Contributed By Global Law Office
There are three principal forms of corporate/business organisation in China:
Only companies have the status of legal persons, and shareholders shall bear liabilities for a company to the extent of their respective subscribed capital contribution/shares. However, a shareholder who abuses the independent legal person status of the company or the shareholder’s limited liabilities to evade debts, thereby prejudicing the interests of creditors of the company, shall be jointly and severally liable for the debts of the company.
Companies are categorised as limited liability companies and joint stock limited companies. Joint stock limited companies whose shares are listed and traded on a stock exchange are publicly traded companies.
The principal sources of corporate governance requirements for companies are the Company Law of the People’s Republic of China (the “Company Law”) and five judicial interpretations of the Company Law. In addition to the laws, judicial interpretations and regulations, the activities of a company and all participants (including shareholders, directors, supervisors and officers) are governed by the articles of association of the company.
Publicly Traded Companies
Provisions on the supervision and administration of publicly traded companies are numerous and complex. As publicly traded companies are a type of joint stock limited company, the provisions of Chapter 5 of the Company Law, regarding joint stock limited companies, apply to them, and particularly, they are also subject to the special provisions of Section 5 of Chapter 5 regarding the organisation of publicly traded companies. The organisation and activities of publicly traded companies are also regulated by the Securities Law of the People’s Republic of China, the regulatory rules of the China Securities Regulatory Commission (CSRC) and the relevant stock exchanges.
Corporate governance requirements for companies with publicly traded shares mainly include the following:
Corporate governance requirements for companies with publicly traded shares are mainly stipulated in the Code of Corporate Governance of Publicly Traded Companies, which was issued by CSRC in 2018. Some requirements are mandatory, while others are voluntary. However, certain provisions seem to be voluntary, but in fact have become quasi-mandatory, because companies may be confronted with unnecessary complications if they have not strictly complied with them in the IPO procedure.
The Company Law was revised on 29 December 2023, and the new rules become effective on 1 July 2024, with the following hot topics in corporate governance arising:
The new revisions strengthen the protection of shareholders’ rights and creditor’s economic interest, improve the shareholder investment mechanisms, enhance compliance responsibility of corporate control persons and executives, and allow certain simplifications of company governance structure.
The new Company Law specifically focuses on the issues arising from corporate control right competition, shareholder litigation and director responsibility. In addition, it defines the content scope of articles of association that can be agreed upon by shareholders. It still leaves gaps open on many practical issues and increases the need for professional advice and even legal battles for all relevant parties.
According to China regulatory rules, publicly traded companies shall disclose environmental information and fulfil social responsibilities such as poverty alleviation. ESG information disclosure is one of the obligations that publicly traded companies must fulfil, which requires them to incorporate “environment”, “society” and “governance” into the concept of enterprise development.
In 2024, China’s stock exchanges issued more specific requirements on the sustainable development report for publicly traded companies. A combination of mandatory disclosure and voluntary disclosure should be adopted for ESG reports, and violations may cause regulatory or disciplinary actions.
In China, the principal bodies involved in the governance and management of a company include the shareholder meeting, the board of directors, the board of supervisors and the manager.
In general, the new company law allows the removal of supervisors from the corporate governance structure. It may also, however, raise the concern of self-supervision by the board of directors itself, leaving an open question on how to balance the board’s power in such structure.
Decisions of the Board of Directors
The board of directors shall decide on the following matters:
The new Company Law deletes the board’s function of formulating plans in respect of the company’s annual budget and final accounts, which gives the company a discretion to transfer this function from the board of directors to the senior managers by an elaboration in its articles of association.
In addition, the board of directors shall exercise other powers prescribed by the articles of association and empowered by the shareholders’ meeting.
Powers That the Shareholders’ Meeting can Give to the Board of Directors
Based on the empowerment by the shareholders’ meeting, the board of directors can decide on the following matters.
The below resolutions shall be adopted by a majority of all the directors:
The following resolutions shall be adopted by more than two-thirds of all the directors:
If the board of directors goes beyond the function stipulated in the law or the articles of association, and acts without any proper approvals by the shareholders’ meeting, it will constitute a violation with potential damage to the interests of the company in judicial practice.
Decisions of the Shareholder Meeting
In general, the new revision to Company Law narrows the scope of functions of the shareholders’ meeting, and creates more rooms for the board of directors, which was appraised by many commentators as a sign of encouraging professionalism in corporate governance.
