Director’s liquidation liabilities in Company law draft amendment

By Wang Zhenxiang, Jingtian & Gongcheng
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The Standing Committee of the National People’s Congress is reviewing a new draft amendment to China’s Company Law, issued on 22 December 2021. The draft revision seeks to improve corporate governance and benefit companies with a fair and orderly market exit mechanism by modifying the “dissolution and liquidation” chapter of the law, and rationally attributing liabilities of liquidation between directors and shareholders. This article analyses the draft amendment in terms of directors’ liquidation liabilities.

Director’s liabilities

In amendments to the “dissolution and liquidation” chapter of the Company Law, the following proposed changes concern directors’ liabilities:

First, the concept of liquidation obligor is introduced, a role that shall expressly be assumed by directors. Failure to fulfill the liquidation obligation will result in compensation for losses;
Second, composition of the liquidation group changes from shareholders in limited liability companies, and directors or personnel designated at the shareholders’ general meetings in joint stock companies, to directors supported with personnel designated in the articles of association, or by the shareholders’ meeting. Liquidation group members failing to discharge their obligations, leading to company losses, are liable for compensation.

As liquidation obligor

The added concept of liquidation obligor originates from the Civil Code and the Minutes of the National Courts’ Civil and Commercial Trial Work Conference.

Wang Zhenxiang, Jingtian & Gongcheng, Director’s liquidation liabilities in Company law draft amendment
Wang Zhenxiang
Partner
Jingtian & Gongcheng

Under article 70 of the Civil Code, members of a legal person’s executive organ or decision-making organ, such as directors or council members, are liquidation obligors – with a duty to form a liquidation group when the legal person is dissolved. If any failure to fulfill their duties leads to losses, the liquidation obligor will assume civil liabilities.

Under section V, the shareholders, being liquidation obligors, must prove they have not neglected their liquidation duties to be exempt from joint and several liabilities for the company’s debts.

According to the draft amendment, if the directors fail to form a liquidation group in a lawful and timely manner, defined as within 15 days from occurrence of the cause of dissolution, causing the company or creditor any losses, they shall be liable for compensation.

Being part of the company’s decision-making body, directors are in charge of or take part in the company’s operation, bearing obligations of fidelity and diligence. In the event of any cause of dissolution, a timely liquidation procedure will help preserve the company’s asset value and prevent escalation of debts.

Hence, delegation of the role of liquidation obligor to the directors is in line with the legal definition of directorship. Any compensation will be attributed to tort liability, based on direct causality between the directors’ failure to form a liquidation group within the legally required time, and losses suffered by the company or creditor.

As liquidation group member

As part of the liquidation group, other than losses to the creditor due to deliberate or gross negligence, directors must also compensate for any company losses as a result of their negligence in fulfilling their liquidation duties.

To determine a liquidator’s liability, there must simultaneously be negligence on the part of the liquidator, losses suffered by the company, and a direct causality between the two.

With reference to article 14 of the draft amendment, liquidator’s negligence refers to the liquidator’s passive act, such as deliberate delay or refusal when the company could commence liquidation, or that the liquidation cannot commence due to liquidator’s error.

Company’s losses could refer to a depreciation of company assets or an increase in its debts; and causality between the two refers to the passive act leading to damages or loss of the company’s main property, or an inability to provide or loss of the account book or documents essential for liquidation – in turn leading to company losses during the liquidation.

Division of liabilities

The Company Law and its interpretations set out the liquidation obligations of shareholders in limited liability companies, and directors and controlling shareholders in joint stock companies, as well as compensation and joint and several liabilities of shareholders corresponding to different acts.

In reality, however, shareholders are not always in charge of the company’s liquidation property, account book or other essential documents. Consequently, it is unfair for shareholders who do not participate in company operation, nor appoint directors, to have to assume joint and several liabilities.

The draft amendment clarifies liquidation obligations between directors and shareholders in a fair, well-defined manner.

Directors are elected in shareholders’ meetings. They are responsible for company operation, experience and expertise in management, obligations of fidelity and diligence, and are capable of judging whether any cause of dissolution has occurred that would warrant liquidation. Furthermore, compared with shareholders, it is more appropriate for directors to control the company’s property, account book and other essential documents on behalf of the shareholders. It is therefore legally justifiable for directors to assume liabilities for any negligence in fulfilling their liquidation duties.

However, the draft amendment only frees shareholders of their liquidation obligations, not total accountability. If any shareholder, taking advantage of their influence over the directors, infringes on creditor’s interests by abusing the independent status of legal person or the shareholder’s limited liabilities, he/she shall bear joint and several liabilities. Directors, being part of the liquidation group, shall compensate for the creditor’s losses.

Advice to directors

In any circumstance that, by law, would cause the company to liquidate, immediately inform creditors of the cause of dissolution.

Form a liquidation group within 10 days – or in any case no more than 15 days – from occurrence of the cause of dissolution.

Directors who believe themselves incapable of completing the liquidation procedure should without delay engage intermediaries with liquidation-related expertise to assist them in fulfilling their obligations.

Complete liquidation independently and refute any shareholder orders that would infringe upon the interests of creditors or other shareholders.

Wang Zhenxiang is a partner at Jingtian & Gongcheng

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Jingtian & Gongcheng

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