China: A Legal Review On The Reform Of The Company Capital Registration System In China

Last Updated: 23 May 2014
Article by Hongchuan Liu

1. Reform Process of the Company Capital Registration System

The amended PRC Company Law was adopted by the Standing Committee of the National People's Congress on December 28, 2013, which established the hotly discussed reformatory rules regarding the company capital registration system at the national legislative level. Such reform mainly covers the following areas: (i) change of paid-in capital registration system to subscribed capital registration system; (ii) relaxation of requirements on registered capital; and (iii) simplified registration particulars and registration documents.

In fact, pilot rules of the commercial registration system reform have already been implemented in various places in China since 2009. In particular, the abovementioned reform has been carried out in the pilot cities of Shenzhen and Zhuhai Special Economic Zone since March 20131 In September of the same year, such reform was further launched in Shanghai Pilot Free Trade Zone.2

The local pilot reform programs have achieved satisfactory results and call for an amendment to the Company Law so as to avoid the conflict between the pilot rules implemented in various regions and the relevant nation-wide provisions under the Company Law. In the State Council executive meeting in October 2013, Premier Li Keqiang stressed the need to promote the reform of company capital registration system across the board. Under the said background, the amended Company Law was promulgated as a timely response to the call for reform and will come into effect from March 1, 2014.

2. Major Reformatory Policies

(a) Change of paid-in capital registration system to subscribed capital registration system

According to the amended Company Law, unless otherwise specified in the applicable laws and regulations, the requirement on the duration or timing of capital contribution (i.e., shareholders (promoters) should pay up the registered capital within two years after incorporation of the company, or five years after incorporation for investment companies, or in one lump sum at the time of incorporation for one-person limited liability companies) is cancelled. Shareholders (promoters) of a company may now, at their own discretion, agree on the amount of subscribed capital, method and timing of capital contribution and provide the same in the articles of associations of the company.

(b) Relaxation of requirements on registered capital

Unless otherwise specified in the applicable laws and regulations, the amended Company Law also scraped the requirements of minimum registered capital, i.e., RMB30,000 for limited liability companies, RMB100,000 for one-person limited liability companies and RMB5,000,000 for joint stock limited companies. Accordingly, neither the proportion of the first capital contribution nor the proportion of capital contribution in cash will be limited any longer.

(c) Simplified registration particulars and registration documents

In line with the abovementioned amendments, the paid-in capital of the company will not be registered and no verification report will need to be submitted for company registration.

3. Background and Purpose of the Reform

(a) Evolvement of the two capital registration systems

Change of the paid-in capital registration system to subscribed capital registration system is the core of the discussed reform. The paid-in capital registration system requires that the amount of money in the company's capital verification bank account shall equal to the amount of paid-in capital as shown on the company's business license; while the subscribed capital registration system does not require verification or registration of the paid-in capital, but only registers the total registered capital subscribed by all shareholders of the company.

Prior to the year of 2005, PRC Company Law adopted an absolute paid-in capital registration system, that is, a company (other than a foreign-invested company) must pay up its entire registered capital at the time of incorporation. The 2005 amendment to the Company Law introduced certain comprise by allowing the shareholders to pay a certain proportion of the registered capital as initial capital contribution and to pay up the remaining registered capital in installments within a specified period of time. The latest amendment to the Company Law has brought in the change to subscribed capital registration system at the legislative level, with the shareholders being granted the discretion over the amount and timing of capital contribution.

(b) Failure of the paid-in capital registration system

The original purpose of the paid-in capital registration system is to provide credible evidence for a company's contract performance capabilities so as to protect the interests of the transaction counterparties. As the registration authority finds it impossible to actually verify a company's contract performance capabilities, it can only require the company to support its own capabilities by its paid-in capital. However, the paid-in capital can only reflect the amount of capital at the time point of capital contribution. In contrast, the contract performance capabilities of a company is a dynamic concept depending on the company's then current assets, which may be subject to constant change as a result of the company's operation activities. In the same way, the distributable properties of a company in its liquidation are also determined by the company's then existing assets rather than the company's paid-in capital. Therefore, the amount of a company's paid-in capital cannot be a guarantee of the company's contract performance capabilities, but instead may mislead the transaction counterparties' judgment in practice.

Similarly, the government usually considers the amount of registered capital as one criterion of measuring a company's financial strength. A minimum amount of registered capital is required in the application for certain business qualifications, financial incentives and support, and for participation in government procurement projects. The decision or selection made by the government based on the amount of registered capital of a company is not necessarily in line with the company's actual financial strength and thus may be unfair.

(c) Other issues triggered by the paid-in capital registration system

Given the common transaction practice in China, paid-in capital is still prima facie evidence of a company's contract performance capabilities. Accordingly, shareholders often tend to invest into the company a capital higher than the capital actually required for the company's operation so as to secure higher credibility. As a result, capital is often tied up by the legal concept of paid-in capital instead of by the commercial need of a company. When a company finds it unnecessary to maintain a large registered capital, the shareholders are always daunted by the complexity and difficulty of capital reduction. Unnecessary tied-up and idleness of capital has lowered capital efficiency of the companies and meanwhile increased the cost of capital of the society in general.

Against this background, there arise various illegal operations in practice, such as false declaration of registered capital, contribution of registered capital by fraud and withdrawal of registered capital. That is, for the purpose of getting higher credibility, some shareholders seek to have a high registered capital by illegal means of false declaration, third party loans or accounts manipulation, or otherwise withdraw part of the registered capital which is not needed for the actual operation of the company for other use so as to increase capital efficiency.

