Michelle Tzhori, manages the Firm’s China Desk in Shanghai
China’s Company Law was enacted in 1993 and revised four times in the past two decades. The most recent revision came into force on March 1st 2014, and together with other revised regulations, introduced major changes to the concept of an incorporated enterprise in nowadays China. These changes will be summarized below.
Prior to the recent amendment to the company law, any individual or company interested in setting up a legal entity in China had to undertake a commitment to inject a certain amount of capital to the new Chinese entity. The law was specific about the minimum capital required for different types of companies; the final amount required for the establishment of the entity was decided by the relevant approval authority based on various factors including the nature of the company, the industry in which it conducts business and the feasibility study report submitted by the shareholders.
The registered capital (that is, the paid-in capital) was derived from the amount of total investment. The gap between the paid-in capital and the total investment was the debt-financing strip in which a company could leverage its operation.
Capital contribution was by cash and in-kind, where the cash part accounted for at least 30% of the total paid-in capital.
The contribution of the paid-in capital in a limited liability company was spread over two years, where the initial contribution, in the amount of 20% of the total registered capital, should be injected soon after the issuance of the business license, and the remaining capital within two years from the date of incorporation.
The above no longer exists. The changes introduced by the revised Company Law are as follows:
- There is no minimum registered capital requirement. The minimum registered capital is replaced by a subscribed capital decided solely by the investor at his own discretion.
- There is no minimum contribution period. The shareholders, at their own discretion, decide on the timing and proportion of the contribution.
- There is less limitation on the method of capital contribution, such that the cash contribution part is no longer required. It shall be stated, however, that the category of in-kind contribution is still limited to properties that can be valued in cash and be legally transferred, such as intellectual property, material objects and land use rights. Labor, credit, goodwill, name of a natural person, franchise rights or secured property cannot be contributed as in-kind capital, pursuant to the Regulations for Company’s Registered Capital published in February 2014.
The changes introduced by the recent revision are intended to facilitate the registration process of new legal entities. Though seems like encouraging news, these recent changes are yet to be examined and executed. Although the law no longer defines the minimum amount and form of capital required to set-up legal entities in China, the local authorities still have the sole discretion over a registration application, and they will enable the registration only to the extent they are convinced the new entity will have enough capital to execute its business plan. Note that as part of the application review process, government officials carefully look at the feasibility study report submitted by the investor. The officials will have clear view of the capital required for the inception of operation and will not allow the incorporation of an entity lacking sufficient funds.
From the soon-to-be company’s perspective, the amount of prescribed capital may affect its ability to conduct business in the future, as various business counterparts (such as state owned entities and major corporation) may review the amount of prescribed capital in order to evaluate its financial strength, capability and credibility, and will base their decision whether to contract with this entity, inter alia on the amount of capital injected by the investor.That is to say, it needs a complete transformation of mindset from both the investor, their business counterpart and government officials in order to actually benefit from this subscribed capital reform.
Credit information system
China is establishing a credit information system to enable the public retrieve general information about Chinese enterprises.Until recently, if you wanted to collect a certain information – e.g. record of administrative penalties, mortgages and pledges – about a Chinese enterprise you would have had to go through a lengthy process of submitting an application to the local administration of industry and commerce (AIC), waiting for the authorities’ approval to disclose information and eventually go to the local AIC and manually retrieve the information. Although the relevant regulations allowed such disclosure, in practice, the authorities were reluctant to disclose information and put conditions on such disclosure.
Such bureaucracy is nearly over. In February 2014, the State Council issued the Reform Plan for the Registered Capital Registration System (the “Plan”), which confirmed the decision to build enterprise credit information system, and coming soon is the Enterprise Credit Opening Regulation (the “Regulation”) by SAIC, which will implement the Plan.
According to the Plan and the Regulation, the information providers of this system are the enterprises themselves, who are responsible to display data such as their annual reports administrative information and capital situation, the AIC, who will open administrative registration, record information and administration penalties, and other related government departments.
The Plan also points out the importance of improving integrity restraint mechanism. Pursuant to the Regulation, enterprises failing to publish annual reports in time or those who cannot be reached according to the registered domiciles shall be put into the list of “abnormal business operations”. Likewise, there is another blacklist of “serious illegal enterprises”, for those with serious problems. The two blacklists will be open to the public, thus alerting the risks associated with doing business with such enterprises. Relevant departments will take targeted measures against such misconducting enterprises. Enterprises with credit problems will undoubtedly be limited in many ways throughout their business activities.
The national enterprise credit information system has already been established – seehttp://gsxt.saic.gov.cn/. The local AICs are currently building up corresponding systems aimed at better supervising enterprises’ behaviors, following the new principle of “low threshold, strong supervision”. This major step in enterprises’ supervision will certainly lead to a better and more transparent business environment in China.
Annual inspection System
In February 2014, SAIC issued the notice of annulling annual inspection of enterprises as of March 1 2014. Previously, enterprises were subject to an annual inspection, conducted by the local registration authority, according to Enterprise Annual Inspection Measures (the “Measures”). Enterprises were required to submit annul inspection materials to the registration authority during March to June each year. The authority would examine the materials both in content and format. The inspecting items mainly include data regarding change registration, capital contribution, business operation and validity of administrative permission. Once the enterprises passed the inspection, the annual inspecting information would be added into their accounts. Those who failed to complete the annual inspection on time would be fined or even subject to lose their licenses.
According to the Reform Plan for the Registered Capital Registration System (the “Plan”), the Annual Inspection System is replaced by the Annual Report Mechanism. From this year onward, enterprises shall submit annual report to local AICs and publish their reports on the credit information system. The annual report shall contain basic information about the enterprise (name, address, contact information), capital contribution figures (paid-in and subscribed) and business operating status (closed, liquidated, reopened or in normal operation). Pursuant to the Enterprise Credit Opening Regulation (for public review), enterprises can choose whether to expose some of their financial situation, which exposure is not mandatory.
The Plan also briefly regulates a credit supervision mechanism to assist the annual report system:
- To prevent dishonest reporting, the local AIC will conduct random review of the reports. If any false information is found in the annual report, the enterprise shall be fined by the AIC, and the information of its legal representatives and person-in-charge shall be informed to other related departments.
- If the enterprise does not publish its annual report in due course, it shall be listed as an “abnormal business operation”. In the event it fails to comply with the relevant requirements for 3 years, it will be forwarded to the blacklist of seriously illegal enterprises.
This shift from an annual inspection system to an annual report mechanism is part of China’s administrative reform, meant to decrease governments’ supervision and control. It aims at transferring responsibilities to the public and bringing the economy closer to the western-type market-economy. For enterprises, this would substantially save administrative costs and time spent on annual inspection. For the public, it will allow better transparency and a more prudential business encounter.