs must also comply with certain provisions of the faithful and diligent obligations of directors, supervisors, and senior executives. This is crucial for protecting the company and ensuring the interests of other small shareholders and creditors, playing a very effective normative role.
6. Optimizing the appointment and removal process and legal liability of legal representatives
The current Company Law stipulates that the role of the legal representative may be held by the chairman of the board of directors, an executive director, or the general manager. The new Company Law expands the possibility of appointment as a legal representative to directors or managers who represent the company in executing corporate affairs. Additionally, the New Company Law outlines the resignation process for legal representatives, specifying that if a director or manager serving as a legal representative resigns, it shall be considered a simultaneous resignation from the position of the legal representative. The company is required to designate a new legal representative within thirty days from the date of resignation. In case of a change in the legal representative, the application for registration of the change shall be signed by the newly appointed legal representative, thus clarifying the operational practices of the Administration for Market Regulation with clear legal provisions.
The new Company Law also stipulates that if a legal representative causes harm to others in the performance of the duties, the company shall bear civil liability. After assuming civil liability, the company may seek compensation from the legal representative at fault in accordance with the law or the company’s articles of association. This provision further strengthens the responsibility of the company’s legal representative, preventing the abuse of power and safeguarding the interests of the company and its shareholders.
7. Strengthening shareholders’ capital contribution obligations
Along with the time limit for the contribution of registered capital, the new company law generally strengthens the regulation and liability requirements for shareholders’ improper or insufficient contributions.
The New Company Law explicitly states that shareholders who fail to contribute their capital in full and on time shall be held liable for compensating the losses incurred by the company. Directors have an obligation to verify contributions and issue collection notices on behalf of the company. If a director fails to fulfill this obligation in a timely manner, resulting in losses for the company, the responsible director shall bear the liability for compensation. Shareholders who receive notifications from the directors but still fail to fulfill their contribution obligations within the prescribed period may, by resolution of the board of directors, face a notice of loss of rights. This implies that the shareholder loses the rights to their unpaid contributed shares.
In addition, if the company is unable to pay its debts as they become due, the company or its creditors, whose debts are due, are entitled to demand that shareholders who have subscribed to the capital contribution but have not paid it yet (because the term for contribution has not expired) shall pay the capital contribution in advance of the term.
8. Add dismissal compensation and liability insurance for directors
While reinforcing the fiduciary duty of directors, the New Company Law also strengthens the protection of directors at the legal level by introducing a compensation system for dismissal of directors and a director’s liability insurance scheme.
According to Article 71 of the New Company Law, if a director is unlawfully terminated by the shareholders’ meeting before the expiration of their term, the director may request the company to provide compensation. However, this provision is currently a principle provision and lacks specific regulations regarding the scope and calculation of compensation.
Article 193 of the New Company Law stipulates that a company may purchase liability insurance for directors during their term of office to cover the compensation liability incurred by directors in the execution of company duties. This insurance is limited to directors and currently does not include supervisors and other senior management.
9. Improvement of rules on equity transfer
The new Company Law has enhanced the right of consent for other shareholders regarding the transfer of equity and, for the first time, clearly stipulates the sharing of responsibilities between the transferor and the transferee in the event of an equity transfer. Specifically, Article 84 of the new Company Law removes the requirement for shareholders of a limited company to obtain the consent of other shareholders for the transfer of equity, replacing it with a requirement to notify the other shareholders only. If the other shareholders fail to respond to the notification, it will be deemed as waiving their right of first refusal.
According to Article 88 of the New Company Law, in the case of an equity transfer before contribution deadlines, it is expressly stipulated that the contribution liability shall be borne by the transferee. If the transferee fails to do so, the transferor shall bear supplementary liability to the extent of the transferee’s insufficient contribution. Regarding the transfer of equity with defective contributions, both the transferor and transferee shall bear joint liability within the scope of the defective contribution.
10. Optimize the Power of Shareholder Meeting & Board of Directors
The New Company Law has enhanced the powers and functions of the shareholders’ meeting and the board of directors. Notably, Article 59 of the New Company Law relocates the authority of the shareholders’ meeting to “determine the company’s business policy and investment plan” to Article 67 as one of the powers of the board of directors. Additionally, the authority of the shareholders’ meeting to “examine and approve the company’s annual financial budget and final accounts” has been entirely removed. A new provision has been introduced, allowing the shareholders’ meeting to authorize the board of directors to make resolutions on the issuance of corporate bonds. These adjustments to the powers and functions of the shareholders’ meeting and the board of directors aim to avoid overlap and provide greater flexibility to the board of directors of foreign-invested enterprises in managing the company’s daily operations.
Conclusion
This comprehensive revision of the new Company Law adjusts the existing corporate governance structure from multiple perspectives, which will significantly impact the operations of foreign-invested enterprises in China and influence their future investment decisions. Specifically, it will affect the optimization of the current corporate governance structure, the adjustment of registered capital, and the subsequent operation of the company. We recommend that enterprises understand the structural impact of these major amendments before the New Company Law takes effect on July 1, 2024. It is essential to pay attention to subsequent regulations and rules issued by regulatory authorities and consider the actual situation of the enterprise’s operations in China to assess the aspects that need to be adjusted in a timely manner. Taking proactive measures will help mitigate any impact on the company’s compliance and operations.
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