A new round of amendments to the China Company Law seeks to improve the country’s business environment by optimizing corporate governance norms. The draft amendments include changes to the rights of company shareholders, responsibilities of shareholders and directors, deregistration procedures, and more. We look at how the proposed amendments differ from previous legislation and how they may impact companies in China.
On December 30, 2022, the National People’s Congress released a second round of draft revisions to the Company Law of the People’s Republic of China (the “Company Law”) to solicit opinions from the public until January 28, 2023.
This was the second version of the draft revisions to the Company Law (the “second draft amendments”) to be released in the last two years, having made further amendments based on public comments to a previous draft version released in December 2021 (the “first draft amendments”).
The proposed amendments to the Company Law are part of an effort to improve the ease of doing business in China and stimulate market activity through decentralization, reforming the administrative approval system, optimizing public services, and improving investors’ rights, among other measures.
Below we outline a few of the major proposed changes in the latest draft revisions of the Company Law and discuss how they may impact businesses in China.
Changes to shareholder’s responsibility for capital contribution
The latest draft revision to the Company Law strengthens the capital contribution responsibilities of company shareholders. It does this in a few key ways.
Loss of shareholder rights for failure to pay capital contribution
The second draft amendments also add a system for the loss of rights for shareholders that owe capital contributions. According to Article 51, if, after the establishment of a limited liability company, a shareholder fails to pay the capital contribution within the prescribed time and subsequent grace period, then they can lose the equity of the unpaid capital contribution.
A similar clause is included in the Provisions of the Supreme People’s Court on Some Issues Concerning the Implementation of the Company Law of the People’s Republic of China (3) (“Implementation Provisions 3”). Article 17 of Implementation Provisions 3 states that “If a shareholder of a limited liability company fails to fulfill their capital contribution obligation or withdraws all capital contributions, and the company urges them to pay or return the capital contribution, and they still fail to pay or return the capital contribution within a reasonable period of time, the company shall disqualify the shareholder as a shareholder by resolution of the shareholders’ meeting. The people’s court shall not support the shareholder’s request to confirm that the termination is invalid.”
Despite the similarity to the “loss of shareholders rights”, the above clause only applies when a shareholder completely fails to fulfill or withdraws their capital contribution, not in cases where a shareholder fails to fulfill only part of their obligations or withdraws part of their capital contributions. The latest amendment thus serves to close a loophole that has been exploited by some shareholders.
Acceleration of maturity of subscribed capital contributions
The second draft amendments enable limited liability companies to accelerate the maturity of subscribed capital in the event that it is unable to pay off due debts.
Article 50 of the second draft amendments states that “If the company is unable to pay off due debts, the company or the creditors of the due creditor’s rights have the right to require the shareholders who have subscribed for the capital contribution, but whose payment deadline has not yet passed, to pay the capital contribution in advance.”
Under the current system, if a company is unable to pay its debts, creditors of the company have the right to request shareholders who have not fulfilled or only partially fulfilled their capital contribution obligations to provide supplementary compensation for the part of the company’s debts that cannot be paid off within the scope of the uncontributed capital and interest. However, this does not allow for the company to accelerate the maturity of the subscribed capital contribution. This means shareholders can generally avoid their capital contribution obligations in the event that the company cannot pay off its debts.
The new amendment would greatly protect the interests of creditors and improve the security of transactions.
Clarifying the capital contribution responsibilities in equity transfer
The second draft amendments outline the obligations of shareholders that transfer or receive the equity that has been subscribed for through capital contribution but has not yet been paid.
According to Article 88 of the second draft amendments, “Where a shareholder transfers the equity for which they have subscribed through capital contribution, but which has not yet expired, the person receiving the transfer shall bear the obligation to pay the capital contribution; if the person receiving the transfer fails to pay the capital contribution in full [and] on time, the shareholder making the transfer bears supplementary liability for the capital contribution that the person receiving the transfer failed to pay on time.”
