The Chinese legislature adopted at its seventh session the latest amendment to the Company Law, which will come into effect on July 1, 2024. The revised piece of legislation introduces changes to the corporate governance structure, allowing a one-board system.
This will offer more flexibility in a company’s formation of its internal organization, especially in the cases of foreign invested companies in China as many of them can be categorized as “limited liability company with few shareholders”.
On December 29, 2023, the Standing Committee of the National People’s Congress (NPC) adopted an amendment to the China Company Law. The final version of the 2023 Company Law follows many years of draft amendments and deliberations.
The new version of the Company Law will affect companies in China – both old and new – providing more flexibility in areas such as share issuance and corporate structure while strengthening the protection of shareholder rights. Similarly, the new Company Law will have a substantial impact on the compliance obligations
and risks associated with the performance of the duties of directors, supervisors, and senior management in key positions (DSMs).
The new Company Law improves several areas of corporate governance, including the capital contribution system, shareholder rights, and corporate registration and liquidation systems, among many other areas.
Foreign investors and companies are strongly advised to familiarize themselves with the amended China Company Law to assess the possible impact on their investments.
China Two board System and China One board System
The most important change with respect to the corporate structure is the option not to have a board of supervisors.
In China, the Company Law adopts a “two-board system” with respect to the establishment of company’s internal organization: a board of directors to carry out the company’s day-to-day business and a board of supervisors to monitor the members of the board of directors and other senior management.
Both the board of directors and the board of supervisors shall be elected by the shareholder’s meeting. A limited liability company with small scale and few shareholders can only set up one executive director instead of a board of directors and one or two supervisors instead of a board of supervisors.
The two-board system’s main objective is to protect the interests of shareholders. In addition to the board of directors, an independent organization elected by the shareholders is set up to monitor the performance of the management.
In practice, the function of the supervisor and board of supervisors has become a formality. In most limited liability companies, ownership and operation are not separated. The shareholders do not just own the company but are also deeply involved in the day-to-day operations. In some cases, they are members of the board of directors as well.
For this reason, the new Company Law introduces a China one board system as an option. Article 69 states that a limited liability company may set up an audit committee within the board of directors to exercise the power of supervisor instead of a board of supervisors.
Article 83 permits a limited liability company with small scale or few shareholders to choose not to elect a supervisor regardless of whether this is an audit committee within the board of directors.
Audit committee
The new Company Law includes a provision that allows LLCs and joint-stock companies to establish an “audit committee” within the board of directors, in which case it would not need to establish a board of supervisors (or appoint any supervisors). The audit committee can be “composed of directors on the board of directors [and] exercise the powers of the board of supervisors”.
The audit committee in a joint-stock company must have at least three members, of which more than half (at least two if the committee only has three members) do not hold any other positions within the company other than the director. They must also not have any relationship with the company that could affect their independent and objective judgment.
Employee representatives who are members of the company’s board of directors can become members of the audit committee (in both joint-stock companies and LLCs).
The new law outlines specific provisions for the deliberation and voting procedures of the audit committee of joint-stock limited companies and publicly listed companies. These provisions are:
Resolutions made by the Audit Committee must be approved by more than half of its members.
Each member of the Audit Committee has one vote for resolutions.
The deliberations and voting procedures of the audit committee shall be stipulated in the company’s articles of association (AoA), except where otherwise stipulated in the Company Law.
The company may set up other committees on the board of directors following the provisions of the company’s AoA.
No specific provisions on the deliberation and voting procedures of the audit committee of an LLC have been stipulated.
Employee Representative to the Board
The new Company Law requires all companies, state owned or private, with more than 300 employees to include at least one employee representative on its board of directors or its board of supervisors.
However, the law does not clarify the concept of “employee”. In China, most senior management, even directors, enter an employment contract with the company. The new Company Law requires that the employee representative to the board of directors is elected by an employees’ congress or other democratic method but does not explain who is eligible to be elected as employee representative.
No board of directors for small joint-stock companies
The new Company Law allows small joint stock companies or joint stock companies with few shareholders the option not to establish a board of directors. The old version of the Company Law only allowed LLCs this option.
In such cases, a single director may be appointed to exercise the functions and powers of the board of directors. The director may also serve as a manager of the company.
No supervisor for small LLCs
The revised Company Law allows small LLCs or LLCs with few shareholders the option not to have supervisor(s), with the unanimous consent of all shareholders.
Transfer of powers to board of directors
The amended law makes it clear that the functions and powers of the board of directors are composed of three parts: statutory functions and powers, functions and powers prescribed in the AoA, and authorized powers granted by the board of shareholders or shareholders’ meeting.
