New laws tighten DSOs’ criminal compliance obligations

The revised Company Law was passed by the Standing Committee of the National People’s Congress (SCNPC) on 29 December 2023, marking the most extensive amendments to the Company Law since 1993.

It primarily addresses adjustments to company registration systems, shareholder liability for capital contributions, corporate governance systems, controlling shareholders’ obligations, and the fiduciary duty of directors, supervisors and officers (DSOs).

On the same day, the Criminal Law Amendment (XII) was also passed, emphasising stricter punishment provisions for crimes related to the dereliction of duty and breach of trust by insiders of private enterprises, while further expanding the application scope of certain crimes.

The simultaneous, significant revisions of these two laws will undoubtedly have a significant impact on future corporate compliance.

Expansion of corporate personality denial doctrine will increase criminal risks of mingling of public and private interests among shareholders. Article 23 of the new Company Law provides the independent status of horizontal penetration of the personality of a company. This means that if a shareholder holds shares in two or more companies and utilises their control to transfer assets among them, evade debts and harm the interests of creditors, the independent corporate personality of the several companies will likely be denied.

This expansion will potentially undermine companies’ independent corporate personality and shareholders’ limited liability.

Previously, some actual controllers or shareholders did not regard the company as an independent corporate entity in daily operations; and were not sufficiently aware of criminal risks from unclear delineation between the company and shareholders in terms of related-party transactions and the use of funds.

Consequently, they often used their personal accounts to carry out transactions of the company, obtain loans from the company for their personal living purposes, and loaned company funds to affiliates without resolution at the shareholders’ meeting. Under the new law, once a dispute arises, the shareholders are likely to not only bear civil liability but also face the risk of criminal misappropriation of funds.

New provisions on capital contribution period impose new requirements on capital contributions by shareholders, raising potential criminal risk. Article 47 of the new Company Law provides for a time limit of five years for shareholders to make full payment of their capital contributions, further strengthening their obligation to make actual capital contributions.

This means that the shareholders’ capital contribution system of limited companies in China has changed from the “full subscription system” to a “partial contribution, partial subscription system”, again to “full subscription”, and finally to the current system of “contribution during a prescribed period”.

For applicants for company registration, promoters or shareholders, if their declaration or capital contribution actions constitute false declarations or contributions, there is a significant likelihood not only of bearing civil liability for inadequate contributions, but also of violating criminal responsibilities such as false contributions or embezzlement of contributions.

This revision follows the spirit of the provisions of the Interpretation by the Standing Committee of the SCNPC Regarding article 158 and article 159 of the Criminal Law, in 2014.

The law does not require contributions to be made at registration. But if the operator fails to make required payments within five years specified in the articles of association, or the latest five-year period prescribed by law, and has no intention to reduce the contribution amount or deregister the company, but due to the mandatory deadline for payment engages in false contribution or absconding from capital contribution – or transferring contributions after making required payments within the mandatory deadline – there is a risk of committing the crime of false contribution or embezzlement of contributions.

In practice, shareholders’ embezzlement of contributions is often manifested by using their identity as company officers to transfer company assets through related-party transactions, or fabricating creditor and debtor relationships, which may simultaneously violate the crimes of embezzlement of contributions and duty encroachment. In practice, judicial authorities tend to determine it as a breach of duty rather than separate offences.

Strengthening obligations of DSOs and increasing responsibilities of controlling shareholders and actual company controllers. Article 180 of the new Company Law provides the DSOs’ duty of loyalty, prohibiting directors, supervisors and officers from taking advantage of their positions to seek improper benefits.

The concept of improper benefits encompasses leveraging a position for personal or others’ gain by exploiting business opportunities belonging to the company and engaging in self-operation or managing similar businesses. Paragraphs 2 and 3 of article 180 provide DSOs’ duty of diligence and the corresponding responsibilities of controlling shareholders and actual controllers.

It is worth noting that simultaneous revision of the Criminal Law Amendment (XII) alongside amendments to the Company Law also expands the scope of criminal liability for offences such as the illegal operation of similar businesses, illegal profiteering for relatives and friends, private favouritism leading to underpriced stock sales, and asset disposal crimes.

This expansion extends the protection of state-owned enterprises to all companies, increasing criminal accountability for intentional harm to the interests of private enterprises by their personnel, resulting in significant losses. Consequently, this imposes higher dual compliance requirements on businesses.

Ekin Zeng is a senior partner and Chen Yitao is an associate at AllBright Law Offices

Ekin Zeng is also a director of the Chinese Society of Criminology and a member of the Criminal Compliance Committee of the Shanghai Bar Association.