Editorial Note

The newly amended Company Law of the People's Republic of China took effect from July 1, 2024. This comprehensive overhaul represents a significant milestone in China's corporate governance landscape, introducing numerous amendments aimed at enhancing corporate efficiency, protecting stakeholder rights, and fostering a more transparent and responsible business environment. This feature aims to provide an in-depth insight into the capital contribution system of the amended Company.

Catalogue

I. Key Changes on Capital Contribution

1. Time Limit for Capital Contribution

The previous Company Law allows shareholders to have flexibility in determining the schedule for capital contributions in a company's articles of association. In theory, shareholders are not required to fully pay the registered capital until the company's business term ends, which could span several decades. However, the amended Company Law introduces a significant change by imposing a 5-year time limit for capital contributions. Shareholders are now obligated to fully pay the registered capital within 5 years after the company is established. Additionally, the company is required to disclose the subscription and paid-up status of the registered capital through the registration information system, ensuring transparency to the public.

2. Acceleration of Capital Contribution

In accordance with the aforementioned provision, the articles of association of a company can allow a timeframe of up to 5 years for shareholders to fully pay up their registered capital. However, it is important to note that the amended Company Law introduces a caveat to this arrangement. If the company fails to repay any of its debts as they become due, both the company itself and its creditors have the right to demand that shareholders expedite their capital contributions. This requirement applies even if the scheduled payment of registered capital has not yet become due as specified in the company's articles of association.

3. Other Responsibilities Related to Capital Contribution

(1) According to the amended Company Law, shareholders have not only the obligation to make their own capital contributions promptly, but they are also responsible for ensuring that other shareholders duly fulfill their contribution obligations as well. In cases where any shareholder fails to make the required contribution as specified in the articles of association, the other shareholders may be held jointly and severally liable.

(2) Directors have a duty to verify the capital contributions made by each shareholder and are required to urge shareholders to rectify any instances where their contributions are not made in full or in a timely manner, as specified in the articles of association. Directors may be held personally liable if they fail to properly fulfill this obligation.

(3) If a shareholder fails to make the contribution within the prescribed time frame and after urged by the directors, but still fails to pay within a grace period of no less than 60 days, the company's board may forfeit such shareholder's equity interests by issuing a forfeiture notice.

II. Registered Capital Contribution

1. New Companies

Shareholders of all New Companies must fully complete the registered capital contributions within 5 years from their establishment date.

2. Existing Companies

(1) Transition Period

The Provisions provide for a uniform transition period of 3 years, from July 1, 2024 to June 30, 2027. During this period, the Existing Companies whose registered capital has not been fully paid up may need to adjust their registered capital.

(2) Adjustments

1. If its remaining contribution period, as stipulated in its original charter documents, is less than 5 years following July 1, 2027, the Existing Company is not required to make any adjustment.

If its remaining contribution period, as stipulated in its original charter documents, is more than 5 years following July 1, 2027, the Existing Company must make adjustments to ensure that the revised contribution period will conclude no later than by June 30, 2032.

(3) If the contribution period or the registered capital amount stipulated in the charter document of any Existing Company contravenes the principles of authenticity and rationality, local registration authority ("AMR") is authorized to intervene, at its sole discretion, by initiating an independent assessment, and then order the Existing Company to revise its charter document to shorten the contribution period or to reduce the registered capital. The key determinants guiding the AMR's decision include business scope, operation conditions, shareholders' contribution capability, actual businesses, and asset scale, etc.

(4) Risks

If any Existing Company fails to adjust its contribution period and/or registered capital as stipulated, AMR will, among the other things, make a special notation on the file of such company and publish it on the Credit Publicity System. It would adversely affect the company's social credibility, and result in obstacles for the company when financing, participating biddings or applying for any administrative approvals.

III. Mandatory Deadline for the Contribution of Subscribed Capital

The amended Company Law mandates a five-year deadline for shareholders to contribute the capital they have subscribed in a limited liability company ("LLC"). In an LLC, each shareholder subscribes a percentage of the registered capital of the company and commits to pay such capital to the company within a period of time specified in the articles of association of the company (the "Contribution Period"). The Amended Company Law requires that the Contribution Period should be five year or less.

