- The revised China Company Law, set to take effect in July 2024, introduces significant changes, particularly benefiting start-ups and small businesses. Amidst complex explanations found in various blogs, this article by Tetra Consultants simplifies the key changes for small companies, offering a clear and accessible understanding.
- Since its inception in 1993, China’s Company Law has undergone five revisions, with the latest, the sixth amendment, initiated in 2019. After extensive deliberation and consultation, the amended law was passed on December 29, 2023, and will take effect from July 1, 2024. This revision impacts various areas including company formation, governance, and individual accountability. Business operators and shareholders in China must carefully consider these changes. Additionally, those looking to register company in China should closely monitor these developments. We simplify the significant changes, particularly the revised capital contribution system, providing clarity and strategic insights for future company plans. Tetra Consultants is also available to assist with any offshore company incorporation services needed. Let’s explore further!
Revisions to the Capital Contribution System
- In the recent revision, a significant change mandates shareholders of limited liability companies to fulfil their capital commitments within five years of the company’s establishment. This contrasts sharply with previous guidelines, where shareholders had discretion over the timing and manner of their contributions. Since the introduction of subscribed capital in 2013, this flexibility in funding timelines has attracted investments. However, it has also led to instances of deliberate postponement by investors, resulting in inadequate capital for meeting creditor obligations. The latest amendment prioritizes creditor protection, enhancing business security with other Chinese companies. Here’s a comparison of the two capital contribution systems:
Subscribed system
- In this system, shareholders are required to deposit a certain amount of capital in the company’s charter, without immediate disbursement. Not only can cash be used as a means of contribution, but equity, debt, intangible assets, fixed assets, etc., can also serve as methods to pay in capital for company registration. This approach offers operational flexibility and lowers the entry barrier for establishing a company. Pledged capital forms part of the registered capital but is not required to be deposited immediately.
- On the other hand, the subscribed system operates on a promise-based approach. Shareholders commit to contributing capital based on the company’s operational needs, without an immediate financial outlay. Companies have the freedom to decide when to call for actual capital contributions, depending on their operational requirements.
Newly implemented paid-in system
- Under this system, shareholders must deposit their pledged capital when the company is formed or when additional capital is required. The authenticity of these payments is verified by banks or third-party entities. Shareholders are required to make their pledged capital contributions either during registration or within a specified timeframe.
- In the paid-in system, shareholders must provide the necessary funds during the company’s registration to ensure sufficient initial capital. Once these capital contributions are made by shareholders, the funds are recognized as the company’s genuine paid-in capital.
Based on revised China company law key changes
Capital contribution
- The recent amendments to the Company Law in China have brought significant changes, particularly regarding capital contribution by shareholders. Previously, there was no time limit for capital contribution schedules, leading to abuses like excessively long contribution periods. Now, shareholders of limited liability companies (LLCs) must fulfill their entire subscribed capital contribution within five years of the company’s establishment (Art. 47). This aims to add credibility to registered capital and prevent abuse.
- Existing companies with contribution schedules exceeding five years must adjust to comply, with the State Council expected to issue implementing regulations (Art. 266). Additionally, failure to pay subscribed capital on time results in forfeiture of equity interest and other penalties (Art. 52). The new law also enhances transparency by requiring LLCs to publish subscribed and paid-in capital amounts (Art. 40), and holds shareholders jointly liable for contribution shortfalls (Art. 50) and outstanding amounts upon equity interest transfer (Art. 88). These changes ensure accountability and reliability in capital contributions within Chinese companies.
Legal representative
- In Chinese companies, every entity must appoint a legal representative empowered to act on its behalf in civil activities, with flexibility now allowing any director or the general manager to serve in this role (Art. 10). This change offers greater flexibility in selecting top representatives. To address concerns about personal liabilities, the new Company Law introduces a clear exit mechanism. When a director or general manager resigns, they are automatically deemed to have resigned as the legal representative, prompting the company to appoint a new representative within 30 days (Art. 10). This ensures continuity and accountability within the company’s leadership.
Shareholder’s meeting
- In Chinese companies, the shareholders’ meeting holds the highest authority, but recent amendments to the Company Law have streamlined and optimized its duties and powers. Two powers causing confusion and difficulty were removed:
(i) The ambiguous power to determine operating strategies and investment plans, and
(ii) The requirement to review and approve annual financial budgets and final accounts plans, which may not be suitable for every company.
- Now, the shareholders’ meeting can authorize the board of directors to decide on bond issuance (Art. 59). Additionally, single shareholders can make decisions typically requiring a shareholders’ meeting, if done in writing and deposited with the company (Art. 60).
