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
All Rights Reserved
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