In this issue of our series on doing business in China, we will highlight the potential legal liabilities associated with individuals, including foreigners, acting as a legal representatives or directors of Chinese registered companies, e.g. a wholly foreign owned enterprise (WFOE) and Sino-foreign joint venture (JV).
Under China's Company Law, a director or member of "senior management" (defined as the general manager, deputy general manager, head of finance or other individual stipulated in a company's articles of association (AoA)) who breaks Chinese law or breaches the company's AoA (e.g. breach of the fiduciary duties not to compete against the company or "self-deal"), must compensate for any resulting damage caused to the company. Given that the legal representative of a company must be either the president of the board of directors (or the executive director of a smaller company opting not to set up a board), or general manager of the same company, the above would also apply to a legal representative's misconduct.
An individual, including a legal representative and/or director, whose negligence has harmed the rights and interests of others, risks civil liabilities.
Further, if the intentional or negligent wrongful act of a legal representative causes damage to a third party, the company may seek to recover from the legal representative after compensating the injured third party.
If a company going through bankruptcy proceedings violates provisions of China's Enterprise Bankruptcy Law, e.g. prepayment of debt not yet due or fraudulently conveying company properties, the company's legal representative and other personnel who are directly accountable (including directors) are liable for any damage caused.
Unpaid subscribed capital
When the legal representative or the director of a company is also a shareholder of the company and he/she fails to pay the subscribed capital as promised, he/she faces the following liabilities:
- the company and the company's creditors can demand that the non-paying shareholder fulfils its investment commitment;
- the other company shareholder(s) may pursue the non-paying shareholder for civil liabilities based on contractual breach, i.e. failure to contribute the subscribed capital in breach of the company's AoA; and
- If the company is undergoing dissolution, it cannot proceed with the relevant procedure until all outstanding share capital debts are paid in full.
On the other hand, if the shareholder is a company which has failed to fully contribute its subscribed investment, in rare cases it is possible to pierce the 'corporate veil' and hold the individual behind the shareholder company personally liable for the unpaid subscribed capital. A claim could be made that the failure is an abuse of the company's independent legal status in order to evade debt if the interests of the company creditors are seriously harmed.
Unpaid subscribed capital
China's company registration authorities may impose on a shareholder a fine of 5% to 15% of the subscribed capital the shareholder fails to pay.
In addition to assuming liability for his/her own misconduct or negligence, as highlighted above, the legal representative may be held vicariously liable for illegal acts committed on behalf of the company by directors or employees. In particular, a company's legal representative may be subject to fines or administrative sanctions if the company:
- carries out illegal business activities beyond the scope of business approved by and registered with the relevant government authorities;
- conceals facts from the relevant government authorities or engages in fraud;
- removes funds or conceals assets for the purpose of evading debts;
- disposes of the company's assets without approval after the company is dissolved, has been rescinded or has declared bankruptcy;
- fails to apply immediately for the relevant registration and make the requisite public announcement regarding a change in the company's corporate information or the termination of its business, which as a result causes an interested party to sustain substantial losses; or
- engages in other activities prohibited by law, which causes damage to the interests of the state or the public.
In this regard China's highest court, the Supreme People's Court, opined that a fine of up to RMB 2,000 or USD$ 300 as well as detention for up to 15 days, can be imposed on the legal representatives.
Chinese law does not require a legal representative to have actual knowledge of, or be personally involved in, any of the violations stipulated above. Consequently, a strict liability standard could theoretically be imposed on a legal representative for the acts or omissions of his/her company for any of the situations highlighted above.
False or inaccurate disclosure
Additionally, if a company makes false records or, for example, conceals important facts within financial accounting reports provided to the relevant authorities, the person in charge and other directly responsible personnel (including the company's legal representative and directors) shall be subject to a fine ranging from RMB 30,000 to RMB 300,000 (or USD$ 4,700 to USD$ 47,000).
Actions during liquidation
Similarly, during the company's liquidation process, its legal representative and/or other personnel who are directly responsible (including the directors) for concealing company assets or making false records on the company's balance sheet/list of assets, or distributing company assets before settlement of its debts, shall be subject to a fine ranging from RMB 10,000 to RMB 100,000 (or USD$ 1,560 to USD$ 15,600).
Finally, there may be sector-specific laws or regulations which impose additional responsibilities on a company's legal representative or directors. For example, in the architectural design industry, if a fine is imposed on a design company for violating any provision of China's Regulations on the Quality Management of Construction Projects, a penalty in the amount of 5%-10% of the fine imposed on the design company will be imposed on the person directly in charge and other directly liable individuals.
In practice, however, most administrative enforcement actions are based on intentional wrongdoing conducted by the company, and where sanctions are imposed they have primarily targeted the companies involved and not their legal representatives or directors personally.
If a foreigner is the legal representative or director of a WFOE or JV, China has rules in place to prevent the foreigner from leaving China if he/she:
- is involved in a pending civil lawsuit and ordered by a court not to leave China; or
- is ordered by the relevant authorities not to leave China due to outstanding payments of wages and salaries (including applicable social insurance contributions) owed to the employees of the company which the foreigner owns or works for.
Further, a foreigner who is the legal representative, key person-in-charge or officer (including director) and who can effectuate the debt payments of his/her company may be restricted from leaving China if an application to enforce a court judgment against the company is filed.
If a foreigner is required to fulfil certain obligations arising out of a legal document, e.g. a final court judgment, but does not perform his/her obligations thereunder, a Chinese court may restrict the foreigner from leaving China.
If a company enters bankruptcy proceedings, i.e. a bankruptcy application is accepted by a Chinese court, the relevant personnel including the legal representative or directors of the bankrupted company cannot leave his or her city limit or China without the approval of the court.
Therefore, in most cases where the legal representative or director of a company is not allowed to leave China, it is due to the fact that (i) there is an ongoing lawsuit implicating the legal representative, director or his/her company; (ii) the company for which the legal representative or director works owes outstanding employee wages and salaries or has entered into bankruptcy proceedings; or (iii) there is a failure to execute a court judgment against the foreigner or his/her Chinese companies.
Finally, a company's legal representative must represent the company in commencing or defending civil actions. Therefore, if the company is suing or being sued in China, the company legal representative's presence may, in theory, be seen as necessary to the civil action which may affect his/her travel in and out of China.
If a company is held criminally liable, penalties will be imposed on the company's officers who were "directly in charge" and/or "directly responsible" at the time that the criminal activity took place. China's Criminal Law does not define the two quoted terms and more clarification may be needed to determine whether a legal representative or director will indeed personally be held criminally liable for the criminal acts of the company.
It suffices to say that it is rare for a legal representative or director to be subject to criminal liabilities if the company is operating within its ordinary course of business. Criminal liabilities are generally associated with intentional conduct or gross negligence which results in serious consequences. Mere negligent or unintentional misconduct typically would not constitute a crime, except for specific offences involving human casualties or substantial economic loss, particularly related to workplace safety. For example, mere negligence could be sufficient to convict those "directly in charge" or "directly responsible" of a company for major accidents at construction sites or at the workplace.
The preceding discussion has examined laws and regulations applicable to legal representatives and directors of companies established in China. Specifically, we have provided a non-exhaustive list of the civil, administrative and criminal liabilities sanctioning the conduct of legal representatives and directors, including foreigners holding these positions and the grounds to prevent foreigners from physically leaving China.