The Chinese legislature adopted at its seventh session the latest amendment to the Company Law, which will come into effect on July 1, 2024, and introduces sweeping changes to company capital rules, corporate governance structures, liquidation procedures, and shareholder rights, among others.
On December 29, 2023, the Standing Committee of the National People’s Congress (NPC) adopted an amendment to the China Company Law. The final version of the 2023 Company Law follows many years of draft amendments and deliberations.
The draft amendment was reviewed three times, beginning in 2021, and solicited for public opinion.
The new version of the Company Law will affect companies in China – both old and new – providing more flexibility in areas such as share issuance and corporate structure while strengthening the protection of shareholder rights.
Similarly, the new Company Law will have a substantial impact on the compliance obligations and risks associated with the performance of the duties of directors, supervisors, and senior management in key positions (DSMs).
The new Company Law improves several areas of corporate governance, including the capital contribution system, shareholder rights, and corporate registration and liquidation systems, among many other areas.
The amendments also make important changes that bring the Company Law in line with corporate disclosure requirements introduced in recent years through the corporate social credit system.
Foreign investors and companies are strongly advised to familiarize themselves with the amended China Company Law to assess the possible impact on their investments.
Compliance obligations for DSMs
Compared to the current version, the New Company Law imposes clearer and greater compliance obligations on DSMs.
Among the most important changes are:
The New Company Law provides clarification on the guidelines and standards for performing the “duty of loyalty” and the “duty of diligence” of DSMs; includes that supervisors are to be regulated by the rules governing related party transactions and non-competition; and includes the following persons/entities to be regulated by the rules governing related party transactions: (a) DSMs’ close family members, (b) the entities directly or indirectly controlled by DSMs or their close family members; and (c) persons who are considered to be related parties of DSMs;
If directors or senior management personnel cause losses to a third party during the performance of their duties, the company shall be liable for such losses, while the director or senior management personnel concerned shall also be liable for compensation, provided that the losses are caused by the director’s or senior management personnel’s willful misconduct or gross negligence;
Directors and senior management personnel are obligated to exercise independent judgment and ensure compliance with the applicable laws and regulations in performing their duties, and shall assume joint and several liability if they are instructed by the controlling shareholder or actual controller to engage in any act that violates the law and is detrimental to the interests of the company or its shareholders;
DSMs are obligated to protect and preserve a company’s capital. Failure to do so can result in joint and several liability or compensation liability; and
Directors are responsible for a company’s liquidation. Failure to do so can result in the director’s liability for compensation.
Compliance Obligations and Risks
The new Company Law establishes clearer standards and guidelines regarding the duties of loyalty and diligence of DSMs. It states that DSMs shall take measures to avoid any conflict of personal interest with the interest of the company and shall not exploit their position or authority.
With respect to the “duty of diligence”, DSMs shall exercise reasonable care in the performance of their duties as an ordinarily prudent officer would take to make sure that they act in the best interest of the company.
The new version expands the scope of the regulation on related party transactions. If a DSM enters into any contract or transaction, they must report it to the board of directors or shareholders for review and approval.
This provision applies to contracts with a company to which any close family member, any entity directly or indirectly controlled by a DSM or any related person that is affiliated to a DSM.
The new law expands the non-competition restriction as well. A DSM shall not engage in any business similar to that of a company they hold office, unless or until they report the conduct of the business to the board of directors and obtain approval.
Liability for losses
While maintaining the provision of the old Company Law regarding liability of losses suffered as a result of a DSM performance, the new version introduces new obligations for directors and senior personnel to bear the compensation liability for losses caused to third parties in the performance of their duties or gross negligence.
Obligation to preserve company’s capital
After the establishment of a company, the directors shall be responsible for verifying the shareholder’s capital contributions and urge the payment of outstanding contributions, the failure of which will result in the director’s liability for compensation.
Any DSM responsible for withdrawing contributed capital shall bear liability for compensation with the concerned shareholder, which imposes greater obligations on DSMs to protect a company’s capital.
The new version introduces a provision that in the event that a company provides financial assistance for a third party to acquire shares in violation of this law and thereby suffers losses, the DSMs responsible will bear the liability for compensation.
In the event that a company makes profit distribution to shareholders in violation of this law and thereby suffers losses, the DSMs responsible shall bear the liability for compensation.
And in the event that the registered capital is reduced in violation of this law resulting in losses for the company, the DSMs responsible shall bear the liability for compensation.
Obligation of liquidation
The new law states that the directors are the obligors in a company’s liquidation and imposes greater responsibility on them. This aligns with the civil code and further specifies that directors shall compensate for losses caused by their failure to fulfill the obligation of liquidation in a timely manner.
According to the new Company Law, DSMs must perform their duties in compliance with the laws and regulations. However, some provisions regarding the obligations of DSMs require further clarification.
In the event of the illegal withdrawal of contributed capital by a shareholder, unlawful profit distribution or unlawful capital reduction, it is not clear when are DSMs considered “responsible” and are therefore required to compensate for losses.
Judicial interpretations are expected to address these issues in the light of the implementation and application of the New Company Law.
DSMs should ensure compliance in the performance of their duties and minimize the potential liabilities and risks that both companies and DSMs may be exposed to due to non-compliance with the New Company Law.
It is recommended to request legal guidance to fully understand the detailed requirements for compliance obligations and the legal consequences of any violations under the new Company Law.
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