In depth

The Draft Regulations were issued in furtherance of the promulgation of the amended Company Law of the People's Republic of China (PRC or "China") ("2023 Company Law") on 29 December 2023, and are aimed at providing detailed rules with respect to, among others, the implementation of the statutory maximum five-year capital contribution term for limited liability companies (LLCs) under the 2023 Company Law. The Draft Regulations, once finalized and promulgated, will take effect on 1 July 2024 ("Effective Date"), the same effective date as the 2023 Company Law.

According to the 2023 Company Law, the statutory capital contribution term of up to five years stipulated for LLCs will be retroactively applicable to those companies that have been in existence prior to the Effective Date. This has prompted concerns and negative sentiment. The Draft Regulations propose relatively lenient rules to facilitate the implementation of the said requirements stipulated under the 2023 Company Law.

We set out below a brief summary of some highlights of the Draft Regulations:

1. Reiterating the five-year term as a general rule. For new LLCs established on or after the Effective Date, the Draft Regulations reiterate that the shareholder(s) must inject the registered capital in full within five years after the establishment. The maximum five-year term also applies to capital increase registered by an LLC on or after the Effective Date.
2. Granting a grace period of three years to make adjustment for existing LLCs. For existing LLCs established before the Effective Date, the Draft Regulations propose a grace period of three years from the Effective Date (i.e., from 1 July 2024 to 30 June 2027, "Grace Period"), during which LLCs shall make adjustment to their current capital contribution terms to the effect that all the outstanding capital will be contributed within five years after such adjustment.

If an LLC fails to make the adjustment by the end of the Grace Period, the local SAMR may order it to make such adjustment within 90 days. In such case, the capital contribution term after adjustment shall be no longer than five years after the end of the Grace Period.

The above rules essentially give an existing LLC up to eight years ("3 + 5" years) from the Effective Date to contribute its outstanding capital in full. In other words, an LLC established prior to the Effective Date may have up to 30 June 2032 to contribute its outstanding capital in full if it applies for the adjustment at the end of the Grace Period.

3. Two exceptions with respect to the Grace Period. There are two proposed exceptions with respect to the Grace Period:
   1. If a company established before the Effective Date has a capital contribution term of more than 30 years OR a capital amount of more than RMB 1 billion, the local SAMR may initiate an investigation to ascertain if its registered capital is genuine or not based on the financial capabilities of its shareholder(s), its main business operation and current assets value on a case-by-case basis. As a result of the investigation, if the local SAMR concludes that the capital contribution term or the capital amount is "significantly abnormal", then it may, upon approval by the competent provincial SAMR, request the company to make an adjustment within six months despite the three-year Grace Period.
   2. For existing companies engaging in national significant strategic projects or in businesses that are crucial to the national economy and the people's wellbeing, or involving national security and significant public interest, the capital contribution term of such companies may remain unchanged upon approval by the State Council or the provincial governments.
4. Creating a simplified procedure to reduce unpaid registered capital. The Draft Regulations propose to allow a company to reduce its unpaid registered capital via a simplified procedure within the Grace Period. In such case, the company only needs to make a public announcement for 20 days on the National Enterprise Credit Information Publicity System ("Publicity System"), and if no creditor raises objection during such announcement period, the company may register the capital reduction with the local SAMR. The application of the simplified capital reduction procedure is subject to the following conditions:
   1. the company has no outstanding debts or the outstanding debts are significantly lower than the paid-in capital of the company;
   2. all shareholders shall undertake to bear joint and several liabilities for existing debts before the capital reduction to the extent of their respective original subscribed capital contributions; and
   3. all directors shall undertake that the capital reduction will not impair the company's debt-paying ability and its ongoing business operation.

The simplified capital reduction procedure will make it much easier for a company to reduce its unpaid registered capital. That said, it remains to be seen how this will be implemented by the SAMR in practice, and in particular, what specific undertakings will be required from the shareholders and the directors as mentioned in items (ii) and (iii) above.

5. SAMR may reject a registration of unusually high registered capital. The local SAMR is given the discretion to reject a company setup registration if it reasonably believes that the proposed registered capital of an LLC is "significantly too high" based on common sense and the general situation of the relevant industry in which the company is conducting business.
6. Strengthening the public disclosure requirements. All companies will be required to disclose the amount of subscribed and paid-in capital, contribution method and contribution term of each shareholder through the Publicity System within 20 working days after the relevant information is made available. In addition, all companies will need to submit the shareholders' register, relevant financial statements and other documents evidencing the paid-in capital by the shareholder(s) to the Publicity System. It remains unclear whether such documents (especially the financial statements), once submitted, will be made publicly available.

The public consultation period for the Draft Regulations will end on 5 March 2024, and it is expected that the official promulgation will follow soon thereafter. Investors and other stakeholders are still advised to pay close attention to this new legislation and keep abreast of any new and upcoming development relating to capital contribution in China. For existing LLCs whose remaining capital contribution term exceeds five years after the Effective Date, investors may need to plan ahead on when to make adjustment to the capital contribution schedule or, alternatively, apply to reduce its unpaid registered capital via the simplified procedure (if applicable).

For further details, please refer to our previous alert on the New PRC Company Law.

© 2024 Baker & McKenzie FenXun (FTZ) Joint Operation Office. All rights reserved. Baker & McKenzie FenXun (FTZ) Joint Operation Office is a joint operation between Baker & McKenzie LLP, and FenXun Partners, approved by the Shanghai Justice Bureau. In accordance with the common terminology used in professional service organisations, reference to a "partner" means a person who is a partner, or equivalent, in such a law firm.  This may qualify as “Attorney Advertising” requiring notice in some jurisdictions.  Prior results do not guarantee a similar outcome.