Preface
On 29 December 2023, the 7th meeting of the 14th National People’s Congress Standing Committee passed the revised Current Company Lawof the People’s Republic of China (the “New Company Law”), which will come into force on 1 July 2024. As a cornerstone statute for domestic investment and financing transactions, the amendments to the Current Company Lawwill undoubtedly exert profound influence. This article examines the core revisions introduced by the New Current Company Lawand analyses their impact on legal due diligence in equity investments within China.
I. Review of Historical Capital Structures
(1) Adoption of the Authorised Capital System
Current Company Law(2018) New Company Law
/ Article 152
The company’s articles of association or the shareholders’ meeting may authorise the board of directors to decide, within three years, to issue shares not exceeding 50% of the company’s existing issued shares. However, if the shares are to be issued in exchange for non-monetary assets, such issuance must be approved by a resolution of the shareholders’ meeting.
If the board of directors, in accordance with the preceding provisions, resolves to issue shares, resulting in changes to the company’s registered capital or the number of issued shares, the amendment of the relevant provisions in the articles of association shall not require further approval by the shareholders’ meeting.
The New Current Company Lawintroduces a pivotal reform by permitting joint-stock companies to implement an authorised capital system. Under this regime, a company’s board of directors, authorised by the articles of association or a shareholders’ resolution, may issue additional shares within the authorised limit without requiring further shareholder approval. Notably, resultant amendments to the articles of association also do not necessitate shareholder consent.
Key Due Diligence Considerations:
• Examine whether the target company’s articles of association or shareholders’ resolutions authorise the board to issue shares and assess the scope, duration, quantity, pricing, and types of authorised shares.
• Evaluate how additional share issuances may dilute an investor’s equity stake and consider imposing restrictions on authorised share issuances.
• Incorporate provisions in transaction documents to safeguard investors’ rights, such as pre-emptive rights and anti-dilution protections.
(2) Examination of Financial Assistance
Current Company Law(2018) New Company Law
Article 163
A company is prohibited from providing gifts, loans, guarantees, or other forms of financial assistance to enable others to acquire shares in the company or its parent company, except in cases involving the implementation of employee shareholding plans.
However, in the interest of the company and upon a resolution of the shareholders’ meeting, or a resolution of the board of directors authorised by the articles of association or the shareholders’ meeting, the company may provide financial assistance for the acquisition of its shares or those of its parent company. The total cumulative amount of such financial assistance must not exceed 10% of the company’s issued share capital. Any resolution by the board of directors must be approved by at least two-thirds of all directors.
If the provisions of the preceding paragraphs are violated, causing losses to the company, the responsible directors, supervisors, and senior management personnel shall bear liability for compensation.
Prior to the New Company Law, Chinese legislation did not explicitly regulate whether companies could provide financial assistance for acquiring their own shares. Existing regulations primarily prohibited such assistance in the context of listed companies and non-listed public companies. The New Current Company Lawadopts a “principle prohibition + exceptions” approach for financial assistance provided by joint-stock companies, while limited liability companies remain unrestricted.
Key Due Diligence Considerations:
• Review whether the target company has provided financial assistance in prior transactions, including for equity acquisitions involving the parent company or other entities.
• Assess the compliance of financial assistance with statutory decision-making processes and governance requirements, especially in joint-stock companies. Confirm that assistance aligns with permissible purposes such as employee shareholding plans or promoting corporate interests, and verify compliance with the 10% cap of issued share capital.
II. Examination of Shareholders and Ultimate Beneficial Owners
(1) Verification of Capital Contributions
The New Current Company Lawreinforces the principle of capital adequacy, introducing stricter timelines and methods for capital contributions.
Current Company Law(2018) New Company Law
Contribution Timeline No Specified Timeline for Paid-in Capital Contributions (Under the Current Company Law, Article 26)
1. Fixed Timeline for Capital Contributions in Limited Liability Companies (LLCs):
Under the New Company Law, the system introduces clear timelines for registered capital contributions by shareholders:
• Initial Registered Capital:
All shareholders must fully pay their subscribed contributions within five years from the company’s establishment, unless otherwise specified by laws, administrative regulations, or decisions of the State Council (New Company Law, Article 47).
• Additional Registered Capital Post-Establishment:
Any newly added registered capital must also be fully paid within five years from the date of increase (New Company Law, Article 228).
2. Paid-in Capital System for Joint-Stock Companies:
• Initial Contributions:
Founders are required to fully pay their subscribed share capital before the company is established (New Company Law, Article 98).
