Chinese Company Law Amendment: Impact on HR Management

Although the Chinese Company Law does not directly apply to the adjustment of matters related to the labour relationship between employees and the company, the 2023 Company Law’s emphasis on the protection of employees’ interests reflects the government’s further affirmation and strengthening of employee protective concept.

Employees’ Collective Rights

Article 17 of the 2023 Company Law addresses employees’ collective rights to participate in the company’s democratic management.

Employee Rights to Rest and Leave Through Collective Contracts

Under the Trade Union Law of the PRC 2021 (with effect from 1 January 2022), the employees of a company can organise a trade union to carry out union activities and safeguard the lawful rights and interests of employees.

The company should provide necessary conditions for the trade union to carry out its activities. The trade union can, on behalf of the employees, sign collective contracts with the company with respect to, among other things:

• Remuneration.
• Working hours.
• Rest and leave.
• Workplace safety and sanitation.
• Insurance and welfare.

(Article 17(1), 2023 Company Law.)

Amendments to Article 17(1) add “rest and leave” to the items for which a collective agreement may be concluded. Historically, government enforcement in this area has not been strong, with issues mostly raised by employees as a claim for increased pay in the form of overtime wages. Many employees are shifting from traditional office-based activity to more mobile and diversified ways of working anytime, anywhere, with wide use of chat for workplace communications, so that the boundaries between working and non-working time have become blurred. Issues of “invisible overtime” and employee’s rights to take leave have therefore become hot topics in recent years. Some commentators have been critical of a culture of overworking and calls have been made for employee’s rights to rest and leave to be protected. Since 2022, local government authorities in a number of cities have launched campaigns to take a more active stance on investigating and supervising overworking in the corporate environment. This is consistent with the wider national policy on reducing the burden of population pressure and encourage growth in the birth rate.

Employers should:

• Continuously pay attention to compliance in relation to employee rights to rest and leave.
• Take action (including improving overtime and leave policies) to ensure the legitimacy of policies for rest and leave.
• Develop comprehensive family leave policies to make up for lack of detail in local regulations.

Employee Representative Congress (ERC): a Fundamental Form of Democratic Management

A company should establish and improve its democratic management system with the employee representative congress (ERC) as the fundamental form and carry out democratic management through the ERC or any other forms (Article 17(2), 2023 Company Law).

(“Democratic management” is a literally translated phrase. Basically, democratic management addresses that employees’ rights to know, to participate, to express opinions and to supervise should be properly guaranteed in the course of enterprise management. It addresses employees’ participation in the decision-making process rather than ability to decide the outcome.)

The requirement for democratic management through the ERC or other forms is not new; the main amendment to this paragraph is confirming that the ERC should be the fundamental form for a company’s democratic management, a requirement which mainly previously applied to state-owned enterprises (SOEs).

Various existing rules relate to ERCs:

National level. Relevant rules (many of which are expressly applicable to SOEs) are found in various laws, regulations, departmental rules and guiding opinions). A noteworthy national-level regulation is the Corporate Democratic Management Regulation 2012 (2012 CDMR), which specifies:

• the ERC’s structure, function, and daily responsibilities;
• the ERC’s election rules; and
• the rights and obligations of employee representatives.

The 2012 CDMR was jointly issued by:

• the Central Commission for Discipline Inspection;
• the Organisation Department of the Central Committee of the Communist Party of China (CPC); and
• the State-Owned Assets Supervision and Administration Commission (SASAC) of the State Council.

The 2012 CMDR is listed as a type of internal document of the CPC. While the 2012 CDMR does not specify whether it applies to all types of companies or only to SOEs, common previous practice has been that, if a non-SOE is interested in establishing an ERC but there is lack of local rules in its registered locality, the company can rely on, and would refer to, the content of the 2012 CDMR to proceed.

Local level. Many cites and provinces (including Shanghai, Gansu, Jiangxi, Hunan, Yunnan, Sichuan, and so on) have promulgated local regulations on the ERC. Most of these local rules apply to all types of enterprises within the administrative region. For example, the Shanghai Regulations of Employee Representative Congress 2017 (2017 Shanghai ERC Regulations, with effect from 1 January 2018) stipulate that:

• Companies with 100 or more employees must have an ERC.
• Companies with fewer than 100 employees must hold a general assembly of workers

(Article 4, 2017 Shanghai ERC Regulations.)

