CHINA | Corporate Governance Best Practices

A major challenge for foreign investors is corporate governance best practices to generate profitable business.

Whilst there are significant improvements in the business environment, including regulatory reforms to streamline administrative procedures, investors face many challenges. Specifically, establishing corporate governance best practices to ensure their Chinese subsidiary is operating legally.

Usually, the geographic and cultural distances between the shareholders and the Chinese subsidiary could generate miscommunication and misunderstanding. And without corporate governance best practices established, the Chinese subsidiary could face losses and damages.

For foreign investors understanding the corporate governance structure is key to establishing corporate governance best practices.

Limited liability Company – Corporate governance

The Company Law of the People’s Republic of China (“Company Law”) stipulates a three-tiered corporate governance for limited liability companies demonstrated in figure 1.

The board of shareholders holds the highest authority. And determine the major issues in the company.
The shareholders appoint the board of directors (“BOD”) to oversee the company’s daily operations. The BOD is accountable to the board of shareholders.
The senior executives are appointed by the BOD. And manage the day-to-day operations of the company.
Both the BOD and senior executive are regulated by an internal supervisory system, the board of supervisors or the supervisor (“BOS”).

The Role of Shareholders

Limited liability companies may be comprised of shareholders or a sole shareholder. Sole shareholder can be a natural or legal person, although a natural person may only establish one limited liability company. The number of shareholders is limited to 50.

Shareholder Rights

Shareholders of a company are provisioned the following rights:

Participate in important decision-making and selection of managers in accordance with the Law
Draw dividends in proportion to their actual capital contributions and when a company increases its capital.
Hold pre-emptive right to subscribe for the increased capital in proportion to each actual capital contributions, unless otherwise agreed by the shareholders.
Consult and copy the articles of association, minutes of meetings of the board of shareholders, resolutions of meetings of the board of directors, resolutions of meetings of the board of supervisors and financial reports.
Consult accounting books of the company.

Any requests to consult the accounting books of the company shall be submitted in writing to the company, clearly stating the purpose.

If the company finds it reasonable to deem the request as improper and that it may impair the legitimate interests of the company, the company may decline the shareholder’s request. The company within 15 days upon the submission of Shareholder’s written request shall issuing the shareholder with a written reply. It shall state the reasons. If the company declines the request of any shareholder for consultation of the company’s accounting books, the shareholder may request a people’s court.

Shareholders’ Meeting

The shareholders’ meeting is the highest authority in the company. And an indispensable organ in the corporate governance structure. The shareholders’ meeting convenes on resolutions for major issues rather than the daily operations of the business. The members may exercise the following functions:

Determination of the company’s operational guidelines and investment plans;
Election of non-employee representative directors and supervisors and setting the remuneration thereof;
Deliberation on and approval of reports of the board of directors;
Deliberation on and approval of reports of the board of supervisors or of the supervisor;
Deliberation on and approval of annual budgets and final account plans of the company;
Deliberation on and approval of company profit distribution plans and debt recovery plans;
Making resolutions about any increase or reduction in the company’s registered capital;
Making resolutions about the issuance of corporate bonds;
The adoption of resolutions on any merger, demerger, change in company form, dissolution or liquidation of the company;
Revision of the articles of association of the company; and
Any other function specified in the articles of association.

Structure of the Shareholders’ Meetings

The first shareholders’ meeting is convened by the largest capital shareholder. This shareholder presides over the first meeting and exercises its powers in accordance with Company Law. Shareholders’ meetings thereby after the first assembly are convened by the established board of directors. And presided over by the chairman of the board of directors. Where a limited liability company has no board of directors, shareholders’ meetings shall be convened. And presided over by the acting director.

Shareholders are notified 15-days in advance of a meeting unless otherwise specified in the articles of association or agreed by all shareholders.

The methods of deliberation and voting procedures at shareholders’ meetings are also governed by the company’s articles of association. Any revision to the company’s articles of association in the shareholders’ meeting is adopted when there is a vote of two-thirds or more. Shareholder voting rights are based on each shareholders’ respective capital contributions. Unless the articles of association specify otherwise.

The attendance of any director, supervisor or senior executive may be required for a meeting. However, the member is a non-voting representative and answers the inquiries of the shareholders.

For any of the matters where the shareholders unanimously consent in writing to a resolution, the shareholders’ meeting may not be required to convene. Though, decisions may be made without holding a shareholders’ meeting is subject to bear the signatures or seals of all shareholders.

The Company Law stipulates shareholders of a company to abide by laws, administrative regulations and articles of association and exercise shareholders’ rights in accordance with the Law. Shareholders are strictly prohibited from the abusing of shareholders’ rights, the independent company’s status as a legal person or the limited liability of shareholders. Any shareholder that causes loss to the company or to other shareholders by such abuse will be liable for compensation. Equally, shareholder in evasion of debt payment by abusing the company’s independent status as a legal person or the limited liability of shareholders, which results in serious damages to the interests of any creditor of the company, shall be jointly and severally liable for the debts of the company

The Role of Directors

The Board of Directors is the highest governing body in the company and determines the daily operations of the company. Directors shall be appointed by the company’s shareholders pursuant to the articles of association of the company.

