Interpretation of the new“company law”| equity investors focus on key points and countermeasures are suggested

On December 29, 2023, the seventh session of the Standing Committee of the 14th National People's Congress voted to adopt the newly revised Company Law of the People's Republic of China (hereinafter referred to as the “New Company Law”), and the new Company Law will officially come into force on July 1, 2024. The new Company Law has reformed and optimized the company's capital system, internal governance mechanism, protection of shareholders' rights, actual controllers and responsibilities of directors, supervisors and senior executives.

For equity investment and financing transaction items (limited to equity investment and financing of limited liability companies), the conventional transaction arrangements used under the Company Law (2018 revised version) shall be substantially adjusted with the promultion of the new Company Law. From the perspective of key points that equity investors should pay attention to, this paper makes a preliminary analysis of some key amendments of the new Company Law, so as to provide relevant market players with a precautionary measure before the official implementation of the new Company Law and a smooth transition in the commercial market environment reform inspired by the revision of the Company Law.

By Mengyue CAI

Focus on Point 1

Actual status of the amount of capital subscribed by the original shareholders

In equity investment and financing projects, the paid-in capital status of the original shareholders under the equity structure of the target company before investment is one of the matters that investors usually pay attention to. For example, if the investor acquires shares by way of equity transfer, the investor and the equity transferor shall reach an agreement on the performance plan of the remaining paid-in capital contribution obligation under the underlying equity, and determine the final reasonable equity transfer price based on the net asset value of the target company and other factors.

Under the regulatory framework of the new Company Law, investors not only need to pay attention to the “amount” of the remaining paid-in capital contribution obligations under the underlying equity, but also need to pay attention to the "performance period" of the remaining paid-in capital contribution obligations.

The new Company Law provides that:

Article 47 Paragraph 1 The registered capital of a limited liability company shall be the amount of capital subscribed by all shareholders registered with the company registration authority. The capital contribution subscribed by all shareholders shall be fully paid in by shareholders within five years from the date of establishment of the Company in accordance with the provisions of the Articles of Association.

Article 266 Paragraph 2 Where the period of capital contribution of a company registered and established before the implementation of this Law exceeds the period prescribed herein, it shall gradually adjust to within the period prescribed herein, unless otherwise stipulated by laws, administrative regulations or The State Council; If the term and amount of capital contribution are obviously abnormal, the company registration authority may require them to make timely adjustments according to law. Specific measures for implementation shall be formulated by The State Council.

In order to ensure the security of transactions, investors are advised to consider the following measures:

1) Further strengthen the verification of the performance of the original shareholders' paid-in capital obligation in the pre-investment due diligence link, and pay attention to the verification of the remaining paid-in capital obligation of the original shareholders. Under the current articles of association, the shareholders do not have overdue situation, but if the time limit of capital contribution stipulated in the articles of association is contrary to the provisions of “full payment within five years from the date of establishment of the company” in the new Company Law, the original shareholders are also required to pay the remaining capital contribution in advance, and this is regarded as one of the prerequisites for the delivery of investment funds;

2) Rationally review the setting of the total registered capital of the target company and weigh whether the total registered capital matches the current operating status and future business expansion plan of the target company. If the total registered capital of the target company is set falsely high and the original shareholders' ability to pay in the short term is not enough to cover the difference of the actual paid capital, the target company shall be required to reduce its capital reasonably.

Focus on point 2

Implementation of advance notification procedures for equity transfer transactions

Under the Company Law (2018 revised version), a limited liability company must obtain the consent of other shareholders to transfer its equity. Furthermore, in equity investment and financing projects, the resolution document of the shareholders' meeting of the target company containing the consent of other shareholders to the equity transfer transaction is usually attached to the main transaction agreement and delivered to the investors for future reference when signing the main transaction agreement. However, the new Company Law has deleted this provision and changed it into that shareholders of limited liability companies only need to fulfill the notification obligation to other shareholders to transfer their equity.

The new Company Law provides that:

Paragraph 2 and Paragraph 3 of Article 84: Where a shareholder transfers his equity to a person other than a shareholder, he shall notify other shareholders in writing of such matters as the quantity, price, method of payment and time limit of the equity transfer, and other shareholders shall have the pre-emptive right under the same conditions. Shareholders who fail to reply within 30 days from the date of receipt of the written notice shall be deemed to have waived their pre-emptive rights. If two or more shareholders exercise their pre-emptive rights, their respective purchase proportions shall be determined through negotiation; If no agreement can be reached through negotiation, the pre-emptive right shall be exercised according to the respective proportion of capital contribution at the time of transfer.

If the Articles of Association have other provisions on equity transfer, such provisions shall prevail.

