Company Law Revision Draft of China: Further major changes and new provisions

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published on 4 May 2022 | reading time approx. 4 minutes

by Christina Gigler and Xiaolan Zhao
  
In addition to the changes already mentioned in the previous articles, the “Revision Draft” of the Company Law provides further amendments for e.g. the exit of companies, the protection of the rights and interests of minority shareholders, the strengthening of transaction security as well as the stronger obligation of management personnel.

       

  

 

Simplified company deregistration procedure

As a general rule, in China an exit of a company is not as simple as its establishment. In the process of deregistration, liquidation is the most complicated and time-consuming part. The Revision Draft introduces now a new simplified deregistration procedure to facilitate the exit of companies. Although simplified deregistration was firstly proposed in 2014 and has already been applied in practice, it has been incorporated into the Company Law for the first time. The simplified deregistration applies to companies of which no debt arose during its existence or all the debts have been paid off. The simplified deregistration does not require the liquidation, but only commitment of all shareholders and the announcement of this deregistration through the National Enterprise Credit Information Publicity System for at least 20 days. Compared to general deregistration procedure, simplified deregistration can speed up the exit of a company considerably, if there is no objection raised during the publication period by creditors or other interested parties.
 
However, it is important to note that under simplified deregistration the shareholders' liability for company's debt which occurred prior to the deregistration, changed from “corresponding liability” into “joint and several liability”, which increases the risk of shareholders in debt repayment, and may even break though the limited liability of shareholders.
 

Extension of shareholders' right to know

Accounting vouchers are the most important documents for shareholders to know the true financial information of a company. Under the current law, shareholders shall have the right to check the company's accounting books, but not the accounting vouchers. Although the dominant judicial view supports the access to accounting vouchers, if shareholder claims its right in requiring the company to provide accounting vouchers for inspection, some courts may still refuse to uphold the shareholders' claim due to the lack of legal basis. The Revision Draft clarifies this issue and adds the accounting vouchers into the scope of documents which shareholders have access to.
 
Also, the Revision Draft stipulates that a shareholder may, when consulting the company materials, entrust an accounting firm, law firm or any other intermediary that has the obligation of confidentiality according to the code of practice. The requirement that the shareholder has to be present during the inspection, as prescribed in Provisions of Supreme People's Court on Several Issues Relating to Application of the Company Law of the People's Republic of China (IV) (“Provisions IV”) is however removed from the Revision Draft. Thus, shareholders will not have to accompany lawyers or accountants to check their accounts in person. The inspection is thus facilitated especially for shareholders who are abroad.
 
Of particular note is also the right to know of shareholders of companies limited by shares. The current Company Law does not authorize shareholders of a company limited by shares to inspect the accounting books and accounting vouchers of the company, but only the financial and accounting reports, which is changed by the Revision Draft. Pursuant to Accounting Law of PRC, formation of financial accounting reports shall be based on verified records of accounting books, and entries in accounting books shall be based on verified accounting vouchers. So the access to financial and accounting reports alone – as prescribed in current Company Law – does not provide the shareholder of companies limited by shares with many possibilities to detect any hidden financial problems. Based on the Revision Draft, shareholders who solely or jointly hold 1% or more of the shares of a company for consecutive 180 days or more have a right of inspection. The reason for inspection is limited to doubts that the company violates laws, administrative regulations or the articles of association in its operation. Inspection shall be conducted within the necessary scope. If the company refuses the shareholder’s inspection, the shareholder may file a lawsuit before a people's court.
 

Resolution revocation and non-establishment

The shareholders' meeting and board of directors act as the highest decision-making authority and executive body of the company respectively and most of their major decisions are made in meetings, which shall be in conformity with laws and regulations as well as articles of association, otherwise the resolutions may be unestablished, revocable or invalid.
  
A resolution of a shareholders' meeting or a board's meeting can be revoked, where the convening procedure or voting method violates laws, administrative regulations or the articles of association, or if the content of a resolution violates the articles of association. Under the current Company Law, only shareholders can request the people's court to revoke a company resolution. The Revision Draft provides that apart from shareholders, directors or supervisors may also apply to the court as plaintiff. In addition, under the current Company Law, the shareholders shall apply revocation within 60 days from the date of resolution being made, whereas the Revision Draft adds one more circumstance that if the shareholders or directors are not notified to attend the shareholders' meeting or the board's meeting, they may request the people's court to revoke the resolution within 60 days from the date when they know or ought to know the resolution. This change addresses the issue of shareholders or directors missing the above deadline due to lack of knowledge of the resolution.
  
Different to resolution revocation, which occurs due to (mild) violation in its procedure or content, failure to form a resolution (unestablished resolution) was mainly caused by serious procedural defects which results in a failure to form the will of the company. Circumstances which trigger such failure are not stipulated in the current Company Law, but provided in Provisions IV. The Revision Draft incorporates now the provisions of the Provisions IV and stipulates that a resolution is not established where
  
1. no meeting is held to make the resolution;
2. no vote is made on the resolution matters;
3. the number of persons attending the meeting or the number of voting rights they hold does not reach the number as prescribed in the Company Law or the articles of association; or
4. the number of persons consenting to the resolution matters or the number of voting rights they hold does not reach the number or voting right as prescribed in the Company Law or the articles of association.
  
