Legal guide for company directors and CEOs in China

ESG refers to environmental, social and governance-related matters. They are commonly regarded as criteria for a company’s operations in relation to the environment, employees, customers, corporate governance, etc. Under PRC law, there is currently no specific statutory directors’ duty on or in relation to matters that could be categorised as an ESG consideration. Such duties are, currently, also not stipulated or recommended in any nationwide applicable legal framework. In particular, China does not have a unified Corporate Governance Code to regulate ESG-related duties.

However, from a civil and corporate law perspective, Article 147 of the PRC Company Law stipulates that directors, supervisors and senior management personnel shall comply with laws, administrative regulations and the Articles of Associations of the company, and bear a duty of loyalty and diligence towards the company. Thus, it is possible that the Articles of Association, a code of conduct or other internal rules of a company stipulate specific duties of directors and management personnel on ESG-related matters. For management personnel, such duties are additionally possible to be stipulated in their labour contracts. Therefore, in order to identify any ESG-related duties of directors and management personnel, the above-mentioned legal documents should be reviewed in the individual case.

As a basic principle under PRC law, a director or manager of a PRC limited liability company is personally liable towards a third party generally only for his or her personal actions, not for his or her operational activities. It is unlikely that third parties will directly raise civil claims against a director or manager for the acts (e.g. breach of contract) of the company. Under normal circumstances, even if a director, supervisor or manager is internally considered to be responsible for a breach of contract by the company, he or she will not assume external civil liability towards a third party.

From an administrative and criminal law perspective, there are numerous stipulations according to which the “responsible person”, “person directly in charge”, “person directly responsible” or “major person in charge” can be liable. Due to the immense administrative legislation of the PRC, an exhaustive summary of the potential administrative liability is practically unobtainable. Below are some examples:

Under Article 63 of the PRC Environmental Protection Law, where a company commits any of the violations stated below, besides imposing a penalty, the competent departments of environmental protection shall transfer the case to the public security organ which shall impose an (administrative) detention of no less than 10 days, and up to 15 days, on the persons directly in charge and other persons directly responsible. If the circumstances are relatively minor, a detention for no less than 5 days, and up to 10 days, shall be imposed:

• construction projects without an environmental impact assessment in accordance with the law have been ordered to be suspended, but the company of such projects has refused to do so
• the company that discharged pollutants in violation of the law and without a pollutant discharge licence has been ordered to suspend discharging pollutants, but it has refused to do so
• the company has discharged pollutants illegally using measures to avoid supervision
• the company that produced and used forbidden pesticide has been ordered to rectify, but it has refused to do so.

According to Article 338 in conjunction with Article 346 of the PRC Criminal Law, where a company discharges, dumps or disposes of radioactive waste, waste containing infectious disease pathogens, toxic substances or other harmful substances, and thus seriously pollutes the environment in violation of the provisions of the State, detention or imprisonment of up to 7 years (or above 7 years in especially severe cases) shall be imposed on the persons directly in charge and other persons directly responsible, besides a penalty which shall be imposed on the company.

However, there is no statutory definition for the terms “person directly in charge” and “person directly responsible” under PRC law. In a commercial context, the responsible person of a company often refers to the Legal Representative and/or the General Manager. Also, persons to whom a relevant task has been assigned may be regarded as a “person directly in charge” or a “person directly responsible”, if, for instance, they are recorded as “person in charge” for environmental issues or work safety at the competent authorities.

Matters that can be categorised as an ESG consideration on employees’ welfare are usually stipulated as an obligation of the employer under PRC law. According to Article 76 of the PRC Labour Law, for instance, the employer shall create conditions to improve collective welfare and increase the employees’ social benefits. There is currently no specific statutory directors’ duty containing obligations on employee welfare under PRC law.

