2024.01.09 ZHENG, Yu、SHI, Yingru
On December 29, 2023, the Standing Committee of the National People’s Congress (NPC) adopted at its seventh session the latest amendment to the Company Law of the People’s Republic of China, which will come into effect on July 1, 2024 (the “New Company Law”). The draft amendment has been reviewed three times and solicited for public opinion: the first review took place during the Standing Committee of the 13th NPC at its 32nd session in December 2021, the second review took place during the Standing Committee of the 13th NPC at its 38th session in December 2022, and the third review took place during the Standing Committee of the 14th NPC at its 5th session in August 2023.
Compared with the current Company Law of the People’s Republic of China, as amended by the fourth amendment in 2018 (the “Old Company Law”), the New Company Law will have a substantial impact on the compliance obligations and risks associated with the performance of the duties of directors, supervisors and senior management personnel who hold important company roles (collectively “DSMs”).
In this article, we highlight the compliance obligations for DSMs following the implementation of the New Company Law and bring attention to the changes involved to ensure the compliance of DSMs. We aim to mitigate any potential liabilities and risks to which companies and DSMs may be exposed, due to non-compliance.
I. Executive Summary
Compared to the Old Company Law and its judicial interpretations, the New Company Law imposes clearer and greater compliance obligations on DSMs. The key highlights are:
(1) The New Company Law (i) provides clarification on the guidelines and standards for performing the “duty of loyalty” and the “duty of diligence” of DSMs; (ii) includes that supervisors are to be regulated by the rules governing related party transactions and non-competition; and (iii) includes the following persons/entities to be regulated by the rules governing related party transactions: (a) DSMs’ close family members, (b) the entities directly or indirectly controlled by DSMs or their close family members; and (c) persons who are considered to be related parties of DSMs;
(2) If directors or senior management personnel cause losses to a third party during the performance of their duties, the company shall be liable for such losses, while the director or senior management personnel concerned shall also be liable for compensation, provided that the losses are caused by the director’s or senior management personnel’s willful misconduct or gross negligence;
(3) Directors and senior management personnel are obligated to exercise independent judgment and ensure compliance with the applicable laws and regulations in performing their duties, and shall assume joint and several liability if they are instructed by the controlling shareholder or actual controller to engage in any act that violates the law and is detrimental to the interests of the company or its shareholders;
(4) DSMs are obligated to protect and preserve a company’s capital. Failure to do so can result in joint and several liability or compensation liability; and
(5) Directors are responsible for a company’s liquidation. Failure to do so can result in the director’s liability for compensation.
II. Material Compliance Obligations and Risks which DSMs Need to be Aware of
1. Duties of loyalty and diligence
Old Company Law
New Company Law
JunHe Comments
[Specific definition of the duties of loyalty and diligence]
[The Old Company Law only mandates DSMs to bear the duty of loyalty and the duty of diligence toward the company (Article 147). However, it does not define the standards or principles for performing such duty.1]
[Specific definition of the duties of loyalty and diligence]
Directors, supervisors and senior management personnel owe a duty of loyalty towards a company and shall take measures to avoid any conflict of personal interest with the interest of the company and shall not exploit their position or authority to obtain inappropriate gains.
Directors, supervisors and senior management personnel owe a duty of diligence towards the company and shall exercise reasonable care in the performance of their duties as an ordinarily prudent officer would take to ensure that they act in the best interest of the company.
The provisions of the preceding two paragraphs shall apply to controlling shareholders and actual controllers who do not serve as directors but have de facto control of a company’s operations. (Article 180)
The New Company Law establishes more precise standards and guidelines for fulfilling the duties of loyalty and diligence for DSMs.
With respect to the “duty of loyalty”, the New Company Law specifies that DSMs shall take measures to avoid conflict of interest between their personal interests and the company’s interests and shall not exploit their position or authority for inappropriate gains.
With respect to the “duty of diligence”, the New Company Law stipulates that DSMs shall exercise reasonable care in the performance of their duties as an ordinarily prudent officer would take to ensure that they are acting in the best interest of a company.
Furthermore, the New Company Law provides that controlling shareholders and actual controllers who do not serve as directors but have de facto control of a company’s operations, known as “de facto directors”, are also bound by the duties of loyalty and diligence towards a company.
[Related party transactions]
Directors and senior management personnel are prohibited from engaging in the following acts … (4) entering into a contract or transaction with a company in violation of the articles of association or without the approval of the board of shareholders or the general assembly of shareholders … (Article 148)
[Related party transactions]
In case any director, supervisor or senior management personnel intends to, directly or indirectly, enter into any contract or transaction with a company, such director, supervisor or senior management personnel must report the proposed contract or transaction to the board of directors or the board of shareholders for review and approval in accordance with the articles of association of the company.
