Since the revision of Company Law of the People’s Republic of China (hereafter referred to as the Company Law) in July 2024, the framework governing the obligations and liabilities of directors, supervisors and senior management persons (the DSMs) has been further refined. Where directors fail to properly perform their duties, they may take personal liability for losses caused to the company, its shareholders, or creditors.
As a director of a company, how can you quickly check and understand the various obligations and liabilities under the Company Law? In this article, we will briefly outline the main obligations and liabilities of the directors after the revision of Company Law in a tabular form, along with practical suggestions for legal risk prevention. In addition, the article will introduce the director appointment agreements and director liability insurances, offering new perspectives on safeguarding directors' personal interests.
|
Source |
Obligation |
Liability |
|
Company Law Art.51 [obligation to verify and remind capital contribution] |
The board of Directors shall verify the capital contributions of shareholders. If it is found that the shareholders have failed to pay the capital contributions provided in the articles of association in full and on time, the company shall issue a written reminder to the shareholder to call for the capital contribution. |
Failing to perform the above obligations promptly and causing losses of company, the responsible directors shall bear the liability for compensation. |
|
Company Law Art.53 [withdrawal of capital contributions] |
After the establishment of the company, shareholder shall not withdraw their capital contributions.The acts of withdrawal include: (a)making the false financial and accounting statements to inflate profits for distribution; (b)Transferring capital contributions by fabricating the creditor-debtor relationships; (c)Transferring the capital contributions by related transactions. (d)Other acts of withdrawal without legal procedures. |
Shareholders shall return the withdrawn capital contributions. If losses are caused to the company, the responsible DSMs and those shareholders shall bear joint and several liability for compensation. |
|
Company Law Art.226 [illegal capital reduction] |
When a company needs to reduce the capital, it shall arrange a legal capital reduction procedures. In that case, the board of directors is responsible for formulating the capital reduction plan. The plan shall clarify the original registered capital amount, reduced capital amount, reduction measure, reduction target, the post-reduction equity structure and arrangements of creditors’ interest. |
In case of illegal capital reduction, shareholders shall return the funds received and any reduction in capital contributions shall be reversed. If losses are caused to the company, the shareholders and the responsible DSMs shall bear the liability for compensation. |
|
Company Law Art.211 [illegal distribution] |
Statutory order for legal distribution of profits: Payment of tax; offsetting losses in previous years; allocation for statutory common reserve funds(until the 50% of the registered capital). Allocation to discretionary common reserve funds(if provided in Article of Association）；distribution of profits. In that case, the board of directors is responsible for formulating the plan of distribution of profits and plan of offsetting of losses. |
Shareholders shall return the profits distributed in violation of regulations to the company. If losses are caused to the company, the shareholders and the responsible DSMs shall bear the liability for compensation. |
|
Company Law Art.232 [the obligation to liquidate] |
Directors, as the liquidation obligors of the company, shall form a liquidation committee to commence liquidation within 15 days from the date of occurrence of the reasons for dissolution. |
If the liquidation obligor fails to perform liquidation obligations in a timely manner and causes losses to the company or creditors, he shall be liable for compensation. |
|
Company Law Art.163 [financial assistance] |
The company shall not provide gifts, loans, guarantees or other financial assistance for others to obtain shares of the company or its parent company, except when the company implements an employee stock ownership plan. For the benefit of the company, upon resolution of the shareholders’ meeting, or the board of directors making a resolution in accordance with the company’s articles of association or the authorization of the shareholders’ meeting, the company may provide financial assistance to others to acquire shares of the company or its parent company, but the cumulative total of financial assistance shall not exceed 10% of the total issued share capital. Resolutions made by the board of directors must be approved by more than two-thirds of all directors. |
If any violation of the above provisions causes losses to the company, the responsible DSMs shall bear liability for compensation. |
|
Company Law Art.182 [obligation to report related transactions] |
The DSMs and their related parties, who enter into contract or transaction with company directly or indirectly, shall report relevant matters to the board of directors or shareholders’ meeting and obtain approval in the form of resolution of the board or shareholders’ meeting in accordance with articles of association. |
Civil liability: The company may claim disgorgement of the income: All relevant income obtained by violating the fiduciary duties shall belong to the company. Criminal liability: Crimes of breach of trust: violating the fiduciary duties may constitute crimes under the Criminal Law Amendment (XII) - Crime of illegal operation of similar businesses. - Crime of illegal profit-seeking for relatives and friends. - Crime of malpractice in selling shares at a low price or selling assets at a low price. |
|
Company Law Art.183 [prohibition of misappropriating business opportunities of the company] |
The DSMs shall not misappropriate business opportunities of company for themselves or others by taking advantage of position. |
|
|
Company law Art.184 [obligation to report similar businesses] |
The directors, who operate or co-operate in similar businesses, shall report to the board of directors or shareholders’ meeting and obtain approval in the form of resolution of the board or shareholders’ meeting in accordance with articles of association. |
|
Obligation |
Key Points to Prevent Risks |
|
obligation to verify and remind capital contributions |
a.Review the articles of association and understand shareholders’ capital contribution amounts, method and deadlines. b.ascertain the status of shareholders’ capital contributions from the finance department. c.Promptly remind shareholders before the contribution deadlines. d.Promptly demand payment after contribution deadlines. |
|
withdrawal of capital contributions |
The directors who know or should know capital withdrawal shall promptly notify the company or other shareholders, and demand corresponding measures. |
|
illegal capital reduction |
The board of directors shall formulate a legal plan for capital reduction and ensure that the procedures comply with all legal requirements, particularly with notifying creditors in accordance with the law. The board who knows or should know irregularities shall notify the company or other shareholders and demand corresponding measures. |
|
illegal profit distribution |
a.Strictly comply with statutory prerequisites for profit distribution, i.e., only distribute profits after paying taxes, covering losses, and allocating statutory reserves. b.Engage auditors to review financial circumstance and base distributions or allocations on audit results. Ensure profit distribution plans are approved by the shareholders’ meeting by resolution. |
|
financial assistance |
Directors shall strictly review proposed financial assistance in accordance with the law and the articles of association, and ensure compliance with corporate interests and amount limits. If any dissent exists regarding a Board resolution, it shall be clearly recorded in the minutes of the Board meeting. |
|
the obligation to liquidate |
a.Form a liquidation committee within 15 days from the occurrence of statutory grounds for liquidation. b.The shareholders' meeting may appoint other management personnel or professionals to serve as members of the liquidation committee so that the director may avoid potential liabilities that the liquidation committee may incur. |
|
the obligation to report related transactions |
Disclose all transactions with the company involving potential interests transfer related to the DSMs personally, regardless of amount. |
|
prohibition of misappropriating business opportunities of company |
Before engaging in relevant business, directors must report to the board of directors or shareholders’ meeting and obtain approval in the form of resolution of the board or shareholders’ meeting in accordance with articles of association. |
|
the obligation to report similar business |
a.Assess in advance whether their business activities constitute a 'competing business' by reviewing:the company's registered business scope, its actual business operations, and any proposed business activities; b.Report promptly such matters to the Board of Directors and the shareholders' meeting, and retain written evidence of such disclosures. |
1.Why sign a director appointment agreement?
