China Passes Significant Amendments to Company Law

Effective on July 1, 2024, the newly amended Company Law of China brings significant changes to the capitalization requirements, corporate governance and other aspects of a company registered in China.

Takeaways

On December 29, 2023, the Standing Committee of the National People’s Congress of the People’s Republic of China (PRC) passed the final version of the long-awaited new Company Law (2024 Company Law) after deliberating on four versions of draft amendments. The new law will come into effect on July 1, 2024. The 2024 Company Law deletes 16 provisions in the latest version of the Company Law, which was amended in 2018, and makes substantial amendments to over 110 provisions. This is the sixth round of amendments and includes the most amendments to the Company Law since its initial introduction in 1993.

The 2024 Company Law applies to all companies registered in the PRC, including state-owned, private- and foreign-invested enterprises (FIE).

Particularly, the PRC Foreign Investment Law (effective on January 1, 2020) requires an FIE to comply with the Company Law, instead of the separate laws and regulations governing FIEs, and provides a five-year transition period (starting from January 1, 2020) for all existing FIEs to review their articles of association and other corporate governance documents to identify and make necessary changes to comply with the Company Law. This five-year transition period ends on December 31, 2024. As such, foreign investors with FIEs in China should be particularly alert to the possible impacts of the 2024 Company Law on their existing FIEs and any new greenfield investment or joint venture project in China in the near future.

Since the most adopted corporate type for foreign investments in China is the limited liability company (LLC), we dedicate our attention in this article primarily to the 2024 Company law provisions applicable to LLCs though the new law also includes provisions applicable to the other commonly used corporate type, joint stock companies.

NEW CAPITALIZATION REQUIREMENTS

A. Five-Year Capital Injection Requirement
The 2013 amendments of the Company Law eliminated requirements on the capital contribution timeline, minimum registered capital and percentage of initial capital contribution. There were concerns that many shareholders have set an unreasonably large amount of registered capital and an overly long period of capital contribution which may confuse creditors about the financial capabilities of the company.

To address this issue, the 2024 Company Law (Art. 47) provides a five-year maximum capital contribution time limit that applies to all LLCs, aiming to enforce actual capital contributions and to protect the interests of creditors.

New Companies to be Established on and after July 1, 2024 (New Companies)
The shareholders of a New Company are required to inject their subscribed registered capital within five years from the date of establishment of the company.

Existing Companies Established before the Implementation of 2024 Company Law (before July 1, 2024) (Existing Companies)

• The 2024 Company Law (Art. 266) generally requires that Existing Companies should gradually adjust their capital contribution timeline to comply with the five-year requirement.
• According to the Draft Regulations on the Implementation of the Registered Capital Registration Management System of the Company Law (Draft Regulations) issued on February 6, 2024, by the State Administration for Market Regulation (SAMR, the national level company registration authority of the PRC), a three-year transition period would be set up for Existing Companies, which period will start from July 1, 2024, and end on June 30, 2027. An existing LLC (including FIE) must adjust its capital contribution timeline to no more than five years during the transition period if its original capital contribution timeline exceeds five years after June 30, 2027. This means that if the Draft Regulations are to be formally adopted, the registered capital of all Existing Companies (with an exception discussed below) must be fully contributed to and completed no later than June 30, 2032, to meet the five-year capitalization requirements.
• The 2024 Company Law grants the company registration authorities (i.e., the SAMR and/or its local counterparts) the power to require the shareholders to make timely contributions in accordance with the law if the authority believes that the company has an obviously abnormal capital contribution timeline and/or amount of registered capital. According to the Draft Regulations, an Existing Company whose capital contribution timeline exceeds 30 years and/or whose registered capital is set at the amount of more than RMB1 billion may be reviewed and determined by the company registration authorities as a company with an “abnormal capital contribution.”
• Exception: according to the Draft Regulations, companies established before the implementation of the 2024 Company Law (July 1, 2024) that undertake major national strategic tasks, or are related to the national economy and people's livelihood or designed for national security or major public interests (including private, foreign-invested, state-funded and other types of companies), with the approval of the competent department of the State Council or the people's government at the provincial level, capital contributions can be made according to the original contribution timeline determined in the company’s articles of association despite the above five-year limit of the contribution requirements.

B. Other New Provisions Against Outstanding Capital Contribution
The 2024 Company Law also adopts several new rules against outstanding capital contribution to e the acceleration of capital contribution obligations can only be triggered under limited circumstances (such as bankruptcy procedure, dissolution of a company, etc.). The purpose of this acceleration right for the company and creditors is to expand the scope of application of the rules on acceleration of capital contribution obligations and protect the rights and interests of creditors.