Board of Directors

The board of directors collectively handle corporate affairs; no director shall act individually rather the resolutions will be the majority vote of the board. The board of directors is permanent institution acting on behalf of the shareholders’ meeting and may be subject to dismissal where the board of directors fails to work in a faithful and diligent manner. A relatively smaller limited liability company with fewer shareholders may establish an executive director with same functions and power of the board of directors.

Number of Directors and Term

According to Company Law, the board of directors of a limited liability company can establish between 3 -13 members and only odd numbers. A relatively small limited liability company may establish one Executive Director and not a Board of Directors. Where a limited liability company is established by two or more state-owned enterprises or other state-owned investors, the board of directors shall include employee representatives elected by the employees of the company.

Though other limited liability companies may also include employee representatives.

The articles of association specify the method for the appointment of a chairman and deputy chairman to preside over board of directors. Furthermore, the articles of association shall stipulate the director’s term of office. Though the term may not exceed three years. Any director or supervisor may, after the expiry of his term of office, hold consecutive post upon re-election.

The Functions and Powers of the Board of Directors

According to the Company Law of the People’s Republic of China, the board of directors shall exercise the following functions:

Convene shareholders’ meetings and present reports thereto;
Adopt resolutions made at shareholders’ meetings;
Determine operational plans and investment plans;
Formulate the company’s annual budgets and final account plans;
Formulate the company’s profit distribution plans and debt recovery plans;
Formulate the company’s plans for any proposed increase or decrease in its registered capital, or on the issuance of corporate bonds;
Formulate the company’s plans for any proposed merger, demerger, change in company form, dissolution, or similar;
Make decisions on the establishment of the company’s internal management departments;
Make decisions on the appointment or dismissal of the company’s manager and his remuneration. And, according to the nomination of the manager, making decisions on the appointment or dismissal of deputy manager(s) and the finance manager and their remuneration;
Establish the company’s basic management system; and
Any other function specified in the articles of association.

The board of directors mainly exercise its powers and functions through meeting. The meeting is convened and presided by the chairman of the board of directors or the deputy chairman. In the meetings, directors shall make resolutions on issues submitted to be deliberated. Resolutions are made on the majority vote of the board of directors. And are calculated on the system of “one vote per director”. Thus, every director shall cast one vote on every issue submitted to the board of directors.

Supervisor

The board of supervisors is set to protect the interest of the investors. It is a legally required standing agency to supervise and check the company’s business activities. A limited liability company may establish a board of supervisors of no less than three members. And relatively small, limited liability companies with a small number of shareholders may appoint 1 to 2 supervisors. The term of office for a supervisor shall be the years. And may be held as a consecutive post upon re-election.

Authorities of the Board of Supervisors or Supervisors

The company’s directors, managers and other senior managers shall be regulated by the supervisory system. In such cases, directors and senior executives are required to faithfully provide relevant information and materials to the board of supervisors or to the supervisor themselves. They may not obstruct the board of supervisors or any supervisor in the exercise of its or his powers.

Supervisors of the board may exercise the following primary authorities:

Review the company’s financial affairs through checking the company’s account books and other accounting materials, financial report, business report, profit distribution program and other accounting materials submitted by the board of directors to shareholders’ meeting. Supervisors may perform a recheck in the event of that questions pertaining to the company’s financial affairs arise.
Supervise the company’s operation and management activities are performed in line with the resolutions of the shareholders.
Where the director or senior manager violates the laws, administrative regulations, articles of association, or resolutions of the shareholders’ meeting
(i) The board of supervisors may propose the removal of any director or senior manager who commits irregularities;
(ii) Correct or stop any director or senior manager’s activities injuring the company’s interests
Propose certain topics and specific issues to the shareholders’ meeting for the discussion and voting.
Propose to convene temporary shareholders’ meetings, as well as convening and presiding over shareholders’ general meeting under special circumstances.
Initiate litigation on behalf of the company to protect the company interests.
Under the premise of not violating compulsory provisions of laws and administrative regulations, the company’s shareholders’ meeting may grant additional authorities to the board of supervisors through the articles of association based on the company’s specific conditions.

Meeting of the Board of Supervisors

A board of supervisors shall hold regular meetings no less than once a year and may hold interim meetings. A resolution of the board of supervisors shall be approved by 50% or more votes of the supervisors and the articles of association shall stipulate the methods of deliberation as well as the voting procedures.

