A New Chapter: Next Evolutionary Phase of the New PRC Company Law – Part I: Commitments on Capital Contribution
Other Author Elfie Wang of Meng Bo Law Office, a PRC law firm based in Shanghai, with which Mayer Brown has a close working relationship.
The long-awaited amended Company Law (New Company Law) was enacted on 29 December 2023, effective from 1 July 2024. The new amendments are arguably the most significant since China established its company law regime back in 1993.
The changes are, in fact, so wide-ranging that we will be issuing a series of short updates on them.
Although the new law contains few surprises – as many of the changes were envisaged in the earlier consultation drafts (refer to our earlier Legal Update here) – it is absolutely essential for investors to familiarise themselves with the amendments, and plan for the new requirements.
In this first article, we discuss one of the most significant changes which concerns shareholders' capital contribution commitments.
A Change in Direction
The total contributions that shareholders agree to make to a company are known as the Registered Capital. As noted in our earlier legal update, in 2014 China lifted minimum Registered Capital requirements and the time period within which shareholders are required to make contributions.
This reform made the structure of Chinese Companies similar to those found in many international jurisdictions that have both authorised capital and paid-up capital.
The intention was to stimulate investment, but over the last decade concerns have arisen about some companies not registering their true level of contributions and appearing financially stronger than they actually are.
These 2014 reforms and relaxations will now be reversed.
This means that investors will once again need to establish the structure of a new company having regard to foreseeable business needs and investment objectives.
A contribution period has been provided for under the New Company Law, requiring shareholders in most cases to make capital contributions within 5 years after a company1 is established. Contribution dates should be specified in the company’s articles of association.
The same 5 year period will apply in cases of capital increase (Article 228 of the New Company Law).
What About Existing Companies?
The New Company Law requires existing companies with a high outstanding Registered Capital to “gradually adjust to meet the timeline provided herein” (Article 266 of the Company Law) – making it clear there will be no special "grandfathering" rules applicable to existing companies, and that all companies will comply with the 5-year contribution timeline (subject only to a transition period discussed below).
A related question concerns the ease with which companies can reduce their Registered Capital if needed. Clearly, many companies now have Registered Capital well in excess of 5-year business needs and action will now be needed. Article 225 of the New Company Law introduces simplified capital reduction procedures which will assist in such circumstances.
There is also reference within the New Company Law to “specific implementation measures” which will be prescribed by the State Council. These measures will probably include a transition period for companies incorporated prior to effectiveness of the new law to make the adjustment. Although these details remain unknown it is likely that all companies will need to restructure or make arrangements to pay up existing Registered Capital within a reasonably short period of time.
Enterprise Information Publicity
Under the original 1993 legal requirements, Chinese companies were required to file their paid-in capital with the company registration authority; which means that each time a shareholder makes a contribution the company needs to file such contribution with the company registration authority. Such requirement has now been removed, along with the above-mentioned reformation, as the paid-in capital is no longer a registration item.
Although companies are still theoretically required to publicise paid-in capital under the Interim Regulations on Enterprise Information Publicity (Publicity Regulation), in practice it has been common for companies to fail to disclose or update such information; making it difficult for third parties to ascertain a company’s real size by relying on published information, leading to confusion about its financial strength.
The New Company Law now expressly requires companies to publicise the paid-in capital of each shareholder through the National Enterprise Credit Information Publicity System2, failure of which may result in a fine of up to RMB 50,000; or in severe cases RMB 200,000 fine on the company and up to RMB 100,000 fine on directly responsible management and other directly responsible persons.
It is so far unclear how the authorities will enforce such requirements and further measures may be issued in this regard.
Pursuant to the Publicity Regulation, companies must publicise paid-in capital, contribution date and contribution method within 20 working days.
What Happens If a Shareholder Fails to Make a Capital Contribution?
The New Company Law attempts to enhance and strengthen the role of the board of directors (Board) within the company governance structure so that they become more independent of shareholders.
