China’s revised Company Law, which will come into effect on 1 July 2024, has 266 articles, about a third of which have been added or substantially modified. Of these, a number relate to the rights and obligations of shareholders.

This article describes the new provisions of the Company Law that will have a significant impact on the officers (legal representatives, directors and supervisors) and senior managers of LLCs, with, as with parts one and two of this series, a particular regard to foreign-invested enterprises (FIEs).

Legal representatives

The new Company Law will create a significant change, from a practical point of view, in relation to the choice of the legal representative of LLCs, particularly FIEs. While the law currently provides that only the chairman or the general manager of an LLC can be appointed legal representative, under the new Company Law this position may be held by a director or a manager who “represents the company in executing company affairs”.

On the one hand, this gives shareholders a wider choice, but, on the other hand, it must fall onto a person who is actually involved in the management of the company’s activities. For foreign-invested LLCs, this may mean the end of the commonly adopted practice of appointing an individual overseas as a legal representative (just to fill in the position) without such a person being actually involved with the decision-making process of the company.

The new Company Law also states that the resignation of the legal representative from the position of director or manager will also determine the end of their office as legal representative.

Under the provisions currently in force, a legal representative would remain in office until a successor is appointed. This rule sometimes gives rise to situations where a person, having resigned as director or manager, would still be formally the company’s legal representative. The new provisions now require that a successor be appointed within 30 days. However, they do not describe what happens if the appointment of a replacement does not occur within the prescribed term.

Directors

As far as directors are concerned, the new Company Law also introduces a few significant changes.

From 1 July 2024, the board of directors of an LLC should have at least three directors, and there will no longer be an upper limit to the number of directors (currently capped at 13). As in the law currently in force, smaller-scale companies or companies with a small number of shareholders will still have the possibility to appoint a sole director (instead of a board of directors).

The new Company Law also states that if a company has at least 300 employees and there is no employee representative on the board of supervisors, at least one employee representative is required to sit on the board of directors.

This is a significant change, and for relatively large foreign-invested companies, this provision will require adjustments to be made to their organisation and governance structure, especially where the composition of the board of directors has been originally designed to specifically reflect the influence of the shareholders on the company (as is usual for joint venture companies).

The presence of an employee director on the board may also raise concerns about the confidentiality of certain issues dealt with by the directors that may relate to or affect the company’s employees.

It could, therefore, be expected that companies will opt to have employee representatives sitting on the board of supervisors and avoid having one appointed as director.

The new law has also slightly amended the distribution of functions and powers between the shareholders’ meeting and the board of directors. Unlike in the law currently in force, the function and power of “deliberating and approving annual financial budget plans and final account plans of the company” is not listed as an item of the functions and powers attributed to the shareholders’ meeting (thus – by exclusion – attributing the same to the board of directors).

Such an exclusion may be seen as surprising because many corporate legal systems actually consider the power to decide over the budget and approve the financials of the company as a prerogative of the shareholders. The articles of association of the company can, of course, provide for otherwise.

Such a provision consistently goes in the direction that seems to be followed by the new law, that is giving more powers (and a higher level of liability associated with such powers) to the directors.

In this same direction, the new law now considers the directors liable

• (i) for any loss caused to the company for not complying with their duty to call for payment of the subscribed capital by the shareholders and to send a notice of forfeiture of the shareholders’ rights to the defaulting shareholders that have not remedied their default within the grace period assigned to them;
• (ii) for losses caused by not calling the payment of the capital subscription ahead of the agreed term in the event of insolvency of the company;
• (iii) for losses caused to the company as a consequence of providing financial assistance for others to acquire shares in the company;
• (iv) for losses that are caused to the company or its creditors in a liquidation procedure where the directors appointed as liquidators have not fulfilled their duties in a timely manner;
• (v) for losses caused to the company by an illegitimate reduction of capital.

Most of these provisions stating liabilities onto the directors are also applicable to the supervisors and senior managers of an LLC.

The officers and senior personnel of a company should, therefore, start familiarising themselves with the latest requirements relating to the liability assigned to them by the new Company Law.

In this regard, the new law expressly mentions the possibility that a company takes up insurance for the liability of its directors. So called “D&O policies” (i.e. directors and officers insurance coverage) are likely to become more and more commonly used and popular products once the new law comes into force.

The post Exploring China’s New Company Law: Impact on Officers appeared first on Focus - China Britain Business Council.

China’s revised Company Law, which will come into effect on 1 July 2024, has 266 articles, about a third of which have been added or substantially modified. Of these, a number relate to the rights and obligations of shareholders.

