Adapting to the New Company Law, Understanding in one article (1/3)

The Company Law of the People’s Republic of China was published on 29 December 2023 and took effect on 1 July 2024. At the same time, the State Council adopted on 7 June 2024, the Provisions on the Implementation of the Regulatory System for the Registration of Registered Capital under the Company Law of the People’s Republic of China (Provisions) which also came into effect on 1 July 2024.

The new Company Law has improved several areas of corporate governance, and in this sharing, we will point out as comprehensively as possible the changes, so that you can steadily plan for follow-up in the early stages of the implementation of the new Company Law.

CHANGES TO COMPANY GOVERNANCE STRUCTURES

• Establish an Audit Committee

The Audit Committee (审计委员会 in Chinese) is composed of directors from the board of directors. The Audit Committee shall exercise the powers and functions of the Supervisory Board provided for in this Law, and therefore may not have a separate Supervisory Board or Supervisor.[1]

Under the traditional supervisory board model, the source of power of both the board of directors and the supervisory board is the shareholders’ meeting, which realizes the separation of powers and checks and balances by directly allocating power to two different bodies. However, since the board of directors and the supervisory board have the same source of power, it is difficult to realize supervision as the major shareholders control the board of directors and influence the supervisory board.

Unlike the Supervisory Board, the Audit Committee is placed under the Board of Directors and is a subordinate body of the Board of Directors. The audit committee is not an independent external supervision, but a supervision embedded in the company’s operation and management decisions, which has more convenient supervision conditions and system advantages compared with the supervisory board. However, for the time being, the new company law does not specify the deliberation and voting procedures of the audit committee. In the absence of existing supporting mechanisms and practical experience, as the audit committee is placed under the board of directors, how to internally coordinate the executive function of the board of directors and the supervisory function of the audit committee may be a challenge in practice.

Nonetheless, audit committees may be more applicable to listed companies or non-listed companies with a large number of minority shareholders. This is because audit committees, like the supervisory board system, focus on addressing agency costs arising from the misalignment of interests between directors and officers (together as a party) and shareholders. In contrast, in practice, foreign-invested companies are usually sole shareholders or joint ventures with minority shareholders. There may be a significant degree of overlap between the functions of the board of directors and the audit committee of a foreign-invested company, including in terms of personnel.

Therefore, foreign-invested companies may not consider establishing an audit committee on its board of directors for the time being. If the system and practice of audit committees become more mature in the future, foreign-invested companies may decide whether to set up audit committees depending on their needs.

• No supervisor for small companies

As mentioned above, the supervisory board is designed to have the intelligence to supervise the board of directors and management. However, in practice, the supervisory function of the supervisory board is often a mere formality, especially in the case of foreign-invested companies, where supervisors are often appointed to fulfill the registration requirements of the company’s registry department and lack assume the actual supervisory role.

Previously, under the old version of the Company Law, a limited liability company was required to have a supervisory board or at least one supervisor to fulfill the duties of supervising the company’s operations and safeguarding the rights and interests of shareholders. A limited liability company with a small number of shareholders or a small scale may have one or two supervisors and no supervisory board.

The new Company Law has adjusted that a limited liability company that is small in size or has a small number of shareholders may not have a supervisory board and may have one supervisor to exercise the powers and functions of the supervisory board as stipulated in the Law; or it may not have a supervisor with the unanimous consent of all shareholders.

• Replace the concept of “Executive Director”

The concept of “Executive Director” in the old version of the Company Law has been replaced. Previously, a limited liability company that is small in size or has a small number of shareholders could have one executive director and no board of directors.

The new Company Law has changed the executive director to a director who executes the affairs of the company on behalf of the company, and who exercises the powers and functions of the board of directors. Such a company – a limited liability company that is small in size or has a small number of shareholders – may not have a board of directors and may have a director who exercises the powers of the board of directors. This director may also be the manager of the company.

• Legal representative system

The old version of the Company Law agreed that three roles can be the legal representative of the company: Chairman of the board of directors; Executive director; and Manager (General Manager).

The new Company Law stipulates that the legal representative is a director who executes the affairs of the company on behalf of the company, or a manager (General Manager).

This emphasizes the premise that the legal representative must act on behalf of the company in the execution of company affairs, stressing that the legal representative must be “in charge of affairs” and execute the affairs of the company, and must not be “nominal, dependent, or indifferent”.

It also stipulates the system of resignation of the legal representative. When the resignation of a director or manager who is the legal representative is deemed to be the simultaneous resignation of the legal representative.

Furthermore, the new company law mentions the fault recovery system, i.e., if a legal representative causes damage to another person while performing his or her duties, the company shall bear the civil liability. After the company has assumed civil liability, it may, in accordance with the provisions of the law or the company’s articles of association, recover the compensation from the legal representative who is at fault. This provision strengthens the sense of responsibility of the legal representative.

In the next article, we will keep on sharing the change to the provision on company capital.

If you are interested in this article, or you have more questions, please feel free to contact us.

[1] Article 69 of the Company Law