• Additional Registered Capital Post-Establishment:
When a joint-stock company issues new shares to increase its registered capital, subscribers must pay in full at the time of subscription (New Company Law, Article 228).
Methods of Capital Contribution Under the Current Current Company Law(Article 48):
Capital contributions can be made in the form of:
• Monetary Contributions: Cash or equivalent.
• Non-Monetary Contributions: Tangible or intangible assets such as physical property, intellectual property, land use rights, or any other non-monetary assets that can be legally valued and transferred. Under the New Current Company Law(Article 48):
In addition to the contribution methods under the current Company Law, the New Current Company Lawexpands the scope of allowable capital contributions to include:
• Equity: Shares or stakes in other entities.
• Debt: Rights to claims or receivables.
Joint Liability of Shareholders at the Time of Incorporation Under the Current Current Company Law(Article 30):
If the actual value of non-monetary assets contributed as capital at the time of incorporation is significantly lower than the valuation stipulated in the articles of association, the other founding shareholders bear joint liability with the contributing shareholder for the shortfall in the contribution.
Under Judicial Interpretation III of the Current Current Company Law(Article 13):
If a shareholder fails to fulfil or fully fulfil their capital contribution obligations during the incorporation of the company, the promoters bear joint liability for the shortfall.
Under the New Current Company Law(Article 50):
If a shareholder:
1. Fails to contribute capital as stipulated in the articles of association; or
2. Contributes non-monetary assets whose actual value is significantly lower than the subscribed amount,
the other founding shareholders will bear joint liability with the defaulting shareholder for the shortfall.
Liability for Capital Contributions in Equity Transfers
Under Judicial Interpretation III of the Current Current Company Law(Article 18):
In a limited liability company, if a shareholder transfers equity without fully fulfilling their capital contribution obligations, and the transferee knew or should have known about the shortfall, both the transferor and the transferee bear joint liability for the unpaid portion of the contribution.
Under the New Current Company Law(Article 88):
1. Equity Transfer Before Contribution Deadline:
• The transferee assumes the obligation to pay the outstanding capital contributions.
• If the transferee fails to pay the contributions on time and in full, the transferor bears supplementary liability for the unpaid portion.
2. Equity Transfer After a Missed Contribution Deadline or for Insufficient Contributions:
• Both the transferor and the transferee bear joint liability for the unpaid portion.
• If the transferee neither knew nor should have known about the contribution shortfall, the transferor bears sole liability.
Key Due Diligence Considerations:
1. Verify compliance with stipulated contribution deadlines for both newly established companies (post-2024) and existing companies. Pay particular attention to any necessary adjustments required for compliance with transitional arrangements.
2. Examine existing shareholders’ contribution records, payment methods, and contribution schedules. Investigate whether any shareholder defaults exist and evaluate the sufficiency of their financial capacity.
3. Assess whether the company’s registered capital aligns with operational needs, projected growth, and shareholders’ contribution capabilities. Where necessary, recommend capital reductions as a precondition for investment.
4. For newly established companies, scrutinise the capital contribution capacity of co-investors to avoid joint liability for insufficient contributions.
(2) Review of Related Party Transactions
Current Company Law(2018) New Company Law
Article 20: Responsibilities and Liabilities of Shareholders
1. General Responsibilities:
Shareholders must comply with laws, administrative regulations, and the company’s articles of association. They must exercise their shareholder rights in accordance with the law and refrain from:
• Abusing shareholder rights to harm the interests of the company or other shareholders;
• Abusing the company’s independent legal personality or the principle of limited liability to harm the interests of the company’s creditors.
2. Liability for Abuse of Rights:
• Damage to the Company or Other Shareholders:
Shareholders who abuse their rights and cause losses to the company or other shareholders shall be held liable for compensation.
• Damage to Creditors:
Shareholders who abuse the company’s independent legal personality and limited liability to evade debts, causing serious harm to the company’s creditors, shall bear joint liability for the company’s debts.
Article 88: Abuse of the Company’s Legal Personality and Limited Liability
1. Liability for Abuse by Shareholders:
• Shareholders who abuse the company’s independent legal personality or the principle of limited liability to evade debts and severely harm the interests of the company’s creditors shall bear joint liability for the company’s debts.
2. Liability Across Multiple Controlled Companies:
• If a shareholder controls two or more companies and engages in such abusive practices, each controlled company shall bear joint liability for any one company’s debts.
