Case analysis: retroactive applicationof new Company Law

The new Company Law, which took effect on 1 July 2024, presents a fundamental issue: should people’s courts apply the new or the old law to corporate dispute cases in their first and second instances, where the legal facts occurred before the new law was implemented?

Several provisions of the Supreme People’s Court on the Retroactivity in the Application of the Civil Code of the People’s Republic of China reaffirm the basic principle that “laws do not have retroactive effect”, yet it specifies exceptions for the retroactive application of the new law. The following discussion will attempt to illustrate scenarios where the new law is applied retroactively.

The case. Consider a major asset restructuring (backdoor listing) project involving a listed company, company B. The original controlling shareholder of company B is company C, and company A intends to acquire C’s shares in company B to gain control and complete the restructuring. A and C signed a share transfer agreement and other transaction documents in October 2023. In August 2024, A, B and C signed an asset swap agreement.

In principle, disputes arising from the share transfer agreement should be governed by the old law, while disputes from the asset swap agreement should be governed by the new law. However, given that the transaction spans both the old and new Company Law, many disputes may involve retroactive application of the new law.

Retroactive application based on the principle of beneficence. The new Company Law will retroactively apply in the following seven aspects: (1) the statutory period for revoking company resolutions is limited to one year; (2) legal relationships formed between bona fide third parties and the company are not affected by defects in resolutions; (3) recognition of debt-to-equity swaps; (4) shareholders of limited liability companies can transfer shares without majority consent from other shareholders; (5) individuals involved in illegal profit distribution and unauthorised capital reduction are liable for damages; (6) companies must distribute profits within one year of the distribution resolution; and (7) company capital reduction should follow the principle of proportional reduction.

For example, if C authorises A to exercise voting rights before the share transfer is completed, and a dispute arises among the parties regarding the voting method at the shareholders’ meeting, C must file a lawsuit to revoke the resolution within one year of its adoption.

Additionally, the new Company Law will retroactively apply in the following three situations: (1) companies can become joint and several liability contributors; (2) capital reserves can be used to cover losses; and (3) simplified mergers do not require a shareholders’ meeting resolution.

For instance, if A challenges the validity of a resolution made by B’s board in May 2024 to use capital reserves to cover losses, the court should apply article 214 of the new Company Law and uphold the resolution.

Furthermore, for actions such as illegal nominee shareholdings in publicly listed companies and cross-shareholding between listed companies, which were not regulated under the old laws but are explicitly prohibited by the new Company Law, parties can invoke the new law to claim related agreements invalid if they were executed after the new law came into effect.

For example, if, after A acquires shares from C, a third party claims rights to the shares based on a nominee agreement with C, or requests the annulment of the nominee share portion of the share transfer between A and C, the court should apply article 140 of the new law to deem the nominee holding invalid and dismiss the third party’s claim.

Retroactive application based on the principle of gap filling. Provisions not addressed under old laws but included in new law will be applied retroactively. Key aspects include the following:

1. Transferors of shares not yet due for contribution must assume compensation liabilities;
2. Minority shareholders can demand that the company repurchase their shares under oppressive circumstances; and
3. De facto or shadow directors are required to act with loyalty and diligence, bearing joint liability for actions detrimental to the company or shareholders.

For example, if A, after gaining control of company B, discovers that prior to the signing of the share transfer agreement C directed B’s former directors to engage in extensive related-party transactions contrary to the company’s articles of association and misappropriating non-operational funds, A cannot only demand compensation from the former directors but also hold C jointly liable under article 192 of the new law, suing them as co-defendants and seeking asset preservation.

The application of gap-filling retroactivity may frequently occur in future litigation. The new Company Law contains 266 articles, with 49 new articles and 181 modified or integrated articles.

The retroactivity provisions specify that 27 key articles have retroactive effect and include a catch-all clause allowing courts to apply new articles if they do not significantly violate the reasonable expectations of the parties involved.

This significantly increases the likelihood of retroactive application. On 1 July 2024, the first case adjudicated by the Xicheng District People’s Court in Beijing applied the new law’s accelerated maturity rule based on this catch-all clause.

Retroactive application based on the principle of detailed specificity. The new Company Law clarifies and retroactively applies the following provisions: (1) articles of association of joint-stock companies can restrict share transfers; (2) supervisors are liable for compensation if they breach their duty of loyalty; (3) the determination of directors’ and senior managers’ liability for breaching their duties; and (4) the definition of related parties and the nature of related transactions.

For example, if A discovers that B’s former supervisor, their relatives, and enterprises controlled by their relatives participated in related-party transactions instructed by C, A can claim damages from all involved parties under article 182 of the new law.

In conclusion, retroactive application of the new Company Law is likely to be common. The Supreme People’s Court has emphasised the cautious application of exceptions to retroactivity and the need to unify the discretion in retroactive application cases through platforms like Law-Answer Net, and reporting to higher courts.

Zuo Yuru is a Equity Partner and Wang Zhongyu is an Paralegal at Zhong Lun Law Firm