In order to avoid the negative impact on the effectiveness of equity transfer transactions due to procedural defects, it is suggested that investors consider taking the following measures:

1) Require the equity transferor to send the equity transfer notice letter to other shareholders and the written reply letter signed by other shareholders as attachments to the master transaction agreement and deliver it to the investor for future reference;

2) Carefully check the current and effective articles of association of the target company and other shareholder agreements or documents other than the articles of association. If there are other provisions on the transfer of equity in the articles of association or other forms of shareholder agreements, the relevant parties shall obtain written exemption from such provisions or provisions.

Focus on point 3

Allocation of directors' seats and performance of directors' responsibilities

One of the major amendments of the new Company Law is the transformative adjustment of the internal governance mechanism of the company. The traditional three-meeting mechanism of the company has been adjusted. The term “executive director” has been withdrawn from the historical stage, the status of the board of directors has been enhanced, and the board of supervisors or supervisors may not be set up separately for limited liability companies when certain conditions are met.

Provisions of the new Company Law (partial list) :

Article 67, paragraph 2: The board of directors shall exercise the following functions and powers:...... (3) Decide on the company's business plan and investment plan......

Article 69 A limited liability company may, in accordance with the articles of association, establish an audit committee composed of directors in the board of directors to exercise the functions and powers of the board of supervisors as prescribed in this Law, without a board of supervisors or supervisors. Employee representatives of the board of directors of the company may become members of the audit committee.

Article 51 After the establishment of a limited liability company, the board of directors shall check the capital contribution of the shareholders, and if it is found that the shareholders fail to pay the capital contribution as stipulated in the Articles of Association on time and in full, the Company shall issue a written call to the shareholders to call for the capital contribution.

If the Company fails to timely perform the obligations prescribed in the preceding paragraph and thus causes losses to the Company, the director responsible shall be liable for compensation.

Article 52 If a shareholder fails to pay the capital contribution on the date stipulated in the articles of association and the company issues a written call to pay the capital contribution in accordance with paragraph 1 of the preceding article,...... . If, upon expiration of the grace period, the shareholder still fails to fulfill the obligation of capital contribution, the company may, upon resolution of the board of directors, issue a notice of loss of rights to the shareholder... .

Investors should fully comply with this legislative adjustment, and the personnel appointed to serve as directors of target companies based on the status of investment should no longer serve as dummy positions, but should effectively play the duties of directors. It is recommended that investors consider the following measures:

1) Formulate clear functions and powers of the shareholders' meeting and the board of directors in the articles of association of the target company, and avoid mechanically applying the template of the articles of association before the issuance of the new Company Law, so as to avoid the disconnection between the articles of association and the new Company Law; The liability for breach of contract in which the director not appointed by the investor fails to perform the obligation of shareholders' capital contribution verification and call in accordance with the provisions of the new Company Law shall be implemented into the written provisions of the articles of association and investment agreement;

2) Prudently select the personnel appointed to serve as directors of the target company (shall comply with the provisions on the qualifications of directors in Article 178 of the new Company Law), prudently consider the number of board members of the target company, and urge the board of directors of the target company to earnestly perform the duties of leading the operation and management of the company.

Focus on point 4

Reporting obligations of directors, supervisors and senior managers on related party transactions and peer competition

The new Company Law includes “supervisors” and “close relatives of directors and supervisors, enterprises directly or indirectly controlled by directors, supervisors and senior managers or their close relatives, as well as related persons having other related relations with directors, supervisors and senior managers” and “directors and senior managers” into the scope of related parties of related transactions of companies. It also requires reporting and internal review procedures for related party transactions with the company, whether “direct” or “indirect”. In terms of restrictions on industry competition, the new Company Law stipulates that directors, supervisors and Gao shall not have industry competition without reporting and internal resolution procedures.

The new Company Law provides that:

Article 182 Directors, supervisors and senior management, who directly or indirectly enter into contracts or transactions with the Company, shall report to the board of Directors or the shareholders' meeting on matters relating to the conclusion of contracts or transactions, which shall be passed by resolution of the board of Directors or the shareholders' meeting in accordance with the Articles of Association.

The provisions of the preceding paragraph shall apply to the conclusion of contracts or transactions with the Company by the close relatives of directors, supervisors and senior management personnel, enterprises directly or indirectly controlled by such directors, supervisors and senior management personnel or their close relatives, and connected persons having other connected relationships with such directors, supervisors and senior management personnel.

Article 184 Without reporting to the board of directors or the shareholders' meeting and having been passed by resolution of the board of directors or the shareholders' meeting in accordance with the provisions of the articles of association, a director, supervisor or senior management shall not conduct any business for himself or for any other person similar to the business of the company he works for.

