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Chapter V Standardised Operations

Article 38 [Original Text]

Article 38 Private economic organisations shall improve their governance structures and management systems, standardise the conduct of operators, and strengthen internal oversight to achieve standardised governance. They shall establish and improve democratic management systems with the workers' congress as the fundamental form in accordance with the law. Private economic organisations with the requisite conditions are encouraged to establish and improve modern enterprise systems with Chinese characteristics.

Mass organisations such as trade unions within private economic organisations shall conduct activities in accordance with laws and their charters, strengthen ideological and political guidance for employees, safeguard their lawful rights and interests, play their role in democratic enterprise management, promote the improvement of collective wage bargaining systems, and foster harmonious labour relations.

The organisational forms, structures, and operational principles of private economic organisations shall be governed by the provisions of laws including the Company Law of the People's Republic of China, the Partnership Enterprise Law of the People's Republic of China, and the Sole Proprietorship Enterprise Law of the People's Republic of China.

【Interpretation of Provisions】

Legislative Background and Purpose: Sound corporate governance forms the foundation for the healthy development of enterprises. This provision aims to guide private enterprises in refining their internal governance mechanisms, including corporate governance, democratic management, and the role of mass organisations, while clarifying the legal basis for their organisational forms.

Interpretation of Provisions:

a. Paragraph 1: Internal Governance and Democratic Management:

● ‘Improve governance structures and management systems’: Refers to establishing clear equity structures, standardised shareholders' meetings (or general meetings), boards of directors, boards of supervisors (or executive directors and supervisors), and managerial responsibilities, while strengthening internal decision-making, execution, oversight mechanisms, and management regulations.

● ‘Standardise the conduct of operators’: Implies clearly defining the powers, responsibilities, and behavioural norms of senior executives to prevent issues such as insider control and transfer of benefits.

● ‘Strengthen internal oversight’: This encompasses supervision by the board of supervisors (or individual supervisors) and internal audit mechanisms.

● ‘Achieve standardised governance’: This constitutes the objective for internal corporate development.

● ‘Establish and improve democratic management systems based on the fundamental form of the workers' congress in accordance with the law’: This safeguards employees' rights to participate in corporate management and oversight.

● ‘Encourage private economic organisations with the requisite conditions to establish and improve modern enterprise systems with Chinese characteristics’: ‘Chinese characteristics’ primarily manifest in integrating Party leadership into corporate governance (e.g., Party organisations participating in major decision-making) and emphasising social responsibility. The modern enterprise system typically denotes clear property rights, defined responsibilities, separation of government and enterprise functions, and scientific management.

b. Paragraph Two: Role of Trade Unions and Other Mass Organisations:

● ‘Trade unions and other mass organisations’: Primarily refers to trade unions, though may also include organisations such as the Communist Youth League and Women's Federation.

● ‘Conduct activities in accordance with laws and their constitutions’: Clarifies the legal basis for their operations.

● ‘Strengthen ideological and political guidance for employees, safeguard their lawful rights and interests, play a role in democratic management within enterprises, promote the improvement of collective wage bargaining systems, and foster harmonious labour relations’: Outlines the multifaceted roles of trade unions and other mass organisations within enterprises, with the core focus on protecting employee rights and promoting labour-management harmony.

c. Paragraph Three: Legal Application to Organisational Forms:

● Specifies that common forms of private economic organisations—such as companies, partnerships, and sole proprietorships—shall be governed by corresponding laws regarding their establishment, organisational structures, and operational principles.

【Relevant Legislation】

● Company Law of the People's Republic of China: Provides comprehensive provisions governing the establishment of companies, organisational structures, shareholder rights, duties of directors, supervisors and senior management, and corporate governance.

● Partnership Enterprise Law of the People's Republic of China: Regulates the establishment, conduct of affairs, and liability of partnership enterprises.

● Sole Proprietorship Enterprise Law of the People's Republic of China: Regulates the establishment of sole proprietorship enterprises and the rights and obligations of investors.

● Trade Union Law of the People's Republic of China: Specifies the organisation, rights, and obligations of trade unions, along with the responsibilities of enterprises in establishing trade unions.

● Regulations on Democratic Management in Enterprises: Contains specific provisions regarding the powers and organisational systems of workers' congresses.

