Out-Law Guide | 05 Mar 2013 | 1:59 pm | 7 min. read
Rules on the qualification, powers, duties, and liabilities of the board and their directors are particularly important. Foreign investors and their appointed directors must be aware of these rules in order to ensure compliance with the law, ensure good corporate governance, and guard against potential liability.
Qualification requirements for board members
Directors need not be Chinese nationals or residents. There are usually no general director qualification requirements, although directors of companies engaged in specific industries such as banks, insurance companies and security companies must meet certain criteria to qualify as directors.
Some people are barred from acting as directors, including:
Any election or appointment of a director in violation of these proscriptions is invalid.
Corporate governance structures and powers of the board
A wholly foreign-owned enterprise (WFOE) limited liability company has the same governance organs as a domestic limited liability company, namely:
For WFOEs, the shareholders' meeting or the sole shareholder is the highest authority of the company. For equity joint venture (EJVs) and co-operative joint ventures (CJVs), there is no shareholders' meeting, and the board of directors is the highest organ of authority.
Every company must also have a Legal Representative, who is officially and legally accountable for the activities of the company. The chairman of the board of directors, the executive director or the general manager may serve as the Legal Representative.
Role and Powers of the Board of Directors
Under the People's Republic of China (PRC) Company Law the board of directors or the executive director is responsible to the shareholder to carry out the following functions:
Unless otherwise stipulated in the articles of association or otherwise required by law, decisions of the board or directors are made by a simple majority vote.
According to law the following matters must be decided by a unanimous board resolution in case of an EJV or CJV, or by a resolution of shareholders representing two thirds of equity of the company, in case of a WFOE:
Duties of directors
Directors owe a duty of loyalty and diligence to the companies that they serve, and in carrying out their duties must abide by PRC laws and administrative regulations, and the company's Articles of association.
In particular, the PRC Company Law stipulates that directors, managers and supervisors must not:
Liabilities of directors
Directors of a company can incur civil, administrative, and (in extreme cases) criminal liabilities for their own or the company's acts that they cause or permit.
If directors breach their duties, they may be forced to:
Shareholders, the company itself, or its supervisors can sue directors claiming such remedies.
However, US-style shareholder derivative suits, with shareholders suing the directors on behalf of the company, are not recognized in China.
Where a company violates laws and administrative regulations such as those covering workplace safety; unfair competition law or other areas, its "supervisory personnel with direct responsibility" and "other persons with direct responsibility" may also be punished.
Administrative liabilities include warnings, fines, forfeiting illegal income, and in the most extreme cases even "administrative detention".
Similar to administrative law, where a company commits a criminal offence, its "supervisory personnel with direct responsibility" and "other persons with direct responsibility" may also be punished for that offence.
Depending on the crime, the criminal punishment may include a fine, imprisonment, and in extreme cases, such as significant production safety accidents and incidents relating to food safety that jeopardise public health and safety, even the death penalty.
Limitation of liabilities
Directors' and officers' civil liabilities can be limited by various means. However, exposure to administrative and criminal liability cannot effectively be limited except by full compliance with the law.
The PRC Company Law requires directors to abide by the law, administrative regulations, and the terms of the company's articles of association. If the board of directors/executive director passes a resolution that in violation of law, administrative regulations, or the company's articles of association, causing the company to incur serious losses, the directors taking part in such resolution are liable to the company for damages.
But if a director is proved to have expressed his opposition to such resolution when it was put to the vote, and that opposition is recorded in the minutes of the meeting, the director may be released from liability. Therefore, board resolutions should always be well documented in writing and the records preserved.
Companies may limit directors' liability in the articles of association. For example, the articles could stipulate that:
It is not yet as common in China as it is in some jurisdictions to procure directors and officers (D&O) insurance. However, D&O insurance is available, and international companies operating in China, especially larger companies, often do procure this cover for their directors and managers. Technically, only domestic insurers are allowed to cover domestic risks, but cover for local risks may nevertheless be available under umbrella policies issued by some international insurers.
Protection of Directors' Assets
Certain companies may operate in high risk areas where potential directors' liabilities are not covered by D&O insurance.
To avoid direct recourse to his personal wealth, a director may consider protective measures such as the creation of an asset protection trust in a suitable jurisdiction, which -although sounds a little bit remote – may offer a useful option for protection under really necessary circumstances.
While the above approaches may limit liabilities already incurred, a well-established risk management system helps to reduce potential future liability. This applies not only to civil, but also to administrative and criminal liability as well.
For this purpose we advise conducting regular "health checks" to assess company risk profiles. A legal health check mainly focuses on compliance, but may also address governance issues.
Once the risk profile is established, adequate risk mitigation measures can be designed and adopted. This may include improving corporate governance structures, the adoption of policies and procedures, and remedial measures for any historical compliance violations.