Governance and foreign-invested enterprises under new Company Law

Following the implementation of the Foreign Investment Law, the three previous laws governing foreign investment – the Law on Chinese-foreign Equity Joint Ventures, the Law on Foreign-capital Enterprises, and the Law on Chinese-foreign Contractual Joint Ventures – have been abolished. On 29 December 2023, the Standing Committee of the National People’s Congress passed the new Company Law, which will come into effect on 1 July 2024.

Foreign-invested enterprises not only need to comply with the new Company Law but also need to align with the Foreign Investment Law. Within the five-year transition period (ending on 31 December 2024), companies are required to adjust their organisational structures and operational guidelines, draft and pass new articles of association, and complete relevant registration procedures with the market supervision and administration department. This article discusses explicitly foreign-invested enterprises in the form of limited liability companies.

Responsibilities of senior officers

During the establishment phase of a company, the new Company Law explicitly states the responsibility of directors in maintaining the capital adequacy of the company. After establishment, directors are obligated to verify and urge shareholders to fulfil their capital contributions. Directors who fail to meet these duties in a timely manner, resulting in company losses, will be held liable for compensation. Notably, the new Company Law implements an actual capital contribution system within five years. Directors of existing foreign-invested enterprises with incomplete capital contributions should communicate with shareholders in advance to ensure the execution of collection responsibilities.

The fiduciary duties of director, supervisor or senior executive are further solidified under the new law. All senior officers are now included in the scope of fiduciary duties (the previous Company Law did not cover fiduciary duties for supervisors). In cases of conflicts of interest, senior officers are obligated to report.

Additionally, the new Company Law grants the board of supervisors the right to recommend the dismissal of directors and executives who fail to fulfil their duties. When appointing senior officers, foreign investors should carefully consider whether the candidates have the ability and conditions to perform their duties diligently within mainland China (such as the ease of entry and exit for personnel appointed by overseas shareholders, and their actual involvement in the operation and decision-making of domestic subsidiaries).

Since senior officers of foreign-invested enterprises are usually professional managers hired externally, foreign-invested enterprises in China often opt to provide liability insurance for such individuals to mitigate the risks associated with their duties, following the customary practices of foreign companies.

The new Company Law introduces provisions regarding directors’ liability insurance. After the company obtains or renews directors’ liability insurance, the board of directors should report the insured amount, coverage scope and premium rates to the shareholders’ meeting. Currently, the reporting scope is limited to directors’ liability insurance, with no compulsory requirements for supervisors and other senior executives.

During the dissolution phase, while the previous Company Law stipulated that the liquidation team should consist of company shareholders, the new Company Law designates directors as parties responsible for company liquidation. It also specifies that directors who fail to fulfil their liquidation duties on time will be liable for compensation to the company and external creditors.

Division of powers, responsibilities

Under the framework of the previous Company Law, core operational matters such as annual financial budgets, operation policies and investment plans had to be proposed by the board of directors before being submitted to the shareholders’ meeting for decision-making. However, under the new Company Law, companies have more autonomy in decision-making, allowing them to determine the specific division of powers regarding core operational matters between the shareholders’ meeting and the board of directors through the articles of association.

At the same time, the new Company Law allows the shareholders’ meeting to authorise the board of directors to exercise its powers, excluding statutory powers. In practice, foreign shareholders of foreign-invested enterprises often find it difficult to participate deeply in the daily operations and decision-making of the company. To improve operational efficiency, overseas shareholders may consider delegating powers to the board of directors.

However, it is essential to establish reasonable authorisation rules to prevent the board of directors from monopolising decision-making powers over core operational matters, ultimately safeguarding shareholder interests.

Additionally, the new Company Law eliminates the statutory powers of managers established in the previous law. Their specific powers can be stipulated in the articles of association or authorised by the board of directors. This is conducive to enabling foreign-invested enterprises to fully utilise the active role of the board of directors in supervising the company’s daily operations and management.

Establishment of audit committee

The new Company Law introduces a single-tier governance model, allowing for the establishment of an audit committee composed of directors from within the board of directors, replacing the role of the board of supervisors (or supervisor), further streamlining governance structures and reducing personnel costs for small-scale foreign-invested enterprises with a single shareholder.

However, for foreign-invested enterprises with a larger number of shareholders, the introduction of a single-tier governance model may intensify competition among shareholders for board seats during the company’s establishment phase. Before deciding to replace the board of supervisors with an audit committee, shareholders should make clear agreements regarding the selection process for committee members, rules governing the committee and its rights and duties, and ensure that these are incorporated within the company’s articles of association.

With the imminent implementation of the Company Law and the expiration of the five-year transition period under the Foreign Investment Law, and considering factors such as high communication costs and differences in the legal domain between domestic and foreign jurisdictions, foreign-invested enterprises should proactively plan to reduce compliance risks, and promptly optimise and adjust their corporate governance structures.

Zhou Le is a partner at Blossom & Credit Law Firm