According to Article 17 of the PRC Company Law, a company shall protect the legitimate rights and interests of its employees, enter into employment contracts with its employees in accordance with the law, purchase social insurance for employees and strengthen labour protection so as to ensure work safety. A company shall, through various means, enhance the professional education and in-service training of its employees so as to improve their quality as employees. According to Article 21 of the PRC Work Safety Law, the major person in charge of a production or operation company shall have the following duties with regard to work safety efforts of the company:

• establishing, improving and implementing a responsibility system for work safety of all employees of the entity, and strengthening the development of standards for work safety
• organising the formulation and implementation of work safety-related rules and systems and operating procedures of the entity
• organising the formulation and implementation of work safety education and training plans of the entity
• ensuring the effective execution of input in regard to work safety of the entity
• organising the establishment and implementation of the dual prevention mechanism of level-to-level safety risk management and control and hidden danger identification and management, supervising, urging and inspecting work safety efforts of the entity, and eliminating the potential for work safety accidents in a timely manner
• organising the formulation and execution of emergency rescue plans for work safety accidents of the entity
• reporting work safety accidents truthfully and in a timely manner.

The PRC Work Safety Law requires that a production or operation company shall specify the responsible persons for the respective posts, but it does not define the term “major person in charge”. The “major person in charge”, as defined in the Interpretation of the PRC Work Safety Law (jointly released by the Legislative Affairs Commission of the Standing Committee of the National People’s Congress and the Ministry of Emergency Management) and the Reply from the Ministry of Emergency Management, must be the main decision-maker in the production and operation activities of the production and operation unit; enjoy the final decision on the production and operation activities of the unit, including production safety matters; and lead the overall production and operation activities. For example, if the major production and operation matters of the production and operation unit should be decided by the Board of Directors, then the Chairman of the Board of Directors will likely be regarded as the major person in charge. However, a director who is not the Chairman but has given an affirmative vote for a Board resolution on a work safety related matter may possibly also be regarded as the major person in charge in regard to the resolved matter and bear the relevant liability under the PRC Work Safety Law.

As to ESG considerations on gender pay inequality, Article 48 of the PRC Constitutional Law stipulates that women in the PRC shall enjoy equal rights with men in all spheres of life: political, economic, cultural, social and familial. However, there is no specific regulation on any obligation of directors in this regard.

We have not identified any recent changes to directors’ responsibilities in relation to ESG considerations in the PRC. Also, no changes with regard to directors’ responsibilities in relation to ESG considerations are expected in the near future according to the latest legislation plans issued by the PRC legislative body.

We have not identified any explicit statutory obligations on directors in relation to ESG disclosure and/or reporting in the PRC.

There are merely reporting and/or disclosure obligations for directors of listed companies. This is reflected under Articles 82 and 85 of the PRC Securities Law, under which the directors, supervisors and senior officers of an issuer shall guarantee that the issuer discloses information in a timely and fair manner, and guarantee the authenticity, accuracy and completeness of the information so disclosed. Where an information disclosure obligor fails to disclose information as required, or any published securities issuance document, periodical or ad hoc report or any other information disclosed, contains any false record, misleading statement or major omission, causing losses to investors in the course of securities trading, the information disclosure obligor shall be liable for compensation; the controlling shareholder, actual controller, director, supervisor, senior officer or any other person directly liable of the issuer, as well as the sponsor, underwriting securities company or the person directly liable thereof, shall be jointly and severally liable for compensation together with the issuer, unless they are able to prove that they are not at fault. Further, under Articles 80 and 81 of the PRC Securities Law, when any major event occurs that may: (i) materially affect the stock trading price of a listed company or any company whose stock is traded on any other national securities trading place approved by the State Council; (ii) materially affect the trading price of listed corporate securities; and (iii) is not in the public domain; the company shall immediately submit an ad hoc report on the event to the securities regulatory authority under the State Council and the stock exchange and make a public announcement thereon, in which the cause of the event, the current status and any possible legal consequences of the event shall be indicated. Since the scope of the information disclosure obligation of the directors of listed companies is very broad, we do not exclude the possibility that directors of listed companies may be required to disclose and/or report certain matters in relation to ESG in these scenarios

Most foreign-invested enterprises are established as limited liability companies under PRC law. The advantage is that shareholders are generally liable only for their contribution to the registered capital of the company.

