Equity transfers under revised company law

The much anticipated Company Law of China (Third Draft for Revision) was reviewed by the Standing Committee of the National People’s Congress and opened for public comment on 1 September 2023.

This article focuses on the revision of equity transfer rules in the third draft compared to the existing Company Law, based on current judicial practice and results of equity transfer disputes.

Shareholders’ liability

Article 88 of the third draft, based on article 18 of Judicial Interpretation No.3 of the Company Law, makes clear provisions on shareholders’ liability for transfers of equity before contribution deadlines and transfers of defective contributions.

The current Company Law and its judicial interpretations do not clarify shareholders’ liability for equity transfers before contribution deadlines. Courts around China have not reached a consistent result on this issue.

Some have concluded that a transferring shareholder should not be held liable for the contribution, while some decided that the transferor and the transferee are jointly liable for the contribution.

Courts ruling on joint liability usually refer to provisions of Judicial Interpretation No.3 of the Company Law on transfers of defective contributions.

However, defective capital contributions usually refer to specific acts such as malicious contribution, malicious withdrawal of contribution, uncompleted contribution and deferred contribution. These specific acts are significantly different from the equity before contribution deadlines that enjoy interest within the period but which is not yet contributed.

The third draft makes a clear distinction regarding shareholders’ liability between transfers of equity before contribution deadlines and defective contributions, and establishes two completely different sets of equity transfer rules. It avoids confusing application of civil and commercial law mindsets due to errors in the basis of claims.

The third draft specifies that in the case of equity transfer before contribution deadlines, the contribution liability shall be borne by the transferee, and the transferor shall bear supplementary liability to the extent of the transferee’s insufficient contribution.

This amendment unifies the adjudication standards of courts nationwide, improves the corporate equity transfer system, and provides reasonable expectations for parties involved in equity transfer before contribution deadlines.

The third draft delivers a heavy blow to acts of evading capital contribution liabilities and corporate debts through equity transfers, reflecting the value proposition of protecting transaction security and stabilising corporate governance structure. This move is in line with China’s financial and economic policies in recent years that prioritise financial and economic stability.

Transfer to third parties

Under the existing Company Law, the consent of other shareholders is required for the equity transfer of a limited liability company to a third party.

Referring to article 18 of Judicial Interpretation No.4 of the Company Law on equity transfer of a limited liability company under the same conditions, the third draft changes the provision that equity transfers of a limited liability company shall be subject to the consent of other shareholders to the obligation of the transferor to notify other shareholders in writing.

The written notice shall set out the transfer quantity, price, payment method and period, and safeguard other shareholders’ priority to purchase the shares.

In judicial practice, some companies impose disguised restrictions or prohibitions on the rights of shareholders, especially small and medium ones, to freely transfer their shares by free agreement in articles of association.

The third draft deletes the clause that equity transfer to a third party requires the consent of other shareholders, aiming at fixing the loophole in judicial practice, allowing free equity transfer of limited liability companies to safeguard their capital-joining nature and reserving a pathway for small and medium shareholders to withdraw through equity transfer. This is of practical significance in activating market economic activities and distinctly embodies the legislative idea to resolve existing problems in the trial.

Equity changes in effect

The third draft stipulates the procedures and effective time of equity changes, clarifies the obligation of the transferor shareholder to notify other shareholders and the right to request the company to change equity registration, and grants the transferor and transferee the right to seek judicial remedies.

Based on the provisions of article 32 of the current Company Law on the list of shareholders, the third draft specifies that the effective time of equity change shall be the time when the shareholders are registered in the list.

Existing judicial practice treats the change in equity ownership as a special kind of sale, applying the rules for sale contracts of movable assets in the Civil Code. Applying a civil law mindset to resolve equity issues in commercial law has resulted in conflicting opinions on the time point for shareholders to acquire equity, and has led to an increase in equity transfer costs due to ambiguous equity ownership.

The third draft introduces the theory of corporate intervention to clarify the importance of the company in equity transfers and, on this basis, clarifies that the time point at which a shareholder acquires the equity is the time when his or her name is recorded in the shareholders’ list. This amendment aims to stabilise the corporate governance structure, which conforms to the human-joining nature of corporations and is a must to maintain market stability.

Jenny Gu is a senior partner at Brightstone Lawyers. She can be reached by phone at +86 189 3064 1138 and by e-mail at jiani.gu@brightstonelawyers.com