The shareholder meeting is responsible for making decisions on fundamental issues, including but not limited to:
Protection of Bona Fide Counterparts
For the protection of the interests of bona fide counterparts and transaction stability, the Company Law stipulates the following special measures.
The above provisions mean that, if the bona fide counterpart has justifiable reasons to believe that the company is properly empowered and acts based on such belief, the court shall assume that the actions between the company and the bona fide counterpart are valid.
Protection of Stakeholders’ Interests
For the protection of stakeholders’ interests, the Company Law stipulates special procedural requirements as a precondition for the following activities of the company, which essentially reflects the multiple layers of competition among the interests of shareholders and external creditors, and those of majority shareholders and minority ones:
The Validity of Guarantees by the Company When Legal Representatives Violate Internal Procedures
Article 7 of the Interpretation of the Supreme People’s Court of the Application of the Relevant Guarantee System of the Civil Code of the People’s Republic of China stipulates that if the legal representative violates the legal procedure of the company providing the external guarantee and exceeds their empowerment to conclude a guarantee contract with the counterpart on behalf of the company, the validity of the guarantee contract shall be determined in accordance with the following criteria:
The counterpart has the obligation to reasonably examine the validity of the company’s resolutions. If the counterpart has evidence of its reasonable examination, the people’s court shall determine that it acts in good faith, unless the company has evidence showing that the opposite party knows or should know that the resolution is forged or altered.
The criterion for judging the good faith of the counterpart, for a case involving a publicly traded company, is whether the counterpart enters into the guarantee contract based on the information publicly disclosed by the listed company.
Normally, meetings of the board of directors shall be convened and presided over by the chair of the board. When the board of directors votes on a resolution, each director shall have one vote.
Procedural Requirements for Board Meetings
For a limited liability company, the discussion methods and voting procedures of the board of directors shall be specified by the articles of association or bylaws, unless it is otherwise provided for by the Company Law.
In joint stock companies, the convening of board meeting shall follow special procedural requirements.
For limited liabilities companies and joint stock companies, their board meeting shall follow some procedural requirements.
Related-Party Transactions
For the management of related-party transactions, it is clarified that affiliated directors shall recuse themselves from voting; if the number of non-affiliated directors present at the board meeting is less than three, the related-party transaction shall be submitted to the shareholders’ meeting for review and approval.
Voting Deadlock Solution
In practice, if there is a deadlock situation in decision-making, solutions should be clearly stipulated in the articles of association or internal corporate governance rules. For example, the chair of the board can have an additional second voting right, or some key directors can have a veto right.
With respect to the shareholder meeting, please see 5.3 Shareholder Meetings regarding decision-making processes.
The board of directors in a limited liability company shall have at least three members, while there is no upper or lower limit for the number of board members of a joint stock limited company.
Audit Committee or Board of Supervisors
A company may set up an audit committee in the board of directors to exercise the supervisory functions and powers to replace the board of supervisors or supervisor. The audit committee of a joint stock company shall have at least three members.
The board of directors shall be presided over by a chair, and may have one or more vice-chairs. The chair shall be responsible for presiding over shareholder meetings, convening and presiding over meetings of the board of directors, and inspecting the implementation of resolutions of the board. A vice-chair assists the chair in their work. If the chair cannot or does not carry out their duties, such duties shall be carried out by the vice-chair; if the vice-chair cannot or does not carry out its duties, the duties shall be carried out by a director jointly elected by more than half of the directors.
A publicly traded company shall have independent directors and board secretaries. Independent directors shall be responsible for supervising the directors and officers, and shall report their work to the shareholder meeting annually. The board secretary shall be responsible for the preparation of shareholder meetings and meetings of the board of directors, custody of documents, management of shareholders’ materials, disclosure of information, investor relations and other matters.
Qualifications of Directors
Persons may not serve as a director of a company in any of the following circumstances:
Special Requirements for Chairman and Staff in Certain Industries
There are special senior position segregation requirements in specific industries. For an example, the chairman of a bank or an insurance company shall not concurrently serve as the CEO or the general manager for the institution. And members of commercial banks and state-owned companies may not take part-time jobs in other economic organisations.
The directors who are not representatives of the employees shall be appointed and removed by the shareholder meeting. The employees’ representatives shall be democratically elected by the employees through the employees’ congress, through the employees’ meeting or in other ways. The method of appointing the chair and vice-chair of the board of directors in a limited liability company shall be stipulated in the articles of association of the company.
In practice, the chair and vice-chair can be elected or recommended by the shareholder meeting or the board of directors. The chair and vice-chair of the board of directors in a joint stock limited company are elected by more than half of all the directors on the board of directors.