This amendment will serve to further protect the interests of the company and its creditors, as well as the other shareholders that have paid their capital contributions in full, by ensuring that shareholders cannot shirk their obligations to pay subscribed capital by transferring the equity to another person.
Changes to other liabilities of directors, supervisors, and senior management
The second draft amendments make a few key changes to the various liabilities and responsibilities of a company’s directors, supervisors, and senior management.
First, the second draft amendments clarify that the responsible directors, supervisors, and senior managers bear joint liability in the event that a shareholder’s non-monetary contribution is defective (for example, if the value of the non-monetary contribution is significantly lower than the subscribed contribution).
Article 190 of the second draft amendments states that “If in the course of performing their duties directors and executives cause damage to others, then the company shall be liable for compensation; directors and senior managers who act with intention or gross negligence shall also be liable for compensation.”
In the first draft amendments, the wording was such that the directors and the executives would be jointly liable in the event of damages to the company. The “jointly liable” stipulation has therefore been removed. This will give courts more discretion to determine where the fault lies, and place the liability, or even partial liability, jointly or individually on the executives or directors.
It should be noted that the above article only mentions executives and directors, and not supervisors, even though the responsibilities and liabilities of supervisors have been amended to be equal to that of directors and executives in the latest draft revision of the Company Law. Further amendments in this regard may therefore be made to keep the responsibilities and liabilities of directors, executives, and supervisors consistent and avoid abuse of the system.
Finally, a new article (Article 192) enables a company to purchase “director’s liability insurance”. Director’s liability insurance would ensure that, in the event that an executive is liable for personal compensation due to work negligence or misconduct, the insurance company will be responsible for indemnifying the relevant legal litigation expenses incurred by the director when conducting a defense, as well as undertaking other civil liability insurance.
Clearer separation of roles and responsibilities of the board of directors and shareholders’ meeting
The second draft amendments clarify the powers and duties of the board of directors and shareholders’ meetings in a limited liability company.
A previous draft amendment to the Company Law had deleted the specific powers of the board of directors and instead stated that any powers that are not attributed to the shareholders’ meeting would default to the board of directors. This would have left some room for interpretation in practice and could have led to confusion and disputes among company leadership.
In the second draft amendment to the Company Law, Article 67 specifically outlines the functions and powers of the board of directors. These include:
- Convening shareholders’ meetings and reporting work to the shareholders’ meeting, and executing the resolutions of the shareholders’ meeting;
- Formulating the company’s profit distribution and loss recovery plan, plans for the company to increase or decrease its registered capital and issue corporate bonds, and plans for company merger, division, dissolution, or change of company form;
- Deciding on the establishment of the company’s internal management organization, the appointment or dismissal of the company’s manager and his remuneration, and the appointment or dismissal of the company’s deputy manager and financial person in charge, and their remuneration according to the manager’s nomination; and
- Formulating the basic management system of the company;
In addition, the second draft amendments change the scope of responsibilities and liabilities of the shareholders’ meeting. In the new version, the duties of the shareholders’ meeting include:
- Electing and replacing directors and supervisors, and making decisions on the remuneration of directors and supervisors;
- Reviewing and approving the reports of the board of directors and the board of supervisors, as well as the company’s profit distribution plan and loss recovery plan;
- Making resolutions on the increase or decrease of the company’s registered capital, issuance of corporate bonds, and the company’s merger, division, dissolution, liquidation, or change of company form; and
- Amending the articles of association of the company.
The latest version has also removed two items from the scope of duties of the shareholders’ meeting:
- Deciding on the company’s operating policies and investment plans; and
- Reviewing and approving the company’s annual financial budget plan and final account plan.
Establishment of an “audit committee”
The first draft amendment to the Company Law enabled both limited liability companies and joint-stock companies to establish an “audit committee” instead of a board of supervisors.
The current iteration of the Company Law requires companies to set up a board of supervisors to oversee the company’s affairs. However, this board has generally not had a lot of use in practice, which may be the reason that the amendment has introduced a new body – the audit committee.