3. Single-Shareholder Companies:
• If a single-shareholder company cannot prove that its assets are independent from the shareholder’s personal assets, the shareholder shall bear joint liability for the company’s debts.
The New Current Company Lawexpands the concept of piercing the corporate veil to encompass shareholders controlling multiple entities, thereby holding such entities jointly and severally liable for debts arising from abusive conduct.
Key Due Diligence Considerations:
• Investigate the existence of other entities controlled by the ultimate beneficial owner outside the consolidated group.
• Examine related party transactions for fairness and legality, ensuring no improper transfer of benefits or undue harm to minority shareholders.
III. Examination of Shareholder Registers
Current Company Law(2018) New Company Law
Article 32 A limited liability company shall keep a register of shareholders in which the following matters shall be recorded:
(a) The names and residences of the shareholders;
(ii) The amount of capital contributed by the shareholders;
(iii) The number of the certificate of capital contribution.
Shareholders recorded in the register of shareholders may claim to exercise their rights as shareholders in accordance with the register of shareholders.
The company shall register the names of the shareholders with the company registration authority; if there is any change in the registered matters, the change shall be registered. Without registration or registration of changes, it shall not be used against third parties.
Article 56 A limited liability company shall keep a register of shareholders, recording the following matters:
(a) The names and residences of the shareholders;
(ii) The amount of capital contributed by the shareholders, the method of capital contribution and the date of capital contribution;
(iii) The number of the certificate of capital contribution;
(d) The date of acquisition and loss of shareholder status.
Shareholders recorded in the register of shareholders may claim to exercise their rights as shareholders in accordance with the register of shareholders.
/ Article 86 A shareholder who transfers his or her shareholding shall notify the company in writing, requesting that the register of shareholders be changed; where registration of the change is required, he or she shall also request the company to register the change with the company's registration authority. If the Company refuses or fails to respond within a reasonable period of time, the transferor or transferee may, in accordance with the law, file a lawsuit with the People's Court.
The New Current Company Lawmandates comprehensive shareholder registers, specifying details such as paid-in capital, contribution methods, and dates of shareholder status acquisition or loss.
Key Due Diligence Considerations:
• Confirm the existence and accuracy of the shareholder register. Any discrepancies should be rectified before completing the investment.
• Ensure the investor is duly recorded in the register post-transaction to secure legal rights and avoid disputes.
IV. Related Party Transactions
Current Company Law(2018) New Company Law
Article 148 Directors and senior management shall not commit the following acts:
(i) Misappropriating company funds;
(ii) Storing company funds in his personal name or opening an account in the name of another individual;
(C) In violation of the provisions of the Articles of Association, without the consent of the shareholders‘ meeting, shareholders’ general meeting or the board of directors, lending the company's funds to others or providing guarantees for others with the company's property;
(iv) Entering into contracts or transactions with the Company in violation of the provisions of the Articles of Association or without the consent of the shareholders' meeting or general meeting;
(v) Without the consent of the shareholders' meeting or the general meeting, using the convenience of his position to seek business opportunities belonging to the Company for himself or others, and operating on his own account or for others in the same kind of business as the Company he serves;
(vi) Accepting commissions from others' transactions with the Company for his or her own use;
(vii) Unauthorised disclosure of company secrets;
(viii) Other acts in violation of the duty of loyalty to the Company.
The income derived by a director or senior management personnel in violation of the preceding paragraph shall belong to the Company. Article 182 Directors, Supervisors and senior management, who directly or indirectly enter into contracts or conduct transactions with the Company, shall report to the Board of Directors or the shareholders‘ meeting on matters relating to the entering into of such contracts or the conduct of such transactions, which shall be approved by a resolution of the Board of Directors or the shareholders’ meeting in accordance with the provisions of the Company's Articles of Association.
The provisions of the preceding paragraph shall apply to the conclusion of contracts or transactions with the Company by close family members of Directors, Supervisors and senior management, enterprises directly or indirectly controlled by Directors, Supervisors and senior management or their close family members, and connected persons with whom Directors, Supervisors and senior management have other connected relationships.
Article 124 A director of a listed company who is connected with an enterprise involved in a resolution of a board of directors' meeting shall not exercise his voting rights in respect of the resolution, nor shall he exercise his voting rights on behalf of other directors. A meeting of the Board of Directors may be held with the attendance of a majority of the unaffiliated directors, and the resolutions made at a meeting of the Board of Directors shall be passed by a majority of the unaffiliated directors. If the number of unrelated directors attending the board meeting is less than three, the matter shall be submitted to the shareholders' meeting of the listed company for consideration.
