The Top 10 Changes for Foreign Companies Under China’s New Company Law

The Company Law is the most essential law for every company in China. On the date 30 years after it first came into effect, a substantially revised Company Law of China will now come into effect on 1 July 2024. This revision had been in the making for several years, with a first draft for a revised Company Law being published in December 2021, a second draft in December 2022, a third draft in August 2023, and lastly, a fourth and final draft on 29 December 2023.

All companies in China, including limited liability companies and stock corporations, foreign-invested and purely domestic ones, now have time until the end of June to study this new Company Law and adjust where necessary. For foreign-invested companies, this is all the more crucial, as their five-year grace period to fully adjust to China’s Company Law, which began with the Foreign Investment Law coming into force on 1 January 2020, will expire on 31 December 2024.

So, what are the biggest changes that foreign-invested companies in China may have to make under the new Company Law? Below you will find our top 10 picks. As the vast majority of foreign-invested enterprises in China take the form of limited liability companies, our overview focuses on these.

1. Re-introduction of Capital Contribution Timeline

Until 2014, the shareholders of limited liability companies in China had to contribute their subscribed portion of the registered capital of the company within 2 years following the company’s establishment. This timeline was abolished with the 2013 revision of the Company Law, and since then, shareholders were given the liberty to freely determine the timeline of their capital contribution in the articles of association. This resulted in many shareholders opting for rather high amounts for their registered capital and setting rather long timelines for their capital contributions, such as 30 or 40 years following the establishment of the company.

The 2024 Company Law now re-introduces a maximum timeline for the capital contribution, this time of 5 years following the establishment of the company (Article 47).

For companies already established and registered before 1 July 2024, the Company Law states that these shall “gradually adjust” (逐步调整) their capital contribution timelines if their timeline exceeds this five-year period. Furthermore, companies whose capital contribution timeline and amount are “clearly abnormal” (明显异常的) may also be required by the Administration for Market Regulation (AMR) to make timely adjustments.

What this means for foreign-invested companies:

The Company Law states that China’s State Council will publish implementation measures that will likely provide more guidance regarding the unclear provisions in the Company Law, such as the terms “gradually adjust” and “clearly abnormal”. For more clarity on how already existing companies will have to adjust to the new rules, one will therefore have to wait for these measures to be released.

Nonetheless, foreign-invested companies and their shareholders may already want to revisit their capital contribution timeline and the contributions made so far. As a litmus test, they may want to assess whether they would eventually be able to contribute their outstanding contributions within 5 years from 1 July 2024. If the shareholders feel uncomfortable about this and, at the same time, do not see a need for further capital contributions to finance the company’s operations, they may want to consider decreasing the registered capital accordingly.

2. Tightened Rules on Outstanding Capital Contribution

Along with the re-introduced timeline for the contributions to the registered capital, the new Company Law establishes overall stricter rules for undue or insufficient capital contributions.

For example, Article 54 considerably lowers the barrier for creditors of a company as well as the management of the company to request a shareholder to pay in any outstanding or insufficient capital contribution, if the company is unable to pay its debts - even if the timeline of the capital contribution for the respective shareholder has not expired yet.

Under the currently applicable rules, if a company is unable to pay its debts, several additional requirements have to be fulfilled before a creditor or the management of the company can successfully make such request. Most importantly, the company mostly has to either have already filed for bankruptcy or be close to bankruptcy. Pursuant to the new wording of the Company Law, these additional requirements will now likely not be necessary any longer, and it may be sufficient for a company to not pay its debt, for the creditors or the management of the company to require unpaid capital contributions of a shareholder ahead of the timeline.

Two further examples for the overall tightened capital contribution rules in the new Company Law are that shareholders may, in future, be held liable towards the company itself for losses caused to the company due to capital contributions that were not made in full or in time (Article 49), and that shareholders may also be held liable for unpaid or insufficient capital contributions of co-shareholders (Article 50) up to the amount of the unpaid or insufficient capital contribution portion.

What this means for foreign-invested companies:

Similar to the reintroduced capital contribution timeline, shareholders of foreign-invested companies may want to revisit the situation of any potential unpaid capital contributions, especially in situations where the company itself has had or is about to face payment defaults.

Additionally, as the overall tightened capital contribution rules also apply to insufficient capital contributions, shareholders may also want to consider assessing any capital contributions in kind, both of themselves or their co-shareholders. As there is a chance that such in-kind contributions have not been formally evaluated prior to their contributions, this could avoid potential disputes about whether the value was sufficient or arrears have to be paid.

3. Employee Representatives

Likely inspired by the German system of employee co-determination, the new Company Law introduces the requirement to include an employee representative on the board of directors if the company has more than 300 employees (Article 68). Such an employee representative on the board of directors shall be democratically elected by the company's employees.

The new Company Law indicates, however, that if a company exceeding the 300-employee threshold already has a board of supervisors with an employee representative included, it may be exempted from the requirement to have an employee representative on the board of directors.