The highest authority of a limited liability company is the shareholders’ meeting. As a rule, these companies also have a Board of Directors, which must consist of three to 13 members. However, limited liability companies with a relatively small number of shareholders, or which are relatively small in scale, may have one single Executive Director instead of a Board of Directors.

All limited liability companies including joint ventures must have a Supervisory Board consisting of three members. One member of the Supervisory Board must be an employee representative. To avoid this, companies which operate on a small scale, or which have a small number of shareholders, can choose to have only one or two supervisors instead of a Supervisory Board. Supervisors are appointed by the shareholders. Directors and managers may not simultaneously serve as supervisor of the same company.

These categories do not exist for limited liability companies under PRC law.

There are few legal restrictions on who can become a director. In general, any natural person with full civil capacity may become a director. In particular, a director is not required to be resident in China and there is no nationality requirement.

However, according to the PRC Company Law, any person who was convicted of certain financial crimes, who was personally responsible for the bankruptcy of a company in which he or she acted as director or manager, or who was personally responsible for the revocation of the business licence of a company of which he/she was the legal representative, can only be appointed as a director again after a certain time period (three or five years) has passed. Also, persons who have a relatively large amount of debts due but unpaid cannot act as directors. A supervisor cannot act as a director or manager of the same company at the same time.

The members of the Board of Directors are appointed by the shareholders. The term of office of the directors is stipulated in the Articles of Association of the company, but each term of office may not exceed three years. 

A director can be reappointed upon expiry of his or her term of office and hold consecutive terms. If no timely reappointment is carried out after the expiry of the term of office of a director, or if the number of the members of the Board of Directors is less than the quorum due to the resignation of some directors from the Board of Directors prior to the expiry of their term of office, the original directors shall continue to perform their functions as directors according to law before the newly appointed directors assume their roles.

According to the PRC Administrative Regulations on Company Registration (Revised in 2016), the appointment of directors must be filed with the competent Market Supervision Administration for recordal in order to be effective towards third parties.

A director is subject to removal by the shareholder which appointed him/her at any time. A director may also resign from his/her office at any time by giving notice to the company, unless the Articles of Association of the company stipulate otherwise.

According to the PRC Administrative Regulations on Company Registration (Revised in 2016), the removal of directors must be filed with the competent Market Supervision Administration for recordal in order to be effective towards third parties.

Under PRC law, a company only has one legal representative. The legal representative must be registered with the company registration authority, i.e. the competent Market Supervision Administration. Persons other than the legal representative may only represent the company on the basis of a power of attorney issued by the legal representative.

The Chairman of the Board of Directors or the Executive Directors is usually registered as the legal representative. Alternatively, the General Manager may be registered as legal representative.
A specific PRC characteristic to note is that the company seal has the same validity as the signature of the legal representative, i.e. contracts and documents affixed with the company seal are, generally, valid and legally binding, even if they have not been signed.

According to PRC Company Law, a Board of Directors must have between three and 13 members.
Under PRC Company Law, there is no minimum number of board meetings. Normally a limited liability company has at least one board meeting every year. Meetings of the Board of Directors are convened and presided over by the Chairman of the Board of Directors. Each director has one vote.

The discussion methods and voting procedures of the Board of Directors of limited liability companies are flexible and are subject to the stipulations of the Articles of Association.

It is not mandatory for a company and not very common to sign a service contract or employment contract with its board members for their services. Also, it is not mandatory for a company and not very common to pay any remuneration to board members.

PRC Company Law sets out restrictions on a director’s activities so as to prevent situations of conflict of interest. The Articles of Association may stipulate additional limitations. Under PRC Company Law, a director of a company:

• is prohibited from entering into contracts or conducting transactions with the company unless otherwise provided in the company’s Articles of Association or with the consent of the shareholders
• is not allowed to take advantage of his/her position to exploit for himself/herself or third parties commercial opportunities that should belong to the company, or to operate on his/her own behalf or for third parties in the same type of business as that of the company without the consent of shareholders.

