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

The new Company Law will come into effect on 1st July 2024, introducing numerous changes and innovations compared to the previously applicable rules.

The new law consists of 266 articles, of which about one third have been added or substantially modified. It, therefore, can be considered a mini-reform of the legal framework applicable to companies in China.

In this review, we will analyse the most significant changes in the Company Law, dividing them by topic and focusing on their expected impact on the business activities and corporate organization of foreign-invested companies already present in China. In subsequent articles, we will examine and comment on innovations related to shareholders, legal representatives, administrators, supervisors, and senior managers.

We will dedicate our attention primarily to the provisions applicable to Chinese Limited Liability Companies (LLCs), as this is the most adopted corporate type for foreign investments in China. Of course, the new law also touches upon the provisions applicable to the other commonly used corporate type, the Joint Stock Companies.

However, the provisions of the new Company Law are not sufficient to fully outline the new regulatory framework. As indicated in the Company Law itself, further integration and clarification will be needed. These will be provided, on the one hand, by secondary legislation (already announced in the Company Law, but not yet developed) and, on the other hand, by the future judicial and administrative application of the new regulations.

These integrations and clarifications are particularly necessary with regard to some parts of the new Company Law that already raise doubts as to their interpretation and or application.

Capital Contribution Obligation

The most significant change is the introduction of the general obligation for the shareholders to pay in the subscribed capital within five years from the establishment of the company.

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

From 1st 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 installments 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 this stage, 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 is to 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 the shareholder who has not fully or timely 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, 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 fulfill 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 canceled 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.

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 subscribe capital before the expiry of the term indicated in the articles of association.

Obligations of Shareholders in Case of Share Transfer

If a shareholder transfers its 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 (that is does not pay the remaining unpaid capital in full or in time), 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 it was unaware, and ought not to have been aware, of the circumstances regarding the insufficient capital payment (such a fact being, in any case, difficult to verify and even more difficult to demonstrate).

Right of Withdrawal of Minority Shareholders

The new regulations provide for a particular case of right of withdrawal granted to minority shareholders in the event a controlling shareholder abuses its rights deriving from its position and seriously harms the interests of the company or the other shareholders. In such a situation, minority shareholders are given the right to have their shares purchased back by the company at a reasonable price. 

The new provisions also state that the relevant shares must either be transferred or cancelled within six months.

The new rules regarding payment of share capital aim to ensure an effective and adequate capitalisation of companies, in line with the stated scope of business, thereby guaranteeing a sufficient and consistent contribution of financial resources to the company. At the same time, the new provisions give greater weight and offer a higher level of protection - when compared to the previous provisions - 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 the recommendation 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.

Moreover, the new rules on capital payment and the resulting liabilities for the shareholders selling or acquiring shares strongly suggest additional caution both at the moment of incorporation of the company, where the amount of the share capital must be determined with greater care and judgment, and when shares are transferred. 

Such accrued caution in verifying the level of capitalisation, implies a careful analysis of the compliance of the shareholders vis-à-vis their obligations of capital payment, as well as a verification of any possible liability that may arise on the transferees of shares (and, in some cases, also onto the transferors).

Similarly, the new rules on share capital payment assign stronger duties of verification on, and require a more proactive attitude from, the directors, who may find themselves in situations of opposition or actual conflict of interests with the shareholders when called to perform their duties.

Although a separation and sometimes opposition of roles is in line with the principles governing the functions of company organs and their relationships in 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 situation of 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, better, limit) the possibility for a company to provide 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 finalized towards the implementation of a plan promoting the purchase of shares by employees of the company or is in the interest of the company (as expressly established by a resolution of the shareholders or directors, in the latter case based on the provisions of the articles of association or an explicit authorization of the shareholders', and in any case with the positive vote of at least two thirds of all the directors).

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 - like in limited liability companies under 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, a limited liability company 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. 

Such a principle implies that, in the event a company does not pay its debts, its creditors do not have a right of recourse against the personal assets of the shareholders.

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 involve other companies controlled by the same shareholder (so-called "horizontal" abuse), providing for in this latter case a joint and several liability of all the companies involved.

Still on the topic of the limited liability of the shareholders, it is interesting to note the provision that establishes a joint and several liability of the sole shareholder for the debts of the company if the sole shareholder fails to demonstrate that the company's assets are actually independent from the shareholder’s assets. The burden of proving that the assets are indeed separate lying, therefore, with the sole shareholder.

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 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. Such amendments and adjustments will be easier to implement 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, such adjustments could prove more complicated to implement where the collaboration and consent of one or more Chinese shareholders are necessary (like in the case of joint venture companies), as the need or request for adaptation to the new legal environment could also give rise to a pretext for renegotiating some elements of the existing agreements between shareholders, thus redefining the equilibrium in the control and management of the company.

At this stage, it is advisable for those who hold a position of shareholder, director, supervisor or senior manager within a Chinese company to start becoming familiar with the new provisions of the Company Law, while closely monitoring the development of the law, so as to be ready to implement the necessary adjustments when the implementation provisions will be issued to supplement and clarify the new regulations.