Draft Revision of PRC Company Law – What A FIE Should Pay Attention To

Lettre d’information Publié le 17/01/2022

The Company Law of the People’s Republic of China (Draft Revision) (the “Draft Revision”) was published for public consultation on 24 December 2021. The Draft Revision contains 15 chapters and 260 articles, which substantially add and amend about 70 articles to the existing 13 chapters and 218 articles of the Company Law, and will have a direct impact on foreign-invested enterprises operating in China in many aspects. This is particularly so given that the Foreign Investment Law, which came into effect on 1 January 2020, sets a five-year transitional period for foreign-invested enterprises in China to complete the adjustments to their corporate governance structure according to the Company Law, and that a large number of enterprises have not yet completed this adjustment process. This revision to the Company Law, once entering into force, will become the new basis for foreign-invested enterprises to adjust their corporate governance structure. Therefore foreign-invested enterprises need to pay sufficient attention to this revision.

1. On the Party’s leadership of state-owned enterprises

Article 145 of the Draft Revision provides that “the organizations of the Communist Party of China in state-funded companies shall play a leading role in accordance with the provisions of the Constitution of the Communist Party of China, deliberate and discuss major business management matters of the company, and support the shareholders’ meeting, the board of directors, the supervisory board and senior management in exercising their powers in accordance with the law”. Article 143 of the Draft Revision clarifies that state-funded companies include wholly state-owned, state-controlled limited liability companies and joint-stock companies.

Accordingly, the discussions in recent years on the establishment of party organizations in Sino-foreign joint ventures in which state-owned capital is in a controlling position may finally find a clear legal basis.

There is still some room for interpretation of the wording “to deliberate and discuss major business and management matters”, such as what matters are considered to be major business and management matters and whether “to deliberate and discuss” means not to enjoy direct decision-making power. But still, this amendment is providing a legal tool and a clearer legitimacy for the presence of the party organization in the company from a legislative perspective.

2. On the corporate capital

The reform and optimization of the company’s capital regime is one of the main focuses of this amendment. However, most of the relevant amendments are reflected under the company form of joint stock company, rather than limited liability company, which is used by the vast majority of foreign companies.

Under the legal form of joint stock company, the company may adopt an authorized capital system, i.e. a joint stock company is established by issuing only a portion of its shares, and the articles of association or the shareholders’ meeting may make an authorization for the board of directors to decide whether to issue the remaining shares in accordance with the actual needs of the company’s operations (Articles 97 and 164 of the Draft Revision). The company may create different types of shares, including preferred and subordinated shares, special voting shares, shares subject to transfer restrictions, etc. (Articles 157 and 158 of the Draft Revision). The company may choose to adopt denominated or non-denominated shares in accordance with its articles of association (Article 155 of the Draft Revision) etc. Whether these flexible provisions will result in more Sino-foreign joint stock companies in practice in the future is a question that deserves long-term observation.

3. On shareholders’ contributions and transactions of equity interest

Pursuant to Articles 46 and 47 of the Draft Revision, the failure of a shareholder to pay his capital contribution in full and on time will give rise to legal liability on several levels. Firstly, in respect of the shareholder, if he or she fails to pay the capital contribution within the prescribed period after a call by the company, he or she will be deemed forfeiting the part of equity for which he or she did not pay; secondly, in respect of the failure to pay the capital contribution during the establishment process, the shareholder will be liable to the company for interest and damages, while the other shareholders at the time of establishment will be jointly and severally liable; thirdly, the directors, supervisors and executive officers of the company will be liable for compensation if they have knowledge of the failure and fail to take action.

In addition, Article 48 of the Draft Revision also adds a mechanism for the accelerated expiry of the capital contributions subscribed by the shareholders of a limited liability company, stipulating that if the company is unable to settle its debts as they fall due and clearly lacks the ability to do so, the company or its creditors shall have the right to request the shareholders who have subscribed the capital contributions but have not yet reached the deadline for payment to pay the capital in advance.

In the context of equity transactions, defective equity, i.e., for example, equity contributed by the transferring shareholder but not yet due for payment, or equity that is due for payment and the transferring shareholder has not fulfilled its payment obligations, or equity in which the value of the assets used to make the contribution is significantly low in the case of a non-monetary contribution, will make the transferee (jointly and severally) liable for the contribution or the full contribution (Article 89 of the Draft Revision).

