An Overview on China's Revised Company Law

China's Revised Company Law

China’s new Company Law, effective July 1, 2024, represents a substantial overhaul of corporate governance and shareholder rights within the country. Originally promulgated in December 1993 and updated significantly in 2005 and again in 2018, the recent amendments introduce stricter regulations on capitalization, enhance transparency, and recalibrate the decision-making dynamics among shareholders, boards, and management. These changes have profound implications for both domestic enterprises and foreign-invested entities (FIEs). This article delves into the key changes, their implications for foreign investors, and strategic recommendations for adapting to the new regulatory environment.

Key Changes in the New Company Law

Shareholders’ Expanded Inspection Rights

Among the notable changes in China’s new Company Law, effective July 1, 2024, is the expansion of shareholders' rights to inspect company records, including accounting vouchers and records of wholly owned subsidiaries. This enhancement aims to increase transparency and empower minority shareholders by providing them with greater access to crucial financial information. For foreign investors, this change means increased oversight capabilities, facilitating more informed decision-making and better protection of their investments.

More Flexible Decision-Making

The new law revises the allocation of decision-making powers within companies, offering greater autonomy to manage their affairs as stipulated in their Articles of Association (AoA). Specifically, it removes two statutory powers previously reserved for shareholders’ meetings: the power to determine operating guidelines and investment plans, and the power to review and approve financial budgets and final accounts. Additionally, the Board of Directors (BoD) may now approve related-party transactions and competitive activities, provided at least three disinterested directors are present. This flexibility enables companies to tailor their governance structures to better suit their operational needs, promoting more efficient management.

Mandatory Voting Thresholds for Ordinary Resolutions

A significant change in the new law is the imposition of a mandatory voting threshold, requiring more than half of all shareholders’ voting rights for the passage of ordinary resolutions. This uniform requirement aims to prevent companies from setting lower thresholds in their AoAs, ensuring a standardized approach to corporate decision-making. For foreign investors, this change necessitates careful planning and consensus-building among shareholders to achieve the required majority.

Streamlined Process for Equity Transfer

The new law simplifies the process for transferring equity interests in limited liability companies (LLCs). It eliminates the need for majority consent from other shareholders, retaining only the right of first refusal. This streamlining facilitates quicker and more straightforward equity transactions, benefiting foreign investors seeking flexibility in managing their equity stakes. However, companies must still adhere to their AoA provisions, underscoring the importance of well-drafted governance documents.

Non-Pro Rata Reduction of Capital

Capital reductions are generally required to be pro rata, needing approval from shareholders representing at least two-thirds of voting rights. Non-pro rata reductions are permitted only with unanimous consent. This clarification helps ensure equitable treatment of shareholders and prevents potential disputes over capital adjustments.

Forfeiture of Shareholders’ Rights

A major change involves stricter enforcement of capital contribution timelines. Shareholders must complete their contributions within five years of the company’s establishment or new capital issuance. Failure to do so may result in forfeiture of equity interests, subject to a 60-day grace period. This rule underscores the importance of prompt and complete capital infusion, promoting financial stability and accountability.

Implications for Foreign-Invested Enterprises (FIEs)

The new law's implications for FIEs are multifaceted, affecting various aspects of corporate governance and operational strategy. Here are key considerations and recommended actions for foreign investors:

Update Articles of Association (AoAs)

FIEs must review and update their AoAs to comply with the new mandatory requirements, including voting thresholds for ordinary resolutions and the allocation of decision-making powers. Given the five-year grace period ending December 31, 2024, for FIEs to align their AoAs with the PRC Foreign Investment Law, now is the opportune time to incorporate these updates.

Leverage New Governance Flexibilities

The removal of prescriptive governance provisions allows shareholders to tailor decision-making processes to their needs. FIEs should consider reallocating decision-making powers and streamlining equity transfer processes to enhance operational efficiency.

Adapt to New Capitalization Rules

The new five-year limit for capital contributions requires FIEs to secure adequate funding and adhere to strict timelines. Existing FIEs must amend their AoAs by June 30, 2027, to comply, ensuring full capitalization by June 30, 2032. Strategic planning around capital contributions is essential to avoid penalties and ensure financial compliance.

Alternative Market Entry Strategies

In response to the evolving regulatory landscape, foreign companies are increasingly exploring alternative market entry strategies to minimize risks and maintain flexibility. Two prominent strategies are distribution agreements and licensing agreements.

Distribution Agreements

Partnering with local distributors allows foreign companies to leverage established distribution networks, reducing regulatory burdens and accelerating market entry. Key considerations for effective distribution agreements include contractual clarity, clearly defining responsibilities, including sales targets, marketing efforts, and compliance with Chinese regulations.

Licensing Agreements

Licensing intellectual property (IP) to local companies can be a cost-effective way to generate revenue without establishing a physical presence. Advantages include limited upfront investment and steady income from royalties. Critical steps for successful licensing include implementing robust measures to safeguard IP, selecting reliable partners, and ongoing monitoring to ensure adherence to contractual terms.

Conclusion

China’s revised Company Law reflects the government’s intent to enhance corporate governance, transparency, and financial accountability. For foreign investors, adapting to these changes requires a thorough understanding of the new regulations and strategic flexibility. By updating governance documents, leveraging new decision-making flexibilities, and exploring alternative market entry strategies, foreign companies can navigate the complexities of China’s evolving business environment and position themselves for success.