Meanwhile, the competent authority reserves the right to require a company to make timely adjustments to its Contribution Period requirement, if the authority determines that the Contribution Period or contribution amounts of such company's shareholders are inappropriate.

Regarding the interpretation of "gradually" and "inappropriate", the State Administration for Market Regulation ("SAMR") issued the "Provisions on the Implementation of the Registration Capital Registration Management System of the PRC Company Law ("Exposure Draft")" on February 6, 2024, which specifies the approach existing companies should take the adjust the Contribution Period:

1. Existing LLCs whose shareholders are subject to a Contribution Period of more than 5 years are required to adjust the Contribution Period to be less than 5 years during a 3-year transition period following the implementation of the Amended Company Law, effective as of July 1, 2024. Shareholders of joint-stock companies should pay the subscribed capital in full within this 3-year transition period.

2. Companies that will be established after July 1, 2024 are subject to the following rules:

-- Shareholders of LLCs shall fully pay the registered capital within 5 years from the date of establishment, in accordance with their articles of association.

-- Shareholders of joint-stock companies shall fully pay the subscribed capital before the registration of establishment.

-- In addition, for capital increases:

-Shareholders of LLCs shall fully pay the newly subscribed registered capital within 5 years.

-For joint-stock companies, the increase in registered capital shall be registered only after the shareholders have fully paid the capital.

3. The rules relating to the assessment of "inappropriate" Contribution Periods and amount of subscribed capital are as follows:

-- Companies whose shareholders are subject to a Contribution Period of more than 30 years or a contribution amount of more than RMB 1 billion will undergo a comprehensive assessment to be performed by the relevant PRC authority.

-- The authority will either organize professional institutions to conduct evaluations in connection with such comprehensive assessment, or conduct such comprehensive assessment in collaboration with relevant governmental departments.

-- Upon obtaining approval from the provincial-level SAMR, the authority will require the company to adjust its Contribution Period and amount of subscribed capital within 6 months.

-- If the proposed registered capital of a company is highly excessive, the authority may refuse to register such subscribed capital. There are some exceptions to the above rules in the Exposure Draft. For example, certain special companies approved by the competent authorities may permit their shareholders to follow the original Contribution Period.

IV. Introduction of an Authorized Capital System

The amended Company Law introduces an authorized capital system. A joint-stock company is no longer required to have all shares fully subscribed at the time of its establishment. Instead, such a company can authorize certain number of shares as its authorized but unissued capital, and the board of directors, with due authorization, can approve the company to issue shares out of the authorized capital. Specifically, the company's articles of association or the shareholders' meeting may grant the board of directors the power to issue shares out of the authorized capital of the company within 3 years following the grant of such power, provided the shares so issued should not exceed 50% of the company's issued shares, and provided further, that the relevant board resolutions should be approved by more than two-thirds of the directors of the company.

This amendment allows companies to issue shares incrementally based on the company's actual operations and market conditions, reducing the difficulty of company establishment, simplifying the share issuance process, and enhancing the flexibility and efficiency of the company's capital raising activities.

V. New Forms of Capital Contribution Permitted

The amended Company Law permits shareholders to make contribution of registered capital via non-monetary forms including equity or debentures with a resolution of the shareholders' meeting, except that for joint-stock companies with an authorized capital system as described above, shareholders' contribution of registered capital must be in monetary forms.

VI. Liabilities for Default of Capital Paid-in Obligations

If a shareholder fails to pay for the subscribed capital in full and on time, or if the actual value of the in-kind capital contribution is significantly lower than the amount of the subscribed capital, such shareholder is in default of his/her capital contribution obligation (Defaulting Shareholders). In a broader sense, illegal capital withdrawal, illegal profit distribution, and illegal capital reduction also constitute a default in capital contribution.

The previous Company Law provides that the Defaulting Shareholders should make up the difference in capital contributions to the company, and that in the scenario of default at the time of incorporation, the other shareholders are also jointly liable for the shortfall. The amended Company Law upholds and expands upon this requirement, and further provides that the Defaulting Shareholders should also be liable for compensating the company against any losses incurred. Notably, while the initial consultation draft extended this compensation liability to all shareholders at the time of incorporation, the final law omits this provision, limiting the joint liability of other shareholders to capital contribution shortfall only. In addition, with respect to the calculation of losses incurred by the company, while the first consultation draft proposed applying bank interest rate, this was also dropped in the final law, leaving such determinations to the discretion of the judicial bodies overseeing relevant disputes based on the circumstances of each particular case. In light of this, we suggest the relevant parties provide for this matter in their investment contracts.