The new Company Law will most certainly require LLCs to amend their articles of association or adjust their corporate or governance structure so as to comply with the new provisions, which will be easier in LLCs with a sole shareholder (or multiple foreign shareholders that are somehow connected, coordinated, or otherwise sharing the same objectives and interests regarding their investment in China).

However, these adjustments could prove complicated where the collaboration and consent of one or more Chinese shareholders are necessary (like in the case of joint venture companies), as adaptation could give a pretext for renegotiating some elements of the existing agreements between shareholders.

At this stage, shareholders, directors, supervisors or senior managers in Chinese companies are advised to start becoming familiar with the new provisions of the Company Law so as to be ready to implement the necessary adjustments when the implementation provisions are issued to supplement and clarify the new regulations.

Obligations of shareholders in case of share transfer

If a shareholder transfers their shares without the corresponding share capital being fully paid in, the buyer of the shares is liable for paying the unpaid share capital. In the event that the new shareholder defaults, the new regulations stipulate that the selling shareholder has a secondary (and not a joint and several) liability to pay in the unpaid share capital (that is, a claim against the selling shareholder may be brought forward only after enforcement against the acquiring shareholder is unsuccessful).

If, on the other hand, the shareholder transferring its shares is already in breach of the capital payment obligation at the time of the share transfer (i.e., payment has not occurred within the specified terms, has been made for a lesser amount, or assets of lesser value have been contributed), the selling shareholder and the acquiring shareholder are both jointly and severally liable for the amount of unpaid capital.

The acquiring shareholder can avoid such liability only by proving that they were unaware, and ought not to have been aware, of the circumstances regarding the insufficient capital payment (which is difficult to verify and even more difficult to demonstrate).

Right of withdrawal of minority shareholders

Under the new regulations, in the event a controlling shareholder abuses its rights and seriously harms the interests of the company or the other shareholders, minority shareholders have the right to have their shares purchased back by the company at a reasonable price.

The new rules for payment of share capital aim to ensure that companies are capitalised in line with the stated scope of business, thereby guaranteeing a sufficient and consistent contribution of financial resources. At the same time, the new provisions offer a higher level of protection to the rights and expectations of creditors, as opposed to the rights of shareholders, which appear now to be relatively diminished.

Also, the reformed regulations imply that the shareholders control the situation of the share capital payments of the other shareholders, so as not to risk being held responsible for the defaults of others.

In addition, the new rules on share capital payment assign stronger duties of verification to the directors, who may find themselves in situations of opposition or actual conflicts of interest with the shareholders when called to perform their duties.

Although a separation and sometimes opposition of roles is in line with other legal systems, it is important to keep in mind such increased distinction of roles and distribution of responsibilities in the Chinese company legal system, especially with regard to those small foreign-invested companies where the management body (often a sole director) is a direct emanation of the shareholders (or, often, the sole shareholder) and has a close contact and relationship with the ownership.

In this regard, particular attention should be paid to the provisions of the articles of association where a detailed regulation of the roles and responsibilities of shareholders and directors should be included to avoid any potential conflict.

Finally, depending on circumstances, some situations can also be adequately dealt with in shareholders’ agreements, the contents of which are binding only between the parties to the same and prevail over the provisions of the articles of association (that, instead, are meant to be applicable to all current and future shareholders).

Prohibition of financial assistance

The new Company Law introduces basic rules regarding the prohibition of financial assistance, like in many other legal systems. This prohibition intends to prevent or limit the possibility of a company providing loans or guarantees aimed at facilitating the acquisition of its own shares (or shares of its controlling company), primarily to protect the minority shareholders and creditors of the company.

The prohibition is not absolute: financial assistance is still allowed if it is finalised towards the implementation of a plan promoting the purchase of shares by employees of the company or is in the interest of the company.

However, the total amount of financial assistance cannot exceed 10% of the issued share capital.

Exceptions to the limited liability of shareholders

In Chinese LLCs – as in many other legal systems – the shareholders are not personally liable for the company’s debts and obligations, even if they have acted on behalf of the company.

Therefore, in principle, an LLC is liable for its debts and obligations only with its own assets, and its shareholders generally benefit from a liability that is limited to what they had committed to contribute.

The Company Law sets forth exceptions to the principle of limited liability of shareholders by establishing that if a shareholder abuses its rights and prevents the company from paying its debts and, in doing so, causes substantial damage to the company’s creditors, the abusing shareholder is jointly and severally liable for the debts of the company.

The regulations consider not only the abuse by the shareholder of the advantages of the limited liability relating to the company of which it is a shareholder (so-called “vertical” abuse), but also situations where the abuse involves other companies controlled by the same shareholder (so-called “horizontal” abuse).

