I. Overview of Relevant Changes
Under the PRC Company law (revised in 2018) (Current Company Law), shareholders must make their subscribed capital contribution in full and within the specified timeframe, and are prohibited from withdrawing their capital contributions made to the company. The New Company Law upholds this principle of capital adequacy and reinforces it by introducing the following additional requirements to enhance shareho⛎lders’ liability for capital contributions:
● Imposing a maximum time limit for the payment of capital for limited liability companies: while the Current Company Law grants limited liability companies the autonomy to determine the timeframe for capital payment, the New Company Law sets a maximum limit of five🍸 years from the subscription date for completing the capital payment.
● Mandating immediate payment of subscribed capital for joint-stock companies: the Current Company Law grants the same autonomy to joint-stock companies with respect to capital payment. The New Company Law mandates that capital must be paid-in when subscribed. On the other hand, the New Company Law introduces authorized c🔜apital system for joint-stock companies, offering them a degree of flexibility in capital increases.
● Defining accountability for shareholders who fail to pay in capital on time: the New Company Law provides that these shareholders must fulfill the outstanding capital contributions and compensate the company for any losses incurred. It also provides that other shareholders at the time of incorporation shall bear joint and several liabilities with the shareholders that are late in their contribution to the extent of the shortfall in the ꧒capital contributions.
● Implementing a mechanism for recovering outstanding capital: the New Company Law introduces a mechanism that mandates the board of directors to monitor shareholders’ capital contributions and requires the company to request payments from shareholders whꦛo miss their contribution deadlines. Moreover, the law stipulates that shareh🌞olders who do not fulfill their capital obligations may forfeit certain rights associated with the outstanding capital.
● Acceleration of outstanding capital contributio🦋n: the New Company Law ꦓprovides for the right of the company and its creditors to accelerate the shareholders’ obligation to make capital contribution if the company is unable to discharge the debts when they become due.
● Defining the liability for unpaid capital in equity transfers: in relation to equity interests in limited liabওility companies being transferred, the New Company Law provides for the distribution of capital contribution liabilities between the transferor and transferee.
● Outlin⭕ing directors, supervisors and senior management’s liabilities for outstanding capital contribution: the New Company Law s𒀰trengthens the liabilities of directors, supervisors and senior management to monitor and ensure full capital contribution by shareholders.
In the following secti🧸ons, we will look at each of these changes in greater details.
II. Capital Paid-in Requirements
In its initial company law enacted in 1993, the PRC adopted a rigid paid-in capital system,𓂃 requiring shareholders to fully contribute capital at the time of incorporation. Over the past three decades, the PRC gradually transitioned away from this system. It first introduced a moderate paid-in capital system in 2005, allowing shareholders to complete their capital contributions within two years from the time of incorporation. Subsequently, in 2013, the PRC fully embraced a subscription capital system, empowering companies (excluding those in specific regulated sectors) to determine their own timeline for 🍃the actual payment of the subscribed share capital. This framework remains unchanged in the Current Company Law.
While the full subscribed capital system facilitates the relaxed market access restrictions, boosts the efficiency of shareholders’ capital utilization, and minimizes the transaction costs linked to capital registrations, it also presents challenges. The absence of constraints on the capital contribution timeline has led to prevalent misuse of the system, as seen in prolonged subscription periods a𝓰nd excessive subscribed capital amounts, which can be misleading to creditors and investors.
Acknowledging these challenges, the New ܫCompany Law repla🃏ces the full subscribed capital system for limited liability companies with a time-limited subscribed capital system. Shareholders are typically mandated to make capital contributions within five years of the company’s establishment or follow-up capital increases, as the case may be. In addition, the law permits deviations from these timelines through laws, administrative regulations, and State Council directives.
