Legal guide for company directors and CEOs in China

BREAKING: Coronavirus (COVID-19) considerations for directors

1. What are the key issues for directors during the COVID-19 crisis?

Solvency: one of the highest priority 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 are likely to be affected by the crisis. Uncertainty over the timetable for exit from lockdown rules, 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 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.

2. What government relief measures have been made available to directors?

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 include: 

  • Import Tax Exemption for Donated Supplies: qualifying foreign-donated supplies which are used to prevent and control COVID-19 can be exempt from import taxes, including import duty, import VAT and import Consumption Tax, during the period from 1 January 2020 to 31 March 2020.
  • Special Tax Relief for Manufacturers of Key Supplies: if enterprises producing key protective supplies for preventing and controlling COVID-19 acquire new equipment in order to enhance production capacity, the cost of equipment can be deducted against the enterprises’ taxable incomes in a one-off manner (without depreciation during its use lifetime) for PRC Corporate Income Tax purposes. Lists of named manufacturers of Key Supplies are determined by provincial administrations under the PRC National Development and Reform Commission and the PRC Ministry of Industry and Information Technology.
  • Tax Deduction for Cost of Qualified Donation: the cost of donating cash and supplies through social welfare organisations, governments on county level or above and other government bodies for preventing and controlling COVID-19 can be fully deducted from taxable incomes for the purposes of Corporate Income Tax (companies) or Individual Income Tax (individuals).
  • Loss Carry-Over: the State Tax Administration announced on 11 February 2020 that businesses in hard-hit sectors such as transportation, food serving, catering and tourism, which will have losses in 2020 due to COVID-19, can write off the loss over a maximum period of 8 years instead of 5 years. The main business revenue of the qualifying enterprises in these industries should account for more than 50% of their total revenue in 2020.
  • Tax Deadline Extension: the deadlines for the declaration of commissioned withholding and tax collection has been extended by 2 months, i.e. from end of March to end of May. 
  • Subsidies: subsidies are provided in several forms. Companies may be supported in developing their IT capabilities and using tools to work online as an alternative to working from an office. Companies renting from a State-owned enterprise can, subject to certain requirements, apply for rent reductions or exemptions for 2 or 3 months.
  • Earmarked Funds: when allocating earmarked funds, SMEs in foreign trade shall be favoured. According to the Ministry of Finance, small- and medium-sized foreign-invested enterprises shall have equal access to these earmarked funds.
  • Supporting foreign investment: PRC governments on central and local levels issued additional supporting policies on foreign investment to lessen the impact of COVID-19 (more details can be found under: Chinese Governments on Central and Local Levels Issue Additional Supporting Policies on Foreign Investment to Lessen Impact of COVID-19).
  • Designated Credits: on 25 February 2020, the State Council announced that an additional quota of RMB 350 billion had been given to policy banks in 2020, designated for the support of micro-, small- and medium-sized enterprises in the private sector. 
  • Loan Extensions: on 25 February 2020, the State Council requested banks to be lenient when companies have difficulties in repaying debts. Outstanding loans should be renewed rather than withdrawn, and companies should also be allowed to defer interest or principal payments.
  • Social insurance premiums: as from February 2020, medium-, small- and micro-sized companies at all locations can be exempted from paying social insurance premiums payable by the employer for the basic pension, unemployment insurance and work-related injury insurance, depending on the impact of the epidemic situation and fund affordability at the location, for a period of no more than 5 months. The above-mentioned policies apply to all companies located in Hubei Province regardless of the company’s scale. At locations other than Hubei Province, large companies can be exempted from paying 50% of the social insurance premiums payable by the employer for the basic pension, unemployment insurance and work-related injury insurance for a period of no more than 3 months.As from February 2020, companies in all locations can be exempted from paying 50% of the social insurance premiums payable by the employer for the basic medical insurance, depending on the impact of the epidemic situation and fund affordability at the location, for a period of no more than 5 months. Companies suffering from operational difficulties due to the epidemic can apply for deferred payment of social insurance premiums for no more than 6 months in principle without paying late payment penalties.
  • Housing fund contributions: companies affected by COVID-19 can apply to defer payment of housing fund contributions for 6 months (from January to June) without paying late payment penalties
  • 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.
  • Subsidies from the government for stabilising employment relationships: if a company meets certain requirements, including having duly paid the unemployment insurance premium according to law in the past, and its lay-off rate in the previous year is lower than the urban unemployment rate of the location where the company is located, the company can receive subsidies from the government for stabilising employment relationships. The amount of the subsidy varies with location, for example in Shanghai, it is 50% of the unemployment insurance premium paid by the company and employees in the past year.

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 should companies do when employees are back to work?” dated 31 January 2020, “Coronavirus Outbreak: Follow-up updated policies on the treatment of employees” dated 5 February 2020 and “Coronavirus Outbreak: What can companies do in HR management during the epidemic period?” dated 7 February 2020. More details can also be found in CMS Expert Guide to Government Support for Employers and Workers (China).

Duties and responsibilities of directors

1. What form does the board of directors take?

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.

2. What is the role of non-executive or supervisory directors?

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

3. Who can be appointed as a director? 

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 PRC Company Law, any person who was convicted of certain financial crimes, who was personally liable for the bankruptcy of a company in which he or she acted as director or manager, or who was personally liable 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.

4. How is a director appointed?

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.

5. How is a director removed from office?

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.

6. What authority does a director have to represent the company?

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.

7. How does the board operate in practice?

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.

8. What contractual relationship does the director have with the company?

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.

9. What rules apply in respect of conflicts of interest?

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.

10. What other general duties does a director have?

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.

11. To whom does the director owe duties?

Towards the company.

12. How do the director’s duties change if the company is in financial difficulties?

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.

13. What potential liabilities can a director incur?

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 criminal liabilities. 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.

14. How can a director limit his/her liability?

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

  • 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 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.
Picture of Ulrike Glueck
Dr. Ulrike Glueck
Managing Partner
Shanghai
Michael Munzinger
Michael Munzinger, LL.M.
Counsel
Shanghai