(Provides only for the voting system on connected transactions by the board of directors of a listed company) Article 185 When the Board of Directors resolves on the matters provided for in Articles 182 to 184 of this Law, the connected directors shall not participate in the voting and their voting rights shall not be counted in the total number of voting rights. If the number of unrelated directors present at a meeting of the Board of Directors is less than three, the matter shall be submitted to the shareholders' meeting for consideration.
The New Current Company Lawbroadens the scope of self-related transactions to include directors, supervisors, senior management, and their close relatives, as well as entities controlled by them. Stricter procedures and approval mechanisms are required for such transactions.
Key Due Diligence Considerations:
• Investigate whether related parties, including close relatives and controlled entities, engage in transactions with the target company.
• Verify compliance with procedural requirements, including disclosure, board resolution voting, and recusal of interested parties.
V. Profit Distribution
Current Company Law(2018) New Company Law
Article 168 The capital reserve of a company shall be used to make up for the company's losses, to expand the company's production and operation, or to be converted to increase the company's capital. However, capital reserves may not be used to make up for the company's losses.
When a legal reserve is converted into capital, the amount of such reserve retained shall not be less than twenty-five per cent of the registered capital of the company before the conversion. Article 214 A company's provident fund shall be used to make up for the company's losses, to expand the company's production and operation, or to increase the company's registered capital.
When the company's reserve fund is used to make up for the company's losses, it shall first be used as an arbitrary reserve fund and a legal reserve fund; if it still fails to make up for the losses, the capital reserve fund may be used in accordance with the regulations.
When the legal reserve is converted to registered capital, the retained reserve shall not be less than twenty-five per cent of the registered capital of the company before the conversion.
Under the New Company Law, companies may use capital reserves to offset losses, enabling earlier profit distributions.
Key Due Diligence Considerations:
• Review articles of association and shareholder agreements for provisions on loss recovery and profit distribution.
• Evaluate whether using capital reserves to offset losses aligns with investor interests, and consider negotiating restrictions or additional approval thresholds.
VI. Corporate Governance
Current Company Law(2018) New Company Law
Audit Committees
/ 1. Establishment of Audit Committees:
• Both limited liability companies (LLCs) and joint-stock companies may establish an audit committee within the board of directors, as stipulated in the articles of association. The audit committee assumes the supervisory functions of the supervisory board, and in such cases, no supervisory board or supervisors are required. Employee directors may serve as members of the audit committee (New Company Law, Articles 69 and 121).
2. Composition and Independence Requirements for Joint-Stock Companies:
• An audit committee must consist of at least three members, with more than half of the members being independent directors who do not hold any positions in the company other than directorships. Members must not have any relationships with the company that could compromise their independent and objective judgment.
• Decisions of the audit committee require approval by a majority of its members (New Company Law, Article 121).
3. Audit Committees in State-Owned Enterprises:
• In wholly state-owned companies, an audit committee established within the board of directors may exercise the supervisory functions prescribed by law, eliminating the need for a supervisory board or supervisors (New Company Law, Article 176).
Voting Thresholds Under the current Company Law, the voting thresholds for ordinary resolutions in shareholders’ and board meetings of LLCs are not specified and are determined by the company’s articles of association (Current Company Law, Articles 43 and 48).
Shareholders’ Resolutions: Ordinary matters in shareholders’ meetings of LLCs must be approved by shareholders representing more than 50% of the voting rights (New Company Law, Article 66).
• Board Resolutions: Board resolutions in LLCs require the approval of more than 50% of all directors (New Company Law, Article 73).
Employee Directors / In LLCs and joint-stock companies with more than 300 employees, the board of directors must include employee representatives, unless a supervisory board with employee representatives is established in accordance with the law (New Company Law, Articles 68 and 120).
The New Current Company Lawintroduces the option for a single-tier governance model, requiring companies adopting this structure to establish an audit committee.
Key Due Diligence Considerations:
• Verify compliance with governance structure requirements, including the composition and independence of the audit committee.
• Confirm that shareholder and board voting thresholds align with statutory requirements.
Conclusion
Legal due diligence is indispensable for equity investments, serving as the foundation for safeguarding investor rights. The New Current Company Lawsignificantly amends key areas, including capital structures, corporate governance, shareholder obligations, and related party transactions. This article provides a concise analysis of the critical areas requiring attention during due diligence, offering practical guidance for investors navigating the evolving regulatory landscape.
