On 29 December 2023, China officially adopted the Sixth Amendment to the Company Law of the People’s Republic of China, after four rounds of review and public consultation over the past five years. The amended Company Law (New PRC Company Law) will take effect on 1 July 2024, applying universally to all companies in the PRC.
The new law introduces significant changes in various areas, including capital contributions, corporate governance, shareholder rights, management responsibilities, company formation and deregistration processes, share classes, piercing the corporate veil, share transfers, and corporate bonds. It also expands the responsibilities of the board of directors, imposing additional liabilities on directors, supervisors, and senior management in relation to third-party obligations. Directors, including investor directors appointed by financial investors, must be aware of these changes to safeguard the company’s interests and avoid potential liabilities.
Fiduciary Duty Explained
Under PRC law, fiduciary duty comprises two related concepts: the 'duty of loyalty' and the 'duty of diligence'. The New PRC Company Law reaffirms and expands these duties for company directors, supervisors, and senior management.
Duty of Loyalty: Directors, supervisors, and senior management must prevent conflicts of interest between their personal interests and those of the company. They are prohibited from exploiting their position for personal gain.
Duty of Diligence: These individuals must act in the best interests of the company, applying the reasonable level of care expected of someone in management.
Specific requirements under the duty of loyalty include the obligation to disclose and seek approval from the board of directors or shareholders' meetings for any contemplated contracts or transactions with the company (including those involving close relatives or affiliates) as outlined in the company’s Articles of Association (AOA) (article 182). Directors must also refrain from pursuing business opportunities belonging to the company unless approved by the board or shareholders (article 183), and must avoid engaging in competing businesses unless permitted (article 184). If the board resolves on such matters, the involved directors must abstain from voting, and their votes will be excluded from the count. If fewer than three unrelated directors are present, the issue must be presented to the shareholders’ meeting for decision (article 185).
Additionally, directors must be aware of the 12th Amendment to the Criminal Law of the PRC, enacted on 29 December 2023, which expands certain economic crimes to include directors, supervisors, and senior management of private enterprises. These crimes now encompass engaging in competing businesses, improperly benefiting family members or friends, and selling shares or assets at undervalued prices. Violations of the New PRC Company Law could also lead to criminal liabilities, particularly concerning conflicts of interest.
The amendment also introduces the concept of 'de facto directors' (article 192), meaning that controlling shareholders or actual controllers who influence company affairs without formally being directors are still bound by the duties of loyalty and diligence.
Director’s Responsibility on Capital Contribution and Maintenance
One of the most significant changes in the New PRC Company Law concerns capital contributions. The law now includes a five-year cap on the time allowed for shareholders to fully contribute capital to limited liability companies, ensuring actual capital contributions and protecting the company and its creditors. Directors now have additional responsibilities regarding the inspection and maintenance of capital contributions.
Inspection of Capital Contribution: According to article 51, the board must verify that shareholders have made their capital contributions fully and on time. If any shareholder fails to do so, the board must issue a demand letter for the outstanding contributions. If the company suffers losses due to the board's failure to act, directors will be held liable.
While the law does not specify which director is responsible, it is recommended that each director review the AOA and verify capital contributions using appropriate documentation, such as bank receipts or asset ownership certificates.
Withdrawal of Capital: Under article 53, shareholders are prohibited from withdrawing contributed capital. If they do so, they must return the funds, and the defaulting shareholder, along with any responsible directors, will be jointly and severally liable for any resulting losses.
Identifying illicit capital withdrawals can be challenging, as such actions may be disguised through related-party transactions or improper dividend distributions. Directors should scrutinise any transactions involving payments or distributions to shareholders or their affiliates to ensure compliance with the law.
Dividend Distribution: Article 211 specifies that improper dividend distribution will result in shareholders having to return profits, with directors, supervisors, and senior management potentially held liable for any losses caused.
Directors should ensure that the company follows the correct procedures for dividend distribution, including forming a dividend plan approved by the shareholders. They must also ensure compliance with statutory requirements, such as setting aside statutory reserves and using profits to cover previous losses before declaring dividends.
