Supervisory Boards in Chinese Companies: Roles, Responsibilities, and Legal Framework

The Supervisory Committees' role is outlined in China's Company Law, which mandates the appointment of supervisors, and under certain circumstances, a board of supervisors is formed. These supervisors are legally bound to the company's articles of association and bear legal responsibility for their actions and oversights.

Contributing Advisor

Allan Xu

Partner

Their primary duty is to monitor the conduct of the board and the CEO and oversee financial and business affairs, acting in the best interests of the shareholders. In their role, they can demand rectification from directors or management if company policies or procedures are breached, harming the company's interests. This is particularly critical for listed companies in China, where the Code of Corporate Governance mandates the establishment of a Supervisory Committee.

However, the role of a supervisor needs to be more understood and valued, particularly in foreign-invested companies. Unlike the roles of shareholders or directors, which are generally well-understood, the function of a supervisor can be less clear, leading to an underestimation of its importance. This lack of understanding can be problematic, especially when individuals appointed as supervisors are not fully aware of their role's responsibilities and potential consequences.

In this article, we explain the current requirements for company supervisors in China, including their roles and responsibilities, the appointment process, and legal liabilities within the company.

Legal framework

In accordance with the Latest PRC Company Law, a limited liability company may, under the articles of association, set up an audit committee composed of directors in the board of directors, which shall exercise the functions and powers of the board of supervisors as prescribed by this Law, with no board of supervisors or supervisors established. Employees' representatives who serve as members of the board of directors may become members of the audit committee.

Legal mandates for supervisor appointments

The NCL lays out specific guidelines for appointing Supervisors tailored to the nature and structure of different types of companies. For instance, Sino-Foreign Joint Ventures established on January 1, 2006, are required to appoint a Supervisor. However, the exact number of Supervisors varies based on the company's classification.

• For Limited Liability Companies, the NCL allows the appointment of a single Supervisor (Articles 52-57).
• In contrast, Joint Stock Companies are expected to form a panel of at least three Supervisors, constituting a Board of Supervisors (Articles 118-120). In these companies, shareholders can appoint two-thirds of the board, while the company's workers appoint the remaining third.

Supervisors typically serve a tenure of three years, subject to extension. However, only some are eligible for this role. The NCL stipulates certain incompatibilities: company administrators, board members, public officials, individuals declared bankrupt, those with revoked business licenses, or those with significant outstanding debts cannot simultaneously hold the position of Supervisor. If such individuals are appointed, the appointment is deemed invalid. Notably, the NCL does not specify any requirements regarding the supervisor's residency in China or whether they must be external to the company.

Supervisors in Corporate Governance Context

The role of Supervisors in Chinese companies is a cornerstone in the broader framework of corporate governance, a framework that has been undergoing significant evolution and reform. As China's market economy matures, the governance structures within its corporations have been steadily adapting, aiming to align more closely with global standards while addressing the unique aspects of the Chinese market.

Supervisors serve as critical agents of oversight and accountability. They are tasked with monitoring company directors' and senior management's actions and decisions, ensuring that these align with the legal and ethical standards set forth in the company's Articles of Association and relevant laws. This role is particularly crucial in the context of ongoing reforms aimed at enhancing transparency, reducing corruption, and improving overall corporate governance in Chinese enterprises.

Comparison with international corporate governance practices

Compared to corporate governance structures in other jurisdictions, there are similarities and differences in the role and function of Supervisors. In many Western countries, corporate governance often revolves around a board of directors, with distinct roles for executive and non-executive directors and, sometimes, independent directors. These boards typically have committees focused on audit, risk, and remuneration, which are somewhat parallel to the functions of Supervisors in China.

However, the Chinese model places a stronger emphasis on the separation of oversight from management. While boards in Western companies often consist of a mix of executive (internal) and non-executive (external) directors, the Supervisory Board in Chinese companies is distinctly separate from the board of directors, with no overlap in membership. This separation is designed to provide an independent check on management, a principle gaining increasing importance in global corporate governance practices.

Another notable aspect is the inclusion of employee representatives on the Supervisory Board in China. While common to China, this approach is less common in Western corporate governance models, where employee representation at the board level is rare. The inclusion of employees in governance structures reflects a more stakeholder-inclusive approach, acknowledging the role of various groups, not just shareholders, in the company's success.

Composition and appointment of supervisory boards

Under China’s Company Law, limited liability companies (LLCs) and joint-stock companies must set up a board of supervisors with at least three members, meaning each company must have at least three supervisors. An LLC that is either smaller in scale or has fewer shareholders may have only one or two supervisors and does not need to set up a board of supervisors.

In both LLCs and joint-stock companies, the board of supervisors must include shareholder representatives and an appropriate proportion of company employee representatives. At least one-third of the board must be held by employee representatives. This proportion must be stipulated in the company’s AoA.

The board of supervisors must also have a chairman and may also have a vice chairman in the case of a joint-stock company. The chairman of the Board of Supervisors is tasked with convening and presiding over the board of Supervisors meeting. 

Supervisor eligibility requirements

There are various limits on the persons who can take the supervisor role under the Company Law. First, directors and senior managers can not serve as supervisors. 