The board of supervisors already according to the currently effective Company Law requires the inclusion of democratically elected employee representatives. Given, however, that companies with either a small number of shareholders or a small size of operations may decide to not have a board of supervisors, but rather one or two individual supervisors, the majority of foreign-invested companies in China do not have a board of supervisors yet.

What this means for foreign-invested companies:

Foreign-invested companies surpassing the threshold of 300 employees will have to consider how to best embed employee representatives in their company organs, especially if they do not yet have a board of supervisors with employee representatives included. In such cases, they may have to add or clear a spot in the board of directors to allow for the inclusion of an employee representative. Alternatively, they may want to consider establishing a board of supervisors and embed the employee representative there, rather than in the board of directors.

4. Board of Supervisors, One Supervisor, or No Supervisor

As per the currently effective Company Law, companies can either have a board of supervisors, consisting of three or more supervisors, or, if the number of shareholders or the scale of its business operations is rather small, it may elect to have one or two supervisors, without establishing a board of supervisors.

The new Company Law now changes this to the end that companies that are not required to have a board of supervisors may either have one supervisor or, if all shareholders agree, no supervisor. Having two supervisors, however, will no longer be an option.

For one, this means that smaller foreign-invested companies, such as start-ups, or smaller sales entities, may now not have a supervisor at all. This will give more flexibility particularly to those foreign-invested companies who in recent years may have been lacking the suitable personnel on the ground to serve as a supervisor and who at times even outsourced the functions of the supervisor.

For another, however, this means that companies with two supervisors may have to adjust if they are asked to fully comply with this new rule by the AMR. This may be particularly complicated for joint ventures with two shareholders, where each party gets to nominate one shareholder.

What this means for foreign-invested companies:

Foreign-invested companies and their shareholders may want to assess their current set-up of supervisors and consider adjusting it, either because it becomes necessary, or because it appears beneficial.

5. Introduction of the Audit Committee

The new Company Law introduces the idea that an audit committee consisting of directors from the board of directors may be established, which would then exercise the powers and functions of the supervisors (Article 69). If an audit committee is established, it would then exempt the company from having a supervisory board or individual supervisors.

While the idea of an audit committee as a supervisory organ in a company is not new in China’s laws and regulations, this is the first time it is introduced for limited liability companies rather than stock corporations. The idea that directors on the audit committee would be tasked with supervising themselves and the senior management generally seems to be at odds with the Company Law, as it elsewhere states that directors and senior management may not concurrently serve as supervisors (Article 76). At the same time, despite this potential conflict of interests, directors may be closer to the operations of the company and, therefore, in a better position to identify irregularities.

The new Company Law indicates that not all directors on the board of directors would have to be represented on the audit committee, as Article 69 of the new Company Law states that the employee representatives potentially included in the board of directors can become members of the audit committee.

What this means for foreign-invested companies:

We expect that further guidance on the establishment and operation of the audit committee will be published by the Chinese regulators. Such rules may partially draw upon the existing rules for an audit committee for stock corporations, such as the Guidelines on Corporate Governance of Listed Companies.

Foreign-invested companies that had difficulties finding suitable candidates for the positions as supervisor and that have appointed individuals from its group that are not in China, or external service providers, may want to consider establishing an audit committee in lieu of the current supervisors.

6. New Personnel Eligible to Serve as Legal Representative

China’s Company Law proposes a system under which only one individual per company can be registered as the legal representative. Under the currently effective Company Law, only a few individuals within a company are eligible to serve as the legal representative, with the eligibility being tied to their position in the company. This circle of eligible individuals is now extended under the new Company Law.

Under the currently effective Company Law, only the following individuals are eligible to serve as legal representatives: The chairperson of the board of directors, the sole executive director, in case no board of directors was established, or the general manager. The new Company Law now proposes that any director and the general manager can serve as the legal representative of the company (Article 10).

For one, this means that the regular directors of the board of directors, other than the chairperson, can serve as legal representative. For another, however, the new Company Law adds a caveat to this extended circle of eligibility, by stating that the director or manager serving as the legal representative shall be the one who represents the company in executing company affairs. Whether this will be interpreted to mean that the legal representative shall also be involved in the daily operations of the business will have to be seen.

What this means for foreign-invested companies:

Foreign-invested enterprises will now have more flexibility in determining who the legal representative shall be, as regular directors may now also be elected to serve as legal representatives.

7. Compensation for Dismissed Directors

As per the current and the new Company Law, the term of office of directors has to be regulated in the articles of association of a company. In many cases, companies will go with the maximum term allowed for directors, which is 3 years. However, it is also often the case that directors are exchanged or dismissed before the term of operation ends.

The currently effective Company Law generally states that the shareholder or shareholders’ meeting shall not remove the director from office before its term expires. The new Company Law, however, now states that the director may be removed by the shareholder or the shareholders’ meeting, but that in case this happens before the expiration of its term of office and “without a legitimate reason” (无正当理由), the director may request compensation (Article 71).