The previous Company Law provides that Defaulting Shareholders should be liable to the other shareholders for "breach of contract", which was taken out in the amended Company Law. Despite this change, the other shareholders can still claim breach of contract based on the Civil Code and the shareholders' agreements, even in the absence of a specific provision in the amended Company Law.

With respect to Defaulting Shareholder's liabilities towards the creditors of the company, while the previous Company Law is silent, the People's Supreme Court has made certain supplemental provisions in its judicial interpretations. For example, the Provisions on Several Issues Relating to Application of the Company Law of the People's Republic of China (III) (Company Law Judicial Interpretation (III)) provides that, the company's creditors have the right to demand that the Defaulting Shareholders bear the supplementary compensation liability for the company's outstanding debts to the extent of its shortfall in capital contribution or illegal withdrawal capital contribution plus interest. In addition, according to the Regulations on Several Issues Concerning Changing and Adding Parties during Enforcement of Civil Cases, if the company's assets are insufficient to repay its debts, its creditors can seek to include Defaulting Shareholders in enforcement proceedings, holding them liable to the extent of the shortfall in capital contribution and illegal withdrawal of capital contribution. Notably these provisions however have not been incorporated into the amended Company Law, and whether Defaulting Shareholders should be liable to the company's creditors is subject to further observations in subsequent judicial interpretations and practices.

VII. Recovering Mechanism for Outstanding Capital and Forfeiture of Defaulting Shareholders' Rights

The amended Company Law introduces a mechanism obliging the board of directors to oversee the capital contribution of shareholders and requiring the company to formally demand payments in writing for any outstanding shortfalls. Under this mechanism, the board of directors should verify the capital contribution status. If a shareholder is identified as failing to pay the capital contribution in full and on time, the company must issue a written letter to the shareholder to call the capital contribution. Failure to do so may lead to personal liability for the directors responsible for the oversight.

Building upon the provisions of the Company Law Judicial Interpretation (III), the amended Company Law provides for a more detailed procedure of forfeiture of rights of Defaulting Shareholders, which runs as follows:

The Company Law Judicial Interpretation (III) mandates the convening of a shareholders' meeting to forfeit the rights of Defaulting Shareholders, but in practice without the cooperation of the Defaulting Shareholders, it may be challenging to hold a shareholders' meeting or pass a resolution. The amended Company Law simplifies this process by enabling the forfeiture of rights through the issuance of a notice following a board meeting.

In addition, the amended Company Law mandates the board of directors to monitor and urge shareholders' capital contributions, and provides for personal liabilities in connection therewith. We recommend that the board and the company be diligent in monitoring and maintaining good records of all requests and notifications sent to safeguard against potential liabilities.

VIII. Acceleration of Outstanding Capital Contribution

The previous Company Law does not include any provision regarding the acceleration of payment for the outstanding capital contributions. The Minutes of the National Court Work Conference for Civil and Commercial Trials (Minutes), issued by the Supreme Court in 2019, establishes that, under the subscription capital system, shareholders typically have the entire period specified in the articles of association to fulfill their capital contribution obligations and shall not be compelled to pay before the designated schedule. However, in order to maintain a balance between the interests of shareholders and creditors, the Minutes sets out two exceptions where creditors can request shareholders, whose capital contribution obligation has not yet become due, to assume supplementary compensation liabilities for the company's debts. These exceptions include where: (i) the court is unable to locate any assets for enforcement against the company's debts, indicating a de facto state of bankruptcy without any bankruptcy proceedings initiated; or (ii) the company extends the capital contribution period following the incurrence of debts through a shareholders' resolution or other means.

The amended Company Law incorporates the above spirit from the Minutes into Article 54, which provides that where a company is unable to pay off debts when due, both the company and the creditors are entitled to request the shareholders to pay their capital contributions before the expiration of their pay-in period.

