China’s corporate governance regime has undergone the most significant overhaul since it was introduced three decades ago. From enhancing shareholder rights to increasing director and management accountability, the changes seek to modernize the regime – and they take effect from 1 July 2024.
Ratified by the Standing Committee of the 14th National People’s Congress on December 29, 2023, the latest amendment to the PRC Company Law is poised to introduce transformative changes to China’s corporate landscape. This revision, the most comprehensive since the law’s introduction in 1993, aims to modernize the enterprise system and invigorate the market’s dynamics. It promises to significantly influence business operations within China for years to come.
In this insight, we highlight the key aspects and implications of the 2023 Company Law amendment.
Reinforce capital contribution obligations of shareholders
The 2023 Company Law enforces stricter capital contribution requirements for shareholders, marking a significant escalation from previous stipulations. Under this new legal framework:
- the entirety of a limited liability company’s registered capital must be contributed within five years of its formation
- Joint-stock companies are required to have their registered capital fully contributed at the time of establishment.
This contrasts sharply with the previous legislation, which did not specify a timeline for these contributions. Crucially, this law also has retrospective effects, mandating that all companies formed in China prior to its enactment progressively conform to this new capital contribution schedule. Failure to comply results in shareholders forfeiting their rights to the unpaid portion of capital as per the 2023 Company Law’s share forfeiture system.
Moreover, the 2023 Company Law grants companies or their creditors the right to demand immediate payment of contributions not yet due, should the company face insolvency. This provision underscores the law’s commitment to ensuring financial responsibility and protecting creditors’ interests.
Enhance protection of shareholders’ rights
The 2023 Company Law introduces several measures to significantly bolster shareholder rights, demonstrating a clear commitment to ensuring more transparent and equitable corporate governance.
- Inspections: A notable advancement is the expansion of shareholders’ rights to access information, now encompassing the ability to inspect both accounting books and accounting vouchers of the company and its wholly-owned subsidiaries.
- Minority rights: In a move to empower minority shareholders, the law now grants them the right to demand a fair-priced equity redemption in instances where controlling shareholders misuse their powers or significantly harm the interests of the company or its shareholders. This provision aims to mitigate the risks associated with majority control and protect minority interests.
- Fair capital adjustments: Furthermore, in principle, shareholders shall proportionately reduce their capital contributions in alignment with their shareholding ratios, unless otherwise stipulated by law, agreed by all shareholders of limited liability companies or provided under the articles of association of joint-stock companies. This ensures a fair and equitable approach to capital adjustments, safeguarding shareholders' proportional interests.
- Litigation rights: The scope of derivative litigation has been broadened under the new law. Beyond addressing misconduct directly affecting the company, shareholders are now authorized to initiate derivative actions on the company’s behalf against directors, supervisors, and senior management (DSMs), or third-party violators involved in infringing upon the lawful interest and benefits of the company and its wholly-owned subsidiaries. This expansion strengthens the legal mechanisms available for addressing grievances and protecting the company’s interests.
- Selling shares: Lastly, the revised law updates the regulations surrounding external equity transfers. While eliminating the requirement for other shareholders’ consent for such transfers, it preserves their right of first refusal, maintaining a balance between facilitating equity transactions and protecting existing shareholders’ interests.
Optimize corporate governance via ‘single-tier’ and board representatives
The 2023 Company Law revolutionizes corporate governance structures in China by introducing a single-tier governance regime. Specifically, this innovation allows companies to opt out of the compulsory requirement for a board of supervisors or sole supervisor entirely if: (1) an audit committee within the board of directors is established as an alternative, or (2) for limited liabilities companies small in scale or with a limited number of shareholders, their shareholders unanimously agree.
Furthermore, to safeguard employee interests, the law mandates the inclusion of an employee representative on the board of directors for companies employing 300 or more individuals. This requirement is waived if the company’s board of supervisors already includes an employee representative, ensuring that employee voices are heard at the highest levels of corporate decision-making.
In terms of legal representatives, the 2023 amendment broadens the eligibility criteria, allowing any director or general manager who manages corporate affairs on behalf of the company to serve as its legal representative. Additionally, it specifies the procedures for registering changes to this role and outlines the liabilities of legal representatives, particularly focusing on instances of non-compliance or misconduct. This not only clarifies the responsibilities and potential repercussions for legal representatives but also streamlines administrative processes for companies navigating these governance adjustments.
Strengthen responsibilities of directors, supervisors and senior management
The 2023 Company Law significantly refines the concepts of the duty of loyalty and duty of care owed by directors, supervisors and senior management (DSMs). It underscores the importance of DSM conduct in specific scenarios, including related party transactions, adherence to non-compete agreements and avoidance of usurping corporate opportunities.
Moreover, the law amplifies DSM responsibility to safeguard and verify the adequacy of a company’s registered capital. DSMs now face joint and several liabilities for actions that compromise the integrity of the registered capital, such as inadequate capital contributions, unauthorized capital withdrawals, or other violations affecting capital sufficiency.
Additionally, DSMs may assume joint and several liabilities for any damages suffered by third parties due to their intentional or grossly negligent conduct in fulfilling their duties. This provision aims to ensure that DSMs exercise the utmost diligence and integrity in their roles.
Recognizing the increased risks and responsibilities DSMs bear under the new law, it also introduces provisions allowing companies to obtain insurance for their directors. This move seeks to balance the heightened accountability with measures that protect DSMs against potential liabilities, thereby encouraging prudent and responsible governance practices.
Beyond the significant changes highlighted above, the 2023 Company Law delves into other essential areas such as:
- mergers and acquisitions
- the governance frameworks of state-funded and publicly listed companies, and
- the issuance and management of corporate bonds.
These sections underscore the law’s extensive influence on the corporate environment in China. Given the law’s wide-ranging effect and the broad language used in certain sections that await further elucidation, it’s imperative for businesses to remain vigilant about forthcoming regulatory guidelines and related legal instruments tied to the 2023 Company Law. Ensuring adherence to this updated legal framework is crucial for companies operating within the Chinese market.
