A New Chapter: Next Evolutionary Phase of the New PRC Company Law – Part II: Corporate Governance

Other Author      Elfie Wang of Meng Bo Law Office, a PRC law firm based in Shanghai, with which Mayer Brown has a close working relationship.

The long-awaited amended Company Law (New Company Law) was enacted on 29 December 2023, effective from 1 July 2024. The new amendments are arguably the most significant since China established its company law regime back in 1993. 

Part I of this series (and the subsequent update) considered issues relating to Capital Contributions. This second article discusses changes impacting corporate governance with amendments relating to (among other things) directors’ responsibilities, the role of supervisors, requirements regarding quorum and even the role of the Communist Party.

Background 

PRC companies¹ adopt multi-layer governance structures similar to many other jurisdictions, with the shareholder(s) as the highest authority, empowered to appoint the board of directors (Board), or executive director under the current regime, and supervisor(s).

The Board has the power to engage a general manager responsible for the daily management of the company.

The New Company Law retains this structure but has introduced a series of changes, as outlined below:

Board of Directors

In the past there has often been a general assumption that directors will act in accordance with the wishes of the shareholders that appointed them. The role of the Board has now been strengthened and enhanced, encouraging directors to act much more independently. 

Notably:

• The Company Law has long stated that the Board is responsible to the shareholders – however this provision has been removed from the New Company Law; 
• The New Company Law contains clear requirements regarding directors’ duties of loyalty and obligation to act in the best interests of the company;
• Directors are delegated with the powers to supervise the capital contribution of shareholder(s); and
• Shareholders’ power to remove directors has been restricted under the New Company Law, and directors may now bring a claim against the company for indemnification if they are removed without justification. The law is unclear as to precisely what indemnification would mean in such circumstances but it appears clear that shareholders may no longer remove a director at their discretion. Further regulation or judicial interpretation can be expected.

The New Company Law also amends requirements regarding Board composition with the old size restrictions (until now requiring a Board to comprise 3-13 directors) being changed so that the upper limit has been removed. This allows greater flexibility for companies with multiple shareholders.

Legal Representative

The legal representative has for many years been recognised as having ostensible authority to represent a PRC company vis-a-vis the outside world, and is one of the most important (and indeed onerous) roles in a company. 

It has previously been a requirement that the role of legal representative should be taken by the company’s chairman, executive director or general manager. However, there has been no such explicit requirement that the legal representative should be directly involved in the company’s business affairs. In practice this has sometimes led to a gap between the liability of a legal representative and the actual role he or she plays in the company. 

The New Company Law now requires that the role of legal representative must be taken up by a director or the general manager, having authority and responsibilities to attend to the day to day affairs of the company, thus encouraging active involvement by the legal representative in the conduct of a company's business. 

The intention is to encourage legal representatives to act responsibly and remove the excuse (sometimes given) that such person was not actually involved in the conduct of the business of a company. This reflects the higher level of responsibility now envisaged by the Company Law (a discussion of liability issues will follow in Part III of this series) and individuals may therefore need to exercise caution when taking up such a position.

Supervisory Organ

Under the current Company Law, companies are required to establish a supervisory board (or for small-size companies, either one to two supervisors in lieu of a supervisory board), to supervise the company’s directors and senior management. In practice, such roles are non-active and the supervisors are not usually expected to be involved in company affairs.

The New Company Law includes the following amendments:

• For small size companies, no supervisory organ needs to be established subject to the unanimous consent of all shareholders – reflecting perhaps the enhanced independence of the Board.
• Companies of whatever size may elect to establish an audit committee under the Board (Audit Committee) to exercise the functions and duties of the supervisory board; and in such case, there is no need to establish a supervisory board or appoint supervisor(s).
• In the absence of the above arrangements a supervisory board will still be required. 

It should be noted, however, that if a company with more than 300 employees elects not to establish a supervisory board that includes an employee representative, then the Board of such company must have at least one employee representative. This would appear to be an important factor to be considered at the time company structure options are considered. 

Small companies or companies with limited shareholders have been allowed to have one to two supervisor(s) in lieu of a supervisory board, but under the New Company Law it is no longer possible to have two supervisors – as the requirement is for a board of three or more supervisors or a single supervisor. Companies with two supervisors under the current Company Law will need to restructure.

Audit Committee

As mentioned above, companies may establish an Audit Committee composed of directors to exercise the functions and powers of the supervisory board. The New Company Law does not provide many details, thus giving investors considerable discretion in determining the function and structure of the Audit Committee (such details to be specified in the company’s articles of association).

Supervisors have traditionally been independent of the Board but the Audit Committee seems to depart from this approach. It remains uncertain as to how an Audit Committee composed of directors should supervise the behaviour of the Board (especially if a director sitting on the Audit Committee is involved in an incident under investigation).

Other Matters

There are some other changes regarding the company’s corporate governance structure:

Quorum and Voting

• The New Company Law expressly requires that the quorum of a Board meeting must be constituted by more than half of directors – previously variations were possible if provided for in a company’s articles of association.
• All Board resolutions can now only be passed by more than half of directors – previously this was subject to the company’s articles of association.
• Shareholders resolutions (except for those related to the amendments to the company’s articles of association, capital increase or decrease, or merger, split, dissolution or change of company form, which require approval from shareholders representing at least 2/3 voting rights) can now only be passed by shareholders representing more than 50% voting rights – previously variations were possible if provided for in a company’s articles of association.
• Resolutions of supervisory board can only be passed by more than half of supervisors.

These requirements are significant as they will require the consent of more than half of the shareholders (counted by voting rights), directors or supervisors to pass a resolution and according to the New Company Law, it appears that such requirements cannot be varied or avoided through the company's articles of association. This raises questions about the impact on deadlock provisions in shareholders agreements and the enforceability of language providing (for example) for lower quorums at reconvened meetings where the some directors or shareholders fail to attend meetings. 

Further clarification may be needed to avoid disruption to business and potential variation and interpretation among local registration authorities in different locations.

General Manager

The New Company Law no longer sets out the powers and functions of the general manager - this will be completely subject to the articles of association or the authorisation of the Board. 

CPC Organ in State-funded Companies

In state-funded companies (including foreign invested companies in which the state holds a controlling share), the Chinese Communist Party (CPC) is required to play a leading role which must include the right to study and discuss business management matters; and give or withhold "support" for the company in the exercise of its functions in accordance with the law. 

This new development follows less detailed amendments introduced in 2018 to company law requiring a CPC organ to be established in accordance with the requirements of the CPC's articles of association which applies to all companies. 

The New Company Law now goes one step further for state-funded companies emphasising the need for the CPC to play a "leading role", which is clearly significant and something that may need to be reviewed by foreign investors in the context of both established joint ventures and the establishment of new entities. 

Timeline 

In general, the New Company Law proposes a series of changes in terms of corporate governance structure and companies may need to review existing structures and documentation in the context of the amendments now being introduced.

However, unlike the capital contribution requirements, the new law does not provide for a clear time period for adjustments to be made regarding the corporate governance structure. Further regulations are likely in terms of implementation and in order to add detailed where these are needed.

¹ References to companies in the Update refers to limited liability foreign invested companies rather than alternative legal entitles such as joint stock companies.