Recent amendments to China’s Company Law will require investors in China (domestic and foreign alike) to review and update the corporate documentation of their China companies. Those selling companies in China should take particular care for reasons set out below. Directors and officers will also be open to increased personal liability and should take care accordingly.

 

1. Amendments to China’s Company Law

 

The Standing Committee of the National People’s Congress promulgated amendments to China’s Company Law on 29 December 2023. The amended Company Law will be effective as of 1 July 2024 (2024 Company Law).

 

China’s State Council is expected to issue implementing rules that will provide guidance on how to apply to the new amendments.

 

Subject to implementing rules providing more details, it’s likely that local Administrations for Market Regulation (AMRs), being the regulatory authority in charge of company registration in China, will require the articles of association (AOA) of foreign-invested enterprises (FIEs) to be updated for each of the required changes when any other changes are being made to the AOA. For instance, if an FIE is updating its AOA for an address change, then the local AMR will require its AOA to be updated further so as to be fully consistent with the 2024 Company Law.

 

2. Capital Contributions within Five Years

 

Foreign investors have been permitted to decide on the equity funding needs of their FIEs since 1 March 2014, with the FIE’s AOA specifying the timing of payments. Some AMRs simply required that the entire registered capital must be paid in during the life of FIE.

 

Under the 2024 Company Law, both Chinese and foreign investors have five years from the date of incorporation to fully pay in registered capital. This five-year time limit also applies to increases of registered capital.

 

If a shareholder (foreign or domestic) fails to pay in registered capital within the time limit, then the shareholder will forfeit all rights and benefits attached to the unpaid capital.

 

While the policy goal is likely to protect creditors’ rights, and bring more money into the corporate sector, this new time limit might also result in companies seeking to reduce their registered capital or, in worst case scenarios, close down.

 

3. Transferring Equity

 

Transferring equity has become both easier and riskier.

 

(a) Shareholder consent cancelled

 

A transferring shareholder is currently required to obtain the consent of the majority of other shareholders in order to transfer equity to a third party. From 1 July 2024, such consent will no longer be required. Other shareholders, however, will still have a right of first refusal.

 

(b) Seller’s post-closing liability fixed

 

The 2024 Company Law imposes, by law (as opposed to negotiated liabilities), post-closing liability on a seller in two circumstances:

• If the seller’s payment of registered capital is not yet due at the time of transfer, and subsequently the buyer fails to make the payment in full and on time, then the seller must pay up any shortfall.
• If the seller (i) has failed to pay in registered capital at the time of transfer, or (ii) had injected over-valued assets as registered capital and the actual value of the assets is significantly below the subscribed capital amount, then the seller and buyer will have joint and several liability for the registered capital payments; however, if the buyer has no actual or imputed knowledge of the situation then the seller alone will be liable.

The direct imposition on the seller of potential post-closing liability for registered capital payments will likely mean that sellers will require buyers to provide indemnities or possibly performance guarantees for the future payment of registered capital.

 

The law is silent as to whether the seller will own any equity that corresponds to post-closing payments of registered capital. Pending implementing rules, this will require additional negotiations for deals after 1 July 2024.

 

4. Penalties for Failure of Information Disclosure

 

All companies in China, including FIEs, must publicly disclose the following information on the National Enterprise Credit Information Publicity System:

• subscribed and paid-in capital of shareholders, and dates of contributions;
• changes in the equity or shares of shareholders; and
• receipt, change, or cancellation of any administrative permit.

Under the 2024 Company Law, failure to disclose may result in fines to the company of between RMB10,000 and RMB50,000, or up to RMB200,000. Individuals responsible for the failure may also be fined between RMB10,000 and RMB100,000. These penalties are new under the 2024 Company Law.

 

5. Corporate Governance

 

The 2024 Company Law introduces corporate governance changes for companies in China.

 

(a) Shareholders’ meetings

 

The 2024 Company Law shortens the list of shareholders’ statutory powers, while explicitly requiring a majority of votes for successful resolutions. The 2024 Company Law also explicitly permits the shareholders meeting to authorize the Board of Directors to make resolutions regarding the issuance of corporate bonds. The shareholders’ meeting may also grant other functions or powers to the board of directors.

 

(b) Board of directors

 

Currently, limited liability companies (including FIEs) limit the number of directors to a maximum of thirteen. From 1 July 2024, there will no longer be any upper limit.

 

The 2024 Company Law also specifies that, for limited liability companies, a board of director’s quorum is one-half of the directors, and that to be successful a resolution must be passed by a majority of the directors (and not just a majority of directors present).

 

Insurance for directors is explicitly recognized by the 2024 Company Law.

 

(c) Supervisor(s)

 

The current Company Law requires a board of supervisors (three or more members), and allows small-scale companies to have dual supervisors or a sole supervisor. The 2024 Company Law only allows small-scale companies to have a sole supervisor (and not dual supervisors).

 

As an alternative, the 2024 Company Law permits the establishment of an audit committee, composed of directors. If established, the audit committee will exercise the powers of the board of supervisors.

 

(d) Legal representative

 

A legal representative of a Chinese company (including FIEs) is subject to considerable administrative and criminal risks for the acts and omissions of the company. One strategy to limit that risk, particularly for wholly foreign-owned enterprises, has been to appoint as legal representative someone who is not involved in the operations of the company and who is not based in China. From 1 July 2024, this option may be closed.

 

The 2024 Company Law provides that the legal representative must be either “the director or company manager representing the company for the execution of company affairs”.

 

6. Increased Liability for Directors, Officers and the Controlling Shareholder

 

The 2024 Company Law increases personal liability for directors and officers, as well as for the controlling shareholder, in a number of ways:

• Under the 2024 Company Law, directors have an obligation to oversee the shareholders’ capital contributions and to call unpaid capital. If failure in this regard causes loss to the company then the directors will be liable for compensation to the company. This may result in directors indirectly being liable to creditors.
• The director or directors must act as liquidator and form a liquidation committee (unless otherwise agreed in the AOA or formed by persons otherwise selected by the shareholders’ meeting) within 15 days of the cause for dissolution arising. If any failure to do so results in losses to the company or its creditors, then the director will be personally liable for compensation.
• If any profit distribution or reduction of registered capital violates the 2024 Company Law, and losses are thereby caused to the company, then the shareholders, as well as any directors, supervisors, and senior officers responsible for such violation, will be liable to the company for compensation.
• A controlling shareholder or actual controller of a company that controls and managers the company will, effective 1 July 2024, owe fiduciary duties to the company and may be liable for breach of those duties.

7. Minority Shareholder Redemption Rights

 

If a controlling shareholder of a company abuses its shareholder rights, which causes serious harm to the interests of the company or other shareholders, then the other shareholders will, effective 1 July 2024, have a statutory right to request the company to repurchase their equity at a reasonable price.

 

8. Conclusion

 

The 2024 Company Law revisions, effective 1 July 2024, will require many investors to review and update the articles of association of each company have they have in China. The cash flow implications of a new time limit on the payment of registered capital may also need attention. While implementing regulations are expected, the direction of the changes is clear and investors should get prepared.