June 2022
Di Wu and Teresa Huang
On December 20, 2021, the Standing Committee of the National People’s Congress introduced the draft Amendments to the Company Law (hereinafter, the “Draft”) after deliberation, and public opinions were solicited on December 24, 2021 until January 1, 2022, when the solicitation of public opinions was concluded. Currently, there has been no further deliberation progress. The amendments in the Draft are very comprehensive, including but not limited to: expanding the legal liabilities of legal representatives, shareholders, directors, supervisors, and other officers, increasing some of the rights of shareholders, etc. This Firm will interpret some highlights of the amendments, which are specifically provided below:
I. Simplification of systems concerning a company’s incorporation, adoption of resolutions, and withdrawal
The Draft added Paragraph 3 of Article 26, Article 34, Article 76, and Article 235 to further simplify the company registration system and streamline the process of company establishment and withdrawal. In addition to clarifying the incorporation registration of the company, amendment registration, cancellation registration, and other matters and procedures, company registration authorities are also required to optimize the registration process and enhance the efficiency and convenience of registration. In addition, the legal effects of electronic business licenses, announcements released through a unified enterprise information disclosure system, and resolutions adopted through electronic communications are clarified, and the process of company cancellation is simplified by streamlining the cancellation terms and procedure. Meanwhile, the provisions of Articles 228, 229, and Article 234 of the Draft also improve the company liquidation system by providing that the directors are the liquidation obligors and are simpler and conducive to the faster completion of the liquidation process as compared with the provisions of the current Company Law (i.e., the requirements that the liquidation group of a limited liability company shall consist of shareholders, and the liquidation group of a company limited by shares shall consist of directors or persons determined by the directors or general shareholders’ meeting). The Draft also strengthens the obligations and responsibilities of liquidation obligors and members of the liquidation group, and adds the provision that the registration can be canceled through a simplified procedure after all shareholders have made a commitment to perform the debts.
II. Expansion of the scope of property that can be used as capital contribution
Pursuant to the provisions of Article 43 of the Draft, the property that can be used as capital contribution by shareholders includes money, intellectual property, in-kind contributions, land use rights, equity, and claims. As compared with the provisions of the current Company Law (which are limited to money, intellectual property, in-kind contributions, and land use rights), the scope of capital contribution is more extensive. In practice, it is not uncommon for shareholders to make capital contributions in the form of “equity” and “claims,” which mostly take place in the format of “debt-equity swap” and “employee equity incentive,”etc., but this is not clarified at the legal level, resulting in disputes in practice where no legal provisions can be relied on. The Draft clarifies for the first time that “equity and claims” can be used as capital contribution assets, thus increasing corporate financing channels, effectively reducing the cost of corporate financing, and reducing the financing pressure of operators.
III. Permitted establishment of single-shareholder companies limited by shares
Paragraph 2 of Article 93 added to the Draft provides that one natural person or one legal person that sets up a company limited by shares by way of promotion shall be a single-shareholder company limited by shares. The provision of this article specifically allows the establishment of single-shareholder companies limited by shares. Under the current Company Law, a person can only set up a limited liability company, and if the company is planning to go public, the “share reform” should be conducted first to increase the number of shareholders of a company limited by shares to meet the main qualifications for an entity going public. The Draft expands the scope of a single-shareholder company and encourages more people to start their own businesses independently. In addition, since a company limited by shares can publicly offer shares to society, its financing methods are more flexible, thereby further increasing the financing methods of businesses, reducing the financing pressure of operators, and unleashing market vitality.
IV. Clarification of the collection procedure and liability for defective capital contribution by shareholders and the expansion of the joint and several liability of directors, supervisors and senior executives
Pursuant to the provisions of Articles 46 and 47 of the Draft, if a shareholder fails to make the capital contribution in full on time or if the actual value of the non-monetary property used as capital contribution is obviously lower than the amount of capital subscribed after the establishment of the company, a written reminder shall be sent to the shareholder, and the grace period stated in the reminder shall not be shorter than sixty days. If the shareholder still fails to pay upon expiration of the grace period, the company may issue a notice of loss of rights to the shareholder, and the shareholder shall lose the equity for his/her unpaid capital from the date of the notice, and the company shall transfer or reduce the registered capital and cancel the equity within six months.
If the shareholder supplements the registered capital, s/he shall make up the difference and pay the interest on bank deposit for the same period, and, if the company incurs any losses, be held liable for compensation, while the other shareholders at the time of the company’s establishment should assume the joint and several liability. Directors, supervisors, and senior executives shall also be liable for the damage caused to the company when they are aware or should be aware that the shareholder has engaged in the above-mentioned act.
