Issue4 Unveiling China's Amended Company Law: Highlights, Changes & Actions
China has recently undergone substantial revisions of its Company Law (the "New Company Law"), introducing 112 new or revised articles to its existing framework of 218 articles—an overhaul exceeding 50%. The New Company Law, effective from July 1, 2024, stands as the most fundamental law in the business domain, governing critical aspects of every company. It's important to recognize that certain amendments carry retroactive implications, potentially necessitating adjustments to the governance structures and articles of association for MNCs' Chinese subsidiaries. MNCs engaged in joint ventures in China should also anticipate the need for amendments to shareholder agreements and constructive negotiations with their joint venture partners.
This frontline highlight certain key aspects of the New Company Law and summarize the key impact the New Company Law will have on FIEs, as well as the suggestions as to next steps to be taken.
Here, we present the primary changes that hold significance to MNCs operating in China.
1. Allow A More Flexible Corporate Governance Structure
- No mandatory board of supervisors is required if an audit committee, consisting of directors and performing the same functions as the board of supervisors, is established under the board.
- Under the current Company Law, companies with a small size or a limited number of shareholders have the flexibility to appoint a single director and one to two supervisors in lieu of a board of directors and board of supervisors. Now, such companies may choose to have no supervisor at all with unanimous approval from all shareholders.
- Companies with 300 or more individuals now must include a democratically elected employee representative on the board of directors, unless there is already an employee representative on the board of supervisors — a new requirement for sizable companies.
- Any director or manager executing affairs on behalf of the company is now eligible to serve as the legal representative (the sole statutory agent) of the company, representing an expanded candidate pool for this role.
2. Define Corporate Executives' Fiduciary Duties
- Duty of Loyalty and Duty of Care: The New Company Law formally defines fiduciary duties for directors, supervisors, and senior managers. This includes taking measures to avoid conflicts of interest with the company or using their power for improper gains (duty of loyalty). Additionally, they are required to act in the best interest of the company and exercise the reasonable care normally expected of a manager (duty of care).
- Personal Liability for Third-Party Claims: Directors and senior managers will now be personally liable for damages caused to third parties in the performance of their duties due to intentional misconduct or gross negligence — a newly added dimension of personal liability.
- Self-Dealing and Safe Harbor Rule: Directors, supervisors and senior managers intending to enter into contracts or transactions with the company must report to the board of directors or shareholders meeting and obtain approval. This rule extends to their close relatives, controlled entities and other interested parties.
- Corporate Opportunity and Safe Harbor Rule: Directors, supervisors and senior managers shall not usurp business opportunities of the company, except (i) if such a situation is reported to the board of directors or shareholders and approved; or (ii) if the company is unable to seize such opportunity due to legal restrictions or restrictions in the company's articles of association.
- Non-Compete and Safe Harbor Rule: Directors, supervisors and senior managers shall not engage in a business similar to that of the company, either personally or on behalf of others, unless it is reported to the board of directors or shareholders meeting and approved.
3. Enhance Shareholders' Accountability for Their Subscribed Capital
- Payment Deadline: In contrast to the current practice where shareholders can freely determine the payment period, shareholders of a limited liability company (LLC) must now pay their subscribed capital in full within five years of incorporating the company. A shorter period may be agreed in the articles of association. Shareholders failing to meet the agreed-upon deadline must indemnify the company for any resulting losses. Existing companies will be granted a transition period to gradually adjust their payment period to within five years. Notably, the five-year deadline also applies to subsequent capital increases.
- Payment Acceleration: The five-year payment deadline may be further accelerated by the company or its creditors if the company is unable to discharge its debts as they become due.
- Forfeiture of Unpaid Shares: Shareholders who fails to pay up their subscribed capital within the agreed deadline risk forfeiting the relevant unpaid shares after the company issues a written call for payment and a grace period of no less than 60 days has passed. The company may give effect to the forfeiture through written notice to the non-compliant shareholder, who retains the right to challenge such a decision through legal action.
4. Regulate Controlling Shareholder's Conduct
- De Facto Director: The New Company Law extends the application of corporate executives' fiduciary duties to controlling shareholders or actual controllers who, while not formally serving as directors, actually execute the company's affairs.
- Shadow Director: Instead of operating in the shadows, controlling shareholders or actual controllers who instruct directors and senior managers to engage in acts harmful to the interests of the company or other shareholders shall be jointly liable with such directors and senior managers.
