China: Corporate Governance in China: Limiting the Authority and Liabilities of Directors and Management at Chinese-registered Susidiaries

Last Updated: 9 February 2011
Article by Chen Yun

By Chen Yun, R&P China Lawyers

Directors and managers do not always make wise decisions, and being prepared, knowing the circumstances in which they may be held personally liable to the company for their decisions, and protecting against such occurrences, are all essential to securing a long business life for the company in China. An American company recently learned this lesson the hard way. After hiring a Chinese general manager for its Shanghai subsidiary without outlining the limits on her authority, the GM proceeded to inappropriately use company funds for her own benefit and that of a third-party. Without the evidence that is provided by clear delineation of authority within the company's Articles of Association, the employee's labor contract, or through Board of Directors' resolutions, the company found it unnecessarily difficult to terminate her position for cause, and pursue her for criminal and civil liabilities.

In light of the frequent disputes that arise in this area, companies operating in the People's Republic of China should have the best practices in place to reduce such risk. Clearly regulating the bounds of authority and conduct of directors and (management) employees, and establishing procedural controls such as requiring directors to report any payments or benefits they receive in exchange for benefits, are steps that every business should consider to reduce its exposure in China and abroad.

Obligations and Liabilities of Directors and Managers in China

Directors and senior managers of a Chinese-registered company, including subsidiaries of foreign companies, may be held civilly liable under the Company Law of the People's Republic of China. The PRC Company Law requires directors and senior managers to adhere to the duties of loyalty and duty of care. The duty of care provides that corporate directors and managers comply both with the law as well as the Articles of Association and shareholder resolutions of a company. Certain circumstances where directors and senior managers may bear personal liability to the company under the PRC Company Law include:

- Violating a law, an administrative regulation or the company's Articles of Association in the execution of company duties, thereby causing losses to the company, he or she will be liable for compensation;
- Misappropriating the company's funds;
- Taking business opportunities for themselves without shareholders' approval; and
- Abusing his or her position to take improper benefits for him (her) self or for other parties.

Carefully considering the desired limits of directorial and managerial authority will prepare the company not only for situations where these persons violate the PRC Company Law as described above, but also where they take actions that exceed their desired scope of authority. Firstly, the Articles of Association of the company should include detailed procedural guidance in connection with how directors and managers may exercise their powers. This often entails resisting pressure from local governments to use their preferred "standard" form of articles, which has limited use. A normal compromise is to adopt the basic style and sequence of that form, while adding more detailed provisions on the limits of authority of directors, senior managers and the legal representative, and on other points that are important to the shareholders. This may include certain obligation, such as to fully disclose to the Board of Directors and the shareholders meeting any transactions or arrangements that involve his or her personal interests.

Additionally, binding directors' and manager's authority to limitations from board resolutions provides a flexible method to limit their actions beyond the restrictions of PRC Company Law provisions. Priority is to have documentation in place to determine where the limits lie; absent such documentation, the company will be unable to file a claim against a director or manager for acting in excess of his or her authority, and will be unable to terminate his or her positions at the company for cause on the basis of such acts.

Managing the authority of directors and managers is also important in the context of criminal liabilities. The offering of monetary gifts to officials is prohibited under Chinese law. In commercial practice, directors and managers should therefore be required to promptly report to the Board of Directors or at the shareholders' meeting in the event they receive any payments or treatment in exchange for (expected) benefits. This is especially important because not only can the employee be held liable; the company and its legal representative could be held jointly liable where the employee has engaged in criminal activity on behalf of the company. Therefore, regulating the boundaries of authority and activities of directors and employees in the Articles of Association and in other documents, and establishing clear internal rules and policies for employee conduct, will not only clarify the limits to an individual, but it will also allow the company to limit its exposure to third parties and in government investigations.

Conclusions & Suggestions

Risks can be reduced at all times by clearly allocating particular powers and responsibilities of company directors and managers. Such allocations of authority will not only reduce the risks borne individually and by the company, but will also benefit the company by preventing important matters from 'falling between the cracks' and by enabling the legal representative to be more focused and less defensive. Having clearly-established the boundaries also serve as sound evidence in the case a legal dispute should arise, and procedural controls and reporting requirements will help ensure compliance and limit the liability of the company should a director or manager be accused of accepting special treatment or monetary gifts in exchange for benefits.> 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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