A strengthened regulations
The increasing number of regulations in China over the recent years and the trend to hold individuals personally liable caused additional pressure over executives doing business with and in China. Here is an overview of the dos and don’ts in 2020.
China switching to a technology driven economy.
With China switching to a technology driven economy boosted by internal demand, Chinese laws are updated to reflect the greater complexity of its economy. A structural change of approach towards liability issues over the last few years that emphasizes greater personal accountability of executives has been met by skepticism by foreign players doing business in China. But the political will to put an end to the “anything goes” culture that prevailed doing business in China has led many foreign and domestic players at risk in their daily operations. It seemed to our team extremely valuable to reassess the regulatory framework for liability of executives in China, determining who may be liable, to what extent these liabilities may be incurred, and above all, how to mitigate such potential liabilities.
1. Regulatory trends in the PRC: additional areas have been regulated, involving more pressure on the executives through their personal liability
Civil liabilities arising out of operational activities shall be generally assumed by the company. In the past years, the Chinese authorities have however strengthened regulations and put more pressure on the person in charge, including legal representative and actual decision makers to enforce efficiently regulations. Personal liability can be imposed on those who serve corporate roles in the company if such company commits serious wrongdoings or its illegal activities. In coping with new challenges arising with the rapid growth of China’s economy and development of technologies, the Chinese government has been active in updating laws and regulations of various aspects. Cybersecurity, food safety, environmental protection, e-commerce market and foreign investment are also areas highly regulated in the recent years and which have created new sources of personal liability for the executives. The adoption of the Environmental Protection Law (2018) and related implementing regulations is one example: companies can be more self-regulated and are not required to apply before qualified institutions. However, post-event supervision, such as onsite inspections, are imposed by local authorities which enjoy the discretion to decide the penalties to be given. As an example, we have assisted industrial companies with executives detained for alleged pollution or illegal deforestation operations. Food safety and enforcement of custom rules have generated numerous examples of Chinese and foreign executives arrested and sentenced to prison for period exceeding 10 years and the destruction of companies, even in cases where no victims suffered from the alleged illegal operations.
“A company shall assume civil liability for the business activities of its legal representatives and other employees”.According to the PRC General Principles of Civil Law
The Cybersecurity Law of the People’s Republic of China (2017) and related regulations created a special cybersecurity obligation on operator of a critical information infrastructure, who shall set up a security management body and designate a person in charge of safety in the company. Security backgrounds check shall be conducted on the person in charge and other key security management personnel. Numerous criminal liabilities have put in place to strongly enforce this new body of laws. Similar arrangements are mentioned in the newly revised Environmental Protection Law (2018) and Work Place Safety Law (2018) that relevant intra-corporate bodies shall be set up or the person in charge be designated with corresponding powers and responsibilities in the company. More recently, the social credit system or the COVID-19 crisis and related regulations to fight the virus outbreak have generated significant liabilities for managers, including criminal ones.
The legal representative may personally be subject to fines, administrative sanctions or criminal sanctions.
In China, it shall now be clear that personal liability can be incurred to those who work in the company when it commits serious wrongdoings or illegal activities. In addition, personal liability is also stipulated in more sector-specific laws which expressly provide that liabilities, such as fines, administrative detention and criminal penalties, as the case may be, will be incurred to person in charge or responsible for relevant matters in the company.
2. What are the liabilities?
Personal liabilities can be divided into civil, administrative and criminal liabilities, each of which carries out different legal consequences. Under the PRC Company Law, a director or member of “senior management” who fails to fulfil his/her obligations as stipulated in the articles of association or under the laws, shall compensate the resulting damages caused to the company.
In terms of administrative liability, Article 49 of the General Principles of Civil Law expressively provides that when the company commits serious wrongdoings, the legal representative may personally be subject to fines, administrative sanctions or criminal sanctions. For example, the “person in charge” may bear personal liability in the form of fines up to 100% of the previous year’s income or be dismissed or removed from his/her position for workplace accidents that occur under his/her supervision. As for criminal liability, in the event that the company is sanctioned for a breach of the PRC Criminal Law, the “person in charge” or “person directly responsible” may also be subjected to criminal sentences, as the “Double-Penalty” principle is applied to most of corporate crimes.