5. Protect Minority Shareholders
- Under the current Company Law, dissenting shareholders may request the company to repurchase its shares at a reasonable price if they vote against specific resolutions, such as not distributing profits for consecutive 5 years when the company is capable of doing so, mergers, divisions, or the sale of material assets, etc.
- Under the New Company Law, minority shareholders may also request the company to repurchase its shares at a reasonable price if the controlling shareholder abuses its rights, causing severe harm to the interests of the company or other shareholders.
6. Expand The Scope of Derivative Claims to Wholly-Owned Subsidiaries
- Under the current Company Law, shareholders may file a derivative claim on behalf of the company against corporate executives involved in misconducts or third-party infringers under the following situations:
(i) The shareholder has demanded the board of directors or board of supervisors to file the claim, but such demand was refused;
(ii) The shareholder has made a demand but a claim was not filed within 30 days of the demand; or
(iii) An emergency occurred, and the company may suffer irreparable harm if the claim is not filed immediately.
- Under the New Company Law, the shareholder's right to file a derivative claim also extends to the company's wholly-owned subsidiaries.
7. Reinforce "Piercing the Corporate Veil"
- Vertical Piercing: Under the current Company Law, shareholders who exploit the independent legal personhood of the company and limited liability of shareholders to evade debts, causing severe harm to the interests of the company's creditors, should be jointly liable for the company's debts.
- Horizontal Piercing: The New Company Law goes further to stipulate that whena shareholder uses two or more companies under its control to engage in the above misconduct, these companies shall be jointly liable for each other's debts.
8. Loosen The Right of First Refusal (ROFR) Process
- A shareholder planning to sell shares to an external party must notify other shareholders in writing, specifying the conditions. The previous requirement for approval by more than half of other shareholders has been eliminated.
- Other shareholders have the ROFR under the same conditions. If other shareholders fail to respond within 30 days, their ROFR is deemed waived.
9. Enforce Proportional Capital Reduction
- A reduction in the company's share capital must be proportional to the shareholders' shareholding percentages, unless:
(i) Unanimously agreed upon by all shareholders (in the case of an LLC);
(ii) Agreed upon in the articles of association (in the case of a joint stock company); or
(iii) Prescribed by law.
10. Introduce Different Classes of Shares for Joint Stock Companies
- Joint stock companies now may issue different class of shares including:
(i) Preferred or subordinated shares;
(ii) Shares with greater or fewer voting rights;
(iii) Shares with transfer restrictions; and
(iv) Other classes of shares permitted by the law.
In addition, the New Company Law introduces other notable changes, including streamlining the incorporation and deregistration of companies, broadening shareholders' information rights, and allowing greater flexibility for shareholders in delegating powers to the board, among other revisions.
1. Introduction of a 5-year maximum contribution period
Until 2014, the shareholders of a LLC were required to contribute the full amount of the LLC's registered capital within 2 years as of the establishment of the LLC. This had then been further relaxed, and currently the shareholders of a LLC can freely decide on the capital contribution schedule in the LLC's Articles of Association. Under the current regime, the capital contribution schedule can generally extend to the whole lifetime of a LLC.
However, this will change under the 2023 Company Law, which re-introduces a maximum capital contribution period. According to the 2023 Company Law, the shareholders of a LLC must fully contribute their respective portion to the registered capital in accordance with the LLC's Articles of Association within 5 years from the establishment of the LLC. For a company limited by shares, the promoters shall already make full capital contribution before the establishment of the company.
This new 5-year contribution period will in any case apply to all LLCs to be established on or after 1 July 2024. With regard to LLCs already existing at that time, the 2023 Company Law provides that these LLCs "shall gradually adjust" to the 5-years' contribution period, and that if "the contribution period or amounts are significantly abnormal, the company registration authority may, in accordance with the law, require timely adjustments". It is further provided that the State Council will provide for specific implementation measures in this regard.
Background of this new regulation could be that numerous LLCs opted for a relatively high registered capital combined with a very long contribution period to appear of a bigger scale than they actually are. Another aspect, with regard to foreign-invested LLCs, could be to facilitate the inflow of foreign exchange cash into the PRC. As to already existing LLCs, the current wording of the 2023 Company Law is rather vague and not sufficiently clear. In order to be fully compliant with the 2023 Company Law, shareholders of existing LLCs will likely be required to either fully contribute their respective portion to the registered capital within a 5-years' period starting from 1 July 2024 (i.e., until 30 June 2029) or to decrease the LLC's registered capital before that time. It is to be hoped that the mentioned implementation measures of the State Council will be issued timely and provide for more clarity and guidance on this topic.
