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Corporate governance in China FAQs format

Q. What is corporate governance?

A. Corporate governance has to do with how (business) organizations are run and managed.  Organizations with proper corporate governance have accountability and transparency.  People empowered to take decisions at those organizations know that their actions will be seen and judged by others. Therefore, those officers are more likely to act in ways that benefit the organization’s stakeholders. 

Q. Which are the main pieces of legislation delineating the legal framework for corporate governance?

A. The Company Law and the Securities Law, both introduced in 2006, provide the foundation for drawing up and developing a corporate governance framework in China.

The revised Company Law improved companies’ governance structure and mechanisms to protect lawful shareholders’ rights and public interests. It highlighted the legal obligations and responsibilities of those in actual control of the company – the directors, senior management and supervisors. It improved companies’ financing and financial accounting systems of companies and the systems governing corporate mergers, divisions and liquidation.

 Company Law (2006)

The Company Law (2006) (is formulated to standardize the organization and behavior of companies, to protect the legitimate rights and interests of companies, shareholders and creditors, safeguard socioeconomic order and promote the development of a socialistmarket economy. It governs the incorporation and organizational structure of limited liability companies, equity transfers of limited liability companies, the incorporation, organizational structure, issuance and transfer of shares of companies limited by shares, the qualifications and obligations of company directors, supervisors and senior executives, corporate bonds, corporate finance and accounting, company mergers, splits, capital increases and reductions, company dissolution and clearance, branches of foreign companies and legal liabilities.

Securities Law (2006)

The Securities Law (2006) was drawn up to standardize securities issues and transactions, protect the legitimate rights and interests of investors, safeguard socioeconomic order and public interests and promote the development of a socialist market economy. It governs securities issues, securities transactions, general provisions, listing of securities, disclosure of information, prohibited transactions, acquisition of a listed company, stock exchanges, securities companies, securities registration and clearance institutions, securities service organizations, securities industry associations, securities regulatory institution and legal liabilities.

Criminal Law Amendment Act (2006)

Amendment VI to the Criminal Law (2006) was designed to match the amended Securities Law and Company Law, to give a more complete definition of legal liabilities in the securities field, improve the laws governing the securities market and promote its healthy development. The Amendment governs the following corporate governance related offences: disclosure breaches, non-disclosure of major information, breach of trust and damage of listed company’s interests, insider trading and leakage of insider information and manipulation of securities or futures market.

Q.  Which company organs are involved? What are their role?

A. Concerning allocation and balance of company powers, four specific company organs with power and work division are set up to form the organizational structure:

The general shareholders’ meeting is the power and decision-making organ of the company and has decision making power concerning major issues. The Board of Directors is the operational implementation organ of the company, being responsible to the general shareholders’ meeting, and has the decision making power concerning management issues under the authority of general shareholders’ meeting. The Board of Directors may, according to the resolution of the general shareholders’ meeting, set up special committees, such as strategy committee, auditing committee, nomination committee, remuneration and appraisal committee. The management is responsible to the Board of Directors, and is in charge of the daily operation and management of the company. 

The Board of Directors is mandatory under the Company Law, its Directors appointed by the shareholder and registered with the competent registration authority. An exception is made for small-scale companies that benefit from a simple decision-making structure. In case there is one investor only, he/she will appoint all the Directors, and thus he/she will have a total control of the enterprise.

Under the Company Law, senior managers in a limited liability company are the General Manager, Deputy Manager(s), Chief Financial Officer or any other persons listed as such in the Articles of Association. In China, registration of the General Manager usually is mandatory, while the registration of other senior managers is optional. A Director may concurrently hold the post of General Manager, and either the Chairman of the Board of Directors, the Executive Director or the General Manager may be appointed as the company’s legal representative, a decision which must be confirmed in the company’s Articles of Association. Under PRC law, the legal representative is the official representative of the company and is entitled to act on the company’s behalf; therefore, investors should take extra care to make an appointment which is both practical and safe.

Directors shall exercise their authority through the “Board of Directors,” which in turn is accountable to the shareholder. Article 47 of the Company Law differentiates the functions of the Board of Directors as: (i) Statutory functions; and (ii) Functions stipulated in the Articles of Association.

Q. What are the “statutory functions” of the Board of Directors?

A. Article 47 of the Company Law defines “Statutory functions” the following: The board of directors is responsible for convening shareholders meetings and presenting reports thereto; implementing resolutions adopted by the shareholders; preparing plans for issues such as increasing or reducing the registered capital, annual financial budget, profit distribution, the merger, division, transformation, dissolution and liquidation of the company (subject to shareholder’s approval or decision); appointing or removing the general manager of the company, appointing or removing, upon the general manager’s recommendation, deputy managers of the company and the financial managers, and determining the remuneration for these officers.

Q. What is the specific role of the so called “Supervisory Board”?

A. The Supervisory Board is the supervision organ of the company, which supervises whether directors and managers violate laws or articles of association of the company when accomplishing corporate duties, and is entitled to inspect company’s finance. More specifically the Board of Supervisors is in charge of reviewing and monitoring the activities of directors, the general manager, and company affairs in general.

The Supervisory Board is a permanent supervisory body under the leadership of, and responsible to, the shareholders’ meeting. To ensure the independence of the supervisors and supervisory board, the supervisors may not concurrently take the office of director or senior executive. The supervisory board carries out comprehensive supervision of the company’s operations and management including: inspecting the company’s financial status, supervising the performance of duty by directors and senior executives, and proposing to remove from office any director or senior executive that has violated the law, regulations, articles of association or resolution of the shareholders’ meeting, requesting directors and senior executives to rectify their behaviour when it undermines company interest, initiating ad hoc shareholders’ meetings, calling upon and presiding on shareholders’ meetings when the board of directors fails to do so, according to law, tabling draft resolutions for the shareholders’ meetings and filing suit against directors and senior executives under certain conditions. 

