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Understanding Director Liabilities to the Company and Managing Directors' Authority

20 February 2011

An American company recently learned this lesson the hard way. After hiring a Chinese general manager without outlining the limits on her authority, the GM proceeded to inappropriately use company funds for the benefit of a third-party. Without the evidence that is provided by clear delineation of authority within the articles of association, the employee contract, or through Board of Directors resolutions, the company found it unnecessarily difficult to terminate her position for cause, and pursue her for criminal and civil liabilities.

In light of the frequent disputes that arise in this area, any company operating in the PRC should be advised to have the best practices in place to reduce such risk. Clearly regulating the bounds of authority and conduct of directors and employees and establishing procedural controls, such as requiring directors to report any payments or benefits they receive in exchange for benefits, are steps that every company should consider to reduce their exposure.

Directors and senior managers of a Chinese-registered company may be held civilly liable under either the PRC Company Law. The Company Law requires directors and senior managers to adhere to the duties of loyalty and duty of care. The duty of care provides that corporate directors and officers comply both with the law as well as the articles of association and shareholder resolutions of a company.

Certain circumstances where directors and senior managers may bear personal liability to the company under the Company Law, include:

  • Violating a law, an administrative regulation or the company's articles of association in the execution of company duties, thereby causing losses to the company, he or she will be liable for compensation;
  • Misappropriating the company’s funds;
  • Taking business opportunities for themselves without shareholders’ approval; and
  • Abusing their position to take improper benefits for themselves or other parties.

Carefully considering the desired limits of directorial and managerial authority will prepare the company not only for situations where directors’ and managers’ violate the Company Law as described above, but also where they take actions that exceed their desired scope of authority. Firstly, the articles of association of the company should include detailed procedural guidance in connection with how the directors/managers may exercise their powers. This often entails resisting pressure from local governments to use their preferred “standard” form of articles, which has limited use. A normal compromise is to adopt the basic style and sequence of that form, while adding more detailed provisions on the limits of authority of directors, senior managers and the legal representative, and on other points that are important to the shareholders – such as the obligation to fully disclose to the board of directors and the shareholders meeting any transactions or arrangements that involve his or her personal interests. Additionally, binding directors’ and manager’s authority to limitations from Board of Director resolutions provides a flexible method to limit their actions further than the PRC Company Law. Priority is to have documentation in place; absent such documentation, the company will be unable to file a claim for actions exceeding their authority and be unable to terminate their positions for cause on the basis of those actions.

Managing director authority is also important in the context of criminal liabilities. The offering of monetary gifts to officials is prohibited under Chinese law, regardless of how small. In commercial practice, directors/managers should therefore be required to promptly report to the board of directors or at the shareholders’ meeting in the event they receive any payments or treatment in exchange for benefits. This is especially important because not only can the employee be held liable, the company and its legal representative could be held jointly liable where the employee engaged in criminal activity on behalf of the company. So, regulating the boundaries of authority and activities of directors or employees in the articles of association and other documents, and establishing clear internal rules and policies for employee conduct will not only clarify to the director the practical limits, but it will also allow the company to limit its exposure.

Risks can be reduced at all times by clearly allocating particular powers and responsibilities of company directors and managers. Such allocations of authority will not only reduce the risks borne individually and by the company, but will also benefit the company by preventing important matters from ‘falling between the cracks’ and by enabling the legal representative to be more focused and less defensive. Having clearly-established the boundaries also serve as sound evidence in the case a legal dispute should arise, and procedural controls and reporting requirements will help ensure compliance and limit the liability of the company should a director or officer be accused of accepting special treatment or monetary gifts in exchange for benefits.