China's Revised Company Law Introduces Significant Changes for Foreign Investors
In Short
The Situation: On December 29, 2023, the Standing Committee of the National People's Congress of the People's Republic of China ("PRC" or "China") promulgated the amended Company Law of the PRC ("New Company Law"). The New Company Law took effect on July 1, 2024.
The Details: The edits made under the New Company Law represent the most substantial overhaul of the PRC Company Law since 2005, introducing significant changes in areas such as capital contributions, corporate governance, management responsibilities, shareholder liability, equity transfers, and company registration and deregistration procedures.
Looking Ahead: The New Company Law was introduced in response to China's rapidly changing and competitive international market environment, as well as its ongoing efforts to promote reform and openness to bolster both foreign and domestic investments. We expect an upcoming series of more detailed rules and practice notes to provide further guidance on how the changes will be implemented in practice. Foreign investors should be aware of the changes and keep abreast of implementing regulations and interpretations in order to comply with the new requirements.
This Commentary identifies some of the key changes under the New Company Law to provide high-level guidance to foreign investors with respect to their foreign-invested enterprises ("FIEs") in the PRC.
Capitalization: Under the New Company Law, the registered capital of a limited liability company ("LLC"), as subscribed by its shareholders, must be fully contributed within five years from the date of the company's incorporation. Prior to this change, there was no time limit on the capital contribution schedule, which in some cases resulted in unreasonably high subscribed amounts and very long contribution periods, giving third parties an inflated impression of the scale of such companies.
For LLCs incorporated before June 30, 2024, the deadline for full contribution of capital must be adjusted to be no later than June 30, 2032. To address the historical issue that a significant number of LLCs were established with excessively large subscribed capital, relevant implementation measures under the New Company Law have been promulgated by the PRC State Council permitting eligible LLCs, during the above-mentioned transition period, to apply to reduce their capital 20 days after making an announcement through the National Enterprise Credit Information Publicity System, provided no objections are raised by creditors during the announcement period.
The New Company Law also stipulates that, if an LLC cannot pay its debts whenever due (even before the five-year grace period expires), the creditors can require the shareholders to accelerate their capital contributions to the extent that the LLC is unable to pay off the incurred debts.
Corporate Governance: The New Company Law makes significant adjustments to corporate governance rules. Notably, it provides greater definition with respect to the duty of loyalty and duty of diligence for directors, supervisors, and senior management, including regarding the need for such officeholders to avoid conflicts of interest, and to make a report to the board or shareholders meeting for approval regarding any connected transactions they or their close relatives enter into with the company.
Under the New Company Law, liability is imposed on a controlling shareholder or actual controller who in fact executes the company's affairs (in which case it will also owe directors' duties of loyalty and diligence to the company), or directs the company's officeholders to act in a manner harmful to the company's interests (in which case it shall indemnify the company for any of the incurred losses), akin to the liability of a "de facto director" or "shadow director" in other jurisdictions. The New Company Law also provides for other expanded grounds on which the corporate veil may be pierced to impose liability on a company's shareholders.
The New Company Law stipulates that a company no longer needs to designate a board of supervisors if it has established an audit committee under the board of directors to perform such functions. In addition, an LLC that is small in scale and has only a limited number of shareholders may, if all its shareholders agree, have no supervisors.
Equity Transfer: The New Company Law has streamlined the process to transfer an equity interest in an LLC, by removing the requirement to obtain approval from the majority of the other shareholders. However, it also provides that if a shareholder transfers its equity before it has fully contributed its subscribed capital, the transferor must still contribute any amount of the subscribed capital not subsequently paid in by the transferee first.
Company Registration and Deregistration Procedures: The New Company Law includes a new chapter on company registration, which clarifies the matters and procedures for company establishment, changes, deregistration, and public announcements. In addition, the shareholders may take advantage of a new streamlined company deregistration procedure (without first forming the liquidation committee), provided the shareholders shall undertake the responsibilities of settling all the outstanding debts before the completion of the deregistration procedure.
Interaction with Foreign Investment Law: The Company Law has become the primary governing law for all FIEs since the adoption of the Foreign Investment Law of the PRC ("FIL"), which took effect on January 1, 2020 and abolished the previous laws governing Sino-foreign joint ventures. The FIL requires FIEs to adjust their organizational form, corporate governance structure, and governing documents in accordance with the Company Law and the FIL by January 1, 2025. Consequently, foreign investors should be aware of the provisions of the New Company Law and the FIL, and keep abreast of implementing regulations and interpretations as they are issued.
Four Key Takeaways
- Stakeholders should update the FIEs' articles of association and joint venture contracts/shareholders agreements (as applicable) based on the New Company Law and FIL in the course of 2024.
- Investors should also set a realistic amount for the registered capital of FIEs upon incorporation and for any subsequent capital increases.
- It will also be important to undertake a capital reduction process if any FIE's existing registered capital amounts are excessively high and unlikely to be fully contributed before the mandatory contribution deadline.
- In M&A transactions involving LLCs with unpaid registered capital, stakeholders need to implement appropriate measures to address potential liabilities should the buyer not contribute the outstanding capital.