Acceleration of Capital Contribution Obligations
The 2024 Company Law (Art. 54) provides a company and its creditors with the right to accelerate the shareholders’ obligation to make the capital contribution if the company is unable to pay off its debts when they are due. Before the 2024 Company Law, the acceleration of capital contribution obligations can only be triggered under limited circumstances (such as bankruptcy procedure, dissolution of a company, etc.). The purpose of this acceleration right for the company and creditors is to expand the scope of application of the rules on acceleration of capital contribution obligations and protect the rights and interests of creditors.

Shareholders’ Joint Liability for Outstanding Capital Contribution
The 2024 Company Law (Art. 50) adds a new provision that if any shareholder fails to make actual capital contributions according to the provisions of the articles of association, or the actual value of non-monetary property for actual capital contributions is obviously lower than the amount of capital contributions subscribed by the shareholder at the time of establishment of an LLC, other shareholders at the time of the establishment shall bear joint and several liability with the shareholder to the extent of the outstanding amount of capital contributions.

Directors’ Fiduciary Duty on Verifying and Demanding Capital Contribution
The 2024 Company Law (Art. 51) sets obligations on the board of directors of a company to 1) verify the capital contributions of the shareholders and 2) demand that the shareholders make any capital contribution that is due. If the board of directors fails to meet these obligations and causes losses to the company, the responsible directors will be liable to compensate the company.

Forfeiture of Equity Interest
If a shareholder fails to make capital contributions on the date of capital contribution provided in the company’s articles of association, the shareholder will have a minimum 60-day grace period to fulfill its capital contribution obligations. If the shareholder fails to fulfill the obligations within the grace period, the company may, by resolution of the board of directors, forfeit the shareholder’s equity interests corresponding to the outstanding capital contribution. The forfeited equity interests will be either transferred or cancelled by means of reduction of registered capital. If the forfeited equity interests are not transferred or cancelled within six months, the other shareholders of the company will be responsible for making up for the outstanding capital contribution based on their respective equity ratio.

C. Capital Reduction
It is expected that a company which currently has an excessively large amount of registered capital pending actual and full injection by the shareholders may choose to reduce its registered capital to avoid a significant amount of paid-in capital by its shareholder(s) within five years of the implementation of the 2024 Company Law or a shorter term stipulated in the articles of association.

Proportion Reduction Required Unless Otherwise Agreed by Shareholders or by Law
The 2024 Company Law requires that if a company conducts a capital reduction, it must notify its creditors within 10 days from the date of the resolution of the shareholders' meeting to reduce the registered capital and make an announcement in the newspaper or the National Enterprise Credit Information Publicity System within 30 days. All the shareholders must reduce their capital contributions in proportion to their respective capital contribution ratios in the company, unless otherwise directed in other applicable laws or agreed to by all the shareholders of an LLC (Art. 224). This provides a legal basis for all shareholders of an LLC to agree to an arrangement where capital reduction can be conducted disproportionately among the shareholders.

Special Requirement on Capital Reduction for Making Up Losses
A company must use its reserved funds (statutory reserve (10% of each year’s after-tax profit), discretionary reserve (if any), and capital reserve (if any)) to make up for its losses (Art. 214). Where the accumulative amount of the company's statutory reserve is not enough to make up for the losses of the previous year, the current year's profits must first be used to make up for the losses before the statutory reserve is accrued (Art. 210). If a company still has losses after exhausting the above methods of making up for its losses (e.g., from its reserved funds and profits), the 2024 Company Law allows the company to reduce its registered capital to make up for the remaining losses (Art. 225). Under this type of capital reduction, the company is not required to notify its creditors but must issue an announcement in a newspaper or the National Enterprise Credit Information Publicity System. Also, after a company reduces its registered capital to make up for its losses, it must not distribute profits until the accumulated amount of statutory reserve and discretionary reserve reaches 50% of the company's registered capital.

According to the Draft Regulations, if an Existing Company (incorporated before July 1, 2024) applies, during the transition period (from July 1, 2024, to June 30, 2027), for a reduction of subscribed registered capital (without reducing the actual paid-in capital), the Existing Company can make an announcement to the public for the capital reduction on the National Enterprise Credit Information Publicity System for 20 days to achieve the capital reduction provided that 1) it does not have unsettled debts or the unpaid debt amount is notably smaller than the actual paid-in registered capital of the company; 2) all the shareholders make a written commitment that they will be jointly and severally responsible for the pre-reduction debts of the company to the extent of their originally subscribed amount of registered capital; and 3) all the directors undertake not to impair the company’s ability to pay its debts and continue to operate.