As part of the Board of Directors, the duties of the individual board members are limited to participation in the joint decision-making of the Board of Directors. Besides that, directors, with the exception of the Chairman of the Board of Directors, do not have any independent duties unless specifically entrusted to them by the Board of Directors.

Directors owe obligations of fidelity and diligence to the company. Directors should not infringe the interests of the company by taking advantage of his/her relationship with the company, e.g. directors may not use their functions and powers to accept bribes or other illegal income, misappropriate the company’s funds, deposit the company’s funds into an account under their own names, use the company’s property to provide loans or guarantees to a third party without consent of the shareholders’ meeting, seize property belonging to the company, take commissions on transactions between others and the company, take advantage of his/her position to exploit for himself/herself or third parties commercial opportunities that should belong to the company, or operate on his/her own behalf or for third parties in the same type of business as that of the company without the consent of shareholders. In addition, PRC Company Law imposes a statutory obligation of confidentiality on directors.

Towards the company.

PRC law does not provide for specific stipulations in this regard. As set out above, the members of the Board of Directors owe obligations of fidelity and diligence to the company and shall act in the best interests of the company. According to Article 125 of the PRC Enterprise Bankruptcy Law, the directors, supervisors or officers of a bankrupt enterprise that have violated the duties of loyalty and diligence and led to the bankruptcy of the enterprise shall bear relevant civil liability. Further, persons involved in circumstances as set out in the preceding sentence shall not act as a director, supervisor or officer of any enterprise for three years from the date of conclusion of bankruptcy proceedings. 

It is further noteworthy that, unlike in other jurisdictions, under PRC law, even if a company is insolvent, there is no obligation of the legal representative, the members of the Board of Directors or the General Manager to apply for insolvency proceedings.

It is suggested that, as soon as the directors are aware that a company is in financial difficulty, they seek external advice.

If directors of a company breach the law, administrative regulations or the Articles of Association of the company in the performance of their functions and cause losses to the company, they are liable to compensate the company. With regard to third parties, the company as a legal person bears civil liability for the operational activities of its personnel including directors. Therefore, as a basic principle, in respect of civil liability, a board member of a company is personally liable towards a third party only for his personal actions but not for his/her corporate actions.

In addition to the civil liabilities mentioned above, the directors of a company may also be subject to administrative and criminal liabilities. Administrative liability of board members can occur by being the “responsible person”, “directly responsible person” or “main person in charge”, as set out above. Criminal liability of board members can occur through providing false financial and accounting reports  and, thereby, causing damages to the shareholders or the public; concealing property in the process of liquidation and, thereby, impairing the interests of creditors; tax evasion of more than 10% of the tax payable and more than RMB 10,000; forging VAT invoices; misappropriation of corporate funds; misuse of credit; insurance fraud; smuggling of certain goods; money laundering; fraudulent use or violation of intellectual property rights; disclosure of confidential information and corruption. In all of the above cases, a director’s criminal liability requires the criminal act to have been committed within the area of responsibility of the relevant  person and the relevant person to have been at fault and to have acted at least with gross negligence.

In practice, the liability risks for directors can be mitigated through the following measures:

• Companies should stipulate a clear allocation of the responsibilities of their directors and management personnel and strict compliance with PRC law in the Articles of Association, management by-laws, code of conduct, employees' labor contracts, etc. They should obtain all necessary permits for their operation and introduce and document sufficient standards and control measures in relation to ESG.
• An indemnification clause can be included in the Articles of Association stipulating that if directors, in performing their duties on behalf of the company, incur liability towards third parties, they shall be indemnified by the company except for intentional misconduct or gross negligence or serious dereliction of their duties. Such a clause protects the directors against any remaining risk of compensation or monetary fines in case of negligent breach of their duties.
• Companies may further consider taking out a Director and Officer Liability Insurance in order to protect directors from liabilities incurred when they perform their duties on behalf of the company.

