Draft of PRC company law may affect FIE’s in transition period!

Jingyun Wang

Jingyun Wang is a legal consultant. She holds a bachelor’s degree in French Language from the Xi’an International Studies University (China). Before joining DaWo Law Firm, Jingyun worked at a French law firm’s representative office in Shanghai.

As one may recall the revised Foreign Investment Law (FIL – effective from January 1, 2020), provided a five-year transition period for previously registered Foreign Invested Enterprises (FIE’s), to adjust their legal form and corporate governance structures to the common rules of the PRC Company Law, same as any other company in China.

As we are at the midway point of this transition period, it may be useful to point to some of the approximately 70 substantive additions and amendments to the PRC Company Law which are set out in the draft revision of the Company Law (the Draft) which was issued and has been under consideration since late last year. Indeed it is reasonable to expect that the proposed draft will be approved and thus become law before the transition period ends.

1. More options for the choice of legal forms

The legal forms of corporate entities available for FIEs under the current Company Law are either “Limited Liability Company” or “Company Limited by Shares”. The Draft does not propose to change this but it cancels the restriction on the number of Limited Liability Companies in which an individual person can be an investor.

As for Companies Limited by Shares, the Draft provides that it may be incorporated also by a sole shareholder who can be, either an individual, or another moral person.

2. More flexible financing ways

In practice many FIEs will transform their debt to equity or capital by way of “debt to equity swap” or “stock options”. However capital contribution under the form of creditor’s rights is currently not a recognized form of capital contribution. Obviously this situation regularly causes problems and disputes. The Draft intends to change that as it will affirm the legality of creditor’s rights contribution. This change, if confirmed, will greatly facilitate the refinancing of foreign invested companies.

As for Companies Limited by Shares, the Draft introduces a new regime relative to authorized share capital. The initial shareholder(s) of a Company Limited by Shares may choose not to issue all the registered shares at incorporation of the company. The shareholder(s) may authorize the board of directors to issue the outstanding shares according to the operational needs of the company. The aim is obviously to facilitate fundraising options for the company.

3. Corporate Governance Structure

Under the current Company Law, the body exercising the highest authority in a company is designated as the “Meeting of Shareholder(s)” in a Limited Liability Company and as “General Assembly of Shareholders” in a Company Limited by Shares. The Draft unifies the designation to “Meeting of Shareholders”. This change does not affect the substantive functions of this body. It is however advisable to standardize the designation in the documents to be submitted to the registration authority (especially in the articles of associations).

Articles 46 and 109 of the Draft provide that the company may deliver a notice to a shareholder who has failed to contribute all or part of the subscribed capital within the agreed grace period. From the issuance date of such notice the shareholder will lose the rights on the equity share for which the capital was not contributed. The company shall transfer such equity share or deregister the equity share by means of capital decrease within six months.

Where a Limited Liability Company does not have a board of directors, the Draft stipulates that the company may have either a single director or a General Manager instead of an Executive Director. Furthermore, the number of directors on the board will no longer be limited to 13.

The Draft no longer enumerates or specifies the powers and functions of directors. Instead it provides that the Board of Directors shall exercise the powers and functions other than those reserved to the shareholder(s) under by the Company Law or Articles of Associations. This is an important shift in the balance of power within companies organized under PRC Company Law. It could lead to a more independent and decentralized management of subsidiary companies in China.

The Draft provides that the Supervisor (or Board of Supervisors) will no longer be mandatory in a PRC company. However if there’s no Supervisor the Board of Directors shall establish an Audit Committee.

4. Reinforcement of duties and responsibilities of senior management

The Draft provides some changes which aim to broaden the duties and liabilities of the senior management of a company. For instance, if the company is found to have irregularities with regard to the capital contributions by its shareholder(s) (e.g. outstanding contribution, illegal withdrawal of capital), or if the company is found to have illegally distributed profits or allowed an illegal reduction of registered capital all of which eventually causes losses to the company (or eventually its creditors), the responsible directors, supervisors or senior managers may be required to bear the corresponding liability for compensation.

Furthermore, the responsibility for the liquidation of the company will no longer lie with the shareholders but instead with the directors. If the directors fail to initiate the liquidation of the company in a timely manner and this causes further losses to the company or its creditors, they may be held liable for compensation.

Going Forward
DaWo Law Firm will of course keep you informed when the Draft will be approved and the Company Law will be amended. In the meanwhile however you may want to review the current status of your FIE if it was registered before 2020. If you have any questions, please feel free to contact us!

Related Articles