The Role of the Chinese Community Party in FIEs

What is the truth and how to deal with it?

Foreign investors involved in joint ventures with Chinese state-owned firms have been asked in recent months to give internal Communist Party cells an explicit role in approving management decisions. In the recent few years, only wholly Chinese state-owned firms, including listed public companies, gave their internal Party cells a governance role, higher in the hierarchy than that of the board of directors. Before that, although Party cells had always been a staple in Chinese state-owned firms, they were not given any substantive governance role. It was only since a few years ago when the Party cells were given a more prominent role to play in the operation of the firms through the amendment of their articles of association.

In the last several months, however, the trend of adding Party cells to the governance structure of companies in China has seemed to expand to foreign-invested enterprises (FIEs). What is the truth behind this recent move? Is it a legal requirement that all firms must comply with? What types of FIEs are affected? How to deal with such request should it come into your company’s way? This Client Alert intends to provide you with our legal analysis on the phenomenon and our suggestions on compliance issues implicated within.

What is the request about?

Multiple foreign executives reported being approached by their Chinese joint venture partners demanding that they involve internal Party committees in strategic decisions. Specific demands include requiring the board of directors to consult with the committee before making business decisions, amending joint venture agreements to include language mandating Party personnel be brought into the business management organization, and requesting that the posts of board chairman and Party secretary be held by the same person. No matter exactly how the requests are worded, the risks they pose are similar—they may alter the governance structure of FIEs by introducing and giving Party cells a direct, and most likely prioritized, role in the management of the companies.

Is the request based on any legal requirement?

No. Up until now, no law or regulation has explicitly imposed such requirement—commanding a governance role on the part of the Community Party cells—on FIEs. At most, China’s Company Law stipulates that a company shall provide the requisite conditions for Party organization activities.[1] This rule applies across the board without exception. It not only governs Chinese state-owned enterprises and Chinese private companies, but it is also applicable to Chinese-foreign invested joint ventures and wholly-owned foreign enterprises. In addition, this rule is nothing new—it was added into the Company Law in 2005 and has been in effect since then.

The decision-making power of the internal Party cells, however, depends to a large extent on the types of firms the Party cells are located in. In large state-owned companies, including those with publicly listed entities, Party cells tend to be active at the executive level, making business decisions alongside the board of directors. For those companies, the Party’s role has become more solid in recent years. For instance, Sinopec, ICBC and China Railway Group changed their articles of incorporation to give the Party a greater role. On the contrary, the role of Party cells has not, up to now, been intrusive in FIEs. While they are a fixture in many foreign-managed workplaces, they were seen by foreign executives as more like social clubs.

What types of FIEs are affected?

Presently, not all FIEs are affected the same. Joint ventures with majority Chinese equity partners, especially state-owned companies, are those under the heaviest pressure to add the Party cells to their management structure. In particular, industries in which foreign partners are prohibited from holding majority shares, such as the automobile industry, are most vulnerable. For instance, Honda has recently changed its legal documents to give the Party a say. Dongfeng Motor Group has recently taken steps to intensify the Party’s activities at its joint ventures with foreign investors, including Cummins, Peugeot Citroën and Dana. GAC, a subsidiary of Guangzhou Automobile Group, is pushing its joint ventures to change their articles of association to give the Party a greater role.

In comparison, joint ventures where foreign partners hold the majority shares and 50-50 joint ventures are less impacted, although they have reported a growing demand from their Chinese partners. For the moment, wholly owned foreign ventures have not faced the same pressure, and they are the ones least likely to be influenced by the trend. As far as we know, wholly foreign-owned enterprises have not received similar formal requests and have not thus far been affected. However, some wholly foreign-owned enterprises may have established Party committees or Party branches and participate in activities organized by higher-level Party committees, just like unions.

How to deal with similar requests?

As discussed above, the request of adding another layer of governance to the management structure of FIEs for the Party cells to play a more material role is not grounded in any legal requirement under Chinese law. The current legal framework governing joint ventures provides an additional layer of protection. The Sino-Foreign Equity Joint Ventures Law of the PRC and its implementing regulations provide that the highest authority within a joint venture is the board of directors, that directors must come from both Chinese and the foreign parties, and that resolutions on amendment to the articles of association of the joint venture shall be made only after being unanimously agreed upon by the directors present at the board meeting.[2] Since the most likely requests coming from the Chinese partners will take the form of their demanding amendment to the articles of association, requiring all important matters to be discussed by the internal Party cell before being submitted to the board of directors, the fact that no amendment can be made without the approval of directors from the foreign party at least provides a buffer zone.

As such, should your company be posed with similar requests, you are not obliged to nod to them unconditionally from a compliance point of view. However, from a practical perspective, Chinese partners may insist giving the Party a larger voice as they are under pressure to align with the Party’s development scheme. There may be political and economic costs to them and to your joint ventures should the requests be rejected straightforwardly.

It is hard to measure with limited information on the assertiveness of such requests. Many joint ventures who are alleged to have received similar requests and adopt corresponding measures have declined to comment. We will keep a close eye on the development of this matter and update you should any changes occur.

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This Client Alert is to inform you of developments that may affect your business and are not to be considered legal advice, nor do they create a lawyer-client relationship. Information on previous case results does not guarantee a similar future result.

[1] Article 19 of the Company Law of the PRC: Where a Chinese Communist Party organization is to be established in the company in accordance with the articles of association of the Chinese Communist Party to develop Party activities, the company shall provide the requisite conditions for such Party organization activities.

[2] Article 6 of the Sino-Foreign Equity Joint Ventures Law; articles 30 and 33 in the implementing measures.