The provisions of the preceding paragraph shall apply to contracts or transactions with a company to which any close family member of a director, supervisor or senior management personnel, or any entity directly or indirectly controlled by a director, supervisor, senior management personnel or their close family member, or any other related person that is affiliated with a director, supervisor or senior management personnel, is a party to. (Article 182)
The New Company Law expands the scope of the regulations on related party transactions in the following respects:
Expanding the range of persons subject to regulations and restrictions governing related party transactions, to cover not just directors and senior management personnel, but also supervisors.
Further expanding the range of related persons to include: (1) close family members of DSMs; (2) entities directly or indirectly controlled by DSMs or their close family members; and (3) other related parties of DSMs.
Introducing additional obligations on DSMs to report related party transactions to the board of directors or the board of shareholders for approval in accordance with the articles of association of a company.
[Non-competition]
Directors and senior management personnel are prohibited from engaging in the following acts … (5) seeking business opportunities for themselves or for any other person by exploiting their positions or authority, or engaging in for their own account or for any other person, any business similar to that of a company, without the approval of the shareholders’ meeting … (Article 148)
[Non-competition]
Directors, supervisors and senior management personnel shall not engage in, for their own account or for any other person, any business similar to that of a company in which they hold office, unless and until they report the conduct of such business to the board of directors or the board of shareholders and obtain approval from the board of director or the board of shareholders, as applicable, in accordance with the articles of association of a company. (Article 184)
The New Company Law expands the scope of non-competition restrictions in the following respects:
Expanding the range of persons bound by non-competition restrictions to cover supervisors.
Introducing additional obligations on DSMs to report their undertaking of or employment with competing business to the board of directors or the board of shareholders for approval in accordance with the articles of association of a company.
2. Liability for losses suffered by third parties arising from the performance of duties
Old Company Law
New Company Law
JunHe Comments
Where directors, supervisors or senior management personnel perform their duties in violation of any law or administrative regulation or the articles of association of a company, they shall compensate the company for any resulting losses. (Article 149)
(This liability for compensation does not extend to losses caused to a third party.)
Where directors, supervisors or senior management personnel perform their duties in violation of any law or administrative regulation or the articles of association of a company, they shall compensate the company for any resulting losses.
If the directors or senior management personnel perform their duties and cause any losses to a third party, the company shall bear the liability for compensation; and the concerned directors or senior management personnel shall also bear the liability for compensation in case of willful misconduct or gross negligence. (Article 191)
While retaining the provisions of the Old Company Law regarding the liability of DSMs for losses suffered by a company as a result of their performance of duties in violation of the laws or administrative regulations or the articles of association, the New Company law introduces new obligations for directors and senior management personnel (other than supervisors) to bear the compensation liability for losses caused to third parties in the performance of their duties due to willful misconduct or gross negligence.
3. Obligations of directors and senior management personnel to exercise their duties independently and compliantly
Old Company Law
New Company Law
JunHe Comments
N/A
Where the controlling shareholder or actual controller of a company instructs any directors or senior management personnel to take action that is detrimental to the interests of the company or its shareholders, the controlling shareholder or actual controller, as the case may be, shall assume joint and several liability with the concerned directors or senior management personnel. (Article 192)
The New Company Law reinforces the obligations of directors and senior management personnel to exercise their duties independently and compliantly, and refrain from being influenced by controlling shareholder or actual controller to act detrimentally to the interests of the company or its shareholders.
Failure to fulfil such obligations could result in the risk of joint and several liability with the controlling shareholder or actual controller.
4. Obligations to preserve a company’s capital
Old Company Law
New Company Law
JunHe Comments
[Shareholder’s failure to make capital contributions]
[Directors and senior management personnel owe a duty of diligence only in case of any capital increase of a company and shall be liable if failing to fulfil their obligations. (See Article 13 of the Third Juridical Interpretation on the Old Company Law)2]
[Shareholder’s failure to make capital contributions]
Upon the establishment of a limited liability company, the board of directors shall verify the capital contributions made by shareholders and pursue the payment of any outstanding contributions by procuring the company to send a written capital call to the defaulting shareholder which fails to pay the full amount of contributions on time as set forth in the articles of association of the company.
Directors who fail to fulfil their obligations set forth in the preceding paragraph and thereby cause losses to the company shall be held liable for compensation. (Article 51)
The New Company Law specifies that after the establishment of a company, the directors shall be responsible for verifying the shareholders’ capital contributions and urge the payment of outstanding contributions, the failure of which will result in the directors’ liability for compensation.
