China Publishes Draft Amendment to Company Law
The Standing Committee of the 13th National People’s Congress issued the draft Amendment to the Company Law (“Amended Company Law”) on December 24, 2021 for comment through January 22, 2022.1 Since its enactment in 1993, the Company Law has already been amended five times. The draft Amended Company Law consists of 15 chapters and 260 articles and has made roughly 70 substantive changes on the basis of the 13 chapters and 218 articles of the current Company Law (rev. 2018).
The draft Amended Company Law would (i) refine special provisions on state-funded companies; (ii) improve the company establishment and exit system; (iii) optimize corporate structure and corporate governance; (iv) optimize the capital structure; (v) tighten the responsibilities of controlling shareholders and management personnel; and (vi) strengthen corporate social responsibility.
This newsletter will focus on the implications of the draft Amended Company Law for foreign-invested enterprises (“FIEs”) in China, as opposed to domestically-invested companies. FIEs here refer to companies that are invested in and established by foreign investors in China. They are incorporated as limited liability companies or companies limited by shares in China with foreign ownership. Partnership enterprises with foreign investment, such as venture capital and private equity investment funds and fund managers, are subject to the Partnership Law and will not be the focus of this newsletter.
On January 1, 2020, the Foreign Investment Law (“FIL”) and its Implementing Regulations took effect and replaced the Chinese-Foreign Equity Joint Venture Law, the Chinese-Foreign Cooperative Joint Venture Law and the Wholly Foreign Owned Enterprise Law (collectively, the “Three FIE Laws”). The FIL forms the new foreign investment legal regime in which FIEs may invest in sectors outside the negative lists and are entitled to national treatment equivalent to their domestically-invested counterparts. The negative lists include the Negative List for Market Access, the Special Administrative Measures for Foreign Investment Access, and the Special Administrative Measures for Foreign Investment Access in Free Trade Pilot Zones.2
After the Three FIE Laws were repealed and replaced by the FIL, FIEs became subject to the Company Law which applies to all companies registered in China, with or without foreign investment, with respect to company formation, corporate governance, fiduciary duties of directors and officers, protection of minority shareholders, share transfer, distribution of profits, liquidation and other elements. Existing FIEs have five years (until December 31, 2024) to convert to the appropriate corporate form and update their articles of association and shareholders agreements to comply with the Company Law. Newly established FIEs will be formed under the Company Law.
The draft Amended Company Law would provide the following major changes with respect to FIEs:
- Improvement of the company establishment and exit system
- Optimize the registration process and improve the efficiency of company registration. For example, the draft Amended Company Law would require that company registrars make a single request (instead of repeated and piecemeal requests) during the registration process in case the application documents received are incomplete or contain errors;
- Make use of informatization through electronic business licenses, a unified enterprise data publication system, and electronic communication. Electronic business licenses have already been implemented in major cities such as Shanghai;
- Expand the scope of capital contributions to include equity and creditor’s rights. In the past, shareholders of a company could make capital contributions to the registered capital of such company only in the form of cash, equipment, intellectual property rights, land use rights and other tangible or intangible assets. The draft Amended Company Law would allow shareholders to make capital contributions by share swap and debt-equity conversion;
- Improve the liquidation system; provide for a simplified dissolution mechanism upon commitment to the honoring of all debt by all shareholders. Liquidation of companies in China has been a challenge to many business owners in the past because of the complicated liquidation procedures and lengthy process. As a practical matter, a liquidation process can take 6-12 months or even longer and involve multiple government procedures (including tax clearance, public announcement, filings with industry regulators, courts as well as company registration authorities (i.e., the State Administration for Market Regulation or its local offices). The draft Amended Company Law would now establish a “simplified liquidation” procedure allowing companies to liquidate and dissolve in a much more efficient manner so long as its shareholders are willing to undertake joint and several liability for unsettled debts after the dissolution and liquidation of a company.
- Optimizing company organizational structure and corporate governance
- Clarify that the board of directors is the executive body of the company;
- Relax the organizational structure requirements for smaller scale companies, eliminating the requirement to establish a board of directors and board of supervisors. Small and medium-sized companies could choose to have one executive director or manager in lieu of a board of directors.
- Improvement of the company’s capital structure
- Authorized capital system: a company limited by shares could issue only a portion of its authorized shares at the time of establishment; the board of directors can decide to issue the remainder in accordance with the company’s actual requirements;
- Different classes of shares: to meet the different investment requirements, allow for the issuance of classes of shares having rights different from ordinary shares, such as preferred shares and inferior shares, special voting rights shares, and transfer restricted shares; allow companies to choose between shares with face value and shares without face value. This new development suggests that China is moving towards international standards with respect to more sophisticated capital structures and shareholder rights. Under the draft Amended Company Law, a company limited by shares can issue common shares and different classes of preferred shares (including convertible preferred shares), with different preference rights (such as liquidation preference) and voting rights attached, in accordance the company’s articles of associations. This revision would provide companies with greater flexibility on equity financings in each stage of development, including seed, early stage, growth and pre-IPO;
- Simplify the capital reduction system: if the company still has losses after making up for losses in accordance with regulations, it would be able to conduct a simple capital reduction without the right to make any distribution to shareholders. Under the Company Law, shareholders of a company have an obligation to meet their respective commitments on capital contributions to the registered capital of the company. “Registered capital” in China is analogous to “paid in capital” in leading western jurisdictions. The difference is that shareholders in China who have made commitments on capital contributions may not reduce or cancel such commitments absent government scrutiny. The draft Amended Company Law would offer shareholders greater freedom to exit a business if the business underperforms and lighten the burden of customers and creditors to assess the underlying creditworthiness of the company;
- Loss of right to contribute: if a shareholder fails to make its capital contribution in full and on time, and within the prescribed time limit after being called by the company, the shareholder would forfeit the right to contribute;
- Accelerated maturity system for capital contributions: if a limited liability company cannot pay off its debts when due, the company or creditors have the right to require that subscribed for but unpaid capital contributions be paid in advance.
- Tightening responsibilities of controlling shareholders and management personnel
- Improve the provisions of duties of loyalty and diligence for directors, supervisors and senior managers, and tighten their responsibilities to maintain the company’s capital;
- Strengthen the regulation of related party transactions by expanding the scope of related parties and increasing the reporting obligations of related party transactions. The draft Amended Company Law would impose a reporting and approval requirement on related party transactions where directors, officers or supervisors must report a related party transaction to the board of directors or shareholders meeting for review and approval. The scope of related party transactions would expand to also cover family relatives of directors, officers and supervisors as well as entities or individuals associated with them. Directors who have a conflict must abstain from voting at the board meeting;
- Clarify the joint liability of controlling shareholders and management personnel in the event of wrongdoing attributed to them. Directors and officers who commit willful misconduct or gross negligence in performing their duties in the company causing damages to third parties will be jointly liable for such damages. Directors and officers who aid or abet a controlling shareholder in abusing its power causing damages to legitimate interests of the company or its minority shareholders will also bear joint liability.
- Strengthening corporate social responsibility
- Companies to consider interests of stakeholders such as employees and consumers;
- Encourage companies to participate in social welfare activities and publish social responsibility reports.