Significant revisions in the second draft revision of the Company Law improve corporate governance and standardise market order.
The Company Law of the People’s Republic of China (Revised 2018) was revised and published in 24 December 2021 for public comments. A year later, the second draft revision of Company Law (‘Second Draft’) was released on 30 December 2022 for public comments and review.
The Second Draft significantly revises the current Company Law by furthering enterprise development, standardising the market, and improving corporate governance. And refines the first draft to reflect public opinions.
For companies in China, the Second Draft signals a legislative commitment to developing a sustainable business environment and improving protection of shareholders’ rights and interests. Below, we outline what companies need to know about the Second Draft.
Accelerated Obligations for Registered Capital Contribution
Currently, the Company sets no limitation to the proportion of initial capital contribution during the company establishment or the deadline for the full capital contribution. Therefore, the current system greatly relaxes requirements to establish a company, yet simultaneously, such provisions can be misused.
For example, shareholders may set the contribution period as 100 years, in order to bypass the full capital contribution.
The Second Draft accelerates capital contribution obligations. Under Article 53 (Second Draft), if the Company cannot pay due debts, the company or the creditors with due creditor’s rights have the right to require the shareholders to fulfil their capital contribution subscriptions – even though the contribution period is not expired.
The Second Draft accelerates shareholders’ capital contribution obligations on a legislative level – even when the company is not under a termination status, such as liquidation. Under such revision, the capital contribution subscription system is maintained and the shareholder’s contribution responsibility is strengthened.
Increased Flexibility for Corporate Governance
The Second Draft enables more flexibility to the corporate governance structure. Namely, a single-layer governance model can be adopted, with a board of directors and no board of supervisors (both a limited liability company and a joint stock limited company can adopt such a model).
Instead of the board of supervisors, an audit committee comprising the directors shall be established within the board of directors. And in a joint stock limited company, more than half of the audit committee shall be non-executive directors.
Therefore, the Second Draft enables the company to tailor the corporate governance structure to the company’s needs. For example, “board of directors + audit committee of board of directors” or “board of directors + board of supervisors”.
It is worth noting that, the Second Draft relaxes the requirement for a supervisor within small-scale limited liability companies. Through the unanimous consent of all shareholders, a small-scale limited liability company may have no supervisor or audit committee. This reflects an intention to further relax the structural requirements for different company sizes. Though how it translate for small-scale companies is left blank for public comments.
Clarified Directors, Supervisors and Senior Management Responsibilities
The Second Draft deepens the legal responsibilities of directors, supervisors, and senior management in three main aspects.
Duties of Fidelity and Diligence
Firstly, the Second Draft specifies an explicit definition of the fidelity and diligence duties acceded to directors, supervisors and senior managers. Such roles shall not use their powers to seek illegitimate interests and when performing their duties. They shall be duly diligent for the best interests of the company.
Secondly, a reporting system is introduced to regulate related party transactions of limited liability companies. Prior to the related party transactions, the relevant directors, supervisors and senior management personnel shall report to the board of directors or shareholders’ meeting. And it shall be resolved by the board of directors or shareholders’ meeting according to the company’s articles of association. And as a rule, the board of directors shall abstain from voting (that is, related directors shall not participate in voting, and their voting rights shall not be counted in the total voting rights).
Equally, the scope of related party transactions is expanded.
- Roles expanded from directors and senior management to include directors, supervisors and senior management, and enterprises directly or indirectly controlled by them or their close relatives and persons with other relationships with them;
- Transaction types expanded from “direct transaction” to include “indirect transaction”.
Thirdly, directors, supervisors and senior management shall supervise the capital sufficiency of shareholders. If such personnel recognises that shareholders have made false capital contributions or withdrew their capital contributions, without taking necessary measures and resulting in company losses, they will be liable for compensation.
This liability is also applicable under the following circumstances:
- when the company suffers loss from financial assisting others to obtain shares of the company and in violation of regulations;
- when the company distributes profits to shareholders in violation of regulations; or
- when the company reduces its capital in violation of regulations.
These amendments set a higher and stricter standard for directors, supervisors, and senior management. Simultaneously, the revisions further protect the rights and interests of shareholders and investors, improve corporate governance, and prevent management corruption and misconduct within the company.
The Second Draft deepens the reform and promotion of enterprise development. Specifically, it paves improvements to corporate governance and the business environment for companies. Concurrently, it enhances the protection of shareholders’ rights and interests, and on a macro-level promotes economic development and social progression. Overall, the Second Draft signifies strengthened legislation and institutional support for sustainable enterprise development.