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Exploring the revisions to China’s corporate law: Implications and insights for LLCs

Exploring the revisions to China’s corporate law: Implications and insights for LLCs.

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Towards the end of 2023, after several years of revisions and discussions, China released a fresh Company Law set to be enforced starting from July 1, 2024. This legislation is poised to influence foreign investors operating in China significantly.

The new company law has 15 chapters and 260 articles and based on the existing company law with 13 chapters and 2018 articles, about 70 articles have been substantially added and amended.

For limited liability companies, compared to the current company law, the new company law has significant revisions in the paid-in capital system, the system of shareholder disqualification, the legal representative system, the supervisory system, the duty of loyalty of diligence of directors, supervisors and senior management, and the liquidation system. This article briefly comments on several significant amendments to the new company that apply to limited liability companies, which include:

  • Introduce a maximum period in which LLC shareholders must make capital contributions and standardise the accelerated expiration of shareholders’ capital injections.
  • Assigning the responsibility to the board of directors to call for capital contributions and deprivation of shares and enhancing the laws concerning LLC shareholders’ failure to fulfil capital contributions.
  • Broadening the range of situations for appointing a legal representative.
  • Instituting procedures for simplified and compulsory deregistration.
  • Considering the option to forgo the appointment of a supervisor.

Changes in the paid-in capital system

Article 47 The registered capital of a limited liability company shall be the amount of capital contributions made by all shareholders as registered with the company’s registration authority. The amount of capital contributed by all shareholders shall be paid in full by the shareholders in accordance with the provisions of the articles of association within five years from the company’s establishment date.

Where laws, administrative regulations and decisions of the State Council provide otherwise for the paid-in registered capital, minimum registered capital and the period of contribution by shareholders of a limited liability company, such provisions shall apply accordingly.

Insights: Adding a maximum period for LLC shareholders to make capital contributions and normalising the accelerated expiry of shareholders’ capital contributions.

According to Article 266, a transitional period will be permitted for companies established before the 2023 Company Law comes into effect till 1 July 2024 that have subscribed capital payment terms exceeding this time limit. The State Administration for Market Regulation will also soon formulate specific implementation measures for the existing companies.

The amendment will, to a certain extent, help to rectify the drawbacks arising from the application of the full subscription system of registered capital, encourage shareholders to assess their own asset status and business needs more rationally when investing, and protect the reasonable expectation of creditors in the realisation of their claims, to reduce the transaction risks and the instability of the company’s operation. The standard of five years as the most extended period of capital contribution is based on the average survival period of the enterprise, according to the registration authority’s statistics.

However, the economy is slowing nowadays, and the new company law’s provision on the maximum period for capital contribution may further dampen the enthusiasm for investment and entrepreneurship. It may lead to more company cancellations, capital reductions, and litigation.

Article 54 If a company is unable to pay off its due debts, the company or its creditors whose claims have expired have the right to require shareholders who have subscribed for capital contributions but have not yet expired to pay their capital contributions in advance.

Insights: Accelerated expiry of subscribed capital contribution

Although there is a 5-year capital contribution period limit, if the company cannot pay off its due debts to protect the interests of creditors, the company or creditors have the right to require shareholders to pay capital contributions in advance.

Deprivation of shares and shareholder responsibilities

Deprivation of shares

Article 51 Upon establishing a limited liability company, the board of directors shall verify the capital contributions of the shareholders. Suppose it is found that a shareholder has not paid the capital contributions stipulated in the articles of association in full and on time. In that case, the company shall issue a written reminder to the shareholder to call for the payment of the capital contributions.

If the failure to fulfil the obligations stipulated in the preceding paragraph promptly causes losses to the Company, the responsible director shall be liable for compensation.

Article 52 If a shareholder fails to pay the capital contribution in accordance with the date specified in the articles of association, and the company issues a written reminder to call for the payment of the capital contribution in accordance with the provisions of paragraph 1 of the preceding article, the company may specify a grace period for the payment of the capital contribution. The grace period shall not be less than sixty days from the date of the issuance of the reminder by the company. Suppose the grace period expires and the shareholder fails to fulfil the capital contribution obligation. In that case, the Company may, by resolution of the Board of Directors, issue a notice of forfeiture of rights to the shareholder, which shall be given in written form. From the date of issuance of the notice, the shareholder loses their shareholding in the unpaid capital.