Board of directors
- The board of directors’ powers remain largely intact, with changes aligning with adjustments to shareholders’ meeting powers. Notably, the board no longer formulates annual financial budgets but retains authority over operating plans and investments (Art. 67). Additionally, there’s no longer a set limit on director numbers, with a minimum of three required for both LLCs and JSCs (Art. 75, 128). Small Enterprises may have a sole director (Art. 75, 128). Employee representatives are usually optional but required in wholly state-owned companies or if the company has 300+ employees without an employee representative on the supervisory board (Art. 173, 68, 120).
Supervisor
- Chinese companies follow a “two-tiered” governance structure, featuring both a board of directors and a supervisory board. Unlike some other jurisdictions, the supervisory board in China doesn’t make business decisions but ensures compliance with laws and regulations. Prior to the 2023 amendment, exemptions from the supervisory board requirement were limited. Now, Small Enterprises and certain JSCs can have one supervisor or none (Art. 133, 83). Furthermore, companies with an audit committee comprising only directors can forgo the supervisory board requirement (Art. 69, 121). However, this may lead to conflicts of interest, as the audit committee consists of directors.
Joint stock company
- The new Company Law in China introduces significant relaxations for Joint Stock Companies (JSCs), the only corporate form eligible for listing. Firstly, the requirement prohibiting founders from transferring shares within one year of the company’s establishment has been abolished (Art. 141). Additionally, JSCs no longer need at least two founders, enabling single-person incorporation if other conditions are met (Art. 92). The law now permits JSCs to authorize their board of directors to issue new shares within three years, not exceeding 50% of issued shares, subject to specific conditions (Art. 152, 153).
- Furthermore, JSCs are now allowed, though not obligated, to issue shares without a par value, providing flexibility in capital structuring (Art. 142). These amendments aim to streamline processes and enhance flexibility for JSCs, potentially encouraging their adoption as a preferred corporate form.
Multiple classes of share
- Under the new regulations, Joint Stock Companies (JSCs) are now permitted to issue multiple classes of shares, a change from previous restrictions necessitating State Council approval for certain conditions, such as financial institutions and hi-tech companies (Art. 131). Each class of shares may have distinct rights, including preferred profit distribution, varying voting rights, transfer restrictions, and other specifications set by the State Council.
- Listed JSCs can only issue certain classes of shares before their initial public offering (IPO) and are subject to additional restrictions imposed by listing rules (Art. 144). With this expanded flexibility, JSCs offer more structural options for founders and shareholders to define their rights and obligations within the company. Despite stricter establishment and governance requirements, JSCs are expected to become a more popular corporate form due to these regulatory changes.
Financial assistance
- Prior to the recent amendments, financial assistance was a vague area in Chinese law, leading to conflicting practices and court cases, causing uncertainty among market players. The new Company Law introduces fundamental rules on financial assistance for the first time. A company is prohibited from providing gifts, loans, guarantees, or other financial aid for acquiring shares unless for employee stock ownership plans or company benefit, approved by the shareholders’ meeting or board of directors. The total assistance cannot exceed 10% of the issued share capital. However, details such as differentiation between listed and unlisted companies and shareholders’ meeting approval requirements are expected to be clarified in future judicial interpretations or listing rules (Art. 163).
Fiduciary duty
- The revised Company Law in China delineates the fiduciary responsibilities of directors, supervisors, and senior managers, comprising the duty of loyalty and duty of diligence (Art. 180). Upholding the duty of loyalty entails avoiding conflicts of interest and refraining from exploiting their positions for personal gain (Art. 182). Moreover, they must exercise due care in company matters, acting in its best interests (Art. 180).
- Additionally, they are obligated to report contracts and transactions to the shareholders’ meeting or the board of directors and obtain approval as per the articles of association (Art. 183). They must also seek approval before pursuing company opportunities or engaging in competing businesses (Art. 184). These provisions safeguard corporate integrity and shareholder interests in Chinese corporate governance.
Controlling shareholder and actual controller
- The new Company Law in China addresses illegitimate interference by controlling shareholders and actual controllers through several amendments. Strengthened rules for piercing the corporate veil include both “vertical” and “horizontal” piercing, holding shareholders accountable for company liabilities. Additionally, single-shareholder companies must prove asset independence to avoid joint liability for company debts.
- Controlling shareholders and actual controllers now owe a duty of loyalty and diligence, akin to directors, and can be held liable for breaches. Instructions to directors or senior managers that harm company interests render shareholders jointly liable. Further, shareholders can require acquisition of equity interests if a controlling shareholder abuses rights to detriment of the company or other shareholders.
Conclusion
- In essence, the recent amendments to China’s Company Law signify a pivotal shift towards enhanced transparency, accountability, and credibility within the corporate landscape. At Tetra Consultants, we understand the importance of navigating these changes seamlessly. With a comprehensive range of services including offshore company incorporation, offshore financial licenses, legal drafting, name reservation, corporate bank account opening, and more, we ensure that your business objectives align with regulatory requirements. Trust Tetra Consultants to guide you through the complexities of the updated Company Law, facilitating your journey towards sustainable growth and compliance in the Chinese market.
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