China’s Revised Company Law and Criminal Law

This article was originally published in the German Chamber Ticker magazine, spring 2024 edition. For the full magazine, please click here.

On December 29, 2023, China’s legislature passed a vastly revised Company Law, which will take effect on July 1, 2024. It is the most comprehensive revision of the Company Law since the 2005 revision following China’s accession to the World Trade Organization.

In this big shadow, it went almost unnoticed that, on the same day, China’s legislature also passed a revised Criminal Law, which came into force even earlier, on March 1, 2024.

The attention of companies in China in the first weeks of 2024 was focused on certain notable changes introduced by the revised Company Law, such as the re-introduction of the capital contribution timeline, the new audit committee, or the requirement to include employee representatives on the boards of large-sized companies. It is becoming increasingly clear that the synopsis of the revised Company Law and the revised Criminal Law will demand even more attention in the future. This is because both laws will significantly increase the obligations, responsibilities, and liability reasons for Directors, Supervisors, and Senior Management staff (DSMs), to a point that the revised Company Law even expressly suggests that companies take out liability insurance for their directors.

This article summarizes the increased scrutiny for DSMs under China’s revised Company Law and Criminal Law and provides suggestions for what companies and their DSMs can and should do to stay compliant.

China’s Company Law and Criminal Law: Defining key stakeholders

Before summarizing the newly introduced or refined governance requirements under the revised Company Law and Criminal Law, it is worth reviewing which individuals in a Chinese limited liability company are considered directors, supervisors and senior management staff. While the directors (董事) and supervisors (监事) are generally easily identifiable as those company organs that have been registered as directors and supervisors with the National Enterprise Credit Information Publicity System, identifying senior management staff can sometimes be less obvious.

The individuals considered as senior management staff (高级管理人员) can be determined from three different aspects: Firstly, the Company Law clearly stipulates that, in the case of limited liability companies, senior management staff includes the general manager(s) (经理), the deputy general manager(s) (副经理), and the person responsible for the financial affairs of the company (财务负责人).

Secondly, the Company Law also states that any person referred to as a senior management staff member in the company’s articles of association shall be considered as such. In mid-size and large companies, for example, it is common that the articles of associations refer to certain department heads as senior management staff, such as the head of R&D or the head of procurement.

Thirdly, senior management staff may also include employees who exercise senior management’s functions and powers and have corresponding decision-making or executive powers.

What are the new responsibilities, obligations and liability risks for DSMs?

For the above-described individuals, both the revised Criminal Law and the revised Company Law introduce various new responsibilities, obligations, and liabilities, including several new scenarios for criminal liability. Some of the most noteworthy changes include:

a. Economic crimes expanded to private enterprises

Three economic crimes from the Criminal Law that previously only targeted state-owned enterprises and their management were expanded by the revised Criminal Law to now also target private enterprise DSMs, such as those in companies. These crimes include operating businesses similar to that of the enterprise they work for and are employed by; illegal profit-making for relatives or friends; engaging in favoritism or malpractice for personal gain and selling the shares or assets of the enterprise at low prices.

Compared with state-owned enterprises, however, DSMs of private enterprises must violate the provisions of other laws and regulations in the course of committing the above-mentioned crimes. Such other law could, for example, be the Company Law, which among other things, stipulates that DSMs should comply with the company’s articles of association.

For companies, this creates opportunity and necessity at the same time: If, for example, companies become aware of a DSM engaging in similar types of business, the potential for criminal liability may provide the company with a stronger leverage in addressing the respective DSM, aside from terminating the respective DSM and paying compensation. At the same time, companies should ensure that the articles of association and other corporate documents provide clear and stringent rules for DSMs, so as to be able to provide evidence that the relevant behavior is in violation thereof.

b. Increased loyalty and diligence requirements for DSMs

The revised Company Law substantially specifies the obligations of loyalty and diligence of DSMs. Previously, the Company Law broadly stated that DSMs have a duty to be loyal and diligent towards the company. Further specifications were only included in the laws and regulations for state-owned or listed companies, which are not directly applicable to private, non-listed companies. For private companies, the specification only came in the form of the case law of courts, which was inconsistent.

Now, the revised Company Law specifies that, with respect to the duty of loyalty, DSMs shall take measures to avoid conflicts between their own interests and the interests of the company, and shall not utilize their positions to gain undue advantage. With respect to the duty of diligence, the revised Company Law now states that DSMs shall, when performing their duties, exercise the reasonable care normally required of a manager in the best interests of the Company.

These specifications appear to draw from the business judgment rule, which is widely used in US case law. For German investors, this may also seem reminiscent of the concept of German limited liability company managing director due diligence requirements.

c. Strengthened obligations for DSMs to maintain capital contributions

The one change in the revised Company Law that seemingly drew the most attention was the re-introduction of the five-year capital contribution timeline. Along with it, the revised Company Law also introduced various obligations for the DSMs, aimed at the retention of the capital contributions. This includes the obligation of the directors to verify the capital contribution of the shareholder(s), including in-kind contributions; the DSMs’ obligation to supervise that no shareholder directly or indirectly withdraws a portion of their capital contribution and thereby causes losses to the company; and, the obligation for DSMs to ensure that capital reductions or profit distributions do not result in losses to the company.

d. Legal representatives shall be included in the operations

On the surface, the revised Company Law expanded the scope of eligible individuals that may serve as the company’s legal representative by stating that any director and manager may serve as the legal representative. At the same time, the revised Company Law seemingly reduces the scope of eligible individuals by stating that the respective director or manager shall “perform the company's affairs on behalf of the company.” Whether this will, in the future, be interpreted to mean that there cannot be nominal legal representatives who are not involved in the daily operations of the company, remains to be seen.

e. Liability towards the company

The revised Company Law expressly describes the liability of directors and senior management staff in cases where their actions cause losses to a third party while performing their duties. Specifically, the law states that the company shall be held liable for such losses in the first place and, following this, the director or senior management staff involved may be held liable for compensation by the company, provided that the losses are a result of their willful misconduct or gross negligence.

f. Responsibility for company liquidation

The revised Company Law changed the responsible company organ for the liquidation of the company from the shareholder(s) to the director(s). That means, among others, that in the event of a liquidation, the liquidation group shall generally consist of directors and that the directors shall be liable towards the company or its creditors if they do not perform their liquidation obligations in time.

Conclusion and recommendations

With the revised Criminal Law and the revised Company Law taking effect this year, companies and their DSMs will need to study the new responsibilities, obligations, and liability risks relevant to them. To stay compliant and ahead of the developments, they may want to consider taking the following actions:

a. Companies should update their corporate documents, including the articles of associations and any by-laws, such as rules of procedures for the management, in order to properly reflect new DSM responsibilities and obligations.

b. Companies should also update their corporate practices and consider training for their DSMs to ensure that they have a clear understanding of the new responsibilities, obligations, and liability reasons. This is all the more worth considering as compliance measures are increasingly taken into consideration by courts when judging compliance cases.

c. In light of these increased responsibilities and obligations, the revised Company Law, for the first time, expressly suggests that companies take out liability insurance for the liability assumed by a director due to the performance of their duties. For those companies that have already taken out liability insurance, they may want to consider adjusting the scope accordingly.