Q. Is the supervisor’s function specifically regulated?

A. Substantially the supervisor serves as an external controller of the company and mainly supervises the activities of the Directors and senior Managers to ensure their compliance with relevant PRC laws and the company’s Articles of Association. The supervisor may demand of any Director or senior Manager that he/she makes corrections if his/her act has injured the interests of the company. This is also the reason why by law, a Director or senior Manager may not concurrently serve as supervisor. It is important to monitor the activities of Directors and senior Managers; in fact even a perfectly-designed system can be subject to abuse where implementation is not monitored. After years of operations, Directors and Managers may be so used to one way of doing things that they forget about the checks and balances that the system was designed with. Therefore the investors or shareholders should ensure compliance, or instruct the Supervisor to complete this task.

Q. In what capability the supervisory board perform its duties?

A. The Supervisory Board acts in a direct supervisory capacity vis a vis the Board of Management. The supervisory board also has no negative veto rights over any area of corporate entity decision-making, thus, it has no ability to block or cause re-appraisal of corporate board decisions.

In China, the supervisory board is also obliged to be loyal and diligent and to protect the interests of the company and shareholders. The Company Law revised in 2006 clearly provides that the supervisory board is obliged “to abide by the law, administrative laws and regulations and the articles of association of the company and have the duty of loyalty and diligence for companies”.

Q. What are the other functions of the Board of Directors?

A. Resolution reached by the Board of Directors’ must be approved by the Shareholders’ Committee before they can be adopted. The Board of Directors is accountable to the Shareholders’ Committee and is mainly in charge of implementing the resolution adopted by the Shareholders’ Committee and managing other daily business. The General Manager then is accountable to the Board of Directors, while the Board of Supervisors is an independent monitoring body. The law also mandates that all directors, managers and supervisors owe duties of best interest and loyalty to the company; anyone violating these duties is subjected to compensation to the company and the statute does not provide for indemnification.

Q. What are the other instruments which regulate the correct management of a business entity?

A. Under the Company Law, the General Manager is to implement Board of Directors’ resolutions and is responsible for the company’s business operations. Moreover he/she shall also engage in activities and have the right to make decisions on matters as provided in the Articles of Association, or as authorized in a resolution of the Board of Directors. In practice, to prevent the General Manager from obtaining too much control over the company’s operations, and to avoid the pursuit of private gains, it is best to include in the Articles of Association a clear scope of the General Manager’s scope authority and the limitations thereto; alternatively or in addition, these may be confirmed in a resolution by the Board of Directors. Directors and senior Managers shall bear legal obligations of fidelity and diligence to the company; Articles 148, 149 and 151 of the Company Law provides more details on what this entails. Where Directors or senior Managers fail in their performance or neglect their duties, this may result in civil liabilities. Noteworthy, if involving third parties, the company can generally be held liable for such losses, but in turn the company can demand compensation from the responsible Director or senior Manager. Article 152 of the Company Law also specifies the shareholder’s right to request the Supervisor or the Board of Directors to sue a Director or senior Manager. In case the Supervisor or the Board of Directors fails to do so or in case of an emergency, then the shareholder may, on its own behalf, directly file the lawsuit.

According to Articles 148, 149 and 151 of the Company Law where directors and senior managers fail in their performance or neglect their duties, this may result in civil liabilities: 1) The income of any director or senior manager from any act in violation of their obligations shall belong to the company; (2) Meanwhile where any director or senior manager violates any law, administrative regulation, or the Articles of Association during the course of performing his duties, if any loss is caused to the company, he shall be liable / responsible for compensation.

Q. What are the obligations and liabilities of Directors and Managers in China?

A. Directors and senior managers of a Chinese-registered company, including subsidiaries of foreign companies, may be held civilly liable under the Company Law of the People's Republic of China. The PRC Company Law requires directors and senior managers to adhere to the duties of loyalty and duty of care. The duty of care provides that corporate directors and managers comply both with the law as well as the Articles of Association and shareholder resolutions of a company. Certain circumstances where directors and senior managers may bear personal liability to the company under the PRC Company Law include:- Violating a law, an administrative regulation or the company's Articles of Association in the execution of company duties, thereby causing losses to the company, he or she will be liable for compensation;- Misappropriating the company's funds;- Taking business opportunities for themselves without shareholders' approval; and- Abusing his or her position to take improper benefits for him (her) self or for other parties.Carefully considering the desired limits of directorial and managerial authority will prepare the company not only for situations where these persons violate the PRC Company Law as described above, but also where they take actions that exceed their desired scope of authority. Firstly, the Articles of Association of the company should include detailed procedural guidance in connection with how directors and managers may exercise their powers. 

Q. There exist other type of liability?

A. Managing the authority of directors and managers is also important in the context of criminal liabilities. The offering of monetary gifts to officials is prohibited under Chinese law. In commercial practice, directors and managers should therefore be required to promptly report to the Board of Directors or at the shareholders' meeting in the event they receive any payments or treatment in exchange for (expected) benefits. This is especially important because not only can the employee be held liable; the company and its legal representative could be held jointly liable where the employee has engaged in criminal activity on behalf of the company. Therefore, regulating the boundaries of authority and activities of directors and employees in the Articles of Association and in other documents, and establishing clear internal rules and policies for employee conduct, will not only clarify the limits to an individual, but it will also allow the company to limit its exposure to third parties and in government investigations.



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