KEY UPDATES TO CORPORATE GOVERNANCE STRUCTURE

The 2024 Company Law introduces the following changes that may affect the corporate governance structure of Existing Companies (including FIEs).

A. Legal Representative
Every Chinese company (whether domestic or FIE) must have a legal representative who has the statutory power to represent the company. The current company law allows the chairman, executive director (if there is no board of directors) or general manager of a company to act as the company’s legal representative, regardless of whether the person is managing or executing the company’s business operations.

In addition to the above personnel, the 2024 Company Law further allows the legal representative to be a director or executive manager who actually conducts the company’s business operations (Art. 10). The resignation of a director or manager who serves as the legal representative will be deemed to be a simultaneous resignation from the position of legal representative. If the legal representative resigns, the company must choose a new legal representative within 30 days from the current legal representative’s date of resignation.

If the legal representative causes damage to a third party due to the performance of their duties, the company will bear the relevant civil liabilities. After the company assumes its civil liabilities, it may require the at-fault legal representative to indemnify the company.

B. Employee Representative on Board of Directors/Supervisors
The current Company Law only requires state-owned companies to have employee representatives on the board of directors.

The 2024 Company Law extends this employee representative rule to a non-state-owned company with no less than 300 employees (including both LLCs and joint stock limited companies) (Art. 64). Specifically, a company with no less than 300 employees must have at least one employee representative on the board of directors, unless the company has a board of supervisors with employee representative(s) on the board of supervisors. The employee representative must be elected by the company’s employees through the employees’ congress or meetings.

C. Board of Supervisors vs. Audit Committee
The 2024 Company Law introduces a new mechanism that allows an LLC to set up an audit committee under the board of directors that is composed of directors to exercise the powers of the board of supervisors (Art. 69) under which circumstance the company does not need to have a board of supervisors. However, for companies (including FIEs) with 300 or more employees, if it chooses to set up an audit committee under the board of directors in lieu of the board of supervisors, it must include employee representative(s) on the board of directors.

The 2024 Company Law also allows an LLC with a small scale or a small number of shareholders to eschew a board of supervisors and elect one supervisor who will exercise the powers of the board of supervisors. In addition, with the unanimous consent of all shareholders, the company may choose not to have a supervisor.

Another practical issue for existing FIEs, in particular those Sino-foreign joint ventures with only two supervisors (where each of the Chinese and foreign parties appoints one supervisor), is whether such an FIE will be required to either have one supervisor or establish a board of supervisors with at least three supervisors, with the third supervisor being appointed by the employees.

D. Updates to the Statutory Authorities of the Board of Shareholders/Directors and Management

Shareholders

• The board of shareholders remains the highest authority within a company, but the 2024 Company Law has streamlined its duties and powers.
• The powers of 1) “determining the operational guidelines and investment plans of the company” and 2) “reviewing and approving the company’s annual financial budgets and final accounts” are removed from the statutory authorities of the board of shareholders (Art. 59).
• For companies that only have one shareholder (such as a wholly foreign-owned enterprise), the shareholder can decide on matters that would otherwise have required the board of shareholders to decide, provided that the shareholder’s decision is made in writing, signed or stamped by the shareholder and deposited with the company (Art. 60).
• Except for the amendments to the articles of association, increase or decrease of registered capital and merger, split, dissolution or change of corporate form, which must be approved by shareholders representing at least two-thirds of those with voting rights, other matters shall be passed by the shareholders representing more than half of those with voting rights (Art. 66).

Directors

• The powers of the board of directors are largely unchanged except that, in line with the changes to the powers of the board of shareholders, under the 2024 Company Law, the board of directors does not have “to formulate the company’s annual financial budget plan and final accounts plan,” though it retains the power to “determine the company’s operating plans and investment proposals.”
• In addition to other powers provided in the articles of association, the board of directors can exercise powers authorized by the board of shareholders, such as the issuance of corporate bonds (Art. 67).
• Meetings of the board of directors can only be held if more than half of the directors are present. Resolutions made by the board of directors must be approved by more than half of all the directors (Art. 73).
• The board of directors must comprise at least three directors, and there is no upper limit (Art. 68). If a company is a small-scale company or the number of its shareholders is limited, it can have only one executive director (Art. 75).

Senior Management
The 2024 Company Law deleted all of the general and deputy managers’ statutory authorities under the current company law and provides that the managers should perform their duties in accordance with the company’s articles of association or with authorization from the board of directors.

OTHER NOTABLE AMENDMENTS

A. Clarity to Facilitate Equity Transfer
Under the 2024 Company Law (Art. 84), consent by at least half of the other shareholders (required by the current Company Law) is no longer required, but the transferor is required to provide notification of the proposed transfer to the other shareholders. Also, the 2024 Company Law clarifies that the transferor should notify the other shareholders of at least the amount, price, payment method and schedule of the proposed equity transfer, and other shareholders will have the right of first refusal under these same conditions. If a shareholder fails to respond within 30 days from the date of receipt of the written notification from the transferor, it will be deemed to have waived the right of first refusal.