In addition, the new law stipulates that the board of shareholders or shareholders’ meeting can authorize the board of directors to make resolutions on some matters within the scope of its functions and powers (such as issuing corporate bonds).
Article 46 lists the powers of the board of directors. A company can grant more powers to the board of directors on its AoA.
Under the current scheme, the board of directors shall only exercise the powers authorized by the AoA or the Company Law. Powers which are not expressly granted to the board of directors shall only be exercised by the shareholders.
In most foreign invested companies, it will make no material difference whether it shall be exercised by shareholders or by the board of directors, because they are usually wholly owned by one shareholder.
In a joint venture company, the powers of the board of directors shall be carefully tailored to achieve a proper balance between the efficiency and fairness of the company’s operation.
Though the new Company Law maintains the “non-exhaustive list” style to set forth the powers of the board of directors, it removed one item, namely the preparation of the company’s annual budget and final accounts, from the power of the board of directors, and allows the board of directors to delegate it to the general manager or other senior management.
Powers of Shareholders
The new Company Law also provides a non-exhaustive list of reserved matters for the shareholders’ meeting.
However, the list was shortened by two items: approval of the company’s business policy and investment plan and preparation of the company’s annual budget and final accounts.
Article 59 of the Company Law allows the AoA to grant more powers to shareholders’ meeting. The reduction of the mentioned two items does not mean that the shareholders’ meeting can no longer exercise such powers.
In a limited liability company where the shareholders are also actively involved in the day-to-day operations, it will not make a difference if a certain matter shall be approved by shareholders or by the board of directors.
The new Company Law requires that a notice of shareholders’ meeting shall be delivered to each shareholder at least 15 days in advance and there is no requirement on notice period with respect to meeting of the board of directors, it can be more efficiently resolved if such matters are to be approved by the board of directors.
The new Company Law also allows the AoA to provide otherwise with respect to the notice period of shareholders’ meeting.
Changes to provisions on shareholder rights
The new Company Law enhances shareholders’ powers in several ways, enabling them to better protect their rights. These include expanding their right to information, powers to convene extraordinary general meetings, and rights to require share buybacks.
Rights to access information
Article 57 has been amended to allow shareholders of an LLC to request to inspect the company’s accounting vouchers, in addition to the accounting books.
In addition, the new law stipulates that shareholders of an LLC can entrust accounting firms, law firms, and other intermediaries to review the company’s AoA, shareholder list, shareholders’ meeting minutes, board meeting resolutions, supervisory board meeting resolutions, and financial accounting reports.
Shareholders of joint-stock limited companies who individually or collectively hold more than 3 percent of the company’s shares for more than 180 consecutive days can review both the company’s accounting books and accounting vouchers, in accordance with relevant provisions.
Shareholders of joint-stock companies are now permitted to duplicate company materials (AoA,
shareholder list, shareholders’ meeting minutes, board meeting resolutions, supervisory board meeting resolutions, and financial accounting reports). They can also inspect and duplicate relevant materials of a wholly owned subsidiary company.
Right to request share buybacks
Article 89 states that shareholders have the right to request the company to acquire their equity at a reasonable price if a company’s controlling shareholder abuses shareholder rights and seriously damages the interests of the company or other shareholders.
In addition, Article 161 stipulates a series of circumstances under which shareholders who vote against a resolution of the shareholders’ meeting can request the company to acquire their shares. Some of these are:
The company has not distributed profits to shareholders for five consecutive years, but the company has made profits for five consecutive years and meets the conditions for profit distribution stipulated in the Company Law;
The company transfers its main assets; and
When the specified operational period in the company’s AoA expires, or when other dissolution reasons specified in the AoA occur, and the shareholders’ meeting passes a resolution to amend the AoA to keep the company in existence.
If the shareholder and the company cannot reach a share acquisition agreement within 60 days of the date of the resolution in question, the shareholder may file a lawsuit within 90 days of the date of said resolution.
The right to require share buyback in the above scenarios does not apply to shareholders of publicly listed companies.
Loss of shareholder rights for defaulting on capital contributions
The new Company Law adds provisions stipulating the loss of rights for shareholders that owe capital contributions. Under Article 51, if a shareholder fails to pay the capital contribution within the prescribed time and subsequent grace period after the establishment of an LLC, then they can lose the equity of the unpaid capital contribution.
Appointment of legal representatives
The current Company Law requires that the legal representative of company holds the post of chairman, executive director, or manager, which can be difficult to implement in practice. The new version expands the scope of selection of legal representatives to all directors or managers who carry out affairs on behalf of the company.
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