[Illegal withdrawal of contributed capital]
[This only provides that DSMs who assist a shareholder in withdrawing its contributed capital shall assume joint and several liability. (See Article 14 of the Third Juridical Interpretation on the Old Company Law)3]
[Illegal withdrawal of contributed capital]
Shareholders are prohibited from withdrawing their contributed capital after a company is established.
Any shareholder in breach of the preceding paragraph shall refund the capital it has withdrawn; and if it causes losses to the company, the directors, supervisors and senior management personnel who are responsible shall bear joint and several liability for compensation with the concerned shareholder. (Article 53)
Any DSMs who are “responsible for withdrawing contributed capital” shall bear joint and several liability for compensation with the concerned shareholder, which undoubtedly imposes greater obligations on DSMs to protect and preserve a company’s capital.
[Providing financial assistance to a third party to acquire the shares of a company]
N/A
[Providing financial assistance to a third party to acquire the shares of a company]
A company shall not provide grants, loans, guarantees or other financial assistance for a third party to acquire the shares of a company or its parent company, except in connection with an employee stock ownership plan implemented by the company.
To promote the best interests of a company, a company may, subject to the resolution of the board of shareholders, or the resolution adopted by the board of directors in accordance with the articles of association or with the authorization by the board of shareholders, provide financial assistance for a third party to acquire the shares of the company or its parent company; provided that the total amount of such financial assistance in aggregate shall not exceed ten percent of the total amount of issued share capital. Resolutions of the board of directors require approval and adoption by more than two-thirds of all directors.
In case of any breach of the preceding two paragraphs leading to losses to the company, the directors, supervisors and senior management personnel who are responsible for such breach shall bear the liability for compensation. (Article 163)
The New Company Law introduces a new provision that in the event that a company provides financial assistance for a third party to acquire its shares in violation of this law and thereby suffers losses, the DSMs who are responsible for such financial assistance shall bear the liability for compensation.
[Unlawful profit distribution]
N/A
[Unlawful profit distribution]
If a company distributes profits to its shareholders in violation of this law, the shareholders shall return the profits unlawfully distributed to the company; in case of any losses to the company, the shareholders and the directors, supervisors, and senior management personnel who are responsible for such unlawful distribution shall bear the liability for compensation. (Article 211)
The New Company Law introduces a new provision that in the event that a company makes profit distributions to its shareholders in violation of this law and thereby suffers losses, the DSMs who are responsible for such unlawful distribution shall bear the liability for compensation.
[Unlawful capital reduction]
N/A
[Unlawful capital reduction]
In case of a reduction of the registered capital of a company in violation of this Law, the shareholders shall refund the funds they have received, and the capital contributions subscribed by the shareholders that are reduced or discharged shall be restored to the original amount; in case of any losses to the company, the shareholders and the directors, supervisors, and senior management personnel who are responsible for such unlawful capital reduction shall bear the liability for compensation. (Article 226)
The New Company Law introduces a new provision that in the event that the registered capital of a company is reduced in violation of this law resulting in losses to the company, the DSMs who are responsible for such unlawful capital reduction shall bear the liability for compensation.
5. Obligations of liquidation
Old Company Law
New Company Law
JunHe Comments
[The liquidation procedures of a limited liability company are under the responsibility of shareholders, while those of a joint stock company are under the responsibility of directors and controlling shareholders. (See Article 18 of the Second Judicial Interpretation on the Old Company Law)4]
If a company is dissolved in accordance with items 1, 2, 4 or 5 of the first paragraph of Article 229 hereof, the company shall be liquidated. Directors shall be the obligors in the company’s liquidation and shall set up a liquidation committee within 15 days after a liquidation event occurs.
The liquidation committee shall be composed of the directors, unless otherwise provided in the articles of association of the company or otherwise appointed by the board of shareholders upon resolution.
If the liquidation obligor fails to fulfill the liquidation obligation in a timely manner and causes losses to the company or creditors, this liquidation obligor(s) shall bear the liability for compensation. (Article 232)
The New Company Law expressly states that directors are the obligors in a company’s liquidation and imposes greater responsibility on the liquidation obligors. This amendment aligns with the Civil Code5 and further specifies that directors shall compensate for losses caused by their failure to fulfill the obligations of liquidation in a timely manner.