According to the provisions of the preceding paragraph, the loss of equity shall be transferred according to law, or a corresponding reduction in the registered capital and cancellation of the equity within six months of the transfer or cancellation of the other shareholders of the company in accordance with the proportion of its capital contribution to the full payment of the corresponding capital.

If a shareholder disagrees with the loss of equity, he or she shall, within thirty days from the date of receipt of the notice of loss of equity, file a lawsuit with the People’s Court.

Insights: Adding the board of directors’ responsibility to call for capital contributions and deprivation of shares and improving the laws for defaulting on capital contributions by LLC shareholders.

The new articles added for the deprivation of shares in Articles 51 and 52 of the Companies Law (Revised 2023) are also breakthroughs affecting the rights of shareholders. This concept is derived initially from the “forfeiture of shares” under the Anglo-American company law system. The forfeiture of shares system is a system whereby the directors of a company forfeit the shares of a company that have not been paid within a specified period after a call is made on the paid-up capital.

Essentially, the deprivation of shares system is an additional safeguard mechanism for shareholders to make full and timely contributions based on the new five-year contribution period system established in Article 47. According to the Article, if a shareholder fails to contribute in full and on time, the board of directors has the legal obligation to verify the contribution and shall send a reminder notice to the shareholder in the name of the company; otherwise, the responsible director shall be liable for compensation.

Thereafter, if a shareholder fails to fulfil the capital contribution obligation after the expiry of the grace period set out in the reminder notice, the company may issue a notice of forfeiture to the shareholder by resolution of the board of directors. From the date of issuance of the notice of forfeiture, the shareholder automatically loses the rights of shareholders with respect to the unpaid portion of the capital contribution.

Shareholder’s responsibilities

1. Mutual oversight responsibilities

Article 50 When a limited liability company is established if a shareholder fails to pay the capital contribution in accordance with the company’s articles of association, or the actual value of the non-monetary property contributed is significantly lower than the amount of capital contribution subscribed, other shareholders at the time of establishment shall be jointly and severally liable with the shareholder to the extent of insufficient capital contribution.

2. Joint and several liabilities of front and rear shareholders

Article 88 If a shareholder transfers equity for which the capital contribution has been subscribed but the capital contribution period has not expired, the transferee shall bear the obligation to pay the capital contribution; if the transferee fails to pay the capital contribution in full on time, the transferor shall be liable to the transferee for failure to pay the capital contribution on time. The capital contribution paid shall bear supplementary liability.

If a shareholder fails to pay the capital contribution in accordance with the capital contribution date stipulated in the company’s articles of association or the actual value of the non-monetary property used as the capital contribution is significantly lower than the amount of capital contribution subscribed, the transferor and the transferee shall bear the liability within the scope of the insufficient capital contribution. Joint and several liability; if the transferee does not know and should not know that the above circumstances exist, the transferor shall bear the liability.

Insights: Clarifying shareholder responsibilities, including mutual oversight responsibilities and joint and several liabilities of front and rear shareholders. If the transferee fails to pay the capital contribution on time, the transferor will also be liable. And no matter how many times it is transferred, everyone in the entire transfer chain may bear relevant responsibilities.

Clarification of the legal representatives’ resignation

Article 10 The legal representative of a company shall, in accordance with the provisions of the articles of association, be a director or manager who executes the affairs of the company on behalf of the company.

The resignation of a director or manager who serves as the legal representative shall be deemed the resignation of the legal representative at the same time.

If the legal representative resigns, the company shall determine a new legal representative within thirty days from the legal representative’s resignation date.

Article 11 The legal consequences of civil activities conducted by the legal representative in the company’s name shall be assumed.

Any restriction on the legal representative’s right of representation imposed by the articles of association of the company or the shareholders’ meeting shall not be set up against bona fide counterparts.