Similar to the 2012 CDMR, the 2017 Shanghai ERC Regulations cover rules relating to:

• the ERC’s structure, function, and daily responsibilities;
• the ERC’s election rules: and
• the rights and obligations of employee representatives.

In addition, the 2017 Shanghai ERC Regulations further specify that:

• implementation of the Regulation should be included as an aspect of labour inspection; and
• companies that violate the regulation will be required to make corrections within a time limit.

However, such local regulations have not previously been strictly implemented.

Article 17(2) of the 2023 Company Law can be interpreted to mean that an ERC is the highly recommended but not mandatory format for non-SOEs, since other forms of democratic management are also permitted, including:

• General assembly of workers.
• Disclosure of company affairs.
• Collective bargaining.
• Employee director or employee supervisor.

It remains unclear how the government will enforce Article 17(2). It is possible that new, nationwide rules expressly applicable to all types of companies could be promulgated, or that more cities and provinces will introduce local regulations or strengthen the implementation of existing local regulations. Employers are advised to pay close attention to any future changes to legislation and practice with regard to ERCs and other forms of democratic management.

A company should solicit the opinions of its trade union and opinions and proposals from employees through the ERC or in any other way, for any of the following matters:

• Decisions on the company’s reformation, dissolution, or application for bankruptcy.
• Decisions on any important issue relating to business operations.
• Formulation of any important rules or regulations,

(Article 17(3), 2023 Company Law.)

Dissolution and application for bankruptcy are newly added items to Article 17(3). Though the requirement is only to solicit the opinions of the trade union and employees, and not to seek their agreement, it remains unclear how this will be enforced in practice (for example, whether the government will request the company to submit a written record of the process by which trade union and employee opinions are solicited).

(For more information on the mandatory democratic consultation process under Chinese law, see Practice Note, Creating an Employee Handbook for Staff in China: Mandatory Democratic Consultation Process.)

Employee Director and Employee Supervisor

Under the 2018 Company Law, the employee director and employee supervisor system is only mandatory for certain types of SOEs, and not mandatory for other companies (which can choose to have employee representatives as board members, or not). However, this has changed under the 2023 Company Law. For a company (including non-SOEs, and regardless of whether a limited liability company or a company limited by shares) with more than 300 employees, the board of directors (BoD) must include employee representative director(s), unless the company has established a board of supervisors which includes employee representative supervisor(s) (Articles 68 and 120, 2023 Company Law). Under this provision, it is mandatory for companies with more than 300 employees to have either employee director(s) or employee supervisor(s) to participate in democratic management. For more information on requirements for:

• An employee representative on the BoD in China, see Practice Note, Chinese Company Law Amendment: Impact on Corporate Governance: Employee Representative Required in BoD.
• The supervisor and audit committee, see Practice Note, Chinese Company Law Amendment: Impact on Corporate Governance: Supervisor and Audit Committee.

In choosing between employee director(s) and employee supervisor(s), a key question for companies to consider is whether to establish a board of supervisors. Under the 2023 Company Law, it is no longer mandatory to have supervisor(s), but an audit committee composed of directors may be set up to exercise functions of the board of supervisors (Articles 69 and 121). For more information on the option to replace a supervisory board or supervisor with an audit committee, see Practice Note, Chinese Company Law Amendment: Impact on Corporate Governance: Audit Committee: an Alternative Option.

The 2023 Company Law only briefly mentions that employee directors and employee supervisors should be elected through the ERC, assembly of all employees or other format of democratic election, and is silent on further details (Articles 68 and 76). It is not currently clear whether further interpretations, rules, and provisions regarding employee directors, employee supervisors, and the ERC will be issued in future.

The All-China Federation of Trade Unions (ACFTU) issued the following two opinions on employee directors and employee supervisors in 2006 and 2016, respectively, which mentioned election procedures:

• Opinions on Further Implementing the System of Employee Directors and Employee Supervisors 2006.
• Opinions on Strengthening the Construction of Employee Director System and Employee Supervisor System in Corporate Enterprises 2016.

Based on the two opinions (especially the opinion issued in 2016):

• Candidates for employee directors and employee supervisors may be nominated by:
  
  
  • the company’s trade union, based on self-recommendations and referrals, and after fully listening to employees’ opinions;
  • more than one-third of the employee representatives;
  • a joint group of more than one-tenth of all employees; or
  • a joint meeting of the ERC.
  