● Laws, regulations, and policies concerning collective wage bargaining.

【Practical Guidance】

a. Corporate Governance Development for Private Enterprises:

● Gradually establish and improve modern enterprise systems according to enterprise scale and development stage, clarifying equity structures and standardising the operation of the ‘three meetings and one layer’ (shareholders' meeting, board of directors, board of supervisors, and management).

● Prioritise the development of internal control and risk management systems.

● Legally safeguard employees' democratic management rights by convening employee representative conferences or general meetings as stipulated.

b. Supporting Trade Union Operations:

● Legally guarantee the establishment and activities of trade union organisations, providing necessary conditions.

● Facilitate effective communication with employees through trade unions, conduct collective wage bargaining, resolve labour disputes, and foster harmonious labour relations.

c. Selecting an appropriate organisational form:

Upon establishment, enterprises should choose a suitable legal organisational form based on their specific circumstances (such as the number of investors, liability arrangements, and management models), and strictly comply with relevant legal provisions.

d. Modern enterprise systems with Chinese characteristics:

Enterprises are encouraged to explore governance models with Chinese characteristics—incorporating Party leadership and strengthening social responsibility—by drawing on the general principles of modern enterprise systems while adapting to China's national conditions and their actual circumstances.

Article 39 [Original Text]

Article 39 The State shall promote the establishment of institutional mechanisms for private economic organisations to prevent and govern corruption at its source. It shall support and guide such organisations in establishing sound internal audit systems, strengthening integrity risk prevention and control, and enhancing their level of lawful and compliant business management. This aims to enable timely prevention, detection, and resolution of illegal or non-compliant issues in their operations.

Private economic organisations shall strengthen legal education for their personnel and foster a culture of integrity, honesty, and lawful compliance.

[Interpretation of the Provision]

Legislative Background and Purpose: Internal corruption and non-compliant conduct within enterprises not only harm the enterprises' own interests but may also disrupt market order. This provision aims to encourage private enterprises to strengthen internal integrity building and compliance management, thereby preventing risks at their source.

Interpretation of the Provision:

a. Paragraph 1: Establishment of Systems and Mechanisms and Risk Prevention and Control:

● ‘Promoting the establishment of institutional mechanisms for private economic organisations to prevent and govern corruption at its source’: This initiative will be advanced at the national level.

● ‘Supporting and guiding private economic organisations to establish sound internal audit systems’: Internal audit serves as a crucial oversight mechanism for detecting and preventing corruption, fraud, and non-compliance.

● ‘Strengthening integrity risk prevention and control’: Identifying potential integrity risks across all operational and management processes and implementing corresponding preventive measures.

● ‘Promote private enterprises' enhancement of lawful and compliant operational management standards’: Emphasising compliance as the norm.

● ‘Timely prevent, detect, and address illegal or non-compliant issues in operations’: Establish mechanisms for early detection and resolution.

b. Clause Two: Legal Education and Cultural Development:

● ‘Strengthen legal education for staff’: Enhance employees' legal awareness and compliance consciousness.

● ‘Foster a culture of integrity, honesty, and lawful compliance’: Integrate integrity and compliance principles into corporate culture.

【Relevant Legislation】

● Anti-Unfair Competition Law of the People's Republic of China: Article 7 prohibits commercial bribery.

● Criminal Law of the People's Republic of China: Covers offences related to internal corporate corruption, including bribery of non-state personnel, embezzlement of duties, and misappropriation of funds.

● Accounting Law of the People's Republic of China: Establishes requirements for accounting practices, forming the foundation for internal auditing.

● Regulations on Internal Audit Work issued by the National Audit Office, alongside internal audit standards published by the Chinese Institute of Internal Auditors.

【Practical Guidelines】

a. Corporate Anti-Corruption and Compliance Framework:

● Establish robust internal reporting, investigation, and disciplinary mechanisms, clearly defining anti-corruption policies and disciplinary provisions.

● Establish an internal audit department or position commensurate with the enterprise's scale and risk profile, conducting regular audits.

● Strengthen integrity risk prevention and control in high-risk areas such as procurement, sales, tendering, and finance.

● Develop employee codes of conduct and enhance compliance training.

b. Fostering a Culture of Integrity:

● Senior management should lead by example, championing values of integrity and honesty.

