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Amendments to the China Company Law seek to optimize corporate governance system

The Chinese government is looking to optimize the way businesses work in China and stimulate market activity through a series of measures, including decentralization and improvement of investors rights. A new round of amendments to the China Company Law seeks to refine special provisions on state-invested enterprises and improve the company establishment and exit system.


The National People’s Congress released in 2022 a second round of draft revisions to the Company Law to solicit opinions from the public until January 28, 2023. This was 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 published in 2021 (first draft amendments).

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Among other things, the second draft amendments aim to optimize corporate structure and corporate governance; optimize the capital structure; tighten the responsibilities of controlling shareholders and management personnel; and strengthen corporate social responsibility.


Foreign invested Enterprises (FIEs) are subject to the Company Law which applies to all companies registered in China, with or without foreign investment, with respect to company formation, corporate governance, fiduciary duties of directors and officers, protection of minority shareholders, share transfer, distribution of profits, liquidation and other elements.


Existing FIEs have five years (until December 31, 2024) to convert to the appropriate corporate form and update their articles of association and shareholders agreements to comply with the Company Law. Newly established FIEs will be formed under the Company Law.


There are a few major proposed changes in the latest draft revisions of the Company Law that will impact business in China.


The second draft improves the registration process and the efficiency of company registration. For example, the draft Amended Company Law would require that company registrars make a single request (instead of repeated and piecemeal requests) during the registration process in case the application documents received are incomplete or contain errors.


It also makes use of informatization through electronic business licenses, a unified enterprise data publication system, and electronic communication. Electronic business licenses have already been implemented in major cities such as Shanghai.


The second draft expands the scope of capital contributions to include equity and creditor’s rights. In the past, shareholders of a company could make capital contributions to the registered capital of such company only in the form of cash, equipment, intellectual property rights, land use rights and other tangible or intangible assets. The draft would allow shareholders to make capital contributions by share swap and debt-equity conversion.


The proposed document improves the liquidation system and provides for a simplified dissolution mechanism upon commitment to the honoring of all debt by all shareholders.


Liquidation of companies in China has been a challenge to many business owners in the past because of the complicated procedures and lengthy process. A liquidation process can take 6-12 months or longer and involve multiple government procedures (including tax clearance, public announcement, filings with industry regulators, courts as well as company registration authorities (i.e., the State Administration for Market Regulation or its local offices).


The second draft would now establish a “simplified liquidation” procedure allowing companies to liquidate and dissolve in a much more efficient manner so long as its shareholders are willing to undertake joint and several liability for unsettled debts after the dissolution and liquidation of a company.


The second draft eases the organizational structure requirements for smaller scale companies, eliminating the requirement to establish a board of directors and board of supervisors. Small and medium-sized companies could choose to have one executive director or manager in lieu of a board of directors.


If this was to be approved as the final draft, then shareholders should ensure that all powers of the board of directors are specifically stated in the articles of association.


Additionally, in the second draft, conditioned on unanimous approval of all shareholders, a small-limited liability company without setting up an audit committee is also permitted to choose not to set up a board of supervisors or supervisor(s) at all.


This rule was based on the theory that in a small-limited liability company, shareholders (or only one shareholder in many cases) are usually actively involved in the day-to-day operation of the firm, and there is no reason to have a supervisor to oversee the directors and protect the interests of the shareholders.


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).


“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,” states article 190.


The “jointly liable” stipulation has been removed, which means that courts will have more discretion to determine where the fault lies, and place the liability, or even partial liability, jointly or individually on the executives or directors.


A new article (Article 192) enables a company to purchase “director’s liability insurance”. If an executive is liable for personal compensation due to work negligence or misconduct, the insurance company will be responsible for the relevant legal litigation expenses incurred by the director when conducting a defense, as well as undertaking other civil liability insurance.


The second draft amendment specifically outlines the functions and powers of the board of directors, such as convening shareholders’ meetings, 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 merger, division, dissolution, or change of company form.


The board can also decide 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.


Regarding the audit committee in a company limited by shares, the second draft hardens the conditions by requiring more than half of its members to be “independent directors” and at least one of them must be an accounting professional. To be eligible to be an independent director, such a person shall not take a position in the company other than the director and shall not hold any relationship that may affect his/her independent and fair judgement.


The second draft requires that in a limited liability company that sets up an audit committee, it shall exercise the powers and responsibilities of board of supervisors.


The current version 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 allows that any director and general manager who exercise matters on behalf of the company could be the company’s legal representative. In the first draft, only chairman of the board, executive director and general manager could be the legal representative.

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In the second draft, a company is allowed to convene a shareholder meeting, board of directors meeting and board of supervisors meeting in electronic communication manner as long as the articles of association permit it.


Electronic communication has been broadly adopted by most companies, especially during the COVID-19 pandemic.


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.


Additionally, the second draft enables limited liability companies to accelerate the maturity of subscribed capital in the event that it is unable to pay off due debts.


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 protect the interests of creditors and improve the security of transactions.


With the proposed amendments to the Company Law, China is looking to optimize its corporate governance system and bring it further in line with the country’s overall economic goals, as well as international standards.


 

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