Following the initial draft amendment to the PRC Company Law by the National People’s Congress of China (NPC) on 24 December 2021 (“First Draft Amendment”), the NPC released further amendments on 30 December 2022 (“Second Draft Amendment”) and 1 September 2023 (“Third Draft Amendment”) respectively for seeking public opinion on the proposed changes. The proposed amendments entail increased responsibilities for shareholders and directors of companies in China. Upon implementation, these amendments will directly affect foreign-invested enterprises (FIEs), particularly those structured as limited liability companies (“LLC”) and companies limited by shares (“CLS”), engaged in business activities across various sectors within China.
The key aspects of the proposed amendments in the Second Draft Amendment and Third Draft Amendment to which FIEs should pay particular attention are as follows:-
1. Capital Contribution Requirements
A major revision in the Third Draft Amendment is the proposed requirement for shareholders of LLCs to fully pay up their registered capital within 5 years from the company’s date of incorporation. Currently, the timeline for making capital contributions can be determined by the shareholders and it is common that a relatively long period (for example, 20 or 30 years) be provided.
The proposed amendment significantly reduces shareholders’ flexibility in relation to the timeline for fulfilling capital contributions. However, the draft amendment does not address the treatment of companies that were previously established with longer capital contribution periods, creating potential practical challenges upon the implementation of the new PRC Company Law. It is anticipated that this practical issue will be addressed in subsequent amendments.
2. Directors’ Liabilities
Directors of a LLC are responsible for verifying the status of the contribution of the company’s registered capital. Specifically, the Third Draft Amendment introduces a new notice requirement whereby the board of directors is required to serve a notice to demand capital contributions from a shareholder who has failed to fulfil its capital contribution obligations within the stipulated timeframe. Such payment notice may include a grace period of not less than 60 days. Upon expiration of the grace period, if the shareholder still fails to fulfill its contribution obligations, such defaulting shareholder will lose its rights associated with the unpaid registered capital.
Where it is found that the directors failed to diligently oversee and enforce the shareholder's capital contribution obligations, resulting in financial losses incurred by the company, such directors will be held responsible and shall be personally liable for such losses.
As it is common for FIEs to appoint senior employees of the head office to serve as directors of the subsidiary in China, the proposed amendment's imposition of personal liabilities on directors may impact decisions for these individuals to serve as directors.
3. Accelerated Capital Contribution Obligations
Under the current PRC Company Law, shareholders of a LLC are not obligated to make full contribution of the registered capital before the specified due date in the Articles of Association, even when the company fails to pay off its due debts.
A significant revision was made in the Second Draft Amendment which provided that if a LLC is unable to pay off its due debts, the company or the relevant creditors have a right to demand the shareholders to fulfill their capital contribution obligations for their subscribed but unpaid capital, even though the contribution period has not yet expired. This is followed in the Third Draft Amendment.
In such situations, creditors have the option to initiate bankruptcy proceedings against the company and the shareholders will not only lose their rights associated with the unpaid capital, but also be accountable for the company's debt up to the extent of their subscribed but unpaid capital.
4. Equity Transfer – Responsibilities of Transferor and Transferee
The current PRC Company Law does not address whether the transferor or transferee in an equity transfer of a LLC shall bear the contribution obligations involving unpaid capital contribution. The Second Draft Amendment shed some light on this matter:
(i) If at the time of transfer, the relevant capital contribution is not yet due, the transferee shall be responsible for the future contribution obligations.
(ii) Further, if upon the capital contribution becoming due and the transferee fails to make the contribution, then a secondary liability will be imposed upon the transferor to fulfil such outstanding capital contribution.
Selling shareholders should bear in mind the potential risk of making a capital contribution despite having already transferred their equity interest to another.
5. Corporate Governance and Organizational Structure
The First Draft Amendment introduced the option of a single-tier organizational structure composing a board of directors and an audit committee (dispensing the board of supervisors or supervisors). The composition of the audit committee was elaborated in the Second Draft Amendment.
While there are no prescribed requirements regarding the number or qualifications of members serving on the audit committee of a LLC, the Second Draft Amendment did provide that a CLS can form an audit committee consisting of three or more members and more than 50% of such members should not hold any other position within the company, other than as a director. The above proposed changes have also been followed in the Third Draft Amendment.
6. Introduction of Employee Representative in the Board of Directors
It is proposed in the Third Draft Amendment that LLCs with less than 300 employees may consider including employee representatives on their board of directors. However, for larger companies exceeding 300 employees, this requirement becomes mandatory.
7. Enhanced Protection of Shareholders’ Rights
The Third Draft Amendment introduces provisions aimed at reinforcing the protection of shareholders' rights. Key emphases include:
(i) Enhanced Shareholder Access: the amendment recognizes the importance of empowering shareholders by granting them the right to review and obtain copies of relevant company documents, including resolutions of directors and supervisors and accounting documents.
(ii) Upholding Shareholder Participation: The amendment prohibits companies from raising the required percentage of shareholding required to propose a shareholders' resolution.
(iii) Accountability of Directors and Senior Management: The amendment reinforces accountability by establishing joint and several liability for directors or senior management personnel, alongside controlling shareholders or actual controllers who exploit their influence to incite detrimental actions. If such actions result in losses to the company, all involved parties will bear responsibility for the damage incurred.
Conclusion
The successive release of draft amendments to the PRC Company Law demonstrates the commitment of the Chinese government in enhancing the business environment with improved corporate governance practices and protection of shareholders’ rights. FIEs operating in China and potential investors should keep abreast of the updates on the proposed amendments and the potential impact on them upon the amendments being finalised. We will continue to monitor further developments in this area and provide further updates.
© Vivien Chan & Co., Newsletter issue 10, October 2023
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