Key amendments to China’s Company Law from PE/VC perspective

After approximately five years since the amendment of the Company Law was set in motion by the country's top legislators, on 29 December 2023, China (for this article, China refers to the mainland China excluding Hong Kong SAR, Macau SAR and Taiwan region) adopted the Company Law (2023 Revision) (New Company Law, please click here for the Chinese version). The New Company Law will take effect on 1 July 2024.

The New Company Law marks the second overhaul since the birth of China's Company Law in 1993 and changes multiple fundamental principles of corporate governance and capital operation for Chinese companies. In this article, we aim to compare the New Company Law against the existing version in 2018 (Existing Company Law) and highlight key takeaways in connection with the updates of company capital rules in the context of PE/VC transactions. We will continue to discuss the amendments on corporate governance and other important matters in the New Company Law in our upcoming articles.

Capital contribution

• Time limit for contribution

The New Company Law imposes a time limit for shareholders/promoters to make capital contributions upon the company's establishment, as well as for subsequent capital increase. We have prepared a comparison table below for your reference.

Within five years upon the establishment. Newly increased registered capital shall be paid within five years upon relevant resolution.

• Forfeiture of unpaid capital

If a LLC shareholder fails to pay its capital contribution within the prescribed time limit in full or in part, according to the New Company Law, such a shareholder shall forfeit the equity interests with respect to which it has not paid after the expiration of a grace period of at least 60 days after given notice. The forfeited equity interests shall be transferred to a third party (subject to equity transfer provisions) or be deregistered (by way of capital reduction) accordingly.

Previously, the Supreme People's Court of China stipulates that if a shareholder fails to fulfil all its subscribed registered capital, the shareholder may be disqualified from being a shareholder. The New Company Law fills the gap on failure to make partial capital contributions.

• Acceleration of contribution

The Existing Company Law provides for accelerated capital contribution mechanism triggered by specific circumstances including the shareholder's insolvency or dissolution proceedings, and extending time limit of capital contribution maliciously to avoid debts. The New Company Law adds that if a company is unable to discharge debts when they become due, the company itself or creditors to whom the due debts are owed have the right to require shareholders to pay in their capital contributions before the expiration of the time limit.

• Transitional period

The time limit of capital contribution also applies to companies established prior to the effective date of the New Company Law. Unless otherwise provided by laws or the State Council, existing companies shall gradually make adjustments to ensure that the capital contribution period is no longer than five years. However, the law does not further provide a specific transitional period for relevant companies to complete such adjustments. Market views vary at this stage. Subject to further instructions to be issued by the authorities, a literal interpretation of this clause would mean that the capital contribution in existing companies shall be paid up by 30 June 2029 at the latest. Moreover, under the New Company Law, if a company's capital contribution period or capital contribution is abnormal, the company registration authorities have the discretion to request the company to make rectifications. More detailed instructions will be issued by the State Council. We will keep you posted of any updates in this regard.

In common PE/VC transactions, an investor's investment amount usually exceeds its subscribed registered capital and the surplus portion is usually injected into the company's capital reserve, so the capital contribution is not an issue for investors. On the other side, based on our experience, a large proportion of founders or employee shareholders in start-ups may have not paid up their subscribed registered capital until an IPO or out of special considerations such as regulatory requirements or requests from investors. According to the New Company Law, we expect that investors will pay more attention to the founders' capital contribution status and may seek to impose more stringent conditions to ensure founders fulfil their contribution obligations promptly as required. To avoid the forfeiture, founders are also encouraged to adjust the capital contributions as soon as practicable.  

Capital withdrawal

• Company Repurchase

The Existing Company Law only provides for the following events which would trigger a shareholder's repurchase right at a reasonable price against the company: (1) the company has made profits for five consecutive years but has failed to distribute any dividends to the shareholder; (2) the company is going to merge with others, be split up, or sell its material assets; (3) the business term as prescribed under the articles has expired or other circumstances for dissolution have occurred, but the shareholders' meeting approves to revise the articles so that the company continues to exist.

On the one hand, the New Company Law extends the application of the foregoing to JSCs provided that such a JSC is not a public company. On the other hand, the New Company Law adds a new trigger event for LLC shareholders which is that the controlling shareholder abuses its powers and seriously harms the interests of the company or other shareholders. However, like the Existing Company Law, the New Company Law still does not clarify what is a reasonable repurchase price. In our experience, net assets, post-money valuation of the last financing round, the original investment consideration plus a certain amount of interest and etc are common factors to be considered when determining the reasonable repurchase price.

In conjunction with the implementation of the above repurchase rights, the equity interests/shares repurchased by the company shall be transferred or cancelled within six months.

• Equity Transfer

Unless otherwise agreed in the articles of association, the Existing Company Law sets forth two conditions for a LLC shareholder to transfer equities to parties outside of existing shareholders: consent from more than half of the remaining shareholders and waiver of right of first refusal regarding such transfers from the remaining shareholders. The New Company Law removes the consent condition.

Another point in relation to equity transfer which the New Company Law clarifies is when an equity transfer becomes effective. There was some ambiguity under the Existing Company Law which often gives rise to disputes in practice. The Supreme People's Court of China issued relevant guidance providing that the courts shall support a transferee's claim of its acquisition of target equity interests on the grounds that its name has been recorded in the register of shareholders. The New Company Law codifies such test by stipulating that, the transferee may bring a claim to exercise its shareholder rights to the company at or after the time the transferee is recorded in the register of shareholders.

Both the repurchase and equity transfer are key exit mechanisms for PE/VC investors. Especially for the company repurchase, given the principal of capital maintenance in China's Company Law, requiring a company to repurchase equity interests/shares from a shareholder is always controversial and practically cumbersome to implement. As the New Company Law broadens the circumstances of company repurchase, there may be an opportunity for both the investors and companies and founders to re-assess the previous repurchase clauses in the constitutional documents and make necessary adjustments as appropriate.