What new Company Law means for foreign investment in China

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On 29 December 2023, the Standing Committee of the National People’s Congress of China promulgated the amended Company Law, after its deliberation of four versions of draft amendments in the past three years. The new Company Law will come into force on 1 July 2024.

The new Company Law not only governs new companies established after its effective date, but also has significant implications on existing companies. Yet, the implementation of many articles is still subject to further interpretation and/or guidance from the Chinese authorities and courts.

Therefore, companies, investors and other stakeholders should pay close attention to this new legislation and the pertinent regulations, judicial interpretations and other official guidelines that may be issued concerning its implementation in the near future.

Amendment highlights

In terms of capitalisation requirements, the new Company Law:

  • Requires shareholders of a limited liability company (LLC) to make full capital contribution within five years of the establishment of the company;
  • Allocates liabilities between transferor and transferee in case of an equity transfer in an LLC with an unpaid capital contribution;
  • Includes a new expedited capital reduction process;
  • Allows a joint stock company (JSC) to issue different classes of shares and authorise its board of directors to issue new shares;
  • Allows a JSC to issue shares without par value; and
  • Expressly allows additional forms of capital contribution.

In terms of streamlined and alternative corporate governance structure, the new Company Law:

  • Expands the scenarios allowing appointment of a director/supervisor in lieu of a board of directors/board of supervisors;
  • Introduces an audit committee under the board of directors in lieu of supervisors;
  • Emphasises employee representation on the board of directors; and
  • Stipulates quorum of a board meeting and voting rights required for a board resolution of an LLC.

In terms of the liabilities of controlling shareholders, actual shareholders, directors, supervisors and senior management, the new Company Law:

  • Defines duty of loyalty and duty of care;
  • Further regulates connected transactions, seeking business opportunities of the company and engaging in business similar to the company;
  • Holds directors and senior management liable toward third parties in the case of gross negligence or intentional acts; and
  • Imposes liabilities on “de facto directors” and “shadow directors”.

In terms of shareholders’ rights and protectors, the new Company Law:

  • Enhances shareholders’ information rights to review accounting documents of the company and its wholly owned subsidiaries; and
  • Improves other shareholders’ rights.

In terms of streamlined policies for company setup and closure and other amendments, the new Company Law:

  • Introduces a new chapter on company registration;
  • Simplifies the rules on companies with only one shareholder;
  • Improves the company liquidation rules;
  • Introduces simplified company deregistration and mandatory company deregistration mechanisms; and
  • Emphasises the governance roles of party organisations within state-invested companies.

Takeaways and advice

It is advisable for companies and their investors to revisit the companies’ governance structure and assess: (1) if any mandatory adjustment is required in view of the new company law requirements (e.g. number of supervisors or alternatives, applicability of mandatory employee representation, board meeting quorum and resolution); and (2) if the governance structure can be improved (and if a streamlined governance structure would be preferable) in view of the greater flexibility introduced by the new Company Law and based on specific needs of the companies.

Considering the increasing exposure to personal liabilities of directors, supervisors and senior management, companies may consider including indemnification clauses in the articles of association (or enter into separate indemnification agreements with those individuals), and/or purchasing (director) liability insurance to give more protection to directors et al, acting in good faith and with due care.

That said, whether local company registration authorities will accept filing of amended articles of association with such special clauses (including indemnification clauses) is to be tested in practice.

While the new Company Law will not take effect until 1 July 2024, it is advisable for foreign investors to keep abreast of the new and upcoming regulations, rules, guidelines and policies relating to capital contribution for establishing new companies in China or for injecting additional capital into existing invested entities in China. This will help avoid the risk of being challenged by company registration authorities to amend the articles of association shortly after a company’s establishment.

If investors intend to set up an LLC ultimately with a significant amount of registered capital, they may consider not committing a significant initial amount (but only a reasonable amount that is sufficient for early-stage operations of the company) and then inject additional capital in phases to the company as needed, within the five-year statutory time limit.

Furthermore, in light of the statutory liabilities of a transferor and a transferee with respect to unpaid capital contribution, in the event of an equity transfer, the transferee is advised to conduct thorough due diligence on the status of capital contribution of the target company and include appropriate representations and warranties in the transaction documents to seek protections.

If the transferee is aware of the transferor’s failure to make timely capital contribution, it should request a closing condition that the transferor’s subscribed capital has been fully contributed and/or seek other contractual protection between the transaction parties, although the transferee may still be held liable for the unpaid amount on a joint and several basis.

From the transferor’s perspective, a specific indemnity can be included in the transaction documents to expressly specify that the transferee agrees to make the remaining capital contribution when due after closing, as the outstanding capital contribution should normally have already been taken into account by the parties in negotiating the purchase price.

If the transferor were made liable for making any contribution under the new Company Law after closing, then the transferee shall indemnify the transferor for such contribution and any other losses incurred by the transferor.

LLCs have previously been heavily favoured by foreign investors, but the alternative type of corporation (i.e. JSCs) may be considered by investors in light of the greater flexibility given to JSCs in issuing different types and classes of shares in the new Company Law.

Business Law Digest is compiled with the assistance of Baker McKenzie. Readers should not act on this information without seeking professional legal advice.
You can contact Baker McKenzie by e-mailing Howard Wu (Shanghai) at howard.wu@bakermckenzie.com

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