Overview of Good Corporate Governance for Chinese WFOEs – Directors and Officers

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With decades of experience in providing high quality legal services to foreign investors doing business in China, and in particular start-up investments, foreign investors often come to us with questions about executive assignments at their Chinese subsidiary and on the responsibilities of managers under Chinese law. Taking the WFOE – Wholly Foreign-Owned Enterprises, a 100% foreign-owned limited liability company and the main vehicle for foreign investment in China – as an example, we look at the topic of good corporate governance from a legal and practical point of view. perspective.

Officer assignments

Under Chinese corporate laws and relevant regulations, the investor (recognized as the shareholder) is the highest authority of a WFOE and should decide which natural positions will be appointed to the below positions of the WFOE and duly registered with the Chinese authorities. In China, all appointed corporate officers must be natural persons, but there is no nationality or residency requirement.

  1. Directors

Directors are appointed by the investor. The investor can issue a shareholder decision to appoint an executive director (for small WFOEs) or a board consisting of 3 to 13 directors, including a chairman. The role of the board of directors (or executive director) is to manage the business activities of the company with accountability to the investor.

If there is a board of directors, the directors can only make decisions as members of the board. This means that in China directors have no direct individual authority (except in the case of the executive director).

  1. General director

The Chief Executive Officer is appointed by the Board of Directors or the Executive Director by resolution or decision. The Managing Director is responsible for managing the affairs of the company and is responsible to the Board of Directors/Executive Director. The same person can be appointed as both Executive Director/Chairman and General Manager.

  1. Legal representative

The legal representative must be either the Executive Director/Chairman of the Board (as applicable) or the Managing Director, and this role must therefore be confirmed by the investor prior to WFOE registration. The legal representative acts on behalf of the WFOE both in the incorporation of the company (i.e. the opening of bank accounts) and in operations, as the only person directly authorized to represent and sign for the WFOE. It is important to point out that each Chinese company has only one legal representative, who is recognized as the official representative of the company with full power to act on its behalf.

The board of directors or the shareholder can always set limits on the authority of the legal representative, but these are only internal limits.

  1. Supervisor(s)

By shareholder decision, the investor must appoint one or two supervisors, or even a board composed of at least 3 supervisors including a chairman. The supervisor is a relatively independent position that does not involve the business operation of the company. The role of the comptroller is to oversee the performance of duties by the directors and management of the company, and has the right to inspect the finances of the company. The supervisor cannot be simultaneously appointed to another position (director or manager) of the Chinese entity, and is responsible to the investor. In practice, the investor often appoints one of its own directors or managers to this position, or a legal/financial professional.

  1. Financial Administrator

The financial administrator is responsible for dealing with day-to-day tax matters, i.e. usually the contact person for the local tax office. In the past, this role was not a formal appointment, but in Beijing, for example, the financial administrator is now officially registered as a corporate officer, visible in the public company registry database.

Responsibilities of leaders

The Company law in the PRC explicitly states that company officers must abide by laws, regulations and the company’s articles of association (AoA, the company’s internal constitution) and assume fiduciary duties to the company. Willful misconduct and negligence in duties may result in agent liability towards the company.

The main examples of officer misconduct and negligence are listed in the law:

  1. embezzlement of company funds;

  2. open a bank account in his name or in the name of another to deposit the funds of the company;

  3. using company funds to make loans to third parties or provide guarantees to third parties in violation of the company’s AoA and without shareholder or board consent;

  4. entering into contracts or transactions with the company as a contracting party in violation of the company’s AoA or without the consent of the shareholder;

  5. abuse of duties to take business opportunities of the company for himself or others or to engage in any activity similar to that of the company for himself or others without the consent of the shareholder;

  6. misappropriation of transaction fees between the company and other parties;

  7. unauthorized disclosure of trade secrets; and

  8. any other act contrary to his fiduciary duties to the company.

In practice, the categories of liability of directors in violation of their fiduciary duties are as follows:

  1. Public liability

In principle, managers must indemnify the company for losses/damages suffered as a result of their violation of laws, regulations or the company’s AoA.

In judicial practice, the courts will take into account in particular whether the said manager was at fault and whether his act was reasonable and in the interest of the company.

  1. Administrative responsibilities

Officers may, under certain circumstances, take on administrative responsibilities; for example, they may be fined if company assets are intentionally concealed during liquidation, or if a major accident occurs due to failure to perform safety control duties during the operation of the business. Also under certain circumstances, a court or tax office could impose consumption restrictions on the legal representative – for example if the company does not pay its (due) debts.

  1. Criminal responsibilities

Officers can be prosecuted for criminal liability if they commit crimes. Examples of crimes that led to imprisonment include embezzlement, embezzlement and false VAT invoice – all examples of willful misconduct or gross negligence. Additionally, company executives can be held criminally liable not only for their own act, but also if they were “in charge” or “responsible” for a crime – for example for a bribe. paid by another employee on behalf of the company.

Conclusion

The leaders of a company in China have the power to manage, involve or influence business operations, but this automatically combines with potential liabilities.

The first step is to understand the rights and obligations of corporate officers under Chinese law. The second step is to appoint the right people to these positions. For many companies, an optimal balance needs to be struck between maximizing compliance and maintaining control on the one hand (e.g. by appointing head office officials as corporate officers) and minimizing the liability of those officers. on the other hand. Two “tricks” that can be useful:

  • Outsource certain administrative functions (eg accounting, treasury, company stamps) to a reliable third party, in order to minimize the risk of non-compliance by the local team.
  • Develop documentation to specify the authority of the local team and to show who actually controls day-to-day operations (and should therefore take responsibility for any compliance issues).

On the other hand, the legal framework for corporate governance in China continues to develop and new developments should also be taken into account. Published in December 2021, the
PRC Company Law Revision Billpropose a reinforcement of the responsibilities of the directors of the company: a director, manager or supervisor who knows (or should have known) that the shareholder fails to contribute the required share capital or illegally withdraws the share capital, and fails to take the measures necessary actions, can be held personally responsible for the consequences. Again, this illustrates the need to think about how best to organize corporate governance in China.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

Helen D. Jessen