Solvency: one of the highest priorities is to address the short- and long-term financial sustainability of the company. This will require a careful assessment of projected cash flow solvency as well as balance sheet solvency. Directors must ensure that they have up-to-date management information on which to base their decisions, together with a firm grasp on how the company’s markets and prospects were affected and are likely to be further affected by the crisis. Unpredictability on the end of the crisis and the speed of economic recovery means that directors should plan for a variety of different scenarios, and develop alternative plans that can be implemented as necessary, particularly if the worst case outcomes seem likely. Directors of companies threatened with insolvency should (i) seek specialist advice, both legal and financial, (ii) ensure that all directors and key stakeholders and shareholders are kept informed and onside, and (iii) keep a clear record of their decision-making, and the materials available to them to review. Where the company is part of a wider group, the directors must keep in mind that they owe their duties to the company itself and not to the wider group or the parent company.

Risk: even if the company’s solvency is not in question, directors are likely to be faced with a number of difficult decisions as they develop their strategy for the company. For example, the need to ensure safe working conditions for staff will often conflict with purely commercial objectives. Consumer-facing companies will also have to manage new reputational issues as public expectations of those companies shift as a result of the crisis, and ensure their communication strategy is adequately prioritised. Directors need to find a way to balance these competing considerations, in the long-term interest of the company.

Logistics: directors should address the logistical challenges which international lockdown rules and social distancing create. Existing operations including supply and distribution chains, and internal processes such as accounting, reporting and HR management, might be disrupted. During the crisis, it may be difficult for directors to hold meetings in the normal way. There is no restriction under PRC law on holding virtual meetings (although the company’s constitutional documents should be checked). Methods of communication with shareholders should be reviewed, and consideration given to any upcoming shareholder meetings, or any required shareholder authorisations. Many shareholder authorisations may be obtained by written resolutions, and communications to shareholders can be sent electronically (subject to any prohibitions in the company’s constitutional documents). However, shareholder or Board resolutions to be submitted to PRC authorities must be in written form and actually be signed.

In considering the issues noted above, directors need to be aware of the measures that have been announced by government authorities to assist companies through the crisis, and determine which ones are relevant to the company. 

So far in the PRC, a variety of policies and schemes have been published on both state and local levels for the purpose of reducing burdens during the COVID-19 crisis.

These policies and schemes that are still valid and effective in 2021 include:

• Preferential Tax Policies: the expiration date of preferential tax policies provided previously by the Announcement on the Value-added Tax Policy in Support of Resumption of Work and Business among Individual Businesses ("Announcement No. 13") jointly released by the Ministry of Finance ("MOF") and the State Taxation Administration ("STA") in 2020 has now been extended to 31 December 2021. The VAT levy rate of small-scale VAT payers in Hubei Province and the VAT prepayment rate continues to be 1%, compared with 3% prescribed by the nationwide regulations. Also, the expiration date of preferential tax policies provided previously by the Announcement on Relevant Individual Income Tax Policies in Support of Prevention and Control of the Pneumonia Outbreak Caused by Novel Coronavirus ("Announcement No. 10", i.e. IIT exemption on qualified individuals) and the Announcement on Relevant Tax Policies in Support of Prevention and Control of the Pneumonia Outbreak Caused by Novel Coronavirus ("Announcement No. 25", i.e. VAT exemption on the incomes of the film industry, extension of loss carry-forward period for the film industry and the waiver of cultural cause development fee) jointly released by the MOF and the STA have now been extended to 31 December 2021 according to the Announcement on Continuously Implementing Some Tax Preferential Policies in Response to the COVID-19 Epidemic.
• Earmarked Funds: when allocating earmarked funds, SMEs in foreign trade shall be favoured. According to the MOF, small- and medium-sized foreign-invested enterprises shall have equal access to these earmarked funds.
• Training subsidies: companies providing either offline or online occupational training to employees during the periods of work suspension and operational resumption can enjoy training subsidies.

For more details on the relevant national and provincial policies, please refer to: ”The Chinese Government on foreign-invested enterprises to mitigate the impact of the COVID-19 Pneumonia” dated 13 February 2020, “Coronavirus Outbreak: What can companies do in HR management during the epidemic period?” dated 7 February 2020 and "CMS, China | Chinese Tax Regulation Update | March 2021" dated 1 April 2021.