In addition to the relevant obligation subjects should perform the obligation of reporting and internal review and approval in accordance with the provisions of the new Company Law, it is suggested that equity investors:

1) In the process of pre-investment due diligence, the shareholders of the target company, the current directors, supervisors and senior managers of the target company should also be required to fully disclose the list of overseas investment enterprises under their names (and the names of their close relatives), so as to control the operation and management risks of the company after investment. If there is potential competition in the same industry and the possibility of improper related party transactions through related party transactions, the relevant obligor shall be required to rectify within a time limit before delivery, or set up targeted liability clauses for breach of contract for relevant improper behaviors;

2) Attach importance to the division and voting mechanism of the decision-making authority of the shareholders' meeting and the board of directors on related party transactions and inter-bank business behaviors in the articles of association.

Focus on point 5

Strengthening shareholders' right to know

Shareholders' right to know is the right of shareholders to know the company's operation and management information. The new Company Law has promoted the status and importance of the board of directors in the internal governance mechanism of the company.

The new Company Law clearly expands the scope of shareholders' right to know to access the company's “accounting vouchers”, which effectively relives the problem that shareholders' right to know disputes in the trial practice have long lacked the basis for the right to access the “accounting vouchers”. Furthermore, the new Company Law has deleted the expression that the consulting of documents and materials assisted by intermediary agencies shall be “in accordance with the effective judgment of the People's Court” and “the presence of the shareholder” as stipulated in the Provisions of the Supreme People's Court on Several Issues concerning the Application of the Company Law of the People's Republic of China (IV). It stipulates that the reference of relevant materials “can be entrusted to intermediary institutions such as accounting firms and law firms”, which effectively facilitates and guarantees the exercise of shareholders' right to know, and thus guides company operators to operate prudently and manage compliance.

The new Company Law provides that:

Article 57 Shareholders shall have the right to inspect and copy the Articles of Association, register of shareholders, minutes of shareholders' meetings, resolutions of board meetings, resolutions of meetings of the board of supervisors and financial and accounting reports of the Company.

Shareholders may request to consult the company's accounting books and vouchers. Where a shareholder requests to inspect the accounting books and vouchers of the Company, he/she shall make a written request to the Company stating the purpose. If the Company has reasonable grounds to believe that the shareholder's inspection of accounting books and vouchers has improper purposes and may damage the legitimate interests of the Company, it may refuse to provide such inspection, and shall, within 15 days from the date of the shareholder's written request, give a written reply to the shareholder and explain the reasons. If the Company refuses to provide inspection, the shareholders may initiate legal proceedings in the People's court.

Shareholders may entrust accounting firms, law firms and other intermediary agencies to conduct the inspection of the materials specified in the preceding paragraph.

When reviewing and reproducing relevant materials, shareholders and their entrusted intermediary agencies such as accounting firms and law firms shall comply with the provisions of relevant laws and administrative regulations on the protection of state secrets, trade secrets, personal privacy and personal information.

The provisions of the first four paragraphs shall apply if a shareholder requests to consult or copy relevant materials of a wholly-owned subsidiary of the Company.

Investors should make full use of the expansion of the scope of shareholders' right to know in the new Company Law, effectively protect their shareholders' rights and interests, and supervise the operation and management of the company. It is suggested that investors consider taking the following measures to consolidate their shareholders' right to know:

1) Make full due diligence on the financial management mechanism of the target company before the investment, require the target company to establish a sound financial management system before the delivery, clarify the accounts before the investment, properly prepare and retain accounting reports, accounting books, accounting vouchers and other financial information, and determine the relevant responsible persons, so as to avoid the relevant parties refusing to cooperate with shareholders to exercise the right to know on the ground of data loss or omission when disputes occur;

2) Specify in the investment transaction documents the frequency of disclosure of financial reports, resolutions of board meetings, accounting books and other materials by the target company to the investor, and agree on the cooperation obligations of the target company and the original shareholders when the investor requires access to accounting vouchers and other materials. If the investor makes a written request for access, the corresponding materials must be prepared in place for access by the investor within a certain period of time. And guarantee that the disclosed and provided materials are true, accurate and complete. Targeted clauses on liability for breach of contract can be formulated in investment transaction documents.

At the beginning of the 2024 New Year, Vientiane is updated. Companies are the most important market subjects, and the introduction of the new Company Law will certainly bring a new wave to the domestic market. At present, the supporting provisions of the new Company Law have not been issued, and many principled provisions in the new Company Law need to be further formulated and clarified. All parties to equity investment and financing transactions should pay close attention to the trend of the rules of the Company Law, balance the rights and responsibilities of all parties, and work together to promote the implementation of transactions and spark the vitality of the market economy.