2. More possibilities for capital contributions in kind
Under the current 2018 Company Law, capital contributions in kind can generally be made by intellectual property rights, land use rights and other non-financial assets the value of which may be assessed in financial terms and ownership of which may be transferred in accordance with the law. The 2023 Company Law extends this in a way that generally also "equity" and "debt claims" can be used for capital contributions in kind, provided that they can be valued in monetary terms and legally be transferred.
This change is welcomed and provides for more flexibility for investors.
3. Liabilities for Shortfall in Capital Contribution and "Forfeiture of Shares"
The 2023 Company Law increases liabilities of shareholders compared to the 2018 Company Law for failure to make timely capital contributions, and introduces a possible "forfeiture of shares". In particular, for LLCs, the following applies:
- When a LLC is established and if a shareholder fails to make payment of its capital contribution in accordance with the LLC's Articles of Association, or if the actual value of non-monetary assets contributed falls significantly below the subscribed capital amount, not only the non-compliant shareholder itself but also all other shareholders of the LLC at the time of establishment shall bear joint and several liability within the shortfall of the capital contribution.
- After the establishment of a LLC, the Board of Directors ("BoD") shall verify the status of the shareholders' capital contributions. If it is found that a shareholder has not timely and fully paid its contribution in accordance with the LLC's Articles of Association, a written payment demand shall be issued by the LLC to the specific shareholder. Directors who fail to fulfill the above obligation in a timely manner, resulting in losses to the LLC, shall be liable for compensation.
- Under the prerequisites of the preceding bullet point, the LLC may grant a grace period in the written payment demand of at least 60 days starting from the issuance date of the payment demand. If the respective shareholder still fails to fulfill its contribution obligations upon expiration of such grace period, the LLC may, upon a resolution of its BoD, issue a written notice of forfeiture to such shareholder. From the date of the notice of forfeiture, the respective shareholder loses its rights to its equity interests for which no contribution has been made.
The forfeited equity interests shall be transferred in accordance with the law or be cancelled by way of a decrease of the registered capital of the LLC. If such transfer or cancelation is not completed within 6 months, the other shareholders of the LLC shall fully pay the outstanding capital contribution in proportion to their respective equity interests in the LLC.
If the affected shareholder has objections to the forfeiture, it may initiate legal action at a People's Court within 30 days from the date of receiving the notice of forfeiture.
- Further, even if the capital contribution period has not yet expired, if a LLC is unable to meet its due obligations, the LLC or the creditors of the due debts have the right to demand early contributions from shareholders whose subscribed capital contributions are not yet due for payment.
The above new stipulations tighten the compliance obligations of shareholders as well as of the BoD of LLCs regarding capital contributions. Shareholders and the BoD of LLCs are advised to familiarize themselves and to comply with the new rules.
1. Increased Requirements on Employee Representatives
Under the 2018 Company Law, at least 1/3 of the members of the Supervisory Board are required to be employee representative(s), and wholly State-owned enterprises as well as companies established by two or more State-owned enterprises are required to have employee representatives in their BoD.
The 2023 Company Law provides for changes in this regard. According to the 2023 Company Law, unless a Supervisory Board is set up and includes at least 1/3 employee representative(s), LLCs with at least 300 employees must have employee representative(s) in their BoD. Further, the maximum number of BoD members (previously: 3 to 13) has been abolished (now: at least 3). The employee representative(s) in the BoD shall be elected by the LLC's employees through an employee representative assembly, employee assembly, or other forms of democratic elections.
This constitutes a major change compared to the 2018 Company Law, under which a LLC (including those with at least 300 employees) could prevent having any employee representatives at all by opting for having only 1 or 2 Supervisors instead of a Supervisory Board, in which case no employee representatives were required. Under the 2023 Company Law, LLCs with at least 300 employees must mandatorily have employee representative(s), either in the Supervisory Board or in the BoD, and it is not possible to prevent this anymore. Affected LLCs should consider what they prefer, i.e. having employee representative(s) in the Supervisory Board or in the BoD. In addition, if there should be employee representative(s) in the BoD, also the specific method for their election, i.e. by way of a representative assembly, employee assembly, or other forms of democratic elections, must be considered and decided.