  

  Generally, the chairperson and vice chairperson of the trade union of a company should be candidates for employee directors and employee supervisors.

• The employee director and employee supervisor of a company should be competitively elected by the ERC by secret ballot and should be elected only with the consent of more than half of the total representatives of the ERC. A company that has not established an ERC should first establish the ERC under the leadership of CPC organisations and the guidance of trade unions at a higher level.
  
  This seems to indicate that establishing an ERC is a necessity, to be able to elect employee directors and employee supervisors. However, the opinions were issued against a background in which employee directors and employee supervisors were only mandatory for limited types of SOEs, instead of all companies. In addition, opinion documents issued by the ACFTU are not legislation, and it remains questionable whether all companies must follow these requirements.
  
  
• Details of the elected employee director and employee supervisor should be reported to the superior trade union and relevant departments for record filing.

Further, current laws and regulations (including opinion documents) are silent on the requirements for a company that:

• Is required to have an employee director or employee supervisor, but which fails to elect one.
• Fails to elect an employee director or employee supervisor in a way that the government deems appropriate.

The company may receive a request to rectify the situation within a limited period of time.

Companies are advised to pay close attention to legislative developments regarding employee directors and employee supervisors.

Heightened Obligations for Directors, Supervisors, and Senior Executives

The 2018 Company Law only provides in principle that directors, supervisors, and senior executives bear a duty of loyalty and duty of diligence to the company but does not define such duties. Article 148 of the 2018 Company Law sets out the duty of loyalty of directors and senior executives by describing prohibited conduct but does not outline the scope of the duty of diligence.

The 2023 Company Law defines the duty of loyalty and duty of diligence and further clarifies the scope of the two obligations:

• The duty of loyalty entails directors, supervisors, and senior executives taking measures to avoid conflicts between their own interests and the interests of the company, and not using their powers to seek improper interests (see Duty of Loyalty).
• The duty of diligence entails directors, supervisors, and senior executives exercising the reasonable care that managers should ordinarily exercise, in the best interests of the company, in performing their duties (see Duty of Diligence).

(Article 180, 2023 Company Law.)

Descriptions of the two types of duty provide a general code of conduct for the performance of duties of directors, supervisors, and senior executives.

Further, the duty of loyalty and duty of diligence also apply to the controlling shareholder and the actual controller of the company (who may not serve as a director of the company but who actually execute the company’s affairs (that is, a “de facto director”; also known as “shadow director”)) (Article 180, 2023 Company Law). For more information on:

• Extension of the duties of loyalty and diligence to shadow directors, see Practice Note, Chinese Company Law Amendment: Impact on Corporate Governance: Extended Obligations and Liabilities to “Shadow Directors”.
• Increased liabilities for controlling shareholders, see Chinese Company Law Amendment: Impact on Dispute Resolution: Controlling Shareholders’ Heightened Liabilities.

Duty of Loyalty

Articles 181 to 184 of the 2023 Company Law list the prohibited activities which could be interpreted as in scope for the duty of loyalty among directors, supervisors, and senior executives.

The following activities are strictly prohibited:

• Embezzling company property and misappropriating company funds.
• Depositing company funds into an account under their own name or any other individual’s name.
• Taking advantage of power to accept bribes or other illegal income.
• Taking commissions on transactions between the company and others into their own pocket.
• Illegally disclosing the company’s confidential information.
• Other acts inconsistent with the duty of loyalty to the company.

The following activities are prohibited in principle, but could potentially be permitted if reported to the BoD or shareholders’ meeting in advance and approved by the BoD or shareholders’ meeting through resolution, in accordance with the provisions of the company’s articles of association:

• Entering into contracts or transactions with the company, directly or indirectly.
• Seeking business opportunities belonging to the company for themselves or others by taking advantage of their position.
• Operating for themselves or for others in any business similar to that of the company for which they work.

Any income acquired by directors, supervisors, and senior executives in violation of these provisions should belong to the company (Article 186, 2023 Company Law). Any director, supervisor, or senior executive who violates any law, administrative regulation, or the company’s articles of association in the course of performing his or her duties should be liable to pay compensation to the company for any loss caused to it (Article 188, 2023 Company Law).