In addition to basic terms such as [contract parties, term, compensation, duties], director appointment agreements may include clauses on [confidentiality obligations, non-compete clauses, termination, breach remedies, dispute resolution]
For examples:
Specify the company’s obligation to provide financial records as necessary to enable directors to promptly and proactively fulfill their statutory duties, including verifying and urging capital contributions from shareholders and supervising whether any unlawful withdrawal of capital has occurred.
Clarify the director’s entitlement to remuneration and the company’s liability for breach if it fails to promptly re-elect a director after resignation, in order to encourage timely re-election.
Clarify that directors shall not be required to bear such liabilities after resignation with respect to the liabilities they are required to assume towards the company as stipulated under the Company Law.
2.How can directors seek remedies for wrongful removal?
In accordance with the Company Law, the shareholders' meeting has the right to remove directors without cause, that is, the shareholders' meeting may resolve to remove a director, and the removal shall take effect on the date of the resolution. If a director is removed without just cause before the expiration of their term, the director may demand compensation from the company
Where a director, after removal from office, initiates a lawsuit due to a dispute over compensation with the company, the people's court shall determine whether compensation should be granted and the reasonable amount of compensation based on laws, administrative regulations, the company's articles of association, or contractual agreements, taking into account factors such as the reason for removal, the remaining term of office, and the director's compensation. Therefore, in the director appointment agreement, both parties may clearly stipulate the compensation amount to which the director is entitled in the event of improper removal, so as to ensure the greatest possible protection in case of such an event.
3.Do directors have the right to "resign at will"?
The relationship between the company and the director is a principal-agent relationship, and each party has the right to terminate the relationship at will. If a director wishes to resign, they may submit a resignation report to the legitimate accepting authority or person, usually the board of directors and the shareholders' meeting, and preserve evidence.
However, if the term of office of a director expires and no timely re-election is held, or if the resignation of a director during their term causes the number of board members to fall below the statutory minimum, the original director shall, before the newly elected director assumes office, continue to perform their duties as a director in accordance with laws, administrative regulations, and the company's articles of association.
4.How can directors seek relief if the company fails to fulfill its change obligations after resignation?
If a director's resignation complies with legal regulations and the company's failure to change the registration affects their own interests, the director may file a lawsuit to demand that the company make the change registration.
If the company ignores the resignation without just cause or fails to go through the change registration procedures, and the resigning director thereby incurs civil liabilities that should not have been borne, the director may seek indemnification from the company for the liabilities already incurred.
1.What is D&O
Directors', Supervisors', and Officers' (D&O) liability insurance is the insurance under which the insurance company compensates for legal litigation costs and bears other corresponding civil compensation liabilities when directors, supervisors, or senior management are held liable for negligence or improper conduct in the performance of their duties. The policyholder is usually the company, or the company and the directors, supervisors, and senior management jointly. The insured parties include the policyholding company and its subsidiaries, as well as its directors, supervisors, and senior management personnel.
2.For which liabilities of directors can D&O liability insurance provide compensation?
Generally, D&O liability insurance can compensate directors for their personal compensation liabilities arising from negligence or improper conduct in their work, that is, the "negligent acts" of the director as an honest member of the management team, excluding malicious acts, breaches of fiduciary duties, intentional false or misleading statements in information disclosure, and illegal acts.
The following liabilities are generally not covered by D&O liability insurance:
Personal interests, self-dealing transactions
Fraud, dishonest acts (subject to final judgment)
Pending or prior litigation, known claims (pollution excepted)
Litigation arising from liabilities covered by other insurance (such as product liability, professional liability, intellectual property liability, etc.) is excluded.
As an encouraging provision, the revision of the Company Law also stipulates that a company may, during a director's term of office, purchase liability insurance for the compensation liability borne by the director for performing the company's duties. For both investor directors and founder directors, director liability insurance is a reasonable and highly cost-effective option. Therefore, as a directly interested party, a director may suggest to the company or stipulate in the appointment agreement to purchase liability insurance, but whether such a suggestion is adopted shall be determined based on actual circumstances such as laws and regulations, the company's articles of association, operational conditions, and the insurance company's assessment results.