Liability of the controlling shareholder and actual controller of a company

The new Company Law contains some provisions for those subjects that control a company and interfere or exercise influence on the management of the company.

Controlling subjects are defined by the company law (both in the current version and in the reformed one) in two categories:

(i) controlling shareholders, who hold at least 50% of the share capital or, if a lower percentage, have sufficient voting rights to exercise a significant influence on the shareholders’ resolutions, and;

(ii) actual controllers, who are subjects (not necessarily shareholders) capable of exercising effective control over the company through investment relationships, contracts, or other arrangements.

The new regulations establish that a controlling shareholder or an actual controller who, although not appointed as a director of the company, effectively carries out activities on behalf of the company, is then obliged to abide by the duties of loyalty and diligence towards the company (similarly to a director, supervisor, or other senior manager) and, consequently, assume the responsibilities for any breach of such duties.

Likewise, if a controlling shareholder or the actual controller gives instructions to a director or a senior manager to engage in behaviours that damage the company or its shareholders, the controlling shareholder or actual controller will be considered jointly and severally liable together with the involved director or manager.

The provisions regarding the controlling shareholder add to those mentioned above concerning the abuse of such a position and the consequent granting of a right of withdrawal to the minority shareholders that have been damaged.

The post Exploring China’s new Company Law: Shareholders appeared first on Focus - China Britain Business Council.

After a long revision process, on 29 December 2023, the Standing Committee of the National People’s Congress issued the new Company Law, 30 years after the first company law was enacted.

The new Company Law will come into effect on 1 July 2024, introducing numerous changes and innovations. The new law consists of 266 articles, of which about one-third have been added or substantially modified.

This new series from HFG focuses primarily on the provisions applicable to Chinese limited liability companies (LLCs), as this is the corporate type most often adopted for foreign investments in China. Of course, the new law also touches upon provisions applicable to the other commonly used corporate type, joint stock companies.

This first article focuses on the most significant change to the Company Law: the introduction of the general obligation for the shareholders to pay in the subscribed capital within five years from the establishment of the company.

How capital contribution obligations will change under the new Company Law

Under the current provisions, there is no general obligation to pay capital within a specified period, nor does a general minimum capitalisation requirement generally exist. The amount of the social capital and the terms and conditions of its payment are left to the free determination of the shareholders, as expressed in the company’s articles of association.

However, from 1 July of this year, the rules will change: whether upon establishment or capital increase of a company, the subscribed share capital must be paid in within the maximum period prescribed by the law (or within the specified terms if a payment by instalments has been agreed to).

LLCs will also be obliged to publish not only their registered share capital, but also the amount of share capital actually paid in (as well as the terms and conditions of contribution) in the National Enterprise Credit Information Publicity System.

At present, the only existing transitory provision of the Company Law states that companies already established at the time of the entry into force of the new law are required to make gradual adjustments to comply with the new terms set by the law. The Company Law then expressly indicates that the State Council will issue implementation regulations in this regard.

The new regulations have codified a previous judicial practice, and now prescribe that if a shareholder does not contribute the subscribed capital within the specified term and for the specified amount, in addition to the liability of such defaulting shareholder towards the company for any damages caused by such default, there is also a joint liability of the other founding shareholders for the portion of capital not contributed by the defaulting shareholder.

This means that an unsatisfied creditor could seek compensation not only against a shareholder that has not fully or punctually  contributed its share capital, but also against the other founding shareholders within the limit of the amount not contributed.

It is now expressly provided for that it is the responsibility of the directors to call, by way of a written request, for the defaulting shareholders to pay in the subscribed capital. The regulations in this regard make the directors liable to the company for any losses caused by their failure to fulfil this obligation to call for the contribution of the subscribed capital.

In the written call to defaulting shareholders, the directors may establish a “grace period” (not shorter than 60 days) within which the defaulting shareholders must remedy.

After the grace period expires without remedy, the company may, by resolution of the board of directors, send a written notice of forfeiture of the shareholder’s rights regarding the portion of the unpaid share capital, meaning that there will be either a transfer of such shares or their cancellation (and, consequently, a reduction of the company’s share capital).

If the portion of the share corresponding to the unpaid capital is not transferred or cancelled within six months from when the forfeiture notice is sent out, the law says that the other shareholders will be obliged to contribute the missing capital in proportion to their respective shares.

A note on accelerated payment

The new regulations also provide for a case of accelerated payment of share capital (compared to the term initially agreed to). Where the company is insolvent before the deadline for the contribution of the share capital, the company itself or its creditors may request the shareholders to pay the subscribed capital before the expiry of the term indicated in the articles of association.

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