Companies are recommended to review and update their articles of association to reflect the impact of the 2023 Company Law amendments; for example, to:

• Specify the respective authority of the board of directors or shareholders’ meeting on the approval of certain activities. 

• Outline conditions under which certain activities may be approved.

For more information the liabilities of directors, supervisors, and senior management under the 2023 Company Law, see Practice Note, Chinese Company Law Amendment: Liabilities of Directors, Supervisors, and Senior Management.

Duty of Loyalty and Labour Law Non-Compete Obligation

The duty of loyalty prevents directors, supervisors, senior executives, and de facto directors from engaging in competing business without approval. It is important to understand the difference between this requirement and the non-compete obligation system specified in the PRC Labour Contract Law and how employers can make good use of both systems.

The duty of loyalty and the non-compete obligation system apply to different groups of people:

• The duty of loyalty applies to directors, supervisors, senior executives, and de facto directors, regardless of whether they have an employment relationship with the company.
• The non-compete obligation system applies to employees:
  
  

• who are senior management;
  (It is not expressly stipulated that “senior management” in the non-compete obligation context under PRC Labour Contract Law has exactly the same scope as “senior executive” under the 2023 Company Law. Employers could try to define a broader scope of “senior management” in their articles of association, policies, and non-competition agreements to impose the non-compete obligations. These definitions are subject to the courts’ reasonableness scrutiny. It is therefore prudent for employers to require certain roles of “senior management” as someone who have access to company confidential information as well.)
  
  
• who are senior technical staff; or
• who have access to company confidential information.

The duty of loyalty is a type of legal duty. It covers the term of office of directors, supervisors, and senior executives but does not cover post-termination, and no extra consideration is required.

The non-compete obligation should be upheld through an agreement between the company and employee. The law only expressly permits post-termination non-compete, and the employer should pay monthly compensation to enforce such obligations. That said, in judicial practice, there are many cases where courts support that employers and employees can agree on non-compete obligations during employment, and for such obligations, no extra consideration is required and the liability of breach can be enforced.

• The liability for breach of loyalty is directly provided for by the 2023 Company Law. Any income acquired in violation of the duty of loyalty should belong to the company, and losses caused to the company should be compensated.

For breach of the non-compete obligation, liabilities should be agreed on in the agreement, generally including:

• a refund of the compensation that has been paid;
• liquidated damages; and
• economic compensation.

Duty of Diligence

The duty of diligence should apply throughout the lifecycle of a company, from its establishment to deregistration.

Provisions relating to the duty of diligence mainly relate to maintenance of the capital adequacy of the company, including:

• Directors must check and call for the capital contribution made by the shareholders. Where losses to the company are caused due to a failure by the directors to perform such obligation in a timely manner, the directors responsible for such losses should be liable for compensation. (Articles 51 and 107, 2023 Company Law). For more information, see Practice Note, Chinese Company Law Amendment: Changes to the Corporate Capital System: Board of Directors’ Obligation to Call for Contribution.
• Directors, supervisors, and senior executives must prevent the withdrawal of capital contribution by shareholders. In the event that withdrawal of capital contribution by a shareholder causes the company to suffer losses, the directors, supervisors, and senior executives who are accountable must bear compensation liability with the shareholder jointly and severally. For more information, see Practice Note, Chinese Company Law Amendment: Impact on Corporate Governance: Responsibilities Related to Strengthening Requirements on Company Capital Adequacy.
• Directors, supervisors, and senior executives must supervise financial assistance provided by the company. Where the company provides financial assistance to others for obtaining company shares in violation of the provisions set out in the 2023 Company Law and the company suffers losses, the directors, supervisors, and senior executives who are accountable should bear compensation liability (Article 163, 2023 Company Law).
• Directors, supervisors, and senior executives must supervise the profit distribution activities of the company’s shareholders. Where a company distributes profits to shareholders in violation of the provisions as set out in the 2023 Company Law and the company suffers losses, the directors, supervisors, and senior executives who are accountable should bear compensation liability (Article 211, 2023 Company Law).

In addition to the above possible liabilities to the company, the 2023 Company Law also provides for liability of directors and senior executives to the third party. Where a director or senior executive causes harm to others in performing their duties, the company should bear the liability for compensation. The director or senior executive should also bear the liability for compensation if they are intentional or grossly negligent. (Article 191, 2023 Company Law.)