In addition, other limitations related to the paid-in capital registration system, such as the minimum registered capital, the proportion of the first capital contribution and the proportion of contribution in cash, also including the aforementioned additional requirements on registered capital imposed by the government in its economic administration, unnecessarily intervene with the market economy. Such judicial or administrative intervention, to a certain extent, has dampened the investment capacity and enthusiasm of entrepreneurs.

In summary, the paid-up capital registration system has not only failed to achieve its original purpose, but also raised many problems in practice. In this context, the Chinese government hopes to solve the abovementioned drawbacks of the paid-in capital registration system by reform, and to create a favorable environment for investment and stimulate market activities.

4. Effects and Influence of the Reform

(a) Positive effects of the subscribed capital registration system

As a commonly adopted capital system in the modern world, the subscribed capital registration system was firstly developed in the common law countries and later followed by several civil law jurisdictions (such as European Union and Japan). The discussed reform will no doubt further promote the integration of the Chinese company law with the prevailing corporate regimes in developed countries in the world.

From a practical point of view, the subscribed capital registration system adopted by the newly amended PRC Company Law can to a large extent, address the negative impacts of the paid-in capital registration system mentioned in section 3(c) above. The amendments may mobilize social capital, reduce and even eliminate the irregularities related to company capital registration, relax the thresholds for establishing companies and thus promote the development of newly-rising micro, small and medium-sized enterprises in particular.

Under the subscribed capital registration system, it seems that the so-called "one RMB company" will become possible. However, since a fair amount of investment is necessary for maintaining a company's basic operation, it is actually not realistic to set up a company with an unreasonably low capital. On the other hand, shareholders also have little motivation to intentionally exaggerate the amount of subscribed capital because they will bear liabilities of the company to the extent of their subscribed capital. Further, shareholders who fail to pay their subscribed capital within the time limit provided in the articles of association of the company will also be held liable to the company and the other shareholders.

Therefore, we believe that the subscribed capital registration system allows shareholders to make more rational decisions on the amount and payment schedule of their investment based on the actual capital need for the company's establishment and operation.

(b) Ancillary risk control rules

As mentioned above, the subscribed capital registration system is notable, nor is it intended, to verify the contract performance capabilities of a company. Therefore, it is necessary to adopt a series of ancillary risk control measures to better protect the interests of creditors or transaction counterparties of a company.

The government should strengthen the promotion and education of the new registered capital system, and should advise business entities and relevant governmental bodies to protect their legal interests in commercial dealings by verifying the actual assets of the company (such as by reviewing the recent assets appraisal report or balance sheets of the company) or requesting performance guarantees (such as bank guarantee, property mortgage or pledge).

In addition, it was mentioned in meetings of the State Council and of the State Administration for Industry and Commerce that efforts would be made to advance the construction of an enterprise integrity system. It was proposed that, among other things, the current enterprise annual inspection system will be replaced by an annual reporting system, electronic business licenses will be adopted and full electronic registration and management will be implemented. The government plans to build a credit and information platform of market players to publish company information regarding business registration, annual reports, and qualifications and permits and etc. All such information will be open and transparent and can be accessed and checked by relevant government authorities, transaction counterparties and even the general public in a convenient and prompt manner.

Meanwhile, it was also proposed that government regulatory bodies should reinforce supervision over the operational activities of companies. Companies with irregularities should be put on a "Black List" that is public to all the society and a company with any violation will be subject to various restrictions from different regulatory bodies, thus increasing the "dishonesty costs". If the proposed regulatory measures could be properly implemented throughout the country, we believe they will work well with the new subscribed capital registration system and help prevent the associated transaction risks.

5. Expected Follow-up Reformatory Measures

In response to the amendment to the Company Law, the Company Registration Administration Regulations and other ancillary administrative rules and regulations should be revised accordingly. Relevant provisions regarding the crime of false declaration of registered capital in the Criminal Law should also be abolished.

As pointed out by the head of the State Administration for Industry and Commerce based on the national treatment principle, relevant reformatory measures of the capital registration system should also apply to foreign-invested companies. Therefore, we expect that corresponding amendments will be made to the laws governing foreign-invested companies as well. Nevertheless, as the reform of the company capital registration system will also have an impact on various legal concepts such as the total investment and foreign debt quota of foreign-invested companies, we believe extensive consultation and coordination among relevant regulatory authorities will be required before any amendments to the laws governing foreign-invested companies could be finally implemented.

Lastly, it is worth mentioning that while the amendment of the Company Law has cancelled the requirements of minimum registered capital in general, it also provides for exceptions. That is, where the laws, administrative regulations and decisions of the State Council require a minimum amount of paid-in or registered capital for a company, such requirement should be followed. We believe that a minimum registered capital will remain necessary for certain special industries such as banking securities and insurance. As for the minimum registered capital requirements for other industries or for certain qualifications as stipulated in existing laws and regulations, it will take some time for relevant legislative and administrative bodies to review and determine whether such requirements will be retained or adjusted.

Footnotes

1 The relevant regulations includeCertain Provisions of Commercial Registration of Shenzhen Special Economic Zone, Regulations of Commercial Registration of Zhuhai Special Economic Zone, and State Administration for Industry and Commerce's Approval on the Reform Plan of Commercial Registration of Business License of Guangdong Province.

2 The relevant regulations include Several Opinions on Supporting the Building-up of China (Shanghai) Pilot Free Trade Zone issued by the State Administration for Industry and Commerce, andRegulations of Registration Administration of Enterprises in China (Shanghai) Pilot Free Trade Zone issued by Shanghai Administration for Industry and Commerce.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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