This is a big change as for many years directors have eventually represented the views of the shareholders appointing them.
However the New Company Law establishes a mechanism obliging the Board to check the capital contribution of shareholders and demand payments if any shareholder fails to make contributions on schedule. Failure to perform such duties may result in personal liability, which we will elaborate on in future updates in this series.
A grace period of at least 60 days must be granted after the company issues a demand; and if the shareholder fails to make contribution within the prescribed grace period, the company may issue a written notice to forfeit a defaulting shareholder's equity interest, effective upon the issuance of such notice.
It should be noted that forfeited Registered Capital should be either transferred or deregistered through capital reduction within six months, otherwise the other shareholders will be required to pay up the corresponding capital contribution, in proportion to their capital contributions.
What Will These Requirements Mean?
The expectation, so far as director action is concerned, is a significant change in direction. In the past, directors have generally followed the instruction of shareholders. The New Company Law seems to put new requirement on shareholders which may be difficult to implement in practice.
To assist compliance with the new law, companies may wish to consider changing their articles of association so that, for example, directors appointed by a defaulting shareholder do not have a vote or are otherwise excluded from the forfeiture procedures.
Also, given the short six months period, it may be advisable for shareholder agreements to provide for quick decision-making procedures allowing either reduction of Registered Capital or streamlining the disposal process.
The shareholder who fails to make contribution may be liable:
- to make up the contribution to the company;
- to indemnify the company for losses;
- for a fine ranging from RMB 50,000 to 200,000, and in severe case a fine of 5-15% of the underpayment.
In addition certain directors/responsible management may also face fines of RMB 10,000 to 100,000 and even obligations to compensate a company for failure to verify contributions of Registered Capital.
Accelerated Maturity of Capital Contribution
Shareholders have long been liable to make immediate contributions in circumstances where a company is liquidated or made bankrupt. However, Article 54 of the New Company Law goes much further, allowing creditors to request shareholders to make capital contributions if the company is unable to discharge the debts when they become due.
The New Company Law appears to indicate that a creditor may be able to enforce against a company’s shareholder, to the extent of its subscribed but unpaid capital, if for example a company cannot pay a debt in a judgment. So far, the details are still unclear and merit further observation. However, the risks to shareholders are clearly increased by having higher but unpaid Registered Capital, which makes restructuring desirable.
There is also potential for shareholder conflict in circumstances where a company has assets that could be restructured/sold to allow the company to meet debts but fails to do so – it remains unclear whether the obligation to contribute accelerated Registered Capital would apply in cases where the directors/shareholders fail to make alternative arrangements to settle debts. Further guidance will be required but in order to ensure certainty, shareholders may wish to make provision for such circumstances in the shareholders’ agreement and/or articles of association.
When forming a new company, investors clearly need to consider their five-year business objectives and structure Registered Capital accordingly. It may also be advisable for companies having multiple shareholders agreed among themselves a mechanism allowing for appropriate monitoring of Registered Capital contribution – and agreed consequences in the event of delays in such contributions.
Existing companies and their shareholders would be well advised to review the Registered Capital and relevant capital contribution schedules. Pursuant to the New Company Law, if the contribution schedule is not in line with the statutory requirement, it should be gradually adjusted to ensure compliance. However, as discussed above, various other matters impacting the shareholders’ agreement and articles of associations need urgent consideration. Some companies may wish to reduce Registered Capital.
Last but not least, the New Company Law indicates that the detailed implementation measures will be formulated by the State Council. It is so far unclear but likely that a deadline for the adjustments may be specified. It is important for any company to stay up to date with developments and be ready to adapt.
1 References to companies in this Update refer to limited liabilities companies relevant to foreign investment, rather than alternative legal entities such as joint stock companies.
2 An online official platform developed and run by the State Administration for Market Regulation, which is mainly used to make information publication of enterprises in China.