What's New about The Coming Amendment of China’s Company Law?
On 24 December 2021, the standing committee of the National People’s Congress published the draft of the amendment of China’s Company Law (the “Draft Amendment”) to hear public comments. After its enactment in 1993, the Company Law has been amended for four times. Among which the amendment in 2005 was the only “full scale” amendment and the rest were only focused on a few certain topics of the Company Law. Now as we are expecting the 6th and another “full scale” amendment in the near future, the Draft Amendment allows us to have a first look into the amendment. This article will focus on some of the most important changes provided by the Draft Amendment.
I. Put the Board at The Center
With respect to the internal organizations, unlike the “one-board system” which is widely adopted in common law jurisdictions, China’s Company Law has generally followed the “two-board system” of Japan which means the company shall establish a board of directors to exercise the power of “execution” and a board of supervisors to exercise the power of “monitoring” based on the election or appointment of the shareholder meeting. However, in case the company only has few shareholders or a small scale, the Company Law allows the company to set one single executive director instead of a board of directors and one or two supervisor instead of a board of supervisors.
In the Draft Amendment, in addition to the “two-board system”, companies are allowed to form an audit committee inside the board of directors to supervise the accounting matters of the company. There is no requirement in the Draft Amendment regarding whether the member of the audit committee shall be non-executive director or independent director. But the Draft Amendment requires that if the company is a company limited by shares, then more than half of the members of the audit committee shall be non-executive director. And in such a audit committee style company, there will be no need to establish the board of supervisors (or individual supervisor).
The Draft Amendment also raised the flexibility of allocating powers between the internal organizations. In the current Company Law, Article 46 provides a non-exhausting list of the powers of the board of directors. And company can add more powers to the board of directors by its articles of association. But the board of directors can only exercises the powers set out in the articles of association. For those powers which are not explicitly provided under the articles of association as the powers of the board of directors, it shall be exercised by the shareholder meeting. But according to the Draft Amendment, the board of directors shall exercise the powers except for those which are assigned to the shareholder meeting by the Company Law and articles of association. Such a scheme will greatly expand the powers of the board of directors.
Furthermore, the Draft Amendment requires any limited liability company having more than 300 employees and any company limited by shares to have representative of employees in the board of directors. The current Company Law only requires the stated-owned or state-invested companies to include representative of employees in their board of directors, but the Draft Amendment has abandoned such “capital approach”. Unlike other countries, it is hard to draw a clear line between “management” and “employee” in China. For example, in Japan when a management is promoted to the position of director, usually he or she will terminate the employment contract with the company and entered into an agency contract with the company instead. But in China, in most cases, management of a company are also hired by the company as an employee. Such a “dual identity” practice has made it difficult to determine who will be eligible to represent employees in the board of the directors.
By the above mentioned modifications, we can see a very clear intention of the legislator to put the board of directors at the center of the internal organization which is closer to the approach adopted in the common law jurisdictions.
II. Introduction of Class Shares
While Article 131 of the Company Law says the state council can adopt regulations regarding the issuance of shares in different classes by company limited by shares, but in practice the China law has been very careful in allowing issuance of class shares and the principle of “same share and same rights” has been well preserved since the enactment of the Company Law. With respect to the limited liability company, considering the rather close relationship between shareholders, the Company Law allows the company to allocate the voting powers and make dividend between the shareholders regardless to the shareholding ratio. Because of such a strict legal approach adopted on class shares, shareholders in China who wanted to allocate different powers and interests between them usually need to establish individual arrangements under the framework of contract law.
But the Draft Amendment opened the door for class shares. Article 96 of the Draft Amendment says the articles of association of a company limited by shares shall include the types of class shares, number, rights and obligations of each class if the company issues class shares. Article 157 further says that the company limited by shares can issue (1) preferred or inferior shares on distribution of dividend and residual assets, (2) shares that have more or less voting rights than the ordinary shares, (3) shares that require the approval of the company to be transferred. But listed company is not allowed to issue class shares of (2) and (3).
Also, the Draft Amendment requires that if the shareholder meeting is going to resolve on the matters like amendment to the articles of association, increase or decrease the registered capital, merge or split, dissolve or restructure and such a resolution may impair the rights of shareholders of class shares, then in addition to a two-thirds approval by the general shareholder meeting, an extra two-thirds approval by the class share shareholder meeting is also required.
It is true that the Draft Amendment only allows a very limited number of class shares, but anyway it is a big step forward from the standpoint.
III. Introduction of Authorized Capital
Article 97 of the Draft Amendment says in a company limited by shares the articles of association or the shareholder meeting can authorize the board of directors to issue new shares and impose restriction on the time limit and ratio of such authorized capital.
The Company Law requires the articles of association must state the amount of the registered capital (in the case of limited liability company) or number of shares and the par value (in the case of company limited by shares). And in the case of limited liability company, although the shareholders can decide the schedule of contributing the capital, but all registered capital must be subscribed by shareholders at the time of establishment. If the company wants to increase the capital or issue new shares, it must be approved individually by the shareholder meeting.