What this means for foreign-invested companies:

There are several uncertainties regarding this potential claim for compensation at this moment. For example, for which financial aspects compensation may be owed, as directors, unlike general managers, in many cases serve the company without compensation. Furthermore, it will have to be determined which reasons will be considered legitimate, for example whether the removal of a director in timely connection with a post-merger integration is legitimate, where the new shareholder or group parent company wants to install directors from its own group and dismiss the directors from the seller’s group.

Regardless, however, shareholders will, in future, have to consider agreeing with a prematurely departing director on the terms and conditions of its departure, to avoid the risk of compensation claims.

8. Quorum Requirements

The new Company Law introduces mandatory quorum requirements for the convening of meetings of the shareholders’ meeting or the board of directors, as well as for the passing of resolutions during such meetings (Article 66 and Article 73). Pursuant to these requirements, at least half of the equity interest of a company needs to be represented during a shareholders’ meeting, and half of the directors need to be present during a meeting of the board of directors.

These mandatory quorum requirements are particularly important for joint ventures with two shareholders, for example, one Chinese and one foreign shareholder. In these cases, both parties will generally have an interest that meetings of the shareholders’ meeting and the board of directors may still be convened and resolutions may still be passed even if one party or the directors of one party repeatedly do not participate despite correct invitations to such meetings. Joint venture or shareholders’ agreements will then often prescribe rules for such scenarios.

With the newly introduced quorum requirements, however, these rules may not come to fruition any longer beginning from July 2024, as despite the circumstances, half of the equity interest and half of the directors must be represented in the convening of meetings and the passing of resolutions.

What this means for foreign-invested companies:

Foreign shareholders of joint ventures in China, particularly those with an even number of shareholders, will have to revisit the mechanisms for deadlock situations in the articles of association of their joint venture and/or the shareholders’ agreement. If clauses are included to the end that meetings of the shareholders’ meeting or the board of directors may be convened and resolutions may be passed despite half of the equity interest or the directors not being in attendance, these will have to be replaced with different solutions.

9. Stricter Liability Rules for Directors and Senior Management

The new Company Law includes several new clauses that create stricter diligence requirements and greater liability exposure for directors and senior management of companies in China. For example, Article 180 of the new Company Law now introduces a diligence requirement for directors, supervisors, and senior managers of a company that is reminiscent to the concept of a prudent businessperson under German law. It states that directors, supervisors, and senior managers have a duty of diligence to the company, and when performing their duties, they should exercise the reasonable care normally expected of managers in the best interests of the company.

As another example, directors are now required combined with liability to verify capital contributions of the shareholders of the company and, in case of undue or insufficient contributions, to issue reminders.

What this means for foreign-invested companies:

Foreign-invested companies in China and their shareholders may want to assess whether the directors, supervisors and senior managers of their company fulfil these new requirements and also have the capacity to fulfil these requirements, for example in case they are normally not involved in the business operations of the company.

Furthermore, management rules included in the articles of association, management by-laws or elsewhere may have to be adjusted according to the new requirements.

10. Shifting of Responsibilities

The Company Law contains non-exhaustive catalogues for the responsibilities of the shareholders’ meeting, the board of directors, the general manager, and the supervisory board. These catalogues were now changed and partially also deleted, resulting in more flexibility when determining the responsibilities of the company’s organs.

In particular, the responsibility to decide on the company’s business policies and investment plans, as well as on the company’s annual financial budget plan and final accounts plan, were deleted from the catalogue of responsibilities of the shareholders’ meeting. While the former was moved to the catalogue of responsibilities of the board of directors, the latter was simply deleted from the Company Law, which could suggest that now either the shareholders’ meeting or the board of directors could be bestowed with this responsibility.

Additionally, the power to decide on the issuance of corporate bonds may now be delegated from the shareholders’ meeting to the board of directors (Article 59), and the new Company Law also allows for the board of directors to decide on a merger of the company in case the company is merged upstream onto its shareholder holding 90 or more percent of its shares (Article 219; squeeze out).

The catalogue of responsibilities for the general manager was completely deleted in the new Company Law, which now provides for greater flexibility when determining the functions of the general manager.

What this means for foreign-invested companies:

The shift of responsibilities between the shareholders’ meeting, the board of directors and the general manager should be particularly interesting for Chinese-foreign joint ventures that have not yet fully adjusted to the Company Law, as required under the Foreign Investment Law. It will also give other foreign-invested enterprises more flexibility to determine the responsibilities of the companies’ organs, in particular if they would like to bestow the board of directors with greater decision-making power.

Conclusion

As can be seen from this Legal Update, the changes in the new Company Law will likely impact every foreign-invested company in China. Although there are currently still uncertainties and rooms for interpretation regarding some of the changes under the new Company Law, it is advisable for foreign-invested companies, their shareholders, and their management to consider and discuss adaptations to the new Company Law as early as possible, while it is still possible to do so on their terms and on their timeline.

Our dedicated China Group lawyers are in continued exchange with branches of the relevant Chinese regulators and advocacy organizations on the ground in China to stay ahead of the legal developments.