China Special Situations Insight (Volume 4 Issue 3)
New Company Law Series: Heightened D&O Obligations and Liabilities
We have prepared a series of articles to highlight the key amendments in the new Company Law that will come in to effect on July 1, 2024 (the “New Company Law”). In this article, we focus on the amendments in the New Company Law regarding the obligations and liabilities of directors, supervisors and senior officers (collectively, “D&O”) of limited liability companies.
Compared to the current Company Law (“2018 Company Law”), the New Company Law imposes more obligations and greater liabilities for D&O, which are worth foreign investors' attention when selecting candidates for these positions.
1.?Key Amendments
1.1??Defining Fiduciary Duty and its Scope of Application
The 2018 Company Law generally stipulates that D&O owe a fiduciary duty to a company, encompassing both the duty of loyalty and the duty of care. However, it does not specify the meaning of these duties, which has caused confusion in practice. The New Company Law establishes precise definitions for fiduciary duties under Article 180, providing clearer guiding principles for D&O in fulfilling their roles:
Furthermore, the New Company Law extends fiduciary duty to the controlling shareholder or actual controller of a company, who may not serve as a director but have de facto control of a company’s operations (Article 180). If any controlling shareholder or actual controller of a company instructs any director or senior officer to act in a way detrimental to the interests of the company or its shareholders, they shall bear joint and several liability with such director or senior officer (Article 192).
1.2??Maintaining Capital Adequacy
As introduced in our previous article, the New Company Law mandates a five-year capital injection requirement for shareholders, who face the risk of the forfeiture of equity interest if they fail to make full and timely capital contributions (see China Special Situations Insight Volume 4, Issue 2). To ensure compliance with these new mandates, the board of directors (the“Board”) is now obligated to verify shareholders' capital contributions according to the injection schedule provided in the company's articles of association within the five-year time limit. If a shareholder is found to have not made the required contribution on time, the Board shall call upon the shareholder for the outstanding contribution. Should the Board fail in the said duties, resulting in losses to the company, the accountable director(s) will be held liable for compensation (Article 51).
Additionally, the New Company Law states that all accountable D&O will be held personally liable for the compensation of losses incurred by the company due to the illegal withdrawal of contributed capital by a shareholder, unlawful profit distribution and unlawful capital reduction.
1.3?Tightened Regulations on Related-party Transactions, the Pursuit of Business Opportunities and Competitive Business Practices
As part of D&O's duty of loyalty, the 2018 Company Law prohibits directors and senior officers from engaging in related-party transactions, pursuing business opportunities from the company, or engaging in business in competition with the company (collectively, the “Matters”) without first obtaining proper internal approval in the company. The New Company Law further strengthens regulations for D&O on the Matters as follows (Articles 182-185):
(1)?Expanding the scope of regulation to include supervisors, in addition to directors and senior officers;
(2)?Establishing the obligation for D&O to report any Matters;
(3)?Requiring interested directors to abstain from voting on the Matters at Board meetings. (If the number of unrelated directors present is less than three, the Matters shall be further submitted for deliberation at the shareholders' meeting).
For related-party transactions, the definition of 'related parties' has been broadened to include: (i) close relatives of D&O; (ii) enterprises directly or indirectly controlled by D&O or their close relatives; and (iii) other related parties with any other related-party relationship with D&O.
Any income obtained by D&O not in compliance with the above requirements will be entirely allocated to the Company.
1.4??Compensation liability for third parties
Under the 2018 Company Law, third parties could only claim damages against the company for harm caused by the acts of its directors and/or senior officers in the performance of their duties. The New Company Law allows third parties to directly claim against and hold directors and/or senior officers personally liable if the damages result from their willful misconduct or gross negligence (Article 191).
2.?Our observations
The New Company Law imposes greater obligations and liabilities on D&O. This is to enhance independence in their roles and strengthen the power balance within corporate governance, thereby fostering the development of the company while safeguarding the interests of its creditors. Candidates for D&O positions in foreign-invested enterprises, however, may be concerned about the increased professional risks.
To mitigate against the repercussions of these growing responsibilities, companies may consider purchasing D&O liability insurance or adjusting their existing coverage to protect their D&O. For the first time, The New Company Law encourages companies to purchase D&O liability insurance (Article 193). Please note that a Board is required to report all details regarding their purchased D&O Policy at a shareholders' meeting.
For further information, please contact Catherine Miao , Head of Special Situations and Alternative Investment at JunHe LLP: [email protected] or +86-21-22086350.