III. Comments and Recommendations
The New Company Law imposes clearer and greater obligations and responsibilities on DSMs to perform their duties in compliance with the laws and regulations, and has a significant impact on DSMs. Some provisions in the New Company Law regarding the obligations of DSMs require further clarification. For example, in the event of the illegal withdrawal of contributed capital by a shareholder, unlawful profit distribution or unlawful capital reduction, when would DSMs likely be considered “responsible” and are therefore required to compensate for losses? If DSMs are held liable for compensation, how will the specific proportion of liability be determined? Judicial interpretations are expected to address these issues in the light of the implementation and application of the New Company Law.
In order for DSMs to ensure compliance in the performance of their duties and minimize the potential liabilities and risks that both companies and DSMs may be exposed to due to non-compliance with the New Company Law, we have the following recommendations:
(1) Keep a close watch on the material impact of the New Company Law on compliance obligations for DSMs, and seek guidance from internal or external counsels to obtain a comprehensive understanding of the detailed requirements for compliance obligations and the legal consequences of any violations;
(2) Actively fulfill all legal duties and obligations in the ordinary course of business and management of the company, in order to avoid liability for non-compliance with laws and regulations; and
(3) If appropriate, advise the company to communicate with insurance companies to adjust the coverage provided under the Directors and Officers Liability Insurance policies against the expanded range of liability that DSMs may be subject to as a result of the implementation of the New Company Law.
1. Current judicial practice adopts, in general, reasonable care as the standard for DSMs to fulfill their duty of diligence. For example, in a dispute between Guangdong Shunwei Precising Plastic Co., Ltd. and Guo Zhiyu over the liability for losses caused to the company (Case No. (2018) Yue 06 Min Zhong No.9456), the court held that the duty of diligence required that in the performance of their duties (i.e. dealing with the company’s affairs), the senior management personnel of a company must act in good faith in the best interests of the company, with due care and diligence as a responsible manager, and exercise reasonable care that an ordinarily prudent manager would exercise.
2. Article 13 of the Provisions of the Supreme People’s Court Regarding Certain Issues Concerning the Application of the Company Law of the People’s Republic of China (III) (2014 Amendment): “… Where any shareholder fails to fulfill or fully fulfill the obligation of capital contribution at the time of capital increase, if the plaintiff initiating a lawsuit in accordance with paragraph 1 or 2 of this Article claims that the directors or senior management personnel who fail to fulfill the obligations as prescribed in paragraph 1 of Article 147 of the Company Law and thereby cause the failure of the company to collect its full capital contributions shall be liable to the extent of their obligations owed, the people’s court shall uphold such a claim; and the directors or senior management personnel may, after assuming the liabilities, recover from the defendant shareholder.”
3. Article 14 of the Provisions of the Supreme People’s Court Regarding Certain Issues Concerning the Application of the Company Law of the People’s Republic of China (III) (2014 Amendment): “Where any shareholder withdraws any contributed capital, if the company or any other shareholder files a claim against such shareholder to refund the principal and interest on the contributed capital to the company and pursue joint and several liability against the other shareholders, directors, senior management personnel or actual controller providing assistance in withdrawing the contributed capital, the people’s court shall uphold such claims. Where the creditors of the company claim that the shareholder who withdraws any contributed capital shall be held liable for supplementary compensation for the debts that the company is unable to pay to the extent of the principal and interest on the capital contributions that have been withdrawn, and that other shareholders, directors, senior management personnel or actual controller providing assistance in withdrawing the contributed capital shall assume joint and several liability, the people’s court shall uphold such claim; and where the shareholder who withdrew the contributed capital has assumed its liability as provided above, if other creditors make the same claim, the people’s court will not uphold such a claim.”
4. Article 18 of the Provisions of the Supreme People’s Court Regarding Certain Issues Concerning the Application of the Company Law of the People’s Republic of China (II) (2020 Amendment): “Where the shareholders of a limited liability company or the directors and controlling shareholder of a joint stock company fail to form a liquidation committee and commence the liquidation procedures within the statutory time limit and thereby cause the depreciation, loss, damage or destruction of company properties, if any creditors claim that the aforesaid persons shall be held liable for the debts of the company within the scope of losses, the people’s court shall uphold the claim. Where the shareholders of a limited liability company or the directors and controlling shareholder of a joint stock company fail to fulfill their obligations and thereby cause the destruction of material properties, books or records or other documents of the company and cause the liquidation unable to be conducted, if any creditors claim that the aforesaid persons shall be held jointly and severally liable for the debts of the company, the people’s court shall uphold the claim.”
5. Article 70 of the Civil Code: “The members of a legal person’s executive body or decision-making body, such as directors or committee members, are liquidation obligors, except as otherwise provided for by any law or administrative regulation.”