The current Company Law does not specify whether the directors of the company shall be liable for the capital contribution owed by the shareholders, including when the company is established and when the capital is increased, but pursuant to the Provisions of the Supreme People’s Court on Several Issues Concerning the Application of the Provisions of the Company Law of the People’s Republic of (III) (hereinafter, the “Judicial Interpretation III of the Company Law”), if shareholders fail to fulfill or fully fulfill their obligations to make capital contribution upon capital increase of the company, the directors and senior executives that fail to fulfill their duties of loyalty and diligence shall assume the corresponding liability. The Draft clearly refers to the provisions of the Judicial Interpretation (III) of the Company Law and extends the scope of joint and several liability of directors, supervisors, and senior executives to include the founding of the company to urge the shareholder to make capital contribution timely, further safeguard the interests of creditors and promote the healthy operation of the company.
V.Provisions on the accelerated expiration of capital subscription and contribution
Article 48 of the Draft provides that if a company cannot pay off its debts as they fall due with an apparent lack of solvency, the company or a creditor has the right to request the shareholders who have subscribed to the capital to pay their contributions in advance when the capital subscription period has not expired.
This article is newly added to the Draft. The current Company Law does not specifically provide for the circumstances where the expiration of the capital contribution is accelerated. Under the registered capital subscription system, shareholders are entitled to the benefit of the term in accordance with law if the term of the shareholders’ capital contribution has not expired. However, there are exceptions. The inability of the company to pay off its debts as they fall due with a clear lack of solvency suggests that the company has become insolvent, requiring the shareholders who have subscribed to the capital to pay the capital contribution in advance when the capital contribution payment period has not expired to enhance the company’s solvency and protect the interests of the company and creditors.
In addition to the requirement in this article that “the company is unable to repay its debts when they fall due,” the condition of “an apparent lack of solvency” is added. As to how to determine if a company “obviously lacks solvency,” Article 4 of the Provisions of the Supreme People’s Court on Several Issues Concerning the Application of the Enterprise Bankruptcy Law of the People’s Republic (I) and Article 6 of the Circular of the Supreme People’s Court on Printing and Circulating the Minutes of the National Courts’ Civil and Commercial Trial Work Conference provide that the following circumstances can be generally summarized as follows:
(1) the company is unable to repay its debts due to a serious lack of funds or the inability to cash its property;
(2) the whereabouts of the legal representative is unknown, and there is no other person in charge of managing the property, resulting in the inability to pay off the debts;
(3) the company is unable to repay its debts after compulsory enforcement by the people’s court;
(4) the company is unable to settle its debts due to long-term losses and difficulties in reversing the losses;
(5) the company is subject to compulsory enforcement in a case where the people’s court has exhausted all enforcement means without any available property for enforcement and the company does not file bankruptcy even though the grounds of bankruptcy have been established;
(6) after the company’s debts are created, the company’s (general) shareholders’ meeting has adopted a resolution or resorted to other means to extend the shareholders’ capital contribution period; or
(7) there are other circumstances that lead to the company’s loss of solvency. From the perspective of creditor protection, a company subject to any of the above circumstances can be deemed to “obviously lack solvency” and should be able to apply for accelerated expiration of the capital contribution period.
VI. Creation of additional classes of shares
Pursuant to the provisions of Article 96, Paragraph (5), Article 157, and Article 158 of the Draft, a company limited by shares may directly issue classes of shares. Classes of shares are shares of different types and with different rights in the equity structure of the company, differing in liquidity, price, rights, and obligations. The current Company Law emphasizes equal rights for the same shares, i.e., shareholders having one vote for each share they hold when attending the shareholders’ meeting. After the Draft provides for classes of shares, a company’s shares can be differentiated in terms of voting rights, profit distribution rights, preemptive rights, share transfer rights, etc. Different requirements for classes of shares may be formulated according to the specific situation of the company and different requirements of investors to better facilitate the operation of the company and meet the needs of investors. Meanwhile, the Draft also stipulates that if a company issuing classes of shares may cause damage to the rights of the holders of the classes of shares, it is required that such matters shall be approved not only by the shareholders attending the meeting and holding shares representing at least two-thirds of the voting rights but also by the shareholders attending the class shareholders’ meeting and holding shares representing over two-thirds of the voting rights. This practice ensures the company’s flexible operation, meets the needs of investors, and protects the rights and interests of class shareholders.
VII. Introduction of the authorized capital system
Articles 97 and 164, as added to the Draft, provide for the introduction of the authorized capital system and related procedures in companies limited by shares. The authorized capital system refers to the company capital system where the total registered capital is determined in the company’s articles of incorporation at the time of its establishment, and the promoters only need to subscribe to part of the shares to set up the company with the board of directors authorized to issue the remaining shares according to the company’s business conditions and the securities market at any time. The authorized capital system grants the company’s board of directors a high degree of governance authority, promotes the flexibility of the company in issuing and raising capital, simplifies the procedures for establishing the company on the one hand and simplifies the decision-making process for issuing new shares on the other hand. This quickens the company’s decision-making process, reduces the company’s agency costs, and is conducive to the company’s ability to raise capital in the capital market. In short, introducing the authorized capital system not only facilitates the establishment of a company limited by shares, but also provides the company with the flexibility to raise capital by issuing new shares and can reduce issues such as inflated registered capital.