B. Shareholder’s Audit Right
The 2024 Company Law expands the scope of a shareholder’s audit right (Art. 57) whereby the shareholders are entitled to, by itself or through an accounting firm, law firm or other intermediate firm, request and copy the articles of association, shareholders’ register and minutes of shareholder meetings, board of directors or board of supervisors resolutions of meetings, and a company’s financial and accounting reports. The shareholders are also entitled to request to review and copy the company’s accounting books and vouchers subject to issuing a written notice to the company regarding the purpose of the review. If the company refuses to provide access, the shareholder may bring a lawsuit against the company to a people's court. These changes aim to further protect the investment rights and interests of the shareholders, especially minority and small shareholders.

C. Fiduciary Duties and Personal Liabilities of Directors, Supervisors, Senior Management and Controlling Shareholders
The 2024 Company Law strengthens the fiduciary duties and personal liabilities of directors, supervisors, senior management and the actual controller of the company:

• Directors, supervisors and senior management personnel should take measures to avoid conflicts between their own interests and those of the company, and they should not use their authority to seek improper benefits. They should perform duties in the best interests of the company with a reasonable level of care normally expected of management personnel (Art. 180).
• If a shareholder withdraws its capital contribution and causes losses to the company, the responsible directors, supervisors and senior management personnel will be jointly and severally liable with the shareholder (Art. 53). The personnel who are directly responsible for the withdrawal will be subject to a fine of not less than RMB 30,000 but not more than RMB 300,000 (Art. 253).
• Where any director, supervisor or senior executive (or respective close relatives thereof, or companies directly or indirectly controlled by them) directly or indirectly concludes a contract or conducts a transaction with the company, they must report the matters relating to the conclusion of the contract or transaction to the board of directors or board of shareholders, which will be subject to the resolution of the board of directors or shareholders' meeting according to the articles of association.
• Where a company dissolves, the directors are responsible for the dissolution of the company and must form a liquidation group to carry out liquidation within 15 days from the date of occurrence of the triggering event for dissolution. The liquidation group will be composed of directors, unless otherwise provided in the company’s articles of association or determined by the board of shareholders. If the directors fail to perform liquidation obligations in a timely manner and cause losses to the company or its creditors, the directors will be liable for compensation (Art.232).
• The controlling shareholders and actual controllers of the company who do not serve as directors of the company but who actually execute the affairs of the company also owe duties of loyalty and diligence to the company (Art. 180).
• The controlling shareholders and actual controllers of the company who instruct the directors and senior management of the company to engage in acts detrimental to the interests of the company or its shareholders will be jointly and severally liable for the damages and losses of the company (Art. 192).

Our Observations
As summarized above, the main objectives of the 2024 Company Law are to improve capital adequacy of companies, protect the interests of companies and creditors, optimize corporate governance structures, and clarify guidelines for equity transfer. Multinational companies with operations and subsidiaries in China should seek the advice of counsel to ensure their new and existing China subsidiaries comply with the 2024 Company Law and any implementing rules/regulations on a continuing basis.

Foreign investors with FIEs in China need to review existing articles of association, shareholder/joint venture agreements and other corporate documents of the FIEs, engage in discussions with the other shareholders (if applicable) and determine whether and how to make amendments to existing corporate documents. Key areas to review and consider may include the following issues:

• The necessity and possibility of adjusting the capital contribution timeline and/or reducing registered capital;
• Whether the company will set up an audit committee under the board of directors in lieu of or in addition to the board of supervisors;
• Since there is no statutory definition of what constitutes “a small scale” and “a small number of shareholders,” whether to consult with a local company registration authority on a case-by-case basis as to whether it meets the “small scale” threshold so that it is allowed to have one supervisor in lieu of a board of supervisors or have no supervisor, if all shareholders agree;
• Whether the company will have one supervisor or establish a board of supervisors with at least three supervisors (for a company currently with two supervisors);
• If the company have more than 300 employees, whether an employee representative will be involved in the board of directors or supervisors; and
• The scope of authority for each of the board of shareholders, board of directors and senior management.

Since many of these potential changes may have a substantial impact on the operation, corporate governance and commercial arrangements of the FIEs, we suggest that foreign investors should review and assess whether any mandatory and desirable changes should be made based on the 2024 Company Law and engage in discussions with their joint venture partners or be prepared to implement such changes for their wholly owned subsidiaries as early as possible.