Changes to New Company Law in China will reshape business environment

With a remarkable degree of revisions, the recently approved China Company Law will introduce a broad spectrum of changes comprising shareholder capital contribution, shareholders' rights protection, company capital system, corporate governance, company registration, company financing, and management responsibilities, among other.  

Last December, China's president Xi Jinping signed into law the newly revised Company Law, which will come into effect July 1, 2024. The legislation will have a significant impact on the business community, both local and foreign. 

China’s adoption of the New Company Law comes at a time when the international market environment is changing fast and becoming more competitive. China has continued its process of promoting reform and opening to foreign and domestic investments. 

Shareholders' capital contribution 

The new Company Law introduces provisions specifying deadlines for limited liability company

(LLC) shareholders to fully pay subscribed capital within five years from the company's establishment date. Founding shareholders of a joint-stock company must fully pay the capital upon its establishment.  

For existing LLCs who do not comply with the new 5-year requirement, the new Company Law demands that such companies gradually adjust their capital contribution schedule to comply. 

The law does not clarify if there will be a special grace period for existing companies, or if the 5-year maximum time limit for existing companies will start from the effective date of the New Company Law. This remains to be clarified in the implementation rules to be released by the State Council. 

This change has been introduced to tackle issues with shareholders oversubscribing capital at the initial stage, as well as very long payment terms, which has sometimes resulted in the subscribed capital never being paid in full. 

The new legislation creates a shareholder disqualification system for LLCs. If a shareholder fails to pay the contribution in full and on time, the company issues a written payment demand with a grace period of no less than sixty days.  

If, by the end of this period, the shareholder fails to fulfill the contribution obligation, the company, through a board resolution, can issue a disqualification notice. From the notice date, the shareholder loses rights to the unpaid contributions. 

A new provision introduces the accelerated maturity of an LLC’s shareholder contribution obligations if the company is unable to pay off its debts when they are due. Under such circumstances, the company or the creditor will be entitled to demand the shareholders’ immediate payment of the outstanding capital prior to scheduled contributions provided under the articles of association of the company. 

Legal responsibilities 

According to the new Company Law, when an LLC is established, if a shareholder fails to make full payment, other shareholders at the time will be jointly liable within the scope of the insufficient contribution.  

Supplementary liability is imposed on the former shareholder who has transferred shares to a buyer that later fails to make a full capital contribution to those shares. Joint liabilities are also applicable to the purchasing shareholder who bought shares from a former shareholder that failed to make a sufficient capital contribution on time. 

There are a few unclear aspects of the new law, in particular regarding how existing companies should transition for full compliance. Foreign-invested enterprises (FIEs) with unpaid registered capital should assess the remaining contribution amount and adjust the timing accordingly.  

It is important to observe future decisions from regulatory authorities and formulate appropriate strategies. For enterprises established after the new law's effective date, investors should consider contribution deadline requirements aligned with initial business development plans, establishing a reasonable initial registered capital to mitigate risks of inability to fulfill contribution obligations. Ultimately, resolutions can be sought through subsequent capital increases. 

Company officers’ responsibilities 

According to the Company Law, the company officers are director, senior executives, and supervisors. Foreign investors have always had special interest in their personal liability. 

In general, the personal liability of officers includes:  

• civil liability arising from breaches of fiduciary duties and unauthorized representation;   

• administrative penalties and even criminal liability for directors and executives who hold relevant positions in the company or serve as key responsible persons in areas where the company violates compliance obligations;  

• directors participating in or driving decisions related to the company's criminal or irregular activities may be deemed to play a certain role in the "decision, approval, or instigation" of the company's actions and may be required to assume personal responsibility. 
  

The new legislation highlights the fiduciary and diligent duties of directors, supervisors, and senior management, adding administrative penalties beyond civil compensation. 

Fiduciary duty requires directors, supervisors, and senior executives to avoid conflicts of interest with the company and not use their power to seek undue benefits. Diligent duty requires them to perform their duties for the maximum benefit of the company with the reasonable care that a manager should normally exercise. 

The new law facilitates claims against company officers for alleged breaches of fiduciary duties. It also states that the "Controlling Shareholder" or "Actual Controller", even if not the company's officers, shall be subject to the same fiduciary duties as company officers if they perform corporate duties.  

They shall also be jointly liable with the company's officers who are instructed by such "Controlling Shareholder" or "Actual Controller" and thus harm the company or shareholders' interests. Just by simply not being the documented officers, the direct or indirect controllers of a company may not be safe and free of legal responsibilities. 

Corporate governance - Corporate powers 

The statutory powers of the shareholders' meeting have been reduced, and certain matters previously reserved for the shareholders' meeting can now be decided by the board of directors or management based on the actual situation of the company. 

Beyond the enumerated powers of the board of directors, the shareholders' meeting can explicitly grant additional powers to the board of directors, including authorizing the board of directors to make decisions on "issuing corporate bonds". 

The manager's authority is entirely subject to the company's articles of association and the agreements of the board of directors. 

The new Corporate Law gives companies more operational freedom, allowing them to allocate powers among the shareholders' meeting, board of directors, and managers based on their specific needs. This is particularly beneficial for FIEs, aligning with international

corporate governance practices that focus on the board's role in significant operational and investment decisions. 

Management measures for employees 

Companies must establish a democratic management system, primarily through the employee congress, according to the new law. Unlike the current legislation, which defines appointment requirements based on the background of the investing state-owned assets, the new law specifies that for a limited liability company with more than three hundred employees, except it has set up a supervisory board with at least one sitting employee supervisor, it must include at least one employee director into its board. 

Even for non-state-owned, foreign wholly owned enterprises or limited liability companies formed as joint ventures, if they meet the mentioned employee threshold, they may need to appoint employee directors. Such requirements may have a potential impact on the structure of board seats, and arrangements should be made in advance. 

Supervisory board or supervisors 

Smaller limited liability companies and joint-stock companies may now choose not to have a supervisory board, appoint one supervisor, or not have supervisors at all.  

Under the new law, a limited liability company can establish an audit committee composed of directors to exercise the powers of the supervisory board, without having a supervisory board or supervisors. 

Smaller LLCs or with fewer shareholders may not need to have a supervisory board and can appoint one supervisor to exercise the powers of the supervisory board; with unanimous agreement of all shareholders, they can also choose not to have supervisors. 

Companies will be able to adapt their governance structures to their specific needs, giving them more freedom and flexibility. 

The changes introduced by the revised legislation will reshape the business environment in China, providing opportunities for improved governance and transparency. 

Foreign companies operating in China should seek professional counsel and carefully consider the changes, as they navigate this new legal landscape.  

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Woodburn Accountants & Advisors is one of China’s most trusted business setup advisory firms.

Woodburn Accountants & Advisors is specialized in inbound investment to China and Hong Kong. We focus on eliminating the complexities of corporate services and compliance administration. We help clients with services ranging from trademark registration and company incorporation to the full outsourcing solution for accounting, tax, and human resource services. Our advisory services can be tailor-made based on the companies’ objectives, goals and needs which vary depending on the stage they are at on their journey.

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