For more information see our overview of doing business in China and our guide to establishing a business in China.
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:
- a person with no or only limited civil capacity, e.g. a child or person with mental incapacity;
- a person who has been convicted of corruption, bribery, conversion of property, or disruption of social order within the last five years;
- a person who has been stripped of political rights for being convicted of a crime within the last five years;
- a person who acted as a director or general manager of a bankrupt or liquidated company and who is personally accountable for the bankruptcy or liquidation of the company, where less than three years have passed since the bankruptcy or liquidation;
- a person who has acted as a legal representative of a company that has had its business license revoked or was ordered to close down for a breach of law and who is personally responsible, where less than three years have passed since the business license revocation;
- a person who is unable to repay a large amount of personal debt.
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:
- a shareholders meeting or a sole shareholder;
- a board of directors made up of between three and 13 members, or in smaller companies, a single executive director, who may also serve as general manager;
- one or two supervisors for smaller companies, or a board of three supervisors for larger companies;
- normally, a general manager an, depending on size, other senior managers.
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:
- convene meetings of the shareholders and present reports to them;
- implement resolutions made by the shareholders;
- determine the operational plans and investment plans of the company;
- work out for shareholders' approval the company's:
- budget and final account plans;
- profit distribution and loss recovery plans;
- plans to increase or reduce registered capital; and
- plans on merger, split, dissolution, or change of company form.
- decide on the establishment of the company's internal management departments;
- decide on remuneration, hiring or dismissal of the company's management;
- work out the company's basic management system;
- exercise other powers stipulated in the articles of association.
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:
- amendment of the articles of association;
- suspension and termination of the company;
- increase and decrease of the registered capital;
- merger and split of the company.
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:
- prejudice the company's interest by taking advantage of his/her connected status;
- take a bribe or accept any other unlawful gain by taking advantage of his/her position or expropriating the company's assets;
- misappropriate company funds;
- deposit company funds in accounts in their own or another person's name;
- in violation of the Articles of Association, without consent of the shareholders or the board of directors, loaning the company’s fund to others or providing any guaranty to any other person using the company’s property;
- conclude contracts or trade with the company, except as allowed by the company's Articles of Association or approved by the shareholders;
- use their position, functions, and powers in the company to seek personal gain, take commercial opportunities rightly belonging to the company, or engage in the same type of business as their company, whether for their own account or that of others;
- accept for themselves commissions for transactions between the company and other parties;
- disclose company secrets without authorization; and
- commit other acts that breach the duty of loyalty of directors to the company.
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:
- indemnify the company for any damages caused to the company by the director's violation of laws, regulations, and the company's AOA;
- indemnify the company for damages caused by taking advantage of their affiliated relationship;
- account for and repay to the company any income obtained in breach of fiduciary duties.
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:
- for damages caused during the performance of their job, the directors shall be liable to the company only for intentional and gross negligence.
- the company will defend and indemnify directors and officers for any suit by any third party except where the director has acted intentionally wrongfully or grossly negligently.
- the directors are not liable to the Company or shareholders if their actions are based on a resolution of the shareholders or instructions which – in accordance with the statutory regulations and articles of association – is binding on them.
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.