Directors' duties and liabilities under China's new Company Law

Duties of directors under the New Company Law

1. A director of a PRC company should continue to owe duties of loyalty and diligence (similar to the English law concept of fiduciary duties, the Fiduciary Duties) to the company but the New Company Law provides more clarity on these duties
   
   As mentioned in our Previous Article, the New Company Law provides more clarity on what the duty of loyalty and duty of diligence entails (Article 180) and introduces new specific requirements on directors in performing the Fiduciary Duties (see sections below).
   
   The New Company Law retains the baseline requirement on a director, which is to perform his/her duties in accordance with the laws, regulations or articles of association of the company; otherwise, he/she shall be liable to compensate the company if his/her violation causes the company to suffer losses. (Article 188)
2. A director of a PRC company is explicitly prohibited from conducting any activity that constitutes a breach of the duty of loyalty
   
   Like the previous Company Law, the New Company Law explicitly sets out various activities that a director must not undertake, including, inter alia, embezzling the assets or misappropriating the funds of the company, conducting bribery or accepting any illegal income by taking advantage of his/her position as a director, and disclosing  confidential information of the company without authorization, etc. (Article 181)
   
   In addition, the New Company Law requires a director to report to, and seek approval from, the board of directors or the shareholders meeting if he/she is to be involved in related party transactions with the company, seeking business opportunities of the company, or competition with the company (Articles 182-184). 
3. The New Company Law imposes stricter requirements on a director’s duty of diligence relating to the capitalization, dividend distribution and dissolution/liquidation of the company where he/she serves as a director
   
   Under the New Company Law, a director is required to undertake the duty of diligence and safeguard the interest of the company in the following circumstances and may otherwise be liable to compensate the company:
   1. when a shareholder illegally withdraws registered capital from the company (Article 53);
   2. when the company distributes dividends to the shareholders (Article 211);
   3. when the company reduces its registered capital (Article 226); and 
   4. when the company is dissolved and liquidated (Articles 232, 234-238).
   In addition, after the establishment of a company, the board of directors must verify the shareholder’s capital contribution status. When a shareholder fails to contribute the subscribed registered capital on time as per the provisions in the company’s articles of association, the board of directors shall cause the company to send written notice to such shareholder for prompt capital contribution (Article 51).

Liabilities of directors under the New Company Law

4. Civil liabilities to different counterparties due to a breach of the director’s duties
   
   A director of a company, in breach of his/her duties or obligations, may bear civil liabilities to the company, the shareholder(s) and third party(ies):
   1. If a director is found to be in breach of his/her duties and this has caused the company to suffer losses, the company would have the right to sue the director and claim compensation. In such circumstances, the company or the  shareholder(s) (for the benefit of the company) may file a lawsuit against the director in breach (Articles 188 and 189).
   2. In the cases where a director’s breach of laws, regulations or articles of association of the Company has caused losses/damages to the shareholder(s) of the company, the shareholder(s) may directly initiate a civil claim against the relevant director for such losses/damages (Article 190).
   3. If a director has acted with willful misconduct or gross negligence when performing his/her duties, and such behavior has caused a third party to suffer losses, then such director shall be liable to the third party for compensation (Article 191). This means that third party(ies) suffering losses may directly initiate a civil claim against the relevant director (in addition to claiming against the company).
5. Administrative liabilities due to breach of the director’s duties
   
   Under the New Company Law, if a director is directly responsible for specific corporate matters and has breached his/her duties in relation to these matters, he/she may be imposed with administrative liabilities such as a fine in an amount ranging from RMB10,000 to RMB300,000. These non-compliance activities include, inter alia, (i) the company providing falsified materials or taking fraudulent measures when applying for corporate registration with the company registration authority, (ii) the information required to be publicly disclosed by the company being untrue, or (iii) the company in liquidation concealing property, recording false information in its balance sheet or financial statements, etc. (Articles 250-253 and 256)
6. Criminal liabilities arising from breach of the director’s duties
   
   A director may also be subject to criminal liabilities under the New Company Law. If (i) a director’s misconduct itself constitutes any criminal offence; and/or (ii) the company’s misconduct constitutes any criminal offence and a director is deemed as directly responsible for such misconduct, such director may be prosecuted and be held to bear criminal liabilities.

Under the New Company Law, being a very passive director in a Chinese company will be exposed to higher risks of being held to bear personal liabilities if he/she does not perform the Fiduciary Duties properly. The New Company Law allows companies to take out insurance to cover the potential liabilities that the directors may incur in preforming their duties. Foreign investors should carefully consider the competence and appropriateness of the candidates who will serve the role as a director of a Chinese company and ensure a good understanding of the scope of their duties and the potential liabilities under the New Company Law.