4. On corporate governance

In practice, the three-tier structure of

  • shareholders/shareholders’ meeting
  • board of directors/executive directors + supervisory board/supervisors
  • managers

required by the existing Company Law is somewhat redundant for many small foreign-owned enterprises. The supervisory board, in particular, is in practice mostly reduced to a single supervisor, who is also mostly a formality and does not really play a role in monitoring the performance of the company’s directors and managers.

The Draft Revision allows companies to choose a single-tier governance model, i.e. a board of directors only, without a supervisory board. According to Article 64 of the Draft Revision, if a limited liability company chooses to have only a board of directors, an audit committee consisting of directors shall be set up in the board of directors to be responsible for supervision.

In addition, for small-scale limited liability companies, the Draft Revision also gives some flexibility. Instead of a board of directors, such companies may have a director or manager (Articles 70 and 130 of the Draft Revision); instead of a supervisory board, they may have one or two supervisors (Article 84 of the Draft Revision).

5. On directors, supervisors and senior management of the Company

One of the common concerns of foreign investors in foreign-funded enterprises is what responsibilities and risks will be borne by the executives of those foreign-funded enterprises in China. Certain content of this Draft Revision also focuses on this issue of liability of executives.

Article 65 of the Draft Revision adds a very detailed provision on the process of change of directors, namely, “If a director resigns, he/she shall notify the company in writing and the resignation shall take effect on the date of receipt of the notice by the company. …… If a director who is the legal representative resigns, he/she shall be deemed to resign from the legal representative at the same time.”

The practical significance of this provision is that when many large multinational enterprises change their executives, this is often achieved through a resignation letter at their foreign headquarters, while in the PRC company registration and filing process, the relevant filing needs to be completed in order to fully release the executive from his or her liabilities. The time lag between the resignation letter and the completion of the filing can sometimes be months to years due to issues such as internal processes at the company’s foreign headquarters, or perhaps even due to lack of cooperation from the subsidiary in China. Executives who have already stepped down are often concerned about incurring some executive liability during this process. This new provision in Article 65 should therefore help to clarify the responsibilities and obligations of corporate executives in such circumstances.

Article 66 of the Draft Revision provides that the shareholders’ meeting may resolve to dismiss a director; if a director is dismissed before the expiry of his or her term of office without due cause, that director may request compensation from the company. This provision seems to echo Article 62 of the Draft Revision, which states that “the board of directors shall be the executive body of the company”. As an executive body, the board of directors has a more specific and routine role than the shareholders’ meeting, which is the “authority” of the company. Although directors are not employees of the company and do not receive a salary, it is a common practice in foreign companies abroad to pay them a certain amount of remuneration through a mandate agreement to compensate them for their work. The dismissal of a director without cause is almost analogous to the dismissal of an employee for those directors who work “full time” on the affairs of the company. It is therefore reasonable for the directors to ask for some compensation from the company in such circumstances.

If the aforementioned detailed rules help to protect directors and clarify their responsibility, the following contents undoubtedly increase and reinforce the responsibilities of the persons concerned.

The Draft Revision strengthens the responsibility of directors, supervisors and senior management to maintain the adequacy of the company’s capital. As mentioned above directors, supervisors and senior management may be held personally liable for inadequate capital contributions by shareholders in the process of capitalization. The above-mentioned persons will also be liable in the process of capital withdrawal by shareholders, distribution of company profits and reduction of capital (Articles 47, 52, 207 and 222 of the Draft Revision).

In addition, the Draft Revision adds the provision that directors and senior management who, in the performance of their duties, intentionally or through gross negligence, cause damage to others, shall be jointly and severally liable with the company (Article 190 of the Draft Revision).

In practice, the issue of the liability of directors has been widely discussed after the court judgment in the Kangmei Pharmaceuticals case was made public at the end of 2021. In that case, the court ruled that several independent directors were jointly and severally liable to bear within certain percentage the debts of Kangmei Pharmaceutical, on the grounds that the directors concerned had failed to exercise due diligence. Accordingly, the aforementioned independent directors may all be liable for hundreds of millions of RMB in damages. This new provision in the Draft Revision will undoubtedly provide a more direct and clearer legal basis for the court to handle such cases.

The Draft Revision is still in the consultation stage and detailed adjustments may still be made subsequently. However, in terms of the general trend, foreign enterprises, which are subject to the uniform application of the Company Law, will need to pay close attention to the adjustments to the corporate governance structure, the more flexible provisions for joint stock companies and the responsibilities of directors, supervisors and senior management in order to operate in China in an efficient and compliant manner.