2. Changes regarding Supervisors and newly introduced Audit Committee
Under the 2018 Company Law, a LLC must in principle have a Supervisory Board comprising at least 3 persons (including at least 1 employee representative). However, LLCs with a smaller number of shareholders or of a smaller scale can opt to only have 1 or 2 Supervisors instead (then no employee representative is required).
Under the 2023 Company Law, a LLC must, in principle, still have a Supervisory Board comprising at least 3 persons (including at least 1 employee representative). LLCs with a smaller number of shareholders or of a smaller scale can now opt to have 1 Supervisor instead of a Supervisory Board. I.e., the option of having 2 Supervisors no longer exists which may, in particular, have impact on existing joint ventures with 2 shareholders, which typically have 2 Supervisors.
Further, the 2023 Company Law provides for the option not to have a Supervisory Board or a Supervisor at all under the following circumstances:
(i) Any LLC may establish a newly introduced Audit Committee composed of a not specified number of members of the BoD. In such case, the Audit Committee shall exercise the statutory functions of the Supervisory Board, and it is not required to have a Supervisory Board or a Supervisor. An employee representative among the members of the BoD, if any, may also become a member of the Audit Committee.
(ii) For LLCs with a smaller number of shareholders or of a smaller scale, all of its shareholders can unanimously agree not to have a Board ofSupervisors or a Supervisor at all.
Also this constitutes a major change compared to the 2018 Company Law. As to the possibility of having an Audit Committee, it appears to some extent contradictory that the Directors within the Audit Committee shall have the responsibility to supervise, inter alia, the BoD and accordingly also themselves. This applies the more, since also the 2023 Company Law still states that no Director or senior manager may concurrently serve as Supervisor. Overall, the (already rather low) importance of Supervisors in LLCs under PRC law appears to be further diminished by the 2023 Company Law.
3. Increase of Range of Persons Eligible to Serve as Legal Representative
- Under the 2018 Company Law, only the Chairman of the BoD, the Executive Director (if there is no BoD) or the General Manager could serve as legal representative of a LLC.
The 2023 Company Law increases the range of persons who can serve as legal representative by stating that "anydirector or company manager representing the company for the execution of company affairs" can serve as legal representative.
This means that in the future also ordinary members of the BoD can serve as legal representative, which was not possible under the 2018 Company Law.
- For the legal representative, the 2023 Company Law further provides for the following rules:
- The legal consequences of civil activities conducted by a company's legal representative in the name of the company shall be borne by the company.
- Restrictions on the powers of a company's legal representative by the company's Articles of Association or the Shareholders' Meeting shall not be enforceable against bona fide third parties.
- If a company's legal representative, in the course of performing duties, causes harm to others, the company shall bear civil liability. After assuming civil liability, the company may seek compensation fromthe legal representative at fault in accordance with the law or the company's Articles of Association.
The above is actually not new and in line with current PRC laws and regulations. However, the 2023 Company Law now expressly stipulates these principles for the first time.
4. Deletion of Catalogue with Responsibilities of General Manager
While the 2018 Company Law contained a (non-mandatory) catalogue of responsibilities of the manager (i.e., the General Manager) of a LLC, such catalogue has been deleted in the 2023 Company Law. The 2023 Company Law only states that a LLC may appoint a company manager, who shall be appointed or removed by the BoD, and that the company manager shall report to the BoD and exercise functions and powers as specified in the Articles of Association or as authorized by the BoD. The company manager attends meetings of the BoD as a non-voting attendee.
Although the catalogue of responsibilities of the General Manager in the 2018 Company Law was not mandatory, this likely provides for more flexibility regarding the functions of the General Manager of a LLC.
5. Changes regarding the Responsibilities of the Shareholders' Meeting and the BoD
Compared to the 2018 Company Law, the 2023 Company Law provides for some changes regarding the responsibilities of the Shareholder's Meeting and the BoD. The items "determining the company's business guidelines and investment plans" and "deliberating on and approve annual budget plans and final account plans of the company" have been deleted as responsibilities of the Shareholder's Meeting. Within the responsibility of the BoD, the item "determining the company's business plans and investment schemes" has been kept unchanged, while the item "formulating the annual budget plans and final account plans of the company" has also been deleted.