If the legal representative causes damage to others in performing his duties, the company shall bear the civil liability. After the company has assumed civil liability, it may, in accordance with the provisions of the law or the company’s articles of association, recover compensation from the legal representative who is at fault.

Insights: Expanded scope of appointment of legal representative

Under the existing Company Law, the legal representative is the chairman of the board of directors, an executive director or a manager. The new Companies Law abolishes the term “executive director” and provides that the legal representative is the director or manager who executes the company’s affairs on behalf of the company. This means that the legal representative can be any director as long as they are appointed to manage the company’s affairs on behalf of the company. This is a significant change to the existing company law provisions as it broadens the scope of the legal representative. However, this provision needs to be further clarified.

Firstly, although it is stipulated that the company shall determine a new legal representative within thirty days from the date of the legal representative’s resignation, it is not clear who has the right to represent the company if the shareholders’ meeting or the board of directors of the company delays in electing a new legal representative in such a case.

Secondly, if a director who is the legal representative only resigns from the position of the legal representative, is it the same as resigning from the director position, or do they still retain the director position? This remains to be clarified.

At the same time, the new company law makes it clear that the company’s articles of association or the shareholders’ meeting’s restriction on the legal representative’s right shall not be opposed to the bona fide counterparty. Suppose the legal representative of the execution of duties caused damage to others. In that case, the company should first assume civil liability and then, according to the provisions of the law or the company’s articles of association, to the “faulty” legal representative to recover.

Optimising the corporate supervisory system

Article 69 A limited liability company may, by the provisions of the articles of association, set up an audit committee consisting of directors in the board of directors to exercise the powers and functions of the supervisory board as provided for in this Law.

The audit committee of a limited liability company may, in accordance with the provisions of the articles of association, set up in the board of directors an audit committee composed of directors, exercising the powers and functions of the supervisory board as provided for in this Law, and there shall be no supervisory board or supervisor. No supervisory board or supervisors shall be established.

Employee representatives among the board of directors of a company may become members of the audit committee.

Article 83 A limited liability company with a small number of shareholders may not have a supervisory board or may set up one supervisor to exercise the powers and functions provided for in this Law.

One supervisor shall exercise the powers and functions of the supervisory board as provided for in this Law; with the unanimous consent of all shareholders, there may also be no supervisor.

Insights: The possibility of no longer appointing a supervisor

The shareholders’ meeting, the board of directors and the supervisory board constitute the three primary organisational structures of the company. Theoretically, the supervisory board assumes a vital role in supervising the company’s management and comprises representatives of shareholders and employees. However, in practice, supervisors’ functions have not been given full play since establishing the supervisory system. For many limited liability companies, the supervisors are more like a fictitious set-up to meet the requirements of the Company Law.

The New Company Law provides that if a limited liability company has an audit committee, the audit committee may perform the supervisory functions, thus eliminating the need for supervisors. Moreover, a limited liability company with a small scale or small number of shareholders can also not have supervisors without the consent of all shareholders. This provision solves the problem of “fictitious” supervisors in practice and retains the necessary functions of supervisors (such as the auditing function), which is a breakthrough to the existing law.

Insights: Strengthen the obligations of company directors, supervisors and senior management

The new company law has improved the regulations restricting related transactions of directors, supervisors and senior management, seeking company business opportunities and horizontal competition.

The new company law also strengthens the obligations of directors, supervisors and senior management in:

  1. Provide for the verification and payment obligations of the board of directors of a limited company on shareholders’ capital contributions and the compensation obligations of responsible directors;
  2. It is stipulated that if a shareholder withdraws his/her capital contribution, in addition to the shareholder’s return of capital contribution, if losses are caused to the company, the responsible directors, supervisors and senior management shall bear joint liability with the shareholders, for compensation for the losses caused to the company;
  3. If additional financial assistance is provided in violation of regulations and causes losses to the company, the responsible directors, supervisors and senior management shall be liable for compensation;
  4. Increase the liability provisions for directors and senior executives who cause damage to others due to their duties; in principle, the company should bear the liability for compensation. Directors and senior management who have intentional or gross negligence should also bear the liability for compensation;
  5. Expand the scope of defendants in shareholder representative litigation to directors, supervisors and senior management of the company’s wholly owned subsidiaries, establish a dual shareholder representative litigation system, etc.