In the event that a crime is committed by a company, both the person in charge or responsible (who could be the legal representative, manager or other personnel) and the company itself will be subject to penalties, while in other cases, only relevant person in charge or responsible will be subject to criminal penalty. Depending on the specific situation, the personnel in charge may be sentenced with detention, imprisonment or even the death penalty. In addition, social credit rating of the manager may be negatively impacted and may result in loss of certain right or access to bank loan. Even if no liabilities above are finally decided, enforcement measures are likely to be imposed on the persons involved in the investigation process, such as detentions, summons, restrictions from leaving China, restrictions on high consumption (e.g. buy flights or tickets for high speed train) or, restrictions to serve as legal representative or management positions, as the case may be.
3. Who is liable?
Liabilities of the legal representative are set forth by multiple PRC laws and regulations. In some cases, such liability may be assimilated as a presumption of liability. For example, the General Principle of Civil Law expressly provides that when the company commits serious wrongdoings, the legal representative may personally be subject to penalties. The Company Law expressly provides that “where any circumstance, in violation of the provisions of this Law, constitutes a crime, the criminal liability of the legal representative shall be investigated”. Such personal liability is mainly due to the fact that the legal representative is invested with the power of representation of the company towards third parties and allegedly acts on its behalf. Directors and board members may also be held liable. If a director is not the Chairman of the board, the Executive Director or CEO of the Company and he/she is not recognized as the person in charge, his/ her liability can be limited. In addition, the regulations target the person who is the actual decision maker or the person who could stop the wrongdoings.
The “person in charge” or “person directly responsible” is referred to as the person who may bear potential liabilities in many sector-specific laws in China.
The “person in charge” or “person directly responsible” is referred to as the person who may bear potential liabilities in many sector-specific laws in China, including without limitation the PRC Criminal Law, Anti-trust law, food safety and Environmental Protection Law. The identity or function of the “person in charge” or “person directly responsible” is not clearly defined by the PRC laws. According to some regulations, the person in charge of an enterprise refers to the leading personnel who has decision-making power in the production and business operations and safety production of the company (the 2014 Provisions on the Administration of Work Safety). In practice, any personnel at any level may be recognized by the authorities as the person in charge of the regulated matters in the company as long as such person has the decision-making power influencing such regulated matter or as been empowered to address such regulated matter. The shareholder who does not directly control the operations of the company by serving any corporate positions may also be recognized as the person in charge if he or she retains an effective control over the company through contractual arrangements, such as an investment agreement. An interpretation jointly released by the Supreme People’s Court and Supreme People’s Procuratorate in 2015 explains that the “person in charge” and “person directly responsible” as provided in Article 135 of the PRC Criminal Law (i.e. the crime of serious labor safety accident) refers to persons in charge, managers, actual controllers, investors of the production and operation entities who are directly liable for non-compliance with requirements of safe production facilities or safe production conditions, and any other personnel who undertake management or maintenance duties for safe production facilities or conditions.
As such, it is widely accepted that the “person in charge” or “person directly responsible” under the PRC laws may refer to the following persons:
- The legal representative;
- Shareholders / investors / actual controller;
- Chairman / Executive Director / General Manager; and
- Other managers (financial manager, production manager, chief accountant, or persons directly in charge of a branch, a site or certain aspect of corporate matters).
4. How to mitigate risks?
Companies shall take actions to assess their risks and define their strategy.
This involves many actions such as the review and update of the organization structure. Rethinking the organization chart and the chain of responsibilities is necessary to put in place healthy reporting. The protection of the holding level, the top management and the continuity of the business are at stake. For individuals, the protection shall imply to review their actual powers and responsibilities as defined the power of attorneys, board resolutions, internal documentation and employment contracts. Contingency plan shall also be reviewed to ensure continuity of operations in the event that local management is under investigation.
Positively change things.
Keeping written objection records during the decision-making process is a must when non-compliant behaviours are identified. In this respect, many executives shall reconsider the use of social networks such as WeChat in the work place and their participation to certain unformal digital groups without real control of the content, as such information may generate a contamination of their personal liability. Compliance policy shall be designed and implemented; culture of compliance shall be strongly promoted. More importantly, the unacceptable idea of “in China, act like Chinese” that we may sometimes still hear shall be more than ever rejected by managers respectful of their Chinese team, their company future and their integrity. Our team regularly assists companies and business leaders to assess their risks and design compliance policies and related trainings to positively change things.