Further, under the 2023 Company Law, the Shareholders' Meeting may authorize the BoD to make resolutions regarding the issuance of corporate bonds.
This will provide more flexibility to some extent. E.g., "deliberating on and approve annual budget plans and final account plans of the company" as well as resolutions regarding the issuance of corporate bonds can then be shifted to the responsibility of either the Shareholders' Meeting or the BoD in the future. Compared to the 2018 Company Law also some more clarity is provided by stating that (only) the BoD is responsible for "determining the company's business plans and investment schemes".
6. Changes regarding the Quorum and Decision Making of Company Organs
While the 2028 Company Law provided that "unless otherwise provided in this law, methods of deliberation and voting procedures at Shareholders' Meetings shall be specified by a company's Articles of Association", the 2023 Company Law requires that "a resolution of the Shareholders' Meeting shall be adopted by shareholders representing a majority of the voting rights".
Similarly, while the 2018 Company stated that "unless otherwise provided in this law, methods of deliberation and voting procedures of the board of directors shall be specified by the company's Articles of Association", the 2023 Company Law requires that "ameeting of the board of directors shall only be held with the presence of a majority of the directors" and that "any resolution of the board of directors shall be adopted by a majority of all the directors".
Thus, the 2023 Company Law reduces flexibility in this regard and the possibility to provide for different and more flexible concepts in the Articles of Association of a LLC. This may have impact on respective stipulations and deadlock mechanisms in current Articles of Association, and potentially amendments will be necessary.
7. Compensation in case of Dismissal of a Director
Another important change introduced by the 2023 Company Law is that now, if a Director is dismissed without good cause before the end of his/her term, the Director may claim compensation from the LLC.
This stipulation raises several questions: first, (as compared to the General Manager who is often employed by the LLC), Directors of LLCs are in many cases not employed by the LLC, so that the right for compensation in case of dismissal from their position as Director seems questionable. Further, it is not further specified what "good cause" for the dismissal would be. It is also unclear, whether it would be possible to reach agreement with Directors (prior to or after their appointment), that they waive such compensation right in advance. It is to be hoped that future implementing regulations or interpretations provide for further guidance on this.
8. Express Introduction of Meetings and Voting via Electronic Communication
While already very common in practice and included in many Articles of Association, the 2023 Company Law now expressly introduces thatmeetings and the voting of the Shareholders' Meeting, the Board of Directors and the Supervisory Board may be conducted through electronic communication methods, except as otherwise stipulated in the company's Articles of Association.
This new stipulation reflects the current practice in most companies and is welcomed.
Overall, the 2023 Company Law grants more flexibility to LLCs regarding their company organs, the allocation of respective responsibilities and general corporate governance. Subject to the LLC's Articles of Association, the BoD may play a more important role in a LLC than under the current law. However, the requirement of mandatorily having employee representative(s) in LLCs with at least 300 employees also brings along obstacles and may be regarded as detrimental by shareholders and LLCs. Further, in particular joint ventures with 2 shareholders, may be required to make changes regarding their Supervisors, e.g. by having only 1 Supervisor or no Supervisor at all or potentially having an Audit Committee composed of Directors in the future.
1. Abolishment of Requirement to Consent
The 2018 Company Law required that where any shareholder proposes transferring his equity interests to any non-shareholder, such proposal is subject to the consent of a majority of the other shareholders and the relevant shareholder shall give the other shareholders written notice of the details of the proposed transfer of equity interests and obtain their consent. Where a majority of the shareholders whose consent is sought disagree with the proposed transfer, the shareholders who disagree with the proposed transfer shall purchase the equity interests to be transferred.
Such consent requirement has been abolished by the 2023 Company Law. The 2023 Company Law only stipulates that shareholders transferring their equity interests to parties outside the existing shareholders shall provide written notice to other shareholders on matters including the quantity, price, payment method, and deadline for the equity transfer, and other shareholders shall have the right of first refusal to purchase on the same terms. If a shareholder does not respond within 30 days of receiving the written notice, it is considered a waiver of the right of first refusal.
