Impact of the new Company Law on investment disputes

The 14th National People’s Congress Standing Committee passed a revised Company Law, which will come into effect on 1 July 2024. This revision summarises practical experience and theoretical achievements, strengthens the responsibilities of all parties, and effectively safeguards the legitimate rights and interests of companies, shareholders, and creditors.

This article examines the potential impacts of the new Company Law, based on the authors’ extensive experience in resolving investment disputes.

Equity transfers

Unpaid equity: There may be situations in the investment process where an equity transfer occurs without full payment.

The current Company Law lacks clarity on the original shareholders’ capital contribution liability for unpaid equity transfers. Although Judicial Interpretation III of the Company Law specifies situations of unfulfilled or partially fulfilled contribution obligations, courts tend to exclude equity transfers that occur before the capital contribution period ends.

The new Company Law explicitly states that, if a transferor transfers subscribed but unpaid equity, a transferee investor assumes the obligation to contribute. Additionally, if the transferee fails to pay in full and on time, the transferor bears supplementary or joint liability.

The changes introduced by the new law also indicate that investors need to thoroughly examine the original shareholders’ capital contributions during their due diligence investigations before investment. This includes assessing whether the contribution period has expired, whether all contributions have been fully paid, the method of contribution, and the design and implementation of employee shareholding platforms.

In cases involving non-monetary contributions, investors should also consider the assessment of non-monetary assets. They should consider hiring third-party valuation and due diligence agencies, and requesting the transferor to provide statements and assurances regarding the authenticity and sufficiency of non-monetary contributions, with special arrangements for compensation liability.

Pre-emptive rights: Attention should be paid to the impact of procedural changes on pre-emptive rights.

During investment negotiations, investors may seek to impose certain restrictions on founders or actual controllers regarding the direct or indirect transfer of equity. For example, they may require prior written consent or the granting of a veto in related resolutions.

The new Company Law only requires the transferor of shares in a limited liability company to provide written notice to other shareholders regarding the quantity, price, payment method and deadline of the share transfer. Other shareholders have the right to decide whether to exercise their pre-emptive rights without the need for approval by a majority of other shareholders.

The simplification of procedures under the new law facilitates the transfer of shares more freely and efficiently, while also allowing company articles of association to separately provide for the transfer of equity and giving shareholders the space to freely agree.

Thus, under the framework of the new Company Law, investors aiming to implement special arrangements regarding equity should consider both their company’s articles of association and shareholder agreements. This highlights an increasing importance of balancing restrictions of articles with shareholder rights.

Information rights

During business negotiations, investors often seek to secure their interests at the post-investment stage by obtaining the right to appoint directors. However, in the actual post-investment management process, investors may find it increasingly difficult to know the actual operations and profitability of the company. This may occur for reasons such as not obtaining appointment rights, weak control over appointed directors, or special arrangements made by the actual controllers.

The new Company Law provides investors with clearer avenues to access information about the target company. It includes shareholder registers and accounting vouchers within the scope of shareholders’ right to information, allowing shareholders to inspect and copy relevant materials of wholly-owned subsidiaries, and to commission intermediary institutions such as accounting firms and law firms to access and copy relevant materials.

The new law provides investors with more diverse and powerful safeguards to exercise their right to information fully.

Governance

Investors typically appoint directors or supervisors to a company. With the enactment of the new law, the responsibilities of directors, supervisors and senior executives have been further strengthened.

Investors need to pay close attention to risks arising from the performance of duties by directors and supervisors. The loyalty and diligence obligations of directors and supervisors require them to take measures to avoid conflicts of interest with the company, refrain from abusing their powers for personal gain, and to act in the best interests of the company with the reasonable care expected of managers.

For example, the new Company Law clarifies that it is the duty of the board of directors to verify shareholders’ capital contributions, and its obligation to urge the fulfilment of contributions. Directors who fail to fulfil this obligation, resulting in losses to the company, are liable for compensation.

On the other hand, in cases where shareholders illegally withdraw their capital contribution and cause losses to the company, the responsible directors and supervisors are jointly liable for compensation. Investors who have appointed directors need to ensure that they fulfil their corresponding duties and take timely actions, such as urging the fulfilment of contributions.

In summary

Once the new Company Law comes into effect, existing companies wishing to adjust shareholder contribution dates, corporate governance structures and equity transfer arrangements in accordance with the new law should review their articles of association and past transaction documents. They should engage in active communication and co-ordination with company shareholders, and ultimately adjust and formulate new corporate governance documents within the legal and contractual framework.

Yao Yuexi is a managing partner and Zhao Tianyue is an associate at Hylands Law Firm