China’s Updated Company Law: Impacts on Shareholders’ Rights

China’s updated Company Law (the “new Law”) took effect on July 1, 2024. First promulgated on December 29, 1993, the PRC Company Law has undergone two substantial updates during its 30 years of development, the previous one undertaken in October 2005, and four less substantial amendments, the latest of which was in 2018.

With its enactment of the new Law, China’s legislature has made sweeping changes to company law rules in various areas, including capitalization, corporate governance, and shareholder rights. Changes concerning shareholder rights for the most part enhance the equal protection of shareholders, particularly minority shareholders. They also recalibrate the allocation of decision-making powers among the shareholders’ meeting, the board of directors (BoD), and company management. This client alert offers a snapshot of the key changes concerning rights for shareholders of a limited liability company (LLC) introduced by the new Law and their implications for foreign investors operating in China.

Key Changes

• Shareholders’ Expanded Inspection Rights. Among other changes, shareholders now have the express right to inspect the company’s accounting vouchers. The new Law also extends the shareholders’ inspection rights to the company’s wholly owned subsidiaries.
• More Flexible Decision-Making. The new Law recalibrates the allocation of decision-making powers among a company’s shareholders’ meeting, its BoD, and its management, giving shareholders the right to provide in the articles of association (AoA) for greater autonomy for the company to manage its own affairs. To illustrate, two of the eleven statutory powers of shareholders’ meetings have been removed from the new Law, namely the power to determine the company’s operating guidelines and investment plans, and the power to review and approve the company’s annual financial budget plans and final accounts. The new Law also contemplates that, subject to the provisions of the company’s AoA, the BoD may be given the power to approve related-party transactions by directors, supervisors, and senior management, as well as competition and solicitation activities, provided that no fewer than three disinterested directors are present at the BoD meeting.
• Mandatory Voting Thresholds for Ordinary Resolutions. The new Law mandates that more than half of the voting rights of “all shareholders” are required for non-fundamental matters approved by ordinary resolutions. This detail was previously absent from the Company Law and hence in practice AoAs of some companies provide a lower threshold for passage of an ordinary resolution.
• Streamlined Process for Equity Transfer. The new Law streamlines the process for completing a transfer of equity interests in an LLC to a party other than an existing shareholder, by eliminating the requirement for the consent of a majority of the other shareholders and retaining only the right of first refusal in favor of all other shareholders. However, it is important to note that the new Law maintains the general principle that the provisions of the AoA will take precedence over the company law rules.
• Non-Pro Rata Reduction of Capital. The new Law clarifies that capital reductions should generally be undertaken on a pro rata basis, subject to approval of shareholders representing no less than two-thirds of the voting rights, and that a non-pro rata reduction of capital of an LLC is only permissible with unanimous shareholder consents.
• Forfeiture of Shareholders’ Rights for Failure to Contribute Capital. One of the key changes effected by the new Law is the reform of the China’s system of corporate capital. Previously, shareholders had flexibility as to the timing of contributions of subscribed capital. With the revised law, shareholders must fully complete their capital contributions within five years after the company’s establishment or the new capital issuance, as relevant, or risk forfeiture of their equity interests if they fail to make their capital contributions within the time frame specified in the AoA. Any forfeiture is decided by the BoD and is subject to a grace period of no less than 60 days.

Implications for Foreign-Invested Enterprises (FIEs)

Different foreign investors will have different “to do” lists associated with the new Law, depending on their situations. Some suggestions for these lists follow.

• Make “Must-Have” Updates to AoAs. The new Law includes new mandatory requirements absent from the 2018 version it replaces. These include, among others, a mandatory voting threshold for ordinary resolutions and a requirement that the AoA specify which body (BoD or a shareholders’ meeting) approves related-party transactions and competition and solicitation activities by directors, supervisors, and senior management. As such, FIEs may wish to review and update their AoAs to reflect those “must-have” changes introduced by the new Law. Remember also that December 31, 2024 marks the end of the five-year grace period for FIEs to update their AoAs (and related governance arrangements) to conform to the PRC Foreign Investment Law, which came into effect on January 1, 2020. FIEs that have not already done so should use the opportunity now to adjust their AoAs to conform them to the Foreign Investment Law.
• Update AoAs to Leverage New Flexibility. The new Law removes various proscriptive governance provisions found in the previous version of the law, leaving shareholders with greater flexibility to agree in a company’s AoA on governance and other arrangements appropriate to the circumstances. Shareholders can, for example, reallocate certain decision-making powers among the shareholders’ meeting, the BoD, and management, and streamline requirements for transfers of equity. FIEs might consider revising their AoAs to leverage this greater flexibility.
• Adapt to New Capitalization Rules. The new time limits for contributing capital under the new Law will impact different FIEs differently. Under a three-year transitional arrangement the new Law provides, existing FIEs that are not already fully capitalized and whose AoAs do not already have a contribution schedule that complies with the five-year rule must amend their AoAs no later than June 30, 2027 to include a compliant contribution schedule (and therefore assure that the capital is contributed in full before June 30, 2032). An FIE whose shareholders are averse to fully capitalizing their FIE subsidiaries by that date will need to undertake a capital reduction. Shareholders setting up a new FIE or working on a new equity financing of an existing FIE need to carefully consider the amount of capital and the contribution schedule, taking account of the new rules.

Additional Details on Practical Law

For additional details of the key changes concerning shareholders’ rights introduced by the new Law, read the Practice Note we authored for Thomson Reuters Practical Law (subscription required).

Please note that any information provided herein is not legal advice. Any information concerning the People’s Republic of China (PRC) is not an opinion on, determination on, or certification of the application of PRC law. We are not licensed to practice PRC law.