The second draft amendments uphold this change, stating that a limited liability company (Article 69) and a joint-stock company (Article 121) “can set up an audit committee in the board of directors in accordance with the company’s articles of association to exercise the functions and powers of the board of supervisors stipulated in this Law, without having a board of supervisors or supervisors”.
The first draft amendment stated that the audit committee of a limited liability company must be composed of directors that are on the board of directors and that the audit committee is “responsible for supervising the company’s finance and accounting, and exercising other functions and powers stipulated in the company’s articles of association” (Article 64 of the first draft amendments).
However, the second draft amendments do not have any requirements for the make-up or structure of the audit committee of a limited liability company, which will expand the scope of candidates for the audit committee.
In addition, the second draft amendment does not outline the specific functions, responsibilities, or powers of the audit committee for either a limited liability or a joint-stock company, having deleted the clause stating that the audit committee must “exercise the functions and powers of the board of supervisors stipulated in this Law, without having a board of supervisors or supervisors”.
On the other hand, for a joint-stock company, the second draft amendments stipulate that the audit committee must consist of at least three directors, more than half of whom (that is, at least two) must be independent directors. In addition, at least one of the independent directors must be an accounting professional.
The independent directors on the audit committee of a joint-stock company are also not permitted to hold a position other than that of a director within the company, and “may not have any relationship with the company that may affect their independent and objective judgment”.
In the case of a publicly listed company, however, it does state that, for a company that has established an audit committee within the board of directors, the board of directors is required to obtain approval from at least 50 percent of the members of the audit committee before making decisions on any of the following matters (Article 137):
- Engagement with and dismissal of the accounting firm that undertakes the company’s audit business;
- Appointment and dismissal of persons in charge of finance;
- Disclosing financial and accounting reports; and
- Other matters prescribed by the securities regulatory authority of the State Council.
Meanwhile, the second draft amendments keeps the clause of the first draft amendments stating that SOEs are required to set up an audit committee within the board of directors instead of a board of supervisors.
Authorization to issue bonds for joint-stock companies
One of the draft amendments allows shareholders’ meetings to “make resolutions on the issuance of corporate bonds”, and authorizes the board of directors to make resolutions on the issuance of corporate bonds (Article 59), thus opening the possibility of an “authorized share capital system” for joint-stock companies.
Under such a system, a joint-stock company only needs to issue some of its shares when it is established, as outlined in its articles of incorporation or memorandum of association. In this way, the board of directors can choose to issue some or all of the remaining shares at a later time if it is in need of more liquidity.
Relaxing restrictions on one-person companies
The new draft amendments expand the type of company that an individual can open on their own, and the number of companies that a single person can establish.
The draft amendments allow one person to set up a joint-stock company. In the current version of the Company Law, at least five people are needed to do so.
Specifically, Article 92 of the draft law says that “To establish a joint-stock company, there shall be at least one and no more than two hundred founding members, and more than half of the founding members must have their domiciles within the territory of the People’s Republic of China.”
This change would significantly lower barriers to entry to starting a business and will provide smaller businesses with the option of starting a joint-stock company, which offers a more flexible financial model.
In addition, the new draft amendments will also enable single individuals to establish multiple one-person companies (OPCs), whereas previously they were only permitted to open one.
Shareholders of OPCs also no longer need to “certify their innocence”. In the current Company Law, if an OPC takes on external debts, the shareholders of the OPC need to evidence that their property is independent of the company property or be willing to bear joint liability with the company. The latest amendments to the Company Law remove this requirement entirely, as well as the requirement for annual audits of OPCs, greatly reducing the burdens placed on OPCs and their shareholders.
However, this change may also make it more difficult for creditors to assess whether the shareholder’s property is independent of that of the company and to require the shareholders to take on the joint liability.
Changes to deregistration procedures
Simplified deregistration procedures
The first version of the draft revision of the Company Law released in 2021 allows for simplified procedures for companies to deregister in the event upon the consent of all or the shareholders.
Specifically, Article 236 of the first draft amendments state that “If the company has not incurred any debts during its existence, or has paid off all its debts, then it may be deregistered through simplified procedures upon the commitment of all shareholders.”
