New responsibilities of shareholders and directors in the Chinese amendments to the Companion Law.

In February 2023, a draft amendment (the "Second Draft Amendment") to the Company Law of the People's Republic of China (the "Company Law") was submitted before the Committee of the Standing Committee of the National People's Congress for reconsideration. The second draft of the amendments contains a number of significant changes that will alter corporate practice. This article will discuss the main changes proposed in the Second Draft Amendments regarding shareholder liability for capital contributions, directors' duties and corporate governance.

1. Liability of shareholders for capital contribution

(1) Defines the responsibilities of the transferor and transferee when transferring a share for uncontributed or insufficiently contributed capital shares.According to Article 88 of the Second Draft Amendments, if a shareholder transfers his share including unvested capital contributions:

• When the subscription payment period has not yet expired, the transferee shall be liable for the unpaid capital contribution. However, if the transferee fails to pay such capital contribution in full within the subscription payment period, the transferor shall have an additional liability to make the unpaid contribution which is overdue. Additional liability is not defined in the Second Draft Amendments. This is generally regarded as a duty that applies only if the primary responsible party lacks sufficient capacity to meet the claim. In such a case, the party with additional liability will be responsible for the missing amount. This is not joint and several liability.
• If the subscription payment period for the transferor has expired at the time of the transfer of the share and if the transferee knew or should have known of this situation, such transferee shall be jointly and severally liable with the transferor for the unpaid capital contribution.
• If the capital contribution is made in kind by contribution of non-cash assets by the transferor, and the actual value of such contribution of non-cash assets is clearly less than the subsidized amount, and the transferee knew or should have known this, such transferee shall be jointly and severally liable with the transferor for the deficiency of the capital contribution.

(2) Acceleration of payment obligations for signed capital contributionsArticle 53 of the Second Draft Amendment states that when a company is unable to repay its debts, both the company itself and its creditors have the right to require the shareholders to pay the subscribed capital contributions in full at that time, even if the subscription payment period has not yet expired. This is a significant change to the Companies Act to protect the interests of creditors of companies.

2. Directors' responsibilities

(1) Liability for compensationThe Second Draft Amendment (Article 190) provides that a director is personally liable for damages caused to others by his intentional or gross misconduct in the performance of his duties. In addition, a director may also be personally liable to the company in the event of:

• If a director of a limited company breaches the Companies Act by allowing financial support to be given to the company to others to acquire its shares (other than the implementation of an employee incentive scheme), resulting in a loss to the company;
• If the company distributes profits to shareholders before losses are settled and statutory reserves are paid, resulting in a loss to the company;
• If a company reduces its registered capital in contravention of the Companies Act, resulting in a loss to the company;

(2) Joint and several liabilityIn addition, a director may be jointly and severally liable with the offending shareholder in compensation for losses to the company if:

• The actual value of the uncashed property used for a capital contribution is clearly less than the amount of the subscribed capital contribution, resulting in a loss to the company;
• A shareholder withdraws funds from the capital contribution, resulting in a loss to the company;and
• Controlling shareholders or the actual owners of the company have instructed the directors to take actions that are detrimental to the interests of the company or the shareholders.

(3) Directors' liability insuranceThe second draft of the amendments provides for directors' liability insurance in the Act The Company may purchase directors' liability insurance to indemnify for liabilities incurred during a director's term of office.

3. Corporate governance

(1) Establishment of an audit committeeThe second draft of the amendments provides that an audit committee may be organized under the board of directors instead of appointing an observer or establishing a board of observers. The audit committee shall exercise the functions and powers provided for in the company's charter.

(2) Removal of mandatory requirement to appoint observer(s)The Companies Act requires the shareholders of a company to appoint at least one observer. According to the Second Draft Amendment (Article 83), with the unanimous consent of all shareholders, a limited liability company of relatively small scale may decide not to appoint an observer. However, the Companies Act and the Second Draft Amendment are silent on the "relatively small scale" criteria. In practice, this may be decided by the registration authority depending on the number of employees, revenue, gross asset value, etc. companies. The elimination of the observer role has long been discussed.

(3) Employee representatives on the board of directorsNote that the Second Draft Amendments require a limited liability company with 300 or more employees to have an employee representative on its board of directors if the company does not have a supervisory board with an employee representative. The employee representative will be a member of the board of directors and will be selected by the employees.

The above are some of the potential major changes in the Second Draft Amendments that may affect subsidiaries of foreign investors in China. Some of these changes are quite significant. The final version is expected to be adopted shortly after a second review by the NPC Standing Committee Committee. We will continue to monitor key developments in the Companies Act.