Navigating the labyrinth: China’s enhanced Corporate and Criminal Law

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​​​​​​published on 8​ April 2024 | reading time approx. 6 minutes


The Chinese legislator enacted the latest amendment to the Company Law of the People’s Republic of China on December 29, 2023, which is effective on 1 July 2024 (“New Company Law”). On this occasion, the legislator also resolved to amend the Criminal Law, Amendment XII of which comes into force on 1 March 2024 (“Amendment XII to the Criminal Law”).


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The New Company Law imposes increased obligations and potential liabilities on, Directors, Senior Officers, Supervisors, Shareholders, and Actual Controllers, compared to the current Company Law. 


Statutorily, the term “Senior Officers” includes the (General or Company) Manager, Deputy Manager, Chief Financial Officer, and any other organ specified as “Senior Manager” in the articles of association. “Controlling Shareholder” is a shareholder whose capital contribution accounts for 50 percent or more of the total registered capital, or less in case the voting rights are sufficient to exert a material influence on resolutions in the shareholders’ meeting. An “Actual Controller” broadly refers to any person who can exert actual control over the company through any investment relationship, agreement, or other arrangement. A “Related-party Relationship” means any relationship between:​
  • ​a Controlling Shareholder, Actual Controller, Director, Supervisor, or Senior Manager of a company on the one side and 
  • an enterprise directly or indirectly controlled by that person on the other side, or any other relationship that may result in the transfer of any interest in the company.



Duty of loyalty and duty of diligence

duty of loyalty 

The New Company Law defines the terms “duty of loyalty” and “duty of diligence” for the first time. 

The expanded “duty of loyalty” focuses on the prevention of conflicts of interest. It means that all Directors, Senior Officers, Supervisors, Controlling Shareholders, and Actual Controllers shall take measures to avoid conflicts between their personal interests and the company’s interests. They shall not exploit their position or power for inappropriate gains. Further details can be spelled out, e.g., in internal regulations, like in a compliance code of conduct, in management by-laws, or an employee handbook. Such internal regulations can also define permitted activities and the processes to solve identified or suspected conflicts of interest. This can lead to the non-participation in respective decisions or approvals.

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​Statutory Prohibition/Obligation (examples)​
​​​​​​Shareholders


​​


​​​

​Prohibition to damage the interests of the company or the interests of other shareholders.
​​   Prohibition to unlawfully withdraw/reduce capital contributions, unlawfully               distribute profits.
   ​​​Prohibition to seriously damage the interests of any creditor of the company             through the evading of debt payments by abusing the independent legal person       status or shareholder limited liability 
   ​​Prohibition to participate in any vote as shareholder regarding the company      providing a guarantee to such shareholder/its Actual Controller.
​Directors, Senior Officers, Supervisors, Controlling Shareholders, and Actual Shareholders 
​Prohibition to damage the interests of the company through exploitation of a Related-party Relationship.
​​​Directors, Senior Officers, Supervisors






​Obligation to report transactions to a higher organ and obtain advance approval, if the transaction is between 
  • ​the company and
  • the Directors, Senior Officers, and Supervisors themselves, or their “close relatives,” or enterprises controlled by either of them, or parties having Related-Party Relationships with Directors, Senior Officers, and Supervisors. ​
   Obligation not to exploit company business opportunities for themselves or               others, unless specified exceptions apply.
   ​Prohibition to compete with the company business directly or indirectly, except       with an approval of a higher company organ.
   ​Explicit prohibition to 
  • embezzle company property or misappropriate company funds
  • divert company funds into their own or into third party accounts
  • engage in bribery or accept illegal income
  • personally, to accept commissions on company transactions
  • disclose confidential company information without authorization
​​Directors


 
​Prohibition of Directors with Related-party Relationship concerns to participate in any vote thereon.
   ​Obligation to check the contribution of registered capital, and to cause written         demand letters to be sent by the company to the defaulting shareholder.
​Legal Representative (can be a Director, or Manager)
​Prohibition to cause harm to others during performance of duties.


duty of diligence

With respect to the “duty of diligence,” the New Company Law specifies that Directors, Senior Officers, Supervisors, Controlling Shareholders, and Actual Controllers shall exercise reasonable care in the performance of their duties, in the same way an ordinary prudent officer would do, to ensure that he/she is acting in the best interests of the company. This express obligation to exercise diligence can be regarded as a considerable progress in the Chinese law, but its detailed definition and limits will still be subject to further scrutiny in the judicial practice. Diligence is also needed despite instructions received from a higher body: A Director or Senior Officer is expressly not relieved of personal liability based on the excuse of “just following the instructions” of a Controlling Shareholder or Actual Controller. In this case, the Director or Senior Officer shall bear the joint and several liability with such Controlling Shareholder or Actual Controller.

Corresponding to the above, the New Company Law also sets out various potential liabilities.