However, in its current form, the draft law does not clarify what the “simplified procedures” for registration will entail. This information may be disclosed in a future revision of the draft law, or in accompanying implementation measures.
The second draft amendments have added a “forced deregistration” mechanism for companies that are no longer permitted to operate but have not completed deregistration.
Article 237 of the second draft amendments states that if a company is revoked of its business license or ordered to close down but has not completed its liquidation after three years, then the company registration authority can give the company a notice period of at least 60 days that it will be deregistered. If there has been no objection from the company after those 60 days, then the company registration authority can cancel the company’s registration.
The article also states that, in the above case, there will be no change to the responsibilities to the original company shareholders and liquidation obligors.
According to an article posted on the NPC website, this forced deregistration mechanism has been added to deal with the prevalence of “zombie companies” in China – companies that are not in operation but cannot exit the market.
The system was first introduced through the Program for Accelerating the Reform of the System for the Exit of Market Players issued in 2019 by the National Development and Reform Commission (NDRC), along with other departments. The compulsory deregistration system was piloted in various regions, including Guangdong Province.
The revised draft provides legal support for the compulsory deregistration system. However, some analysts have pointed out that there may be some issues with the current iteration of the rule. In the current version, companies are notified of possible forced deregistration through the “unified enterprise information disclosure system”, but does not provide another mechanism for notifying companies that can still be contacted. In addition, it doesn’t provide any remedies or procedures in the event of erroneous deregistration on the part of the company registration authority.
New chapter governing state-owned enterprises
One of the major changes in the draft revisions of the Company Law is the addition of a chapter on “special regulations for state-funded enterprises” (SOEs) (called “state-funded enterprises” in the Company Law). This is a completely new chapter that is not found in the current Company Law.
This chapter strengthens government oversight over SOEs and governs the organizational structure of SOEs.
First, the draft amendments to the Company Law codify the leadership of the Chinese Communist Party (CCP) over SOEs, and states that the CCP can “research and discuss major business management matters of the company, and supports the organization of the company in exercising its powers in accordance with the law” (Article 170 of the second draft amendments).
It also expands the scope of application of the Company Law on SOEs from wholly-state-owned enterprises to “wholly state-owned companies and state-owned capital holding companies, including state-funded limited liability companies and joint stock companies” (Article 168 of the second draft amendments).
Finally, it requires that at least half of the board of directors be from outside the company (Article 173 of the second draft amendments) and for an audit committee to be set up in the board of directors to exercise the functions and powers of the board of supervisors (Article 176 of the second draft amendments).
Corporate social responsibility made a legal responsibility
Another significant addition in the draft amendments to the Company Law is the upgrading of corporate social responsibility (CSR) to a legal responsibility.
As stipulated in Article 12 of the second draft amendments, while carrying out business activities, companies must “fully consider the interests of the company’s employees, consumers, and other stakeholders, as well as social and public interests, such as ecological and environmental protection, and assume social responsibilities.”
It also states that the state “encourages companies to participate in social welfare activities and publish social responsibility reports.”
This change could serve to codify companies’ responsibilities when it comes to matters of social development and environmental protection and brings the Company Law in line with China’s other developmental policies and goals, such as the Common Prosperity policy and “dual carbon” climate targets.
However, it is unclear what the specific legal requirements and liabilities will be for companies for CSR, beyond the regulations outlined in environmental, civil, consumer protection, and other relevant legislation.
The potential impact of the revised Company Law
The proposed amendments to the Company Law will modernize China’s corporate governance system and bring it further in line with the country’s overall economic goals, as well as international standards.
However, it is worth noting that the Company Law has been under revision for many years already, and the relevant government departments are still soliciting opinions from the public on the latest changes. Yet another round of revisions and deliberations by the NPC will take place before a final version of the amendments is released, and this could take a few more months or even years.
Companies in China are nonetheless advised to study the proposed revisions to the Company Law in order to prepare for the possible changes and ensure there are plans to comply in the event that it is passed.
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