The catch-all provision “other circumstances in which the resolution is not established” in Provisions IV is not included in the Revision Draft.
    
With regard to procedural compliance, the Revision Draft introduces a significant change in convening and resolution of the board's meeting of a limited liability company. The Revision Draft stipulates that no board's meeting may be held unless more than half of the directors are present and a resolution of the board of directors shall be adopted by the majority of all the directors, which is not mentioned in the current Company Law.
  

Major change in one-person limited liability companies

One-person limited liability companies refers to limited liability companies established by a sole natural person or sole legal person as shareholder. The current Company Law has a special section for one-person limited liability companies. In the Revision Draft, most of the restrictions to the one-person limited liability companies are removed, such as that one natural person can only establish one one-person limited liability company which is prohibited from investing in the establishment of another one-person limited liability company, or that the shareholder of a one-person limited liability company who is unable to prove that the company's assets are independent of the shareholder's personal assets bears joint liability for the company's debt.
  
Furthermore, the Revision Draft allows a sole natural person or legal person to establish a company limited by shares by means of promotion, which provides investors with an additional option to choose the legal form of a company.
  

Stock right and creditor's right as new form of capital contribution

In practice, it is not uncommon for shareholders to make capital contributions in the form of “stock right” or “creditor's right”. However, those contribution forms are not clearly acknowledged by the current Company Law, which causes confusion for companies and registration authorities in practice to do so. The legal basis for contribution in stock right is taken from the provision in current Company Law that shareholders may make capital contributions in the form of “any other” non-cash assets which can be valuated and transferred. According to Article 13 of the Implementing Rules for the Administrative Regulations of the People’s Republic of China on the Registration of Market Entities effective as of 1 March 2022, capital contributions with stock rights and creditor’s rights are, generally, already legally possible.
  
However, he Revision Draft clarifies for the first time the “legal identity” of stock rights and creditor's rights by specifying that shareholders may, among others, make capital contribution in the form of stock rights and creditor's rights.
  
However, due to the instability and uncertainty of stock right and creditor's right, we believe further clarification should be provided as to the remedies for failure of the capital contribution. For example, in the case of a capital contribution by way of creditor's right against a third party, whether the contributor is required to make up the difference if the debtor fails to make the capital contribution in full upon expiration of such claims.
  

Publication of the articles of association

In judicial practice, many disputes regarding the validity of contracts are raised from excess of power of representation or conflict with internal regulations of the concerning company. The Revision Draft adds the provision that articles of association shall be published to the general public through the National Enterprise Credit Information Publicity System. If this provision applies eventually, it would on the one hand reduce transaction risks and strengthen protection of creditors, but on the other hand, this might be contrary to the interests of the company itself, as the articles of association are supposed to be a purely internal document. Based on the wording of the Revision Draft, it is not entirely clear whether the articles of association will indeed be accessible by the general public, without having any special interests. Moreover, it is unclear whether the articles of association must be published in full text or whether only certain major provisions are sufficient.
  

Directors as liquidation obligors

The Revision Draft changes the liquidation obligor of a company from "shareholders" to "directors". This means that the director, as the liquidator, shall be liable for damages caused to the company or its creditors if he fails to perform the liquidation obligations in a timely manner.
 

Time limit for profit distribution

The Revision Draft stipulates that the profit distribution shall be made by the board of directors within six months after such resolution is made by shareholders' meeting, unless it is otherwise provided for in the articles of association or by a resolution of the shareholders' meeting. Such provision is currently stipulated in Provisions of Supreme People's Court on Several Issues Relating to Application of the Company Law of the People's Republic of China (V) (“Provisions V”), however with a time limit of one year.
 

Increased penalties for financial fraud

The Revision Draft increases penalties for corporate financial fraud. The maximum penalty of the company for setting up another accounting book other than the statutory accounting books is increased from RMB 500,000 to RMB 2 million. The maximum penalty for the person-in-charge and other directly liable persons for providing financial accounting reports with false records or concealing any material fact is increased from RMB 300,000 to RMB 500,000. For public companies, in addition to the penalties under the Revision Draft, they will face much more severe penalties or even criminal liabilities under the new Securities Law and other provisions if they commit fraudulent offering or misrepresentation. 
   

Outlook

The current Company Law was last amended in 2018 after four revisions since its first adoption in 1993. This fifth Revision is a rather comprehensive revision to the Company Law. Many significant changes are made, which can be seen as an improvement (e.g. formal introduction of the possibility to make capital contributions with stock rights or creditor’s rights). On the other hand, the Revision Draft contains some changes that could be interpreted as detrimental from the perspective of investors (e.g. the mandatory requirement to have employee representatives in the board of directors of limited liability companies with more than 300 employees). At the same time, it can be seen that the Revision Draft also needs to be polished in practice and may require further supporting regulations in the future, which will also bring new challenges in various aspects such as corporate governance and risk control compliance.
  
As this is currently still a draft, it remains open to what extent it will be further revised or become the new standard. The actual impact in practice remains unclear for the time being.

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