China’s Supreme Court Clarifies Non-Retroactive Application of Article 88 (1) of the New Company Law

 China’s Supreme People’s Court has confirmed that Article 88(1) of the New Company Law will not be applied retroactively to disputes involving equity transfers made before July 1, 2024. This clarification aims to alleviate widespread concerns among prior shareholders and resolve inconsistencies in judicial rulings across regions. However, businesses are advised to implement robust risk management mechanisms in future equity transfers to ensure smooth and equitable transactions.

On December 24, 2024, the Supreme People’s Court issued the Reply on the Non-Retroactive Application of Article 88 (1) of the Company Law of the People’s Republic of China (hereafter referred to as the “Reply”), providing clarity on judicial rules for resolving disputes related to capital contribution liabilities in cases where equity was transferred before the due date for capital contributions. The Reply took effect immediately upon its issuance.

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The application of Article 88 (1) of the New Company Law, enacted earlier in 2024, has been a contentious issue in judicial practice. Courts across China have delivered inconsistent judgments on disputes concerning capital contribution obligations arising from pre-deadline equity transfers. This inconsistency led the Legislative Affairs Commission (LAC) of the National People’s Congress, China’s top legislative body, to conduct a special review in early December. The LAC concluded that Article 88 (1) of the New Company Law should not have a retroactive effect, forming the basis for the Supreme People’s Court’s recent Reply.

This article offers a concise overview of the key controversies surrounding the application of Article 88 (1) of the New Company Law. It aims to provide readers with a clearer understanding of the legal complexities involved and the potential direction of future judicial rulings on disputes related to capital contribution liabilities in equity transfers made before the contribution deadline.

Capital contribution obligation in equity transfers and Article 88 of the New Company Law

In equity transfers, the nature of the equity being transferred can be categorized into three types based on the status of capital contribution obligations:

• Equity with fully fulfilled contribution obligations
• Equity with defective contributions
• Equity for which the capital contribution deadline has not yet arrived

While the first category does not involve issues of capital contribution obligations, the latter two raise questions about who assumes these obligations after the transfer.

Transfers of equity with unfulfilled deadlines refer to cases where a shareholder transfers equity before the agreed contribution deadline. Article 88 (1) of the New Company Law explicitly addresses the responsibilities for capital contribution obligations in such cases.

According to Article 88 (1) of the New Company Law:

“When a shareholder transfers equity for which the agreed contribution deadline has not yet arrived, the transferee assumes the obligation to contribute the unpaid capital. If the transferee fails to make the contribution on time and in full, the transferor bears supplemental liability for the unpaid contribution.”

This provision clarifies that equity with unfulfilled contribution deadlines is not inherently defective in terms of rights. The shareholder’s right to transfer such equity is recognized, and lawful transfers are permitted. In principle, the transferee assumes the capital contribution obligation upon the due date. However, to prevent malicious evasion of contribution obligations—such as transferring equity to “impoverished relatives” to escape liability—the transferor is not entirely absolved and must assume supplemental liability.

Coupled with other reforms introduced in the New Company Law—such as accelerated payment rules for registered capital, forfeiture provisions for failure to contribute, and the five-year mandatory contribution timeline—it is clear that enhancing creditor protection is a central goal of these amendments. These changes underscore the legislature’s intent to strengthen the business environment and establish a robust and fair market order.

Controversies surrounding Article 88 of the New Company Law

Supreme Court’s judicial interpretation in June 2024

The Supreme People’s Court addressed the temporal effect of the New Company Law in its Several Provisions on the Temporal Effect of the Company Law, issued on June 29, 2024, and effective from July 1, 2024.

Article 4 (1) of the judicial interpretation provides:

“For civil disputes arising from legal facts occurring before the implementation of the Company Law, where no provision existed in the law or judicial interpretations at the time but a provision is made in the Company Law, the Company Law shall apply to the following situations: (1) Where a shareholder transfers equity for which the contribution deadline has not yet arrived and the transferee fails to make the contribution on time and in full, the determination of the contribution liabilities of the transferor and transferee shall be made in accordance with Article 88 (1) of the Company Law.”

That is to say, at that time, the Supreme Court held the opinion that Article 88 (1) of the New Company Law should be applied retrospectively for disputes related to capital contribution liabilities in equity transfers made before the contribution deadline, regardless of the timing of the equity transfer.

Issues in practice

This provision effectively introduced retroactive application of the new law, creating anxiety among entrepreneurs who had previously transferred equity. Many transferors, having relinquished their shareholder status and rights, were held liable under the new rules. Courts began issuing judgments requiring former shareholders to bear responsibility for unpaid contributions, leading to widespread concern and inconsistent rulings across different jurisdictions.

Key issues that arose included:

• Whether retroactive application of the law is reasonable.
• Whether the transferor’s intent (e.g., malicious intent to evade liability) should factor into rulings.
• Whether the timing of debt formation can serve as a defense against supplemental liability.

To address these challenges and ensure judicial fairness, some local courts, including those in Sichuan and Chongqing, suspended trials and deferred enforcement of judgments involving Article 88. These courts also sought guidance from the Supreme People’s Court to resolve the inconsistencies.

LAC’s review and response

On December 22, 2024, the LAC presented its review of cases related to Article 88 during the 13th session of the 14th NPC Standing Committee. The report reaffirmed the principle of non-retroactivity under Article 104 of the Legislation Law:

“Laws, administrative regulations, and judicial interpretations are not retroactive unless made to better protect the rights and interests of individuals or organizations.”

The LAC concluded that Article 88 does not meet the criteria for the exception clause and should apply exclusively to actions occurring after the New Company Law’s implementation on July 1, 2024.

Supreme Court’s new reply

According to the Reply issued on December 24, 2024:

• Article 88 (1) of the New Company Law applies only to equity transfers occurring on or after July 1, 2024.
• For disputes arising from equity transfers made before this date, courts should adjudicate based on the previous Company Law and relevant legal principles.

This clarification means that prior shareholders are not retroactively held liable under Article 88 (1) of the New Company Law for equity transfers made before July 1, 2024.

Risk mitigation for future equity transfers

Despite the new judicial interpretation, shareholders transferring equity after July 1, 2024, remain subject to supplemental liability under Article 88 (1) of the New Company Law. To mitigate risks, transferors can consider the following strategies:

• Reduce registered capital: Encourage the company to reduce its registered capital before the equity transfer, thereby eliminating any outstanding capital contribution obligations.
• Conduct risk assessments: Perform comprehensive risk assessments as part of the equity transaction process.
• Implement risk-hedging mechanisms: Establish appropriate contractual safeguards to address potential supplemental liability risks, such as indemnity clauses or insurance coverage.

These measures can help minimize potential liabilities and ensure a smoother equity transfer process.

Also read:

• China’s Revised Company Law in Effect from July 1, 2024: Key Details Here
• China’s New Company Law: Considerations for Foreign Stakeholders and FIEs
• Tax Implications for Businesses Under China’s New Company Law

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