Reduction of Registered Capital
In accordance with Article 226 of the New PRC Company Law, a company is prohibited from reducing its registered capital in violation of the law. If such a reduction occurs, shareholders must return any funds they have received. Additionally, if the company suffers losses, shareholders, directors, supervisors, and senior management responsible may be held liable for compensation.
Statutory Requirements for Capital Reduction:
Preparation of Financial Statements: Before reducing capital, the company must prepare a balance sheet and an inventory of property.
Notification to Creditors: The company must notify creditors within 10 days of the shareholder resolution approving the reduction and publicly announce the reduction within 30 days through a newspaper or the National Enterprise Credit Information Publicity System (NECIPS).
Creditors' Rights: Creditors may demand the company settle debts or provide guarantees within 30 days of receiving notice, or 45 days from the announcement if no notice is given.
Proportionality: Capital reductions must be proportional to shareholders' capital contributions or shares, unless specified otherwise by law or the company’s Articles of Association.
Restrictions on Capital Return: If the capital is reduced to recover accumulated losses, no shareholder may receive a return of the reduced capital or be exempted from their obligation to pay outstanding capital contributions.
Director's Responsibilities in Liquidation
Directors bear increased responsibilities during a company’s liquidation process under the New PRC Company Law. If directors fail to meet legal requirements, improperly manage the company’s assets, or treat creditors unfairly, they may face personal liabilities.
Key Responsibilities of Directors During Liquidation:
Initiating Liquidation: Directors must propose liquidation proceedings and form a liquidation group within 15 days of the cause for dissolution.
Liquidation Group Responsibilities:
Liquidating the company’s property and preparing balance sheets and inventories.
Notifying creditors within 10 days and publishing a public announcement within 60 days.
Handling unfinished business and liquidating claims and debts.
Settling overdue taxes and taxes incurred during liquidation.
Liquidation Obligors and the Composition of the Liquidation Group:
The New PRC Company Law defines “liquidation obligors,” specifying that all directors are responsible for initiating liquidation proceedings.
Director as Liquidation Obligor: Directors must establish a liquidation group within 15 days of the dissolution cause, with their obligations ending once the liquidation group takes over.
Liabilities for Liquidation Obligors and Group Members: Directors or group members may be held liable if they fail to fulfil their duties, causing losses.
Director's Personal Liability to Third Parties
The New PRC Company Law (Article 191) holds directors and senior executives personally liable for damages caused to third parties in the performance of their duties.
Key Points on Directors' Liability to Third Parties:
The company is responsible for compensation for damages caused by a director or senior executive in the performance of their duties.
Directors and senior managers may be personally liable for compensation if their actions are intentional or grossly negligent.
De Facto Directors: "De facto directors" (such as controlling shareholders who act like directors without being formally appointed) may also be held liable under Article 191.
Practical Recommendations for Investor Directors
Investor directors, who may not be involved in daily operations but are appointed by investors, still face legal duties under the New PRC Company Law.
Duty of Loyalty: Investor directors must act in the company’s best interests, even when this conflicts with their appointing investors’ interests.
Duty of Diligence: Investor directors must actively participate in governance, avoid being a figurehead, and ensure their duties are fulfilled.
Avoiding Conflicts of Interest: Investor directors should declare potential conflicts of interest and recuse themselves from decisions where necessary.
Liability Protection: To limit personal liability, investor directors can seek indemnification through the company’s Articles of Association or an indemnification agreement. Directors' liability insurance (D&O insurance) can also be purchased to protect against third-party claims.
Additional Considerations
Timely Updates: Directors must ensure any changes in directorship are promptly updated in public records (e.g., NECIPS) to avoid being held liable for actions taken after resignation.
Court's View on Public Disclosure: If a director claims resignation but public records are not updated, courts may favour creditors acting in good faith and hold the director accountable.
The New PRC Company Law introduces substantial changes that directors must carefully navigate to avoid personal liability and ensure the company's compliance with the law.
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