CHINA Trends and Developments Contributed by: Chen Ma, Michelle Gon, Xinjie Li and John Fitzpatrick, Han Kun Law Offices
Capital maintenance and creditor protection mechanisms Personal liability for board directors Capital maintenance has now shifted for the board of directors from a mainly financial accounting concern to a corporate governance and statutory joint liability issue. Under the framework of the revised Company Law, boards of both LLCs and JSCs are subject to explicit capital contribution verification and call duties. In contrast to the previous Company Law, these newly revised provisions require the board of directors to act as a substantive capital maintenance gatekeeper. If the board fails to timely perform its verification and written capital call notice obligations, thereby caus - ing losses to the company, the responsible directors may directly face severe legal consequences, includ - ing liability attached to their personal assets (Article 51, paragraph 2). Record - keeping requirements With the establishment of this statutory “gatekeeper” liability, it is predicted there will be a significant surge in future lawsuits in which external creditors, faced with an insolvent company, directly sue the company’s directors to demand personal compensation based on claims such as permitting “unlawful dividend dis - tributions” or “improper capital reductions”. Empow - ered by the revised Company Law, these litigants may bypass shell or insolvent PRC subsidiary entities and directly target the personal assets of defaulting board members. To satisfy future substantive compliance requirements, boards of directors should conduct thorough, well- documented solvency and asset impairment tests before approving any profit distribution plans, imple - menting capital reductions or executing major capital restructurings. A board that fails to retain and record these forward-looking financial evaluation reports will face higher risk of liability for breach of fiduciary duty with respect to capital maintenance. Joint liability for unlawful withdrawals of capital The revised Company Law establishes significantly stricter liability standards for boards with respect to the unlawful withdrawal of capital ( choutao chuzi ). For LLCs, Article 53 of the revised Company Law provides that responsible directors, supervisors and senior
this mechanism is expected to be enforceable against both controllers and local management. Article 192 presupposes that the controlling share - holder’s instruction is carried out through the unlawful performance of duties by the local D&Os. As a result, future judicial rulings are expected to look through for - mal corporate hierarchies and hold that blindly imple - menting an overseas instruction that violates PRC law (such as an improper capital sweep or unauthorised asset transfer) constitutes an independent breach of the local D&Os’ statutory duty of diligence. Consequently, local D&Os may now face personal legal risk if they choose to act as passive conduits for non-compliant parent company directives (refer - enced via Articles 188 and 192). This anticipated trend should cause nominee D&Os to cultivate an independ - ent compliance review perspective to avoid this per - sonal legal risk. Eliminating formalistic single - page board resolutions The new Company Law paradigm means it is a necessity for MNC subsidiaries in China to maintain detailed, contemporaneous board minutes. These minutes should fully reflect that the directors have made “reasonable inquiries”. Although the law does not clearly define what constitutes a “reasonable inquiry”, courts are expected to conduct substantive look-through reviews to verify whether directors have actively reviewed professional reports. For instance, regarding JSCs, Article 125, paragraph 2 of the Company Law expressly provides that the board of directors shall be liable for board resolutions that violate laws, administrative regulations or the company’s articles of association and cause serious losses to the company. A director may be exempted from liability only if they are recorded in the minutes as having expressed dissent. In future regulatory campaigns or shareholder derivative actions where a corporate failure or unlawful behaviour triggers an investigation into board conduct, a board of directors that fails to properly preserve the deliberation process and supporting decision-making materials is likely to face significant risk of being deemed in violation of its statutory duty of diligence due to an inability to demonstrate procedural compliance.
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