The New Company Law takes a more stringent approach concerning joint-stock companies, mandating immediate payment of all capital, whether issued during incorporation or in subsequent capital increases. Conversely, aligning with international practices and the requirements of listed companies, the law introduces the authorized capital system for joint-stock companies. This system enables companies to authorize their board of directors, through the articles of association or a shareholders’ meeting, to approve the issuance of new shares up to 50% of the issued shares within a three-year period. Notably, in-kind capital𓆉 contributions require a resolution from the shareholders’ meeting.
The New Company Law allows existing companies with outstanding capital contributions to gradually align with the new requirements. Moreover, it authorizes the company registration authority to mandate adjustments if the capital contribution period or amount appears notably abnormal. On February 6, 2024, the State Administration for Market Regulation (together with its local counterparties, SAMR) released a consultation draft of the Provisions of the State Council on Implementing the Registered Capital Registration Administration System under the Company Law of the People’s Republic of China (Draft Implementation Provisions), s📖eeking to offer detailed guidelines tailored to assist existing companies with ouꦛtstanding capital contributions to align with the requirements of the New Company Law:
i. Transition period: the Draft Implementation Provisions establish a three-year transition period (from July 1, 2024 to June 30, 2027) for existing companies to adjust to the new capital contribution requirements. Specifically, existing limited liability companies🌳 with remaining capital contribution periods extending beyond July 1, 2032 must shorten them to no later than June 30, 2032. For existing joint-st♒ock companies, payment for the subscribed share capital in full is required within the three-year transition period (i.e., no later than June 30, 2027), and no capital increase is permitted until the outstanding capital contribution has been fully paid.
III. Liabilities for Default of Capital Paid-in Obligations
IV. Recovering Mechanism for Outstanding Capital and Forfeiture of Defaulting Shareholders’ Rights
V. Acceleration of Outstanding Capital Contribution
The Current Company Law does not include any provision regarding the acceleration of payment for the outstanding capital contributions. The Minutes of the National Court Work Conference for Civil and Commercial Trials (Minutes), issued by the Supreme Court in 2019, establishes that, under the subscription capital system, shareholders typically have the entire period specified in the articles of association to fulfill their capital contribution obligations and shall not be compelled to pay before the designated schedule. However, in order to maintain a balance between the interests of shareholders and creditors, the Minutes sets out two exceptions where creditors can request shareholders, whose capital contribution obligation♌ has not yet become due, to assume supplementary compensation liabilities for the company’s debts. These exceptions include where: (i) the court is unable to locate any assets for enforcement against the company’s debts, indicating a de facto state of bankruptcy without any bankruptcy proceedings initiated; or (ii) the company extends the capital contribution period following the incurrence of debts through a shareholders’ resolution or other means.
The New Company Law incorporates the above spirit from the Minutes into Article 54, which provides that where a company is unable to pay off debts when due, both the compaﷺny and the creditors are entitled to request the🗹 shareholders to pay their capital contributions before the expiration of their pay-in period.
VI. Capital Contribution Obligations Related to Transfers of Unpaid-in Equity
Under the subscription capital system, it is possible that equity interests can be transferred before the corresponding capital ha🐽s been paid in, and the Current Company Law does not stipulate who shall bear the obligation of paying the capital to the company. This gap was filled by the Company Law Judicial Interpretation (III), according to which where a shareholder of a limited liability company transfers its equity before the capital contribution has been fully paid in, the company may request the transferring shareholder to pay the capital contribution, and the creditors of the company may request such shareholder to assume supplementary liability for outstanding debts of the company to the extent of the outstanding capital contribution and interests thereon. It also provides that if the transferee is aware or should have been aware of the circumstances, then it should bear joint and several liability together with the transferor.
In judicial practice, most case precedents take the stance that the above provisions only apply to Defaulting Shareholders but not the shareholder whose capital contribution period has not yet expired, although some precedents take the opposite view, holding 𝕴that the transferring shareholder remains obligated to fulfill the capital contribution even if the paid-in period has n𒐪ot elapsed at the time of transfer.