In practice, however, we expect that not much will change by this. Also under the 2018 Company Law, the required consent was deemed to be given, if any of the other shareholders failed to respond within 30 days of receiving the written transfer notice or if they refused to acquire the equity interests to be transferred. However, under the 2023 Company Law, no Letter of Consent of other shareholders will be required anymore in case of a transfer of equity interests and a Letter of Waiver of Pre-emptive Right will suffice.
2. Changes regarding Outstanding Capital Contributions
Under the current law, according to a relevant interpretation of the Supreme People's Court, in case of a share transfer, the buyer is only jointly and severally liable with the seller for outstanding capital contribution obligations, if the buyer was aware or should have been aware of the outstanding payment. Further, if the buyer who has borne the liability pursuant to the above seeks recourse from the seller who has not performed its capital contribution obligations or has not fully performed its capital contribution obligations, the People's Court shall uphold the request, unless otherwise agreed between the parties concerned.
According to the 2023 Company Law, where a shareholder transfers its equity interests representing subscribed capital contributions not yet due for payment, the transferee shall assume the obligation to pay such capital contribution. If the transferee fails to do so in time and in full, the transferor shall bear supplementary liability for the shortfall in contribution.
Where a shareholder transfers its equity interests without having paid the contributions by the deadline as stipulated in the Articles of Association or where the actual value of non-monetary assets contributed falls significantly below the subscribed capital amount, the transferee shall bear joint and several liability with the transferor within the shortfall in contribution, unless the transferee does not know and should not have known the above situation.
Due to the above, the 2023 Company Law to some extent increases potential liabilities of the buyer for outstanding capital contributions. This must be taken into account in the future for due diligences, share transfers and the drafting of Share Transfer Agreements (e.g., via representations and warranties, closing conditions, other contractual protection mechanisms or being reflected in the transfer price).
3. Additional Scenario on the Re-purchase of Equity Interests
In addition to the scenarios where a shareholder may request a LLC to repurchase its equity interests as set out in the 2018 Company Law, which are re-iterated in the 2023 Company Law, the 2023 Company provides for an additional scenario in this regard. I.e., where a controlling shareholder of a LLC abuses shareholder rights, causing serious harm to the interests of the LLC or other shareholders, other shareholders shall have the right to request the LLC to repurchase their equity interests at a reasonable price.
The New Company Law, once in effect, will impact MNCs in the following areas.
1. Flexibility in Governance Structure: In addition to the option to appoint a single director or supervisor, MNCs operating on a smaller scale in China or with fewer shareholders now have the flexibility to choose not to appoint supervisors through unanimous shareholder consent. Moreover, those with a board of directors may consider establishing an audit committee under the board to enhance corporate governance.
2. Employee Representation: MNCs employing over 300 individuals must now include an employee director on the board to advocate for employee interests, unless an employee representative already exists on the board of supervisors. The employee director or employee supervisor must undergo a democratic election by the workforce.
3. Challenges in Joint Ventures: Including an employee director on the board within joint ventures can pose challenges, potentially diluting controlling shareholder's existing board seats and voting rights. This shift in board composition requires revisions to articles of association and joint venture agreements, triggering renewed negotiations among shareholders. Proactive planning is essential to effectively navigate these forthcoming changes.
4. Transition Deadline for Foreign-Invested Joint Ventures: Foreign-invested joint ventures in China are traditionally governed by a board of directors as the supreme authority. However, according to the Foreign Investment Law, they must transition to the governance structure mandated by the Company Law, with the shareholders' meeting as the highest authority, before December 31, 2024. As these joint ventures update their governance structures and associated documentation, careful consideration of the amendments introduced by the New Company Law becomes paramount.
5. Capital Contribution: Under the New Company Law, MNCs organized as LLCs with capital contribution periods exceeding five years must adjust their timelines to comply with a maximum five-year span during the specified transition period (details to be provided by relevant authorities). Should a shareholder subscribe more capital to the company than necessary, the company may consider reducing its share capital to ensure all subscribed capital is paid in full and on time.
6. ROFR: The simplified ROFR process introduced by the New Company Law is not inherently mandatory. Shareholders retain the flexibility to define or modify the ROFR process as mutually agreed upon within the articles of association.
7. Equity Financing: The introduction of different classes of shares for joint-stock companies marks the legislature's official acknowledgement of the legal status of common and preferred shares. As a result, startups in China, especially those attracting private equity or venture capital, are expected to increasingly adopt the joint stock company structure to facilitate the issuance of preferred shares to investors. Existing contractual arrangements that mirror the features of common and preferred shares will be phased out from the financing documents of joint stock companies.