In addition, anyone who falls under any of the following circumstances is not permitted to serve as a supervisor: 

• Has no civil capacity or has limited civil capacity (generally, those aged over 18); 
• Has been sentenced for corruption, bribery, encroachment of property, misappropriation of property, or undermining the socialist market economic order, and five years has not lapsed since the expiration of the penalty expired, or has been deprived of political rights due to a crime and five years has not lapsed since the expiry of the penalty expired; 
• Is serving as a director, factory director, or manager of a company or enterprise undergoing bankruptcy liquidation and is personally responsible for the bankruptcy of the company or enterprise, and less than three years have elapsed since the date of completion of the bankruptcy liquidation; 
• Is serving as the legal representative of a company or enterprise that has had its business license revoked or ordered to close due to a legal violation and bears personal responsibility for the violation, and a three-year period has not elapsed since the revocation of the business license of the company; or 
• Being listed as dishonest and is subject to enforcement by the People's Court due to a large amount of personal debt that has yet to be paid off on time. 

The appointment of a supervisor shall be deemed invalid if the candidate falls under any of the above circumstances. In addition, if they find themselves under one of these circumstances after assuming office, the company is required to dismiss them as supervisors.

Election of company supervisors

• In an LLC, Company supervisors who are not employee representatives are selected by the shareholders' meeting.
• The employees must democratically elect the employee representatives on the board of supervisors through employee congresses, workers' conferences, or other forms of democratic meetings.
• A majority of the supervisors on the board must elect the chairman of the board of supervisors.
• Suppose the chairman of the board of supervisors needs to perform their duties. In that case, more than half of the supervisors can jointly elect a supervisor to convene and preside over the board of supervisors' meeting.
• In a joint-stock company, The board of supervisors and supervisors are selected by the founding members after making sufficient capital contributions as stipulated in the company's AoA. The company's supervisors and members of the board of supervisors must be written in the AoA.
• The employees must democratically elect the employee representatives on the board of supervisors through employee congresses, workers' conferences, or other forms of democratic meetings.
• A majority of the supervisors on the board must elect the chairman and vice chairman of the board of supervisors.

Supervisors hold office for a term of three years. When the supervisor's term expires, they may be re-elected. If a supervisor's term expires and they are not re-elected in time, or if a supervisor resigns during their term and the members of the board of supervisors fall below the required number, then the original supervisor must continue to perform their duties as a supervisor until the re-elected supervisor takes office.

In addition to electing the supervisors in an LLC, the shareholders' meeting also has the power to replace supervisors, provided they are not employee representatives, and decide on their remuneration.

Supervisory committees in state-owned and foreign companies

The structure of supervisory committees in state-owned enterprises, whether fully owned or state-controlled, is distinct. These committees must have at least five members, with employee representatives constituting at least one-third, as determined by the AoA. Supervisors in these enterprises are appointed by the State-owned Assets Supervision and Administration Commission (SASAC), with the chairman being appointed from among the committee members by SASAC.

For foreign-invested entities (FIEs), following the implementation of the Foreign Investment Law (FIL) on January 1, 2020, the requirement to establish supervisors and a board of supervisors aligns with domestic enterprises as per the Company Law. FIEs established before this date under different laws may retain their original structures until the end of 2024, after which they must comply with the FIL requirements.

Roles, powers, and responsibilities

The board of supervisors, or individual supervisors in companies without such a board, hold significant responsibilities and powers. These include scrutinizing the company's finances and supervising the performance of duties by directors and senior managers.

The integral role of the Supervisory Committee

The Supervisory Committee, as defined by China's Company Law, bears numerous responsibilities, including: 

• Reviewing the company's financial affairs; 
• Monitoring the performance of directors and senior officers; and,
• In cases of violations, removing them from their positions. 

They have the authority to require rectification from directors or senior officers that cause harm to the company's interests and can propose interim shareholder meetings.

Supervisors are expected to be proactive, especially in situations where directors fail to convene or preside over shareholders' meetings. In such cases, supervisors are responsible for calling and presiding over these meetings. They may also propose to call interim shareholders' meetings and put forward proposals at these meetings.

The duty of diligence further mandates that supervisors perform their roles reasonably, always acting in the company's best interests. This encompasses staying informed about the company's operations and management, diligently exercising their powers to ensure compliance with laws, regulations, and economic policies, and ensuring that the company's commercial activities remain within the scope of its business license.

The role of supervisors in Chinese companies is thus far from passive. It requires active engagement and a deep commitment to upholding the principles of good corporate governance. By fulfilling these roles, supervisors help to foster a culture of accountability and integrity within the company, which is essential for its long-term success and sustainability.

Director actions and power in shareholder meetings

Supervisors play a pivotal role in overseeing director actions.

This authority is reactive and proactive, as supervisors can propose proposals at shareholders' meetings.

The responsibilities of supervisors extend to different corporate structures, including foreign-invested and multi-shareholder companies, where their oversight becomes increasingly crucial. This oversight ensures that management operations and activities align with the varied interests of the shareholders and the company's strategic objectives.

Legal responsibilities and potential liabilities

Supervisors are bound by a general obligation of loyalty and diligence to the company. They must adhere to:

• Laws;
• Administrative regulations; and,
• The company's AoA.

Ensuring they do not exploit their position for personal gains, such as accepting bribes or misappropriating company assets. If supervisors violate these laws and regulations or the company's AoA, resulting in losses to the company, they are liable for compensation.

Should a director or senior executive infringe upon the laws, administrative regulations, or the AoA in their role, leading to damages to the company, they, too, are responsible for compensation. In such scenarios, shareholders of an LLC or a joint-stock company, shareholders holding a certain percentage of shares, can request the board of supervisors or the individual supervisor to file a lawsuit with a people's court.