Effective from 1 July 2024, the new Company Law further details and reinforces directors’ accountability compared to the law’s previous version. Directors’ liabilities now cover the entire life cycle of a company, from establishment and operation to liquidation and deregistration. Through a brief review of the amendments to the scope of directors’ liabilities, this article aims to help current and prospective directors understand and mitigate related risks.
Partner
Han Kun Law Offices
Tel: +86 10 8525 4642
Email: yaxing.zhang@hankunlaw.com
Obligations to supervise shareholders’ capital contributions and increases. Article 51 of the new Company Law clarifies that directors are obliged to “verify” and “urge” shareholders’ actual payment of capital contributions and increases. It also specifies that in case of failure to fulfil these obligations, directors shall be held liable for the company’s losses incurred.
Joint and several liabilities for shareholders’ unlawful withdrawal of capital contributions. Article 53 of the new Company Law explicitly bars shareholders’ unlawful withdrawal of capital contributions at the legislative level. It further stipulates that responsible directors shall be held jointly and severally liable, together with concerned shareholders, for the company’s losses thus incurred.
Liability for damages caused by illegal dividends and capital reduction. Article 211 of the new Company Law stipulates that shareholders who have received illegal profit distributions shall be obliged to return such distributions to the company. It is further specified in article 226 that shareholders who have illegally reduced the registered capital shall be obliged to return to the company such reductions and restore their capital contributions. Responsible directors shall be held liable for any damage caused by such illegal profit distributions or capital reductions.
Liability for damages caused by related-party transactions. Related-party transactions are also addressed in the new Company Law as a typical way in which senior executives may harm company interests. Pursuant to article 182, directors in any direct or indirect related-party transaction with the company shall report the case to the board of directors or the shareholders’ meeting, while the transaction shall proceed subject to the resolution of the board of directors or the shareholders’ meeting in accordance with the articles of association.
Legal liability for improperly seizing company business opportunities. It is stipulated in article 183 that directors shall not take advantage of their positions to seek business opportunities belonging to the company for themselves or for others. Also, article 184 prohibits directors from engaging in or assisting others in operating a business of the same kind as that of the company. Any income obtained by directors in contravention of these provisions shall accrue to the company.
Legal liability for improper performance of duties. Article 191 of the new Company Law lays down the principle that the company shall be liable for damages caused by directors’ improper performance of duties. Rather than limiting the company as the sole indemnifier, it further provides that directors shall be held directly liable for damages caused by intentional misconduct or gross negligence.
Legal liability for failure to perform liquidation duties in a timely manner. Article 232 of the new Company Law stipulates that the directors, as the company’s liquidation obligors, shall promptly form a liquidation group to carry out liquidation in case of a cause for dissolution. The liquidation obligors shall be held liable for damages caused to the company or creditors due to failure to perform the liquidation duties in a timely manner.
Under this provision, the directors shall bear the primary responsibility and liability for the company’s liquidation duties. According to Regulations of the Supreme People’s Court on Several Issues Concerning the Application of the Company Law of the People’s Republic of China (II), circumstances of “failure to perform liquidation duties in a timely manner” includes at least the following: (1) Failure to set up a liquidation group to commence liquidation within the statutory period resulting in the depreciation, loss, damage or destruction of the company property; and (2) neglecting duties, resulting in the loss of major property, books of accounts or important documents of the company, making liquidation impossible.
In such cases, directors may be liable to shareholders or external creditors. Notably, for limited liability companies, the liquidation obligor is shifted from shareholders under the previous Company Law to directors under the new version, and directors shall bear corresponding legal liabilities.
Legal liabilities of liquidation group members. It is stipulated in article 232 of the new Company Law that, in principle, the liquidation group of a company shall be composed of directors, unless otherwise provided for in the articles of association or by resolution of the shareholders’ meeting.
Compared to the previous version, which requires the liquidation group of a limited liability company to be composed of all the shareholders, this provision further increases the duties and risks of directors. Pursuant to article 238 of the new Company Law, the liquidation group members neglecting the liquidation duties shall be liable for the company’s losses thus incurred, and shall compensate the creditors for damages caused by intentional misconduct or gross negligence.
Additionally, the new Company Law retains the list of prohibited actions for directors from the previous version, such as embezzling company property, misappropriating company funds, storing company funds in personal names or in the name of others, commercial bribery, and disclosing company secrets. These will not be elaborated here as no substantive changes have been made.
In summary, the new Company Law significantly increases the liabilities and professional risks for directors. Current and prospective directors are suggested to fully understand their duties and risks, actively fulfil their obligations, and avoid unnecessary risks.
Additionally, when purchasing directors’ liability insurance, be sure to carefully read and analyse the policy terms to avoid denial of claims due to intentional or gross negligence.
Zhang Yaxing is a partner at Han Kun Law Offices. He can be contacted by phone at +86 10 8525 4642 and by email at yaxing.zhang@hankunlaw.com