VIIII. Capital Contribution Obligations Related to Transfers of Unpaid-in Equity

Under the subscription capital system, it is possible that equity interests can be transferred before the corresponding capital has been paid in, and the previous Company Law does not stipulate who shall bear the obligation of paying the capital to the company. This gap was filled by the Company Law Judicial Interpretation (III), according to which where a shareholder of a limited liability company transfers its equity before the capital contribution has been fully paid in, the company may request the transferring shareholder to pay the capital contribution, and the creditors of the company may request such shareholder to assume supplementary liability for outstanding debts of the company to the extent of the outstanding capital contribution and interests thereon. It also provides that if the transferee is aware or should have been aware of the circumstances, then it should bear joint and several liability together with the transferor.

In judicial practice, most case precedents take the stance that the above provisions only apply to Defaulting Shareholders but not the shareholder whose capital contribution period has not yet expired, although some precedents take the opposite view, holding that the transferring shareholder remains obligated to fulfill the capital contribution even if the paid-in period has not elapsed at the time of transfer.

The amended Company Law resolves this ambiguity by outlining rules regarding capital contribution obligations and the distribution of liabilities after the transfer of unpaid-in equity between the transferor and the transferee as follows:

- If, at the time of transfer, the outstanding capital contribution is not yet due, the transferee assumes responsibility for the outstanding capital contribution. In case the transferee fails to meet this obligation by the due date, the transferor becomes the secondary obligor to cover the outstanding capital contribution.

- If, at the time of transfer, the outstanding capital contribution is already overdue or the actual value of the in-kind contribution made by the transferor significantly falls short of the subscribed capital amount, the transferor bears the liability for the outstanding capital contribution. The transferee is jointly and severally liable unless deemed a bona fide transferee, meaning it was unaware and could not have reasonably become aware of the deficient capital contribution status.

Given the provisions in the amended Company Law, it is advisable for both parties involved in the transfer of unpaid-in equities to engage in comprehensive due diligence regarding each other's capital contribution status and payment capacity to avoid unforeseen responsibilities.

X. Directors, Supervisors and Senior Management's Compensatory Liabilities

The amended Company Law strengthens the liabilities of directors, supervisors and senior management to ensure the security of the company's capital. According to the amended Company Law,

- Where the directors fail to monitor the capital contribution status of shareholders or urge them to make contributions on time, the responsible directors should compensate the company for any losses incurred;

- Where shareholders withdraw their capital contributions and cause damages to the company, the responsible directors, supervisors and senior management should bear joint compensation liabilities to the company with the relevant shareholders;

- Where the company distributes dividends to shareholders in violation of the laws and articles of association, causing damages to the company, the relevant shareholders and responsible directors, supervisors and senior management should bear compensation liabilities to the company;

- Where the company provides financial assistance to others to assist them in acquiring shares in the company or the company's parent company in violation of laws, the responsible directors, supervisors and senior management should compensate the company for any losses incurred.

It is important to highlight that in three of the aforementioned scenarios, the amended Company Law expands the scope of liabilities to include supervisors in addition to directors and/or senior management. Regarding the determination of who should be considered "responsible" among directors, supervisors, and senior management, the amended Company Law does not provide explicit guidance. However, it is worth noting that the initial consultation draft stipulated that directors, supervisors, and senior management "who were aware or should have been aware" of a shareholder's failure to complete the full capital contribution and "did not take necessary actions" should bear liabilities for compensation. This specific provision was not included in the final law, leaving the decision to the discretion of judicial bodies. It is understood that being "responsible" should encompass situations where directors, supervisors, and senior management are actively involved in illicit activities or fail to fulfill their legal duties as outlined in laws and articles of association.

XI. Publication of Registered Capital

The Provisions and the amended Company Law further specify that New Companies and Existing Companies shall disclose information related to their registered capital on the Publicity System within 20 working days from the date of its formation or change. This information includes, (i) subscribed and paid-in capital; (ii) method of contribution; (iii) contribution period; (iv) date of contribution; (v) changes in shareholding. This kind of information had not been mandated for disclosure under the previous Company Law. According to the new laws, failure to publish may lead to a fine of up to CNY 200,000. Additionally, the responsible executives and other directly responsible personnel may also encounter a fine of up to CNY 100,000.

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