● Enhance employees' awareness of integrity and self-discipline through publicity campaigns, training programmes, and case studies.

c. Integration with External Oversight: Internal anti-corruption mechanisms should complement external judicial supervision and administrative oversight.

d. Business Partner Compliance: Extend integrity and compliance requirements to suppliers, distributors, and other business partners to jointly foster a sound commercial ecosystem.

Article 40 [Original Text]

Article 40 Private economic organisations shall strengthen financial management, standardise accounting practices, prevent financial fraud, and distinguish between the income and expenditure arising from the production and operation of the private economic organisation and the personal income and expenditure of the operator of the private economic organisation, thereby achieving the separation of the property of the private economic organisation from the personal property of the operator of the private economic organisation.

[Interpretation of the Provision]

Legislative Background and Purpose: Financial standardisation forms the bedrock of sound corporate operations and is a prerequisite for risk prevention and accurate assessment of business performance. Many private enterprises, particularly small and medium-sized enterprises and family businesses, are prone to issues such as non-standardised financial management and commingling of corporate and personal assets. This provision aims to emphasise financial standardisation and asset separation.

Interpretation of the Provision:

a. ‘In accordance with laws, administrative regulations, and the national unified accounting system’: This clarifies the statutory basis for financial management and accounting practices.

b. ‘Strengthen financial management and standardise accounting practices’: This requires enterprises to establish sound internal financial management systems to ensure accounting records are truthful, accurate, and complete.

c. ‘Preventing financial fraud’: Strictly prohibits financial malpractice such as fabricating transactions, forging vouchers, concealing income, or inflating profits.

d. ‘Distinguishing between the production and operational income and expenditure of private economic organisations and the personal income and expenditure of their operators’: This constitutes the core requirement, mandating that the financial dealings of the enterprise must be strictly separated from those of the business owner, preventing commingling of public and private funds.

e. ‘Achieving Separation of Private Enterprise Assets from the Personal Assets of the Private Enterprise Operator’: This constitutes a fundamental characteristic of the modern corporate legal person system, wherein the legal person possesses independent property rights and the enterprise's assets are distinct from the personal assets of shareholders (investors). This is crucial for protecting creditors' interests and clarifying legal liabilities.

【Relevant Regulations】

● Accounting Law of the People's Republic of China: Provides comprehensive provisions on accounting practices, accounting supervision, accounting institutions and personnel, and legal liabilities.

● Accounting Standards for Business Enterprises and their Application Guidelines: The concrete manifestation of the nationally unified accounting system.

● Company Law of the People's Republic of China: Article 20, Paragraph 3 stipulates that ‘Where a company shareholder abuses the independent legal status of the company and the limited liability of shareholders to evade debts, thereby seriously harming the interests of the company's creditors, the shareholder shall bear joint and several liability for the company's debts.’ (Piercing the corporate veil, related to commingling of assets)

● Tax Collection and Administration Law of the People's Republic of China: Financial compliance forms the foundation for lawful tax payment.

【Practical Guidelines】

a. Enterprise Financial System Development:

● Establish sound financial management, accounting, and internal control systems.

● Employ qualified accounting personnel or engage professional bookkeeping agencies.

● Ensure authenticity and completeness of accounting vouchers, ledgers, and financial statements.

b. Distinction Between Business and Personal Funds:

● Business owners must strictly separate corporate funds from personal assets and refrain from misappropriating company funds for private consumption or investments.

● Financial transactions between the enterprise and its owner should follow standardised borrowing or distribution procedures, supported by lawful documentation.

c. Mitigating Legal Risks:

● Financial fraud may incur administrative penalties and potentially constitute criminal offences (e.g., providing false financial reports, tax evasion).

● Significant commingling of corporate and personal assets may result in business owners being held jointly liable for the company's external debts (particularly in sole proprietorships or family businesses).

d. Financing and Development: Sound financial management forms the foundation for securing bank loans, attracting external investment, achieving standardised development, and pursuing listing.

(To be continued)

Special Notice:

This article is an original work by a solicitor of JAVY Law Firm and represents solely the author's personal views. It shall not be construed as formal legal advice or recommendations issued by JAVY Law Firm or its solicitors. Should any part of this content be reproduced or referenced, the source must be duly acknowledged.