Substantive modification of the corporate dissolution & liquidation

Article 232 If a company is dissolved as a result of the provisions of Article 229(1)(a), (b), (d), and (e) of this Law, it shall be liquidated. The directors shall be the obligors for the company’s liquidation. They shall form a liquidation group to carry out the liquidation within fifteen days of the date when the cause of dissolution arises.

The liquidation group shall consist of the directors unless otherwise provided in the articles of association or the shareholders’ meeting resolves to elect another person.

If the liquidation obligor fails to fulfil its liquidation obligations in time and causes losses to the company or creditors, it shall be liable for compensation.

Insights: Establishing liquidation obligors and their liability.

This article is a new provision which clarifies that the liquidation group of a company shall take the director as the liquidation obligor” as the principle, and “the articles of association of the company stipulate otherwise, or the resolution of the shareholders’ meeting elects another person” as the exception. On this basis, new provisions have been added to stipulate the liability for losses caused by the failure of the liquidator to fulfil its liquidation obligations in a timely manner.

The amendment strengthens directors’ liquidation obligations and liabilities to match the management rights they enjoy while allowing the articles of association and the resolution of the shareholders’ meeting to elect another person as the liquidator, which safeguards the company’s autonomy.

Introducing simplified deregistration procedures and forced deregistration procedures

Article 240 If a company has not incurred any debts or has settled all its debts, its registration may be cancelled through a simplified procedure per the provisions upon the commitment of all shareholders.

The cancellation of company registration through the simplified procedure shall be announced through the national enterprise credit information publicity system for not less than twenty days. If there is no objection after the expiration of the announcement period, the company may apply to the company registration authority for cancellation of company registration within twenty days.

Suppose a company cancels its company registration through a simplified procedure. In that case, the shareholders who have made an untrue commitment to the contents of the first paragraph of this Article shall be jointly and severally liable for the debts incurred before the cancellation of the registration.

Insights: Establishing simplified deregistration procedures

The new Company Law introduces a simplified deregistration system to reduce corporate exit costs.

The conditions for applying simplified deregistration are that the company has no current debt relationship and all shareholders have made commitments. If the shareholders’ commitment is untrue, the shareholders shall be jointly and severally liable for the company’s debts before the cancellation.

If a company initiates a simplified cancellation, it does not need to start liquidation procedures. It shall be announced in the national enterprise information publicity system for over 20 days. It can apply for cancellation registration after the expiration of the announcement period if there are no objections.

Article 241 If a company has been suspended its business licence, ordered to close down or revoked, and has not applied to the company registration authority for cancellation of the company registration for three years, the company registration authority may make a public announcement through the National Enterprise Credit Information Publicity System, and the period of the announcement shall be not less than sixty days. If there is no objection after the expiration of the announcement period, the company registration authority may cancel the company registration.

Where a company’s registration is cancelled in accordance with the preceding paragraph, the liability of the original shareholders of the company and the liquidation obligors shall not be affected.

Insights: Establishing forced deregistration procedures

To solve the long-troubled “zombie companies”, the new law establishes a forced deregistration system, in which the company’s business licence is revoked, ordered to be closed or withdrawn, and not liquidated for three years under three circumstances, the company registration authority may cancel the company’s registration after the announcement of the National Enterprise Credit Information Public Disclosure System is uncontested, and the liability of the original company’s shareholders and the person who is liable for the liquidation shall not be affected.

Source:

  1. Company Law of the People’s Republic of China

Contact our teams for expert support and further information about corporate governance in China to ensure you are compliant in the market.

Maxime Van ‘t Klooster, Partner, m.vantklooster@acclime.com
Bram Voeten, Regional Business Development Manager, b.voeten@acclime.com
Christophe Marquis, Director, Shanghai, c.marquis@acclime.com