Senior Officer

The board of directors governs the senior executives to manage the company’s day-to-day operations. Senior executives of a company include the general manager, deputy general manager, chief financial officer, secretary of the board of directors (if the company is listed). And other persons designated by the company’s articles of association. All senior executives are accountable to the board of directors and shall exercise responsibilities within the scope of the board of directors’ authorization.

Responsibilities

Under the Company Law, the board of directors is responsible for appointing and dismissing the senior executives by an affirmative majority vote. It is advised the selection of senior executives is crucially determined by individuals’ qualification and competence. Once a candidate is appointed, the board of director enters into contracts with the individuals. If the board of directors deems a manager is no longer qualified for their position, the meeting may be convened to decide on manager’s dismissal. Furthermore, if the board of supervisors of the company discovers that the conduct of any manager violates any applicable law, administrative regulation, the articles of association or any resolution of the shareholder’s (general) meeting, the board of supervisors can propose to dismiss such a manager.

Despite the terms and conditions restricting a company’s right to dismiss a manager, the company still has the right to dismiss a manager. Although it may be held liable for breach of contract should dismissal happen before the expiration term of office.

Functions of Senior Executives

The manager shall exercise the following powers in accordance with the board of directors:

Take charge of managing the production and business operations of the company. And organizing the implementation of resolutions made by the board of directors;
Organise execution of the company’s annual operational plans and investment plans;
Draft plans on the establishment of the company’s internal management departments;
Draft the company’s basic management system;
Formulate the company’s specific policies;
Propose the appointment or dismissal of the company’s deputy manager and chief financial officer;
Decide on the appointment or dismissal of executives for posts other than those decided by the board of directors;
Attend meetings of the board of directors as a non-voting representative; and
Any other power conferred on the manager by the board of directors.

Authorities of the Board of Supervisors or Directors and Senior Manager

A person shall not be appointed a director, supervisor or director of a company under the following conditions:

Any person without civil capacity or has limited civil capacity[1];
Any person convicted of criminal offence in the nature of corruption, bribery, disseizing, misappropriation or disrupting the economic order of the socialist market and five years has not elapsed since any penalty imposed has been completed. Or any person who has ever been deprived of his political rights due to any crime and five years has not elapsed since the penalty imposed was completed;
Any former director, factory director or manager of a company or enterprise declared bankrupt and liquidated in circumstances such personal was personal responsible and three years has not elapsed since the bankruptcy and liquidation of the company or enterprise was completed;
Any former legal representative of a company or enterprise of which business license is revoked and was ordered to close business operations due to violation of law in circumstances where the former legal representative was personally liable and three years has not elapsed since the date of revocation; or
Any person who has significant unpaid due debts.

Any election or appointment of any director, supervisor, or senior manager made in violation of the provisions of the Company Law shall be invalid. And removed from his post.

Obligations of Directors, Supervisors and Seniors Officers

Also, Company Law stipulation stipulates obligations, also known as fiduciary duties, to senior executives, the board of directors and board of supervisors to the company. Duties of a fiduciary are categorized under the duty of loyalty and the duty of diligence. The duties of loyalty are acts made according to shareholder, company and creditor’s interests and are a conscience-based obligation, characterised by moral consciousness. The duty of diligence is referred as the duty of care. It is a requirement for the directors, supervisors and senior officers to act with goodwill, caution and reasonable care. Any director or senior officer in violation of any law, administrative regulation, or the articles of association in the course of performing his duties, shall be borne the damages and compensation of such violations. Equally, acts of the director(s), supervisor(s) or senior officer(s) constituting as a crime shall face criminal liabilities.

Negligence of Duties

The Company Law prohibits director, supervisor or senior manager to take any bribe or other illegal gains by taking advantage of his position or misappropriate company assets for personal use. Furthermore, the director or senior executive are prohibited from the following:

Misappropriate company funds;
Divert company funds into an account held in his own name or in the name of any other individual;
Loan company funds or provide any guaranty to any other person by using company property in violation of the articles of association without first obtaining the consent of the board of shareholders, the general meeting or the board of directors;
Become a party to any contract or business dealings with the company in violation of the articles of association without first obtaining the consent of the board of shareholders or the general meeting;
Seek business opportunities for themselves or for any other person by taking advantage of his position, or operate on his own behalf or on behalf of any other person any business similar in nature to that of the company, without first obtaining the consent of the board of shareholders or the general meeting;
Personally accept any commission on any transaction to which the company is a party;
Unlawfully disclose confidential company information; or
Act in any way that is inconsistent with his duty of fidelity to the company.
Any income received by any director or senior officer in violation of this Article shall be treated as the property of the company.

[1] Generally, in China a person will have full civil capacity when he/she is 18 years old.

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If you have questions or concerns related to role of the corporate governance in a company in China, please contact us at talktous@horizons-advisory.com. to schedule a consultation session. Horizons can provide insight, expertise and the right solutions for you.

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