The manager shall be appointed and removed by the board of directors. The appointment and removal of the deputy manager and chief financial officer shall be recommended by the manager and decided by the board of directors.
Legal Representative
For the legal representative, the new revision to Company Law has special provisions.
The new revision to Company Law expands the scope of candidacy of legal representatives beyond chairpersons or the CEO, and resolves a potential difficult situation that the legal representative may not be available for performing duty if no successor to the chair or CEO is available. The new revision also encourages the diversity of members of board of directors.
As a general rule of fiduciary duty, directors must act with good faith and independently for the best interests of the company. Regarding the rules or requirements concerning independence of directors, the current regulations about independent requirements are mainly for the independent directors.
Independent Director Requirements
Independent directors of publicly traded companies are required to meet the general requirements for directors as stipulated in the Company Law, as well as the specific qualifications for independent directors under regulatory supervision rules applicable for publicly traded companies.
In addition, there are limitations for some people with a conflict of interest to be an independent director. For example, within three years after resigning or retiring (leaving), leading officials in middle management of the company shall not be appointed as independent directors or independent supervisors of publicly traded companies to avoid potential conflicts.
The principal legal duties of directors and officers of a company are the fiduciary duties – ie, the duty of loyalty and the duty of diligence. The new revision to Company Law clarifies, for the first time, the connotations of the duty of loyalty and the duty of diligence.
The Duty of Loyalty
The duty of loyalty requires directors and officers to take measures to avoid conflicts between their own interests and the company’s interests, and not to take advantage of their powers to pursue improper interests, with the following important restrictions:
Any income arising from the breach of duties of loyalty shall belong to the company.
The Principle of Business Judgement
The new revision to Company Law adds a specific interpretation of the duty of diligence, which indicates that the directors and officers shall act as reasonable business persons do. The principle of business judgement also leaves room for Chinese courts to determine what will be the reasonable level of business judgement for Chinese company directors.
Directors are required to take into account the overall interests of the company and the interests of all shareholders when discharging their duties. In publicly traded companies, the directors are required to pay special attention to the interests of the minority shareholders, as well as other interested parties, such as creditors, employees, clients, suppliers and communities.
Director Accountability Exemption
In a joint stock company, the directors shall be responsible for the board resolutions. If a resolution violates laws, administrative regulations, the articles of association or the resolution of the shareholders’ meeting, and its execution causes serious losses to the company, the directors participating in the resolution shall be liable for loss compensation to the company.
However, if it is proved, as normally recorded in the board meeting minutes, that a director has expressed their objection at the time of voting, that director may be exempted from liability.
If directors or officers breach their duties, they may face the following consequences:
Shareholder Derivative Lawsuits Against Directors or Officers
If directors or officers breach their duties and thereby cause losses to the company or its wholly-owned subsidiaries, the shareholder(s) of the limited liability company, or shareholders individually or collectively holding 1% or more of the total shares of a joint stock company for 180 consecutive days or more, may request the board of directors or board of supervisors in writing to file a lawsuit against the responsible directors or officers.
If the board of supervisors or board of directors does not file a lawsuit or in an emergency, shareholders satisfying the aforesaid conditions have the right to file a lawsuit in their own name representatively, in the interests of the company.
If a shareholder brings a lawsuit against a director, an officer or other persons in accordance with the above procedures, the company shall be listed as a third party to participate in the lawsuit.
Circumstances of Director or Officer Breaching Fiduciary Duty
There are legal bases for shareholder derivative lawsuits against directors or officers for breaching corporate governance requirements:
Shareholder Direct Lawsuit Against Directors or Officers
If directors or officers violate any law, administrative regulations or the company’s articles of association, thereby harming the interests of a shareholder, the shareholder may directly file a lawsuit, in their own interests.
Company Lawsuits Against Directors or Officers
A company can directly sue its directors or officers for their failure to fulfill their duty of loyalty and diligence.
For example, Article 13 of Provisions of the Supreme People’s Court on Several Issues Concerning the Application of the Company Law of the People’s Republic of China (III) stipulates that if a shareholder fails to fulfil the capital injection obligation at the time of the company’s capital increase, the company can request the directors or officers who fail to monitor or manage the process to pay the capital; after the directors or officers repay the capital, they may claim indemnification against the defendant shareholders.
With respect to the shareholder direct lawsuits against company itself, please see 5.4 Shareholder Claims.
