New Company Law’s impact on joint-stock company transition

The new Company Law revised provisions related to the establishment and organisational structure of joint-stock companies when it came into effect on 1 July 2024. For most companies, transitioning from a limited liability company to a joint-stock company is a crucial step towards an IPO. This article analyses the impact of these revisions on transition practice.

Numbers, lock-up restrictions

Firstly, article 92 of the new Company Law reduces the minimum number of promoters for a joint-stock company from two to one, allowing a single-member limited liability company to directly undergo the transition.

Under the previous Company Law, a single-member limited liability company had to introduce a new shareholder before transitioning, particularly in cases where a wholly owned subsidiary of a listed company was preparing for a domestic IPO. The new Company Law removes this restriction, reducing the cost of introducing new shareholders and simplifying the transitioning process.

Secondly, the new law eliminates the previous requirement that “shares held by promoters cannot be transferred within one year from the company’s establishment”, thereby removing the lock-up period for promoters’ shares.

Previously, the timing and method of promoters’ exit were restricted, sometimes leading companies to revert to limited liability status after transitioning to facilitate investor exit (for example, the Zhejiang Taimei Medical Technology case).

The new Company Law abolishes this lock-up requirement, allowing promoters to transfer shares more freely and flexibly before and after transitioning. This significantly enhances the convenience of corporate financing and reduces constraints on financing timing due to transition arrangements.

Inaugural meeting procedures

According to article 90 of the previous Company Law, whether a company was established by promotion or by public offering of shares, the promoters must issue a notice or announcement at least 15 days prior to the inaugural meeting.

In practice, constrained by this provision, a 15-day notice period was often necessary for the transition process, which could create timing challenges for companies undergoing a relatively tight transition schedule.

In such cases, the promoters would typically agree to waive the notice period, but this could still lead to procedural defects that drew regulatory scrutiny, as happened in the Empyrean Technology case.

Article 103 of the new Company Law distinguishes between establishment procedures for companies formed through public offering and promotion.

For joint-stock companies established through promotion, the convening and voting procedures for the inaugural meeting are to be stipulated in the company’s articles of association or the promoters’ agreement. This amendment respects the autonomy of the promoters, making the transition process simpler and more flexible, and potentially shortening the procedural timeline.

Additionally, based on these revisions, companies should specify the notification, convening and voting procedures for the inaugural meeting in their articles of association or promoters’ agreement. Furthermore, the new Company Law standardises the term “establishment meeting” to “inaugural meeting”, and companies should adjust the relevant terminology accordingly when drafting documents for the inaugural meeting.

Capital contributions

Regarding the timing of capital contributions, article 98 of the new Company Law clearly requires that joint-stock companies must fully pay their capital contributions at the time of establishment. Since the essence of the transition involves promoters converting the net assets of a limited liability company into shares of a joint-stock company, the registered capital should already be fully paid during the transition process.

However, in practice, there are instances where the net assets converted into shares are less than the registered capital of the joint-stock company due to accounting errors, mistakes by intermediaries and such, as seen in cases like Miracle Laser Systems.

Typically, shareholders rectify this by making additional capital contributions. Under the previous Company Law, which only required promoters to “pay capital contributions as stipulated in the company’s articles of association”, there was more room to legally justify such rectification measures.

But within the framework of the new Company Law, the compliance of these types of rectifications may be more ambiguous, requiring further clarification in relevant detailed rules.

Regarding the financial structure, article 214 of the new Company Law removes the restriction from the previous Company Law that “capital reserves cannot be used to offset company losses”. Therefore, companies with historical losses can directly use capital reserves to offset losses during the transition stage, reducing concerns related to unaddressed losses during subsequent IPO reviews.

Governance structure

The new Company Law simplifies and adds flexibility to the governance structure of joint-stock companies. Key adjustments include changes to the scope of board and supervisory personnel, and the option to choose between establishing a supervisory board or an audit committee.

Specifically: (1) Smaller joint-stock companies or those with fewer shareholders must have at least one director and may have one or more supervisors, or choose not to appoint any supervisors at all; and (2) Typical joint-stock companies must establish a board of directors with at least three members and have the option to set up a supervisory board or an audit committee with three or more members.

From a regulatory compliance perspective, it is also important to note that joint-stock companies with clear IPO plans should consider appointing independent directors and relevant specialised committees. Generally, it is recommended that the board of directors should have no fewer than five members.

Zhang Ying is a partner and Liang Jing is an associate at Grandway Law Offices