In the latest in a series on China’s new Company Law, Marco Vinciguerra from HFG Law & Intellectual Property explores changes related to the roles and obligations of shareholders
China’s revised Company Law, which will come into effect on 1 July 2024, has 266 articles, about a third of which have been added or substantially modified. Of these, a number relate to the rights and obligations of shareholders.
The new Company Law will most certainly require LLCs to amend their articles of association or adjust their corporate or governance structure so as to comply with the new provisions, which will be easier in LLCs with a sole shareholder (or multiple foreign shareholders that are somehow connected, coordinated, or otherwise sharing the same objectives and interests regarding their investment in China).
However, these adjustments could prove complicated where the collaboration and consent of one or more Chinese shareholders are necessary (like in the case of joint venture companies), as adaptation could give a pretext for renegotiating some elements of the existing agreements between shareholders.
At this stage, shareholders, directors, supervisors or senior managers in Chinese companies are advised to start becoming familiar with the new provisions of the Company Law so as to be ready to implement the necessary adjustments when the implementation provisions are issued to supplement and clarify the new regulations.
Obligations of shareholders in case of share transfer
If a shareholder transfers their shares without the corresponding share capital being fully paid in, the buyer of the shares is liable for paying the unpaid share capital. In the event that the new shareholder defaults, the new regulations stipulate that the selling shareholder has a secondary (and not a joint and several) liability to pay in the unpaid share capital (that is, a claim against the selling shareholder may be brought forward only after enforcement against the acquiring shareholder is unsuccessful).
If, on the other hand, the shareholder transferring its shares is already in breach of the capital payment obligation at the time of the share transfer (i.e., payment has not occurred within the specified terms, has been made for a lesser amount, or assets of lesser value have been contributed), the selling shareholder and the acquiring shareholder are both jointly and severally liable for the amount of unpaid capital.
The acquiring shareholder can avoid such liability only by proving that they were unaware, and ought not to have been aware, of the circumstances regarding the insufficient capital payment (which is difficult to verify and even more difficult to demonstrate).
Right of withdrawal of minority shareholders
Under the new regulations, in the event a controlling shareholder abuses its rights and seriously harms the interests of the company or the other shareholders, minority shareholders have the right to have their shares purchased back by the company at a reasonable price.
The new rules for payment of share capital aim to ensure that companies are capitalised in line with the stated scope of business, thereby guaranteeing a sufficient and consistent contribution of financial resources. At the same time, the new provisions offer a higher level of protection to the rights and expectations of creditors, as opposed to the rights of shareholders, which appear now to be relatively diminished.
Also, the reformed regulations imply that the shareholders control the situation of the share capital payments of the other shareholders, so as not to risk being held responsible for the defaults of others.
In addition, the new rules on share capital payment assign stronger duties of verification to the directors, who may find themselves in situations of opposition or actual conflicts of interest with the shareholders when called to perform their duties.
Although a separation and sometimes opposition of roles is in line with other legal systems, it is important to keep in mind such increased distinction of roles and distribution of responsibilities in the Chinese company legal system, especially with regard to those small foreign-invested companies where the management body (often a sole director) is a direct emanation of the shareholders (or, often, the sole shareholder) and has a close contact and relationship with the ownership.
In this regard, particular attention should be paid to the provisions of the articles of association where a detailed regulation of the roles and responsibilities of shareholders and directors should be included to avoid any potential conflict.
Finally, depending on circumstances, some situations can also be adequately dealt with in shareholders’ agreements, the contents of which are binding only between the parties to the same and prevail over the provisions of the articles of association (that, instead, are meant to be applicable to all current and future shareholders).
Prohibition of financial assistance
The new Company Law introduces basic rules regarding the prohibition of financial assistance, like in many other legal systems. This prohibition intends to prevent or limit the possibility of a company providing loans or guarantees aimed at facilitating the acquisition of its own shares (or shares of its controlling company), primarily to protect the minority shareholders and creditors of the company.
The prohibition is not absolute: financial assistance is still allowed if it is finalised towards the implementation of a plan promoting the purchase of shares by employees of the company or is in the interest of the company.
However, the total amount of financial assistance cannot exceed 10% of the issued share capital.
Exceptions to the limited liability of shareholders
In Chinese LLCs – as in many other legal systems – the shareholders are not personally liable for the company’s debts and obligations, even if they have acted on behalf of the company.
Therefore, in principle, an LLC is liable for its debts and obligations only with its own assets, and its shareholders generally benefit from a liability that is limited to what they had committed to contribute.
The Company Law sets forth exceptions to the principle of limited liability of shareholders by establishing that if a shareholder abuses its rights and prevents the company from paying its debts and, in doing so, causes substantial damage to the company’s creditors, the abusing shareholder is jointly and severally liable for the debts of the company.
The regulations consider not only the abuse by the shareholder of the advantages of the limited liability relating to the company of which it is a shareholder (so-called “vertical” abuse), but also situations where the abuse involves other companies controlled by the same shareholder (so-called “horizontal” abuse).
Liability of the controlling shareholder and actual controller of a company
The new Company Law contains some provisions for those subjects that control a company and interfere or exercise influence on the management of the company.
Controlling subjects are defined by the company law (both in the current version and in the reformed one) in two categories:
(i) controlling shareholders, who hold at least 50% of the share capital or, if a lower percentage, have sufficient voting rights to exercise a significant influence on the shareholders’ resolutions, and;
(ii) actual controllers, who are subjects (not necessarily shareholders) capable of exercising effective control over the company through investment relationships, contracts, or other arrangements.
The new regulations establish that a controlling shareholder or an actual controller who, although not appointed as a director of the company, effectively carries out activities on behalf of the company, is then obliged to abide by the duties of loyalty and diligence towards the company (similarly to a director, supervisor, or other senior manager) and, consequently, assume the responsibilities for any breach of such duties.
Likewise, if a controlling shareholder or the actual controller gives instructions to a director or a senior manager to engage in behaviours that damage the company or its shareholders, the controlling shareholder or actual controller will be considered jointly and severally liable together with the involved director or manager.
The provisions regarding the controlling shareholder add to those mentioned above concerning the abuse of such a position and the consequent granting of a right of withdrawal to the minority shareholders that have been damaged.