Class Action Lawsuit in Securities Litigation
Directors and officers of publicly traded companies, along with the company and other responsible parties, may also be held accountable for misbehaviour including false statements, breach of promises, insider trading and market manipulation, and shall be responsible to compensate the investors who have suffered losses as a result of such conduct, according to the following special procedures of shareholder representative lawsuits under the Securities Law of China. The lawsuits are similar to class action lawsuits in western developed markets but with special procedures.
Furthermore, the China Supreme People’s Court issued a judicial interpretation in 2022 stipulating that such civil litigation does not need to wait until an administrative authority or criminal court makes a formal finding on the wrongfulness of the alleged misconduct.
There are other bases for claims or enforcement against directors or officers according to new revisions of Company Law, which already cause attention from the public.
Claims Against Legal Representatives
If the legal representative causes damage to others due to the performance of their duties:
That means, for the protection of the legal representative in the performance of their duty, normally the plaintiff is required to first bring a case against the company itself instead of the legal representative.
Liability to Third Parties for Directors or Officers Performing Duties
If a director or an officer acts in their official capacity and causes damage to other third parties, the company shall be liable for compensation.
Directors and officers who have malign intention or act with gross negligence shall also be liable for compensation.
Either the company or its directors or officers can be listed as defendant in the lawsuit.
In reality, it is expected that both the company and its directors and officers will be listed as co-defendants at the same time as a result of litigation strategy. It is more clear, however, that the company will normally bear the responsibility first. It will be the company’s decision on whether to claim indemnification against directors, officers or the legal representative.
Claims Against Controlling Shareholders and Actual Control Persons (Shadow Shareholders and Shadow Directors)
In addition, the new revision to the Company Law adds the following liabilities of controlling shareholders and actual control persons. To some extent, this revision tries to solve some serious governance problems caused by Shadow Shareholders or Shadow Directors who are manipulated by controlling shareholders or actual control persons in practice.
According to the Company Law, remuneration, fees or benefits payable to directors are decided by the shareholder meeting. Payments to the manager are decided by the board of directors, and payments to the deputy manager and chief financial officer are decided by the board of directors upon proposals by the manager.
In a publicly traded company, when the board of directors or the remuneration and assessment committee is evaluating the performance of a director or is discussing their compensation, the director shall not participate in such evaluation or discussion. The remuneration distribution plan for officers shall be approved by the board of directors, explained at shareholder meetings and fully disclosed.
Incentive Payment and Deferred Payment
Financial institutions such as banking and insurance institutions have deferred remuneration requirements for directors, officers and key positions. In general companies, this kind of mechanism can also be stipulated through the articles of association to limit such incentive payment.
According to the Company Law, a joint stock limited company shall regularly disclose to its shareholders the remuneration, fees or benefits payable to directors and officers. A publicly traded company shall disclose the appointments, changes of shareholding and annual remuneration of its directors and officers in its annual report.
Shareholders mainly have the following rights with regard to the company.
Shareholders’ Obligation
The shareholders’ principal obligation to the company is to invest capital in accordance with their committed payment schedule provided in the articles of association of the company.
Shareholders’ Civil Liabilities
Shareholders who fail to fulfil their investment obligations may bear civil liabilities, and directors, officers and promoters may also be jointly liable.
Shareholders’ Criminal Responsibilities in Capital Contribution
According to the Criminal Law, shareholders who fail to fulfil their investment obligations may bear criminal responsibilities for making a false capital contribution or withdrawing the contributed capital. According to a legislative interpretation, the rule only applies to companies that legally implement the paid-in system of registered capital. Shareholders of joint stock companies shall pay more attention to this criminal liability of capital contribution.
The Boundaries of Shareholders’ Rights: Piercing the Corporate Veil
The shareholders shall not abuse the independent legal person status of the company and limited liabilities of shareholders to damage the interests of the company’s creditors.
Ownership of companies is somewhat separated from management rights. The managers are responsible for the operation and management of the company while, as owners of the company, shareholders do not normally participate directly in the daily operation and management of the company. Their management in a company is indirect, which means they exercise their rights in a collective manner by participating in shareholder meetings and voting on proposals in accordance with the procedures provided by laws and the articles of association of the company. The shareholders may make decisions on fundamental issues and elect the main members of the board of directors by exercising their voting rights and thereby control the company.
Generally, shareholder meetings are convened by the board of directors and presided over by the chair of the board.
However, a decision may be made without convening a shareholder meeting if shareholders unanimously agree in writing (all shareholders sign and seal on the resolution documents).