The New Company Law resolves this ambiguity by outlining rules regarding capital contribution obligations and the distribution of liabilities after the transfer of unpaid-in equity between ༒the transferor and the transferee as꧂ follows:
■ If, at the time of transfer, the outstanding capital c🅘ontribution is not yet due, the transferee assumes responsibility for the outstanding capital contribution. In case the transferee fails to meet this obligation by the due date, the transferor becomes the secondary obligor to cover the outstanding capital contribution.
■ If, at the time of transfer, the outstanding capital contribution is already overdue or the actual value of the in-kind contribution made by the transferor significantly falls short of the subscribed capital amount, the transferor bears the liability for the outstanding capital contribution. The transferee is jointly and severally liable unless deemed a bona fide transferee, meaning it was unaware and could no𒉰t have reasonably become aware of the deficient capital contribution s🥂tatus.
Given the provisions in the New Company Law, 🐲it is advisable for both parties involved in the transfer of unpaid-in equities to engage in comprehensive due diligence regarding each other’s capital contribution status and payment capacity to avoid unforeseen responsibilities.
VII. Directors, Supervisors and Senior Management’s Compensatory Liabilities
The New Company Law strengthens the liabilities of directors, supervis🃏ors and senior management to ensure the security of the company’s capital. According to the New Coꦐmpany Law,
● Where the directors fail to monitor the capital contribution status of shareholders or urge them to make contributions on time, the responsible directors shoulꦐd compensate the company for any losses incurred;
● Where shareholders withdraw their capital contributions and cause damages to the company, the responsible directors, supervisors and senior management should bear joint compensati💞on liabilities to the company with the relevant shareholders;
● Where the company distributes dividends to shareholders in violation of the laws and articles of association, causing damages to the company, the relevant shareholders and responsible directors, supervisors and senior management should bear compensation lia༺bilities to the company;
● Where the company provides financial assistance to others to assist them in acquiring shares in the company or the company’s parent company in violation of laws, the responsible directors, supervisors and senior management should com🐈pensate the company fo🐼r any losses incurred.
It is important to highlight that in three of the aforementioned scenarios, the New Company Law expands the scope of liabilities to include supervisors in addition to directors and/or senior management. Regarding the determination of who should be considered “responsible” among directors, supervisors, and senior management, the New Company Law does not provide explicit guidance. However, it is worth noting that the initial consultation draft stipulated that directors, supervisors🅺, and senior management “who were aware or should have been aware” of a shareholder’s failure to complete the full capital contribution and “did not take necessary actions” should bear liabilities for compensation. This specific provision was not included in the final law, leaving the decision to the discretion of judicial bodies. It is understood that being “responsible” should encompass situations where directors, supervisors, and senior management are actively involved in illicit activities or fail to fulfill their legal duties as outlined in laws and articles of associatꩲion.
VIII. Other Changes
In addition to the significant amendments high🍸l🐠ighted earlier, the New Company Law introduces several other changes concerning the company’s capital:
● The law specifies that any capital reduction must be carried out proportionally, unless otherwise mandated by law, agreed upon by all shareholders, or stipulated in the articles of association. This differs from the Current Company Law, which allows capital reduction by designated shareholders, a practice that has ofte✃n been utilized as a means for shareholders to exit.
● A new provision prohibits joint-stock companies from providing financial assistance for the purchase of their own shares, with two exceptions: (i) when the financial support is intended for implementing ൩an employee stock ownership plan, or (ii) when the financial support benefits the company and is approved either by the shareholders’ meeting or by the board of directors as per t🌟he authorization granted in the articles of association or shareholders’ meeting. In such cases, the maximum amount of financial support allowed is 10% of the issued share capital.
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The New Company Law, while largely retaining the principles of capital adequacy from the Current Company Law, tightens the deadline for payment of registered capital. It incorporates judicial interpretations and judicial practices regarding shareholder contribution responsibilities, optimizing and enhancing these rules. Overall, it places greater emphasis on protecting companies and their creditors, and sets higher requirements for shareholders and company directors and senior management in fulfilling capital contribution obligations and maintaining the company's capital adequacy.