VIII. Addition of an audit committee
Article 64 of the Draft provides that a limited liability company may, in accordance with the provisions of its articles of association, set up an audit committee consisting of directors under the board of directors to take charge of supervising the company’s financial and accounting matters and exercising other authorities as provided for in the articles of association. A limited liability company that has an audit committee under the board of directors may do without a board of supervisors or supervisors.
The board of supervisors has been unable to perform its functions over the matters provided for under the Company Law. The intention of the Draft to set up an audit committee is also to perform the duty of supervising the company’s finance and accounts to ensure the compliant and lawful operation of the company. Of course, the establishment of an audit committee is also an option, not a mandatory requirement, in the revised Draft.
Article 153 of the Draft provides that a wholly state-owned company must have an audit committee composed of directors and other special committees under its board of directors, and that the majority of the members of the audit committee shall be outside directors, while the establishment of the board of supervisors or supervisors is abolished. It is also clear that the audit committee will play an increasingly important role, and setting up an audit committee is likely to become a mandatory requirement for companies in subsequent amendments.
IX. Addition of the provision that shareholders can review accounting documents
Pursuant to Article 51 of the Draft, shareholders have the right to review and copy the company’s articles of incorporation, the roster of shareholders, minutes of shareholders’ meetings, resolutions of the board meetings, resolutions of the supervisory board meetings, financial and accounting reports, the company’s accounting books and accounting receipts. Compared with the provisions of the current Company Law, the scope of review that may be conducted by shareholders is broader.
Article 113 of the Draft provides that shareholders who individually or collectively hold one percent of the company’s shares or more for 180 consecutive days or more and have reason to suspect that the execution of the company’s business is in violation of laws, administrative regulations or the company’s articles of incorporation may entrust accounting firms, law firms and other intermediaries, which bear confidentiality obligations in accordance with their code of professional conduct, to inspect the company’s accounting books and accounting receipts to the extent necessary. If the company refuses to provide access, the shareholders may file a lawsuit in the people’s court.
Pursuant to the above two articles, the Draft strengthens the protection of shareholders’ right to know, which has especially important implications to shareholders who are not involved in the management of the company. The current Company Law does not stipulate whether shareholders can inspect the company’s accounting receipts. As a result, there is no clear legal basis in practice if a plaintiff shareholder requests access to the company’s accounting receipts. If a shareholder files a lawsuit on this ground, some courts will dismiss it on the ground that the law does not provide that shareholders can inspect accounting receipts. The release of the Draft can better clarify the scope of shareholders’ right to know and better protect shareholders’ rights.
X. Strengthened regulation of connected transactions
Article 183, as added to the Draft, stipulates that directors, supervisors, and senior executives who directly or indirectly enter into contracts or transactions with the company shall report to the board of directors or the shareholders’ meeting on matters related to the conclusion of contracts or transactions, and shall be subject to resolutions adopted by the board of directors or shareholders’ meeting in accordance with the provisions of the articles of association. When a resolution is being deliberated at a board meeting, the connected directors shall not participate in the voting and their voting rights shall not be counted in the total number of voting rights. In addition, the foregoing provisions shall also apply to the close relatives of the directors, supervisors, or senior executives, or enterprises directly or indirectly controlled by the directors, supervisors, or senior executives, the close relatives of the directors, supervisors or senior executives, as well as connected persons with whom the directors, supervisors and senior executive have any other association relationship, when they enter into contracts or conduct transactions with the company.
In practice, it is common for directors, supervisors, or senior executives to improperly transfer the company’s assets through their connected transactions with the company, resulting in a large number of unsatisfied creditors’ claims as they fall due and seriously undermining the interests of creditors. Such an article strengthens the requirement that companies shall fulfill the statutory reporting and resolution procedures when conducting connected transactions with their directors, supervisors, senior executives, and their connected persons.
Compared with the current Company Law, the Draft focuses more on the protection of minority shareholders and creditors, strengthens the responsibilities of shareholders as well as directors, supervisors, and senior executives, and is more conducive to the healthy development of the market. The Draft also expands a company’s scope of financing and reduces the pressure on its operation. Overall, there are many innovative ideas in the revision of the Draft, and the effect of its implementation in practice after its formal adoption can be expected in the future.
(The authors’ opinions do not represent the position of this law firm.)