8. Fiduciary Duties: Directors and senior executives of MNCs should anticipate heightened fiduciary requirements as the duty of care and duty of loyalty are now clearly defined. Rather than solely following instructions of the sole shareholder or the controlling shareholder, MNC executives are expected to act in the best interest of the company and exercise reasonable care. In addition, MNC executives seeking to enter into transactions with the company, conduct competing business with the company, or pursue a business opportunity that can be taken by the company should secure safe harbor protection before moving forward. Furthermore, they may be personally held liable to third parties for intentional misconduct or gross negligence.
The New Company Law will have a major impact on the operation and corporate governance structure of FIEs in China. MNCs must be well prepared for what's next as it comes into force on July 1st, 2024:
* Currently, some FIEs have subscribed a relatively high registered capital but never planned to contribute capital in full much less within five years. Such companies will need to consider whether they will need to reduce their registered capital as stricter requirements on capital contribution are coming.
* FIEs will need to consider how wide ranging changes in corporate governance structure, capital contribution requirements, equity transfer rules, will impact their individual circumstances.
FIEs will need to update the relevant corporate documents (such as AoA and joint-venture agreements) to reflect the changes in the New Company Law earlier rather than later. For example, (i) the methods for the appointment and change of the legal representative shall be specified in the AoA; (ii) the authorities of the shareholders' meeting and the authorities of the board of directors shall be adjusted; and (iii) equity transfer to third parties no longer needs consent from more than half of the other shareholders. Shareholders still enjoy a right of first refusal.
* In addition, it is also worth noting the 5-year interim period provided under the Foreign Investment Law is due to expire on December 31, 2024. FIEs which have not updated their corporate governance structure as required by the Foreign Investment Law should also consider a consolidated approach which also takes into account the New Company Law's impact.
* FIEs may need to update their actual controllers, directors, supervisors, and senior management as to how the changes under the New Company Law will impact them.
Given the broad and high-level nature of some amendments, MNCs should closely monitor the implementing guidelines issued by relevant regulatory authorities and validated market practices. Staying informed about developments and updates regarding the New Company Law is essential for proactively understanding and addressing potential implications.
As the New Company Law introduces substantial changes, it is advisable for MNCs to proactively prepare for the upcoming shifts in governance structures, amendments to corporate documents, and potentially, negotiations with fellow shareholders.
The recommended actions include:
1. Review and Adjust Governance Structures:
- Assess the impact of the New Company Law on current governance structures.
- Consider the flexibility introduced for smaller-scale or wholly-owned companies and explore the possibility of appointing a single director or supervisor, or even opting for no supervisor in the governance structure.
- Consider implementing an audit committee under the board of directors.
2. Evaluate Employee Representation Requirements:
- For MNCs with 300 or more employees, assess the feasibility of having an employee director on the board and plan for the democratic election of the employee director. Alternatively, consider the option of including an employee representative on the board of supervisors.
3. Address Joint Venture Challenges:
- Anticipate potential challenges in joint ventures, particularly concerning the change of board composition and dilution of board seats due to the inclusion of an employee director.
- Initiate discussions and negotiations with joint venture partners to address potential complexities.
4. Adjust Timeline for Capital Contribution:
- Ensure compliance with the amended five-year timeline for capital contribution.
- Address potential excess capital subscriptions through capital reduction if necessary.
5. Streamline ROFR Process:
- Consider the necessity of updating the ROFR process in the articles of association and shareholders agreements to align with the New Company Law.
6. Enhance Awareness of Fiduciary Duties:
- Educate directors, supervisors and senior executives on the heightened fiduciary requirements.
- Incorporate safe harbor rules for specific transactions into the articles of association and ensure compliance with these provisions.
- Consider purchasing liability insurance for directors and senior managers to mitigate their increased exposure to personal liabilities.
7. Adhere to the Transition Deadline for Joint Ventures:
- Foreign-invested joint ventures must adopt the governance structure mandated by the Company Law (with the shareholders meeting as the highest authority) and update the associated documentation by December 31, 2024. It is advisable to start internal evaluations and discussions with partners as soon as possible.
8. Examine Corporate Documents:
- Scrutinize existing articles of association and joint venture agreements and identify areas requiring revision to align with the New Company Law.