Voting Rights Required for Adopting a Resolution by Shareholder Meeting
If there is no special provision in the articles of association of the company, all the shareholders shall be notified 15 days before a shareholder meeting is held, and the shareholders shall exercise their voting rights at the meeting in proportion to their capital contribution.
Normally when the shareholders’ meeting makes a resolution, it shall be adopted by shareholders representing more than half of the voting rights.
Specially, some resolutions shall be approved by shareholders representing more than two thirds of voting rights:
There are special voting approaches such as cumulative voting, which can also be used in the shareholders’ meeting according to Chinese Company Law.
Shareholders, on behalf of the company or its wholly-owned subsidiaries, can file derivative lawsuits against a company’s directors, officers or others outside the company for the company’s losses. The specific procedure can be seen in 4.8 Consequences and Enforcement of Breach of Directors’ Duties regarding shareholder lawsuits against directors or officers.
Shareholder Direct Lawsuits
Shareholders can file shareholder direct lawsuits against the company itself based on civil liability for torts.
In some situations, a shareholder or actual control person of a publicly traded company shall inform the board of directors and co-operate with the company in performing information disclosure obligations:
The CSRC also requires that, where any shareholder of the company applying for an IPO has a shareholding structure consisting of two or more layers and is a company or a limited partnership with no actual business activities, the ultimate beneficial owner of such shareholder should be disclosed, in the case that the buy-in price of such shareholder is apparently abnormal.
Publicly traded companies are subject to periodic financial reporting (annual, midterm and quarterly reports) and interim financial reporting requirements.
Directors/Officers Responsibilities in Financial Reporting
The contents of the periodic report shall be examined and approved by the board of directors. The directors and officers of the company shall sign written confirmation opinions on the periodic report, and the board of supervisors shall submit written review opinions on the periodic report.
If the directors or supervisors are unable to guarantee the authenticity, accuracy and completeness of the periodic report or have objections, they shall vote against or abstain from voting. Directors and officers are not absolutely relieved of their responsibility if they can not closely follow the principle of prudence during the report preparation and disclosure.
Gatekeeper Responsibilities
China securities regulations also strengthen the gatekeeper responsibility of intermediary institutions, which generally include securities companies and their personnel as sponsors and/or underwriters, securities service agencies, law firms, accounting firms, and asset evaluation agencies.
In practice, shareholder class action lawsuits can be filed against the company, directors, officers and intermediary institutions for their breach of duties in cases of false statements, breach of promises, insider trading and manipulation of the market.
There are some requirements for publicly traded companies to disclose their corporate governance arrangements in the midterm report and annual report.
In the midterm report, a publicly traded company shall disclose its corporate governance arrangements, including:
In addition to the arrangements mentioned above, a publicly traded company shall also disclose the following in its annual report:
The new revision to the Company Law takes dual approaches to capital contribution for limited liability companies and joint stock companies, which means:
Joint stock companies established by public offering are required to submit a capital verification certificate from a capital verification institution when applying for company registration.
It should be noted that a company shall provide official registry with necessary information for company registration and licence. The company shall also formally file registration or modification documents for its registration matters before it can leverage them against any bona fide counterparts.
A company shall prepare a financial statement at the end of each fiscal year, which shall be audited by an accounting firm in accordance with relevant law. According to the articles of association of the company, the decision to hire or dismiss the accounting firm that undertakes the company’s auditing business shall be taken by the shareholder meeting or the board of directors. When the shareholder meeting or the board of directors votes on the dismissal of the accounting firm, the accounting firm shall be allowed to state its opinions.
Small Companies
The key requirements for directors in connection with internal controls in small companies are based on Internal Control Norms for Small Companies issued by the Minister of Finance in 2017.
Large and Medium-Sized Companies
The board of directors shall be responsible for the establishment and implementation of internal controls. The board of supervisors shall supervise the establishment and implementation of internal controls by the board of directors. Managers shall be responsible for organising and leading the day-to-day operation of the company’s internal controls. A company shall establish a special department or designate an internal department to be specifically responsible for organising and co-ordinating the establishment and implementation of internal controls and daily work.
Publicly Traded Companies
Special requirements for directors in connection with the risk management and internal controls in publicly traded companies include the following.
Overall, with the new Company Law, Chinese companies are given more autonomy in their corporate governance, which leaves more room for them to design their articles of association and to determine the best rules for themselves. It also creates more battlefields for participants in Chinese companies’ corporate governance.
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