As lawyers, we spend a lot of time fielding good, bad, weird, interesting, deep, superficial, and all types of other questions from people. We’re generally expected to be oracle-level wizards, a lot like people are treating AI now. In this series, we’ll share some of these questions that people ask us, along with our answers.
Does China’s New Board Member Requirement Affect My Company?
Quick Question. I heard about the new Chinese law that requires a Chinese employee to be elected to the board of every Chinese company. This is supposed to include Chinese subsidiary companies that are owned by foreign parent companies. What are some of the potential negative consequences to the foreign parent company of having this mandatory Chinese employee on the board of the subsidiary company? And does this apply to all foreign-owned Chinese businesses?
Quick Answer. The new Chinese law you are referring to is an amendment to China’s Company Law. It requires a Chinese employee to be elected to the board of every Chinese company with more than 300 employees, including subsidiaries of foreign parent companies. This new requirement presents several potential negative consequences for foreign parent companies. These consequences primarily revolve around corporate governance, confidentiality, compliance, and strategic control.
This Board Member Requirement Follows the Plan
There is one nice thing about the Chinese Communist Party (CCP). It both publicly declares its plans and then unapologetically executes those plans. Usually, we first see a policy declaration in an official meeting readout, followed by the announcement of the framework plan, and finally legislation to implement the plan.
In recent years, we have seen the CCP do this through its Made in China 2025 Plan (announced in 2015). That preceded the passing or amending a bevy of laws to better position China to increase oversight of its business environment. These laws include the National Security Law (2015), the Cybersecurity Law (2016), the National Intelligence Law (2017; 2018), the Cryptography Law (2019), the Data Security Law (2021), the Personal Information Protection Law (2021), and the Company Law (2018; 2023).
The Board Member Requirement is Limited to Larger Companies
Article 68 of the amended Company Law targets limited liability companies (有限公司) with more than 300 employees. These companies must include an employee representative on the board of directors if they do not have a supervisory board with employee representatives. In practice, we absolutely expect CCP members to be chosen to the board by “democratic election” (民主选举) in which employees vote.
This representative voting is both interesting and paradoxical coming from a piece of Chinese legislation. And where a CCP member is not directly chosen, the designated employee representative will certainly be reporting in detail to one or more CCP cadres inside or outside the company (or both).
Boards Will Become an Additional Risk Vector for China Operations
This requirement is certainly another risk factor for Western businesses active in China. But it may not significantly increase the risk profile of these businesses. They have been on notice for years that any news in China gets reported to the CCP through both in-person and electronic intelligence gathering processes a la the National Intelligence Law requirements. This amendment just means the CCP is overtly gathering intelligence at the highest levels of these businesses rather than merely covertly.
Specific Examples of China’s New Board Requirement Causing Problems at Home
Microsoft and Oracle
Let’s take Microsoft’s Chinese entity (Microsoft (China) Co., Ltd. (微软（中国）有限公司)) and Oracle’s Chinese entity (Oracle (China) Software Systems Co., Ltd. (甲骨文（中国）软件系统有限公司)) as examples. Both are limited liability companies (有限公司) that would be explicitly required to comply with this updated law. We do not see any way around this legal requirement. These companies may choose the slightly less interfering option of adding a board of supervisors if they do not already have one. Or they may take more drastic measures like laying off employees.
Directors as Potential Threats
In most businesses, directors are selected and empowered by the shareholders because they have assets (skills, contacts, and sometimes financial resources) to help the company. These new Chinese directors presumably do not bring any of these to the table. Adding them to the mix would require companies to conduct heightened due diligence. Companies would need to look at additional internal threats to the company and then continuously monitor the new director’s access to information and computer systems.
Increased Potential for Derivative Lawsuits
Assuming the Chinese company is a wholly-owned subsidiary of a U.S parent company, that U.S. parent company could expose itself to derivative lawsuits. These shareholder-driven lawsuits could claim actual and pending damage to the U.S. parent company because of the increased business risks from the addition of the new director. This would require the company to expend funds to defend these types of suits.
Increased Board Size
Companies may consider increasing their board sizes to dilute the voting power of the new Chinese director. This will increase the complexity of the China company’s operations and may include additional expenses if the board members are compensated for their board position.
Keeping Internal Matters Internal
In terms of concrete examples, a company like IBM that recently laid off 1,000 Chinese employees would presumably discuss the layoffs ahead of time with the China subsidiary’s board and key executives. But they would not be able to exclude the new board member from the discussion. So, they would be faced with the option of excluding the new board member, which would probably violate the company’s bylaws and Chinese law. Or they would have to include the new board member, who may unnecessarily tip off the government and the employees as to the planned or potential layoffs. Neither of these scenarios is desirable.
Conclusion
Foreign parent companies must carefully assess these risks and consider implementing risk mitigation strategies. These strategies might include enhancing internal controls and compliance measures, strengthening information security protocols, and developing contingency plans to address potential regulatory or geopolitical issues. Engaging in a thorough legal analysis of the new requirement’s implications is essential for aligning corporate governance practices with both Chinese requirements and the parent company’s global standards.
For more reading, see:
What is China’s Game Plan for International Business Relations?
Should You Work for a Chinese Company?