​Potential Statutory Liability (examples)
Company​
​Civil liability for harm caused to others by a company’s Legal Representative, Director, or by a Senior Officer, during performance of duties.
​   Fines of differing amounts in different cases of statutory incompliance.
   ​Revocation of business license in case of serious illegal activity engaged in the         name of the company that endangers national security or social or public                 interests.
​​​​Shareholders​

​ ​
​Compensation to the company or to other shareholders for any losses caused to the company or to other shareholders due to abuse of shareholder rights.
​   Joint and several liability for company debts, in case of the evading of debt               payments by abusing the independent legal person status or shareholder                   limited liability.
​   Return obligation for unlawfully withdrawn/reduced capital contributions,                 unlawfully distributed profits.
   ​Fines of differing amounts in different cases of statutory incompliance.
​Directors, Senior Officers, Supervisors




​Compensation to company for losses incurred to the company due to violation of laws, regulations, or articles of association, during performance of duties.
   ​Joint and several liability of responsible Directors, Senior Officers,                             Supervisors, in case shareholder unlawfully withdraws/reduces capital                       contribution, unlawfully obtains profits, thereby causing losses to the                         company.
​​Directors, Senior Officers (but not Supervisors)



​Compensation liability for harm caused to others due to intent or gross negligence of Director or Senior Officer.
​   Legal action by shareholders possible, for damages to shareholder interests             due to violation of laws, regulations, or articles of association by Directors or       Senior Officers.
​Directors

​Compensation liability for losses to the company caused by incompliance with the obligation to check the contribution of registered capital, and to cause written demand letters being sent by the company to the defaulting shareholder.
​​Controlling Shareholders, Actual Controllers, Directors, Senior Officers, Supervisors



​Compensation liability for losses to the company caused by the exploitation of a Related-party Relationship.
​   Joint and several liability, in case Controlling Shareholder or Actual Controller         of the company instructs any Director or Senior Officer to engage in action               harmful to the interests of the company or its shareholders.
​Directly responsible management staff and other directly responsible staff
​Fines of differing amounts in different cases of incompliance with the New Company Law.

​Legal Representative 
​Compensation liability to company, if the company has assumed civil liability for harm caused to others due to fault of Legal Representative.
​Liquidators (Directors, or other persons provided for in the articles of association or elected by the shareholders' meeting)
​Compensation liability to company or its creditors if liquidators fail to timely fulfil their liquidation obligations.​

Amendment XII to the Criminal Law

Besides the New Company Law, also the Amendment XII to the Criminal Law should be considered. One of the most significant changes concerns the extension of the scope of application of various corruption and bribery offences to personnel of private companies. Previously, these offences only applied to staff of State-owned companies. The following offences are particularly noteworthy:


​​Potential Criminal Liability (examples)
​​Directors, Senior Officers, Supervisors

​Taking advantage of position in the company to conduct the same business as employer company, either himself/herself or through a third party, and thereby generate profits.
​Employees

​​​​Causing serious losses to the company through
  • ​​handing over the management of the employer's profitable business to his/her relatives or friends
  • ​purchasing goods or accepting services from the entity managed by his/her relatives or friends at a price obviously higher than the market price, or selling goods or providing services to such entity at a price obviously lower than the market price
  • ​​purchasing or accepting goods or services that are not up to standard from the entity managed by his/her relatives or friends
​Directly responsible management staff
​​Engaging in favoritism by converting company assets into equity at a low price or selling them at a low price, thereby causing a serious loss to the company.

The possibility of imposing (additional) fines and the range of prison sentences have been extended in various other criminal provisions on corruption and bribery, so that it will be possible to impose higher prison sentences once this amendment comes into force.​

Our key recommendations

  • ​Remain up to date about all compliance obligations, potential risks, and legal consequences in case of any violations under the Company Law, the Criminal Law, and other laws and regulations. The Chinese legislator is expected to still clarify certain open issues. 
  • Take proactive initiatives to check whether articles of association, internal regulations like management by-laws, employee handbooks, compliance codes of conduct, and employment contracts of Senior Officers, all comply with the revised legal landscape. Consider a respective “Health Check” with the support of legal professionals on a case-by-case basis. If required, adjust these internal documents appropriately, ensure that the persons concerned receive appropriate training, and have their acceptance and acknowledgement of the amended internal rules confirmed in writing.
  • Regularly monitor and improve the actual implementation in the daily operation and management of the company. 
  • Explore the purchase of D&O Insurance from a qualified insurance company or adjust the existing policy to cover the expanded liability range as the result of the implementation of the New Company Law. 

The New Company Law mentions liability insurance for Directors (not for Senior Officers, Supervisors) for the first time. Many multinational enterprises already maintain a global insurance scheme covering its subsidiaries worldwide, including in China. Several large Chinese insurance companies also offer directors’ and officers’ insurance (D&O Insurance) products for the Chinese market. According to the New Company Law, when a company purchases the liability insurance or renews the insurance for Directors, the Board of Directors shall report the insured amount, coverage, premium, etc. of such insurance to the shareholders’ meeting. 

Normally, the D&O Insurance only covers simple negligent mistakes while performing company related duties. Insurance coverage for, e.g., fraudulent, intentional, or grossly negligent acts is normally excluded. The company can also take out fidelity insurance to protect itself against financial losses caused intentionally by employees.​
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