The Draft Amendment for the first time allows the company limited by shares to apply authorized capital while the limited liability company still have to maintain the current mechanism. This is because in the Company Law, company limited by shares are a type of company designed for relatively big company with many shareholders. In such a company, shareholders do not care too much about the identity of other shareholders so long as they have an expectation about to what extent their shareholding in the company may be diluted. While the limited liability company is designed for small company formed by few shareholders who have close relationships. Strong connection and mutual trust between shareholders is the foundation of a limited liability company, thus it is not appropriate to authorize the board of directors to increase capital because new shareholders may join the company without the approval of the existing shareholders. And the second reason is usually in a limited liability company, shareholders themselves are also members of the board of directors or at least represented in the board of directors. Therefore, there will be no difference if such decision to increase capital is made by the shareholders or by the board of directors.
IV. Acceleration of Capital Contribution
Article 48 of the Draft Amendment says if the company failed to pay the debts that were due and the company is obviously in lack of ability to pay the debts, then the company or the creditors can ask the shareholder who has subscribed the capital but the time limit of paying such capital has not yet expired to pay the capital.
Historically speaking, China’s Company Law has been very strict about shareholders’ payment of capital. Before the amendment in 2005, the Company Law required shareholders to make a one-time payment of all the capital at the time of establishment of the company and different types of companies must meet the requirement on minimum amount of capital respectively. After 2005’s amendment, the Company Law allowed the shareholders to pay in the capital no less than 20% of the total amount and the rest can be paid in within two years after the establishment of the company. In 2013, the Company Law finally abandoned the requirement on minimum amount of capital and the payment schedule. The amount of capital and how to pay the capital are all up to shareholders’ agreement and such agreement shall be included in the articles of association.
After the 2013 amendment, in order to secure more flexibility and freedom in paying capital, there occurred a practice that shareholders usually set a long time limit in paying the capital. And in the case of a company failed to pay back any debt owed by the company, in order to protect the interest of the creditor, relevant law says that the creditor can ask the shareholder to bear supplementary liability within the scope of its unpaid capital if the shareholder failed to pay its capital in accordance with the articles of association. However, if the shareholders agreed on a very long time limit in paying capital, then it will be very difficult for the creditor to make such a request, because since the time limit has not expired it is hard to say the shareholder failed to pay capital in accordance with articles of association.
Therefore, in order to better protect the interest of creditor, the Draft Amendment makes it clear that creditor can ask any shareholder to bear supplementary liability if the shareholder has not yet made its capital contribution even the payment limit has not expired.
V. Strengthening the Senior Management’s Responsibility
Article 147 of the Company Law requires the director, supervisor and senior management to bear duty of loyalty and duty of fiduciary to the company but does not clearly what do duty of loyalty and duty of fiduciary mean. The Draft Amendment makes it more clearly by saying that the duty of loyalty means the director, supervisor and senior management shall not seek for appropriate interest by facilitating their powers and positions in the company and the duty of fiduciary means that they shall pay reasonable attention which is generally required as a management in the process of performing their duties in order to secure the interests for the company to maximum extent.
The Draft Amendment also adds more detailed articles about the self-dealing and usurping business opportunity. Article 148 of the Company Law says the director, supervisor and senior management shall not enter into contract or deal with the company in violation to the articles of association or without approval by shareholders. And, without approval by shareholders, director, supervisor and senior management shall not pursuit business opportunity that belongs to the company and directly or indirectly being engaged in the business which is as same as the company’s business.
Article 183 of the Draft Amendment further states that entering into contract and transaction with the next of kin of any director, supervisor or senior management or a company which is directly or indirectly controlled by the next of kin of any director, supervisor or senior management shall also be deemed as self-dealing. With respect to usurping the company’s business opportunity, the Draft Amendment says if the transaction has been approved by board of director or shareholder meeting, or if the transaction is reported to the board of director or shareholder meeting and such business opportunity is rejected by board of director or shareholder meeting, or if the company may not secure such business opportunity due to the regulation in relevant law or articles of association, such a behavior shall not be deemed as usurping company’s business opportunity.
Furthermore, the Draft Amendment makes it clear that if director and senior management intentionally or recklessly caused any damage during the process of performing his or her duties, then such director or senior management shall be jointly and severally liable with the company.
The Draft Amendment relaxes the restriction on establishing one-person company. Under the Company Law, in order to avoid collation between the shareholder’s personal assets and the company’s assets, one-person company must only be a limited liability company and each natural person can only establish one single one-person and such one-person company may not further establish an one-person company. But the Draft Amendment has dropped such restriction and allowing one-person company to be a company limited by shares.
Also the Draft Amendment allows the shareholders to inspect the company’s financial statements and accounting documents. The current Company Law only says shareholder can get access to the company’s financial statements but does not say if the shareholder can also get access to accounting documents. The Draft Amendment also makes it clear that shareholders can engage accounting firms, law firm or other professional institutions to help to review the financial statements and accounting documents.
Except for the above mentioned points, there are other changes that also worth paying attention to but will not be discussed in depth in this article. As mentioned above, the coming amendment of Company Law will be the second “full scale” amendment since its enactment and will have a huge impact on the legal framework of business organizations in China. The published Draft Amendment is only a draft for public comments and it is very likely that some matters are still need to be further discussed and balanced. But, at least, the Draft Amendment has displayed the major topics and basic thinking of the legislator.