Lifelong liability aims to improve oversight of SOEs

On 23 August, the General Office of the State Council issued the Opinions on Establishing a System for Pursuing Liability for Illegal Operations and Investments by State-Owned Enterprises. The opinions are an integral part of the series of documents for intensifying the reform of state-owned enterprises (SOEs).

THE OBJECTIVES

Aiming at improving the oversight of state-owned assets and preventing the squandering of them, the opinions set the following objectives: creation of a system for pursuing liability for illegal operations and investments by SOEs and a liability retracing mechanism by the end of 2017, so as to set the rules for pursuing liability; and comprehensive establishment of a liability pursuit work regime covering authorities that perform investment duties and SOEs at every level, so as to give rise to a liability pursuit work mechanism in which the duties and procedures are clearly defined.

For each SOE, the first order of business will be the establishment of its own system for the pursuit of liability for illegal operations, giving greater detail to the principles, scope, basis, triggering mechanism, procedure, method, criteria and duties of and for operation and investment liability pursuit, and submitting the above-mentioned regulations to the authority performing the investor duties for the record.

PURSUIT OF LIABILITY

The opinions set out 54 circumstances in which the pursuit of liability is required at those stages where the problem of illegal operations and investments are concentrated, including: group management and control; sale and purchase management; project contracting and construction; transfer of property rights and of the equity and assets of listed companies; investment in fixed assets; investment and acquisition; restructuring and reorganization; and fund management and risk management. The coverage of these nine aspects is wide ranging. They are practical, and a catch-all provision has also been included for “other instances of violations of regulations where liability ought to be pursued”, placing stringent requirements on SOE personnel.

In the case of transfers of property rights and of the equity and assets of listed companies, liability will be pursued where the decision-making and approval procedures are not carried out in accordance with regulations or the transfer is carried outultra vires, the financial audit or asset appraisal violates relevant regulations, the provision or disclosure of false information is arranged for, or an intermediary firm is manipulated into issuing a fraudulent financial audit or asset appraisal result, resulting in the loss of state-owned assets or other serious adverse consequences.

Public-private partnership (PPP) projects are now being rolled out on a grand scale throughout the country, of which SOEs constitute the backbone. In situations where an SOE and private enterprise co-operate together as social investors, and there is equity co-operation between an SOE and a financial institution, a PPP project is transferred, etc., then a transfer of state-owned property rights will often be involved, and an appraisal stage is also mandatory. At such time, the persons serving as an enterprise’s decision-makers, and the specific executors of the SOE’s project, need to carry out the financial audit and asset appraisal procedures in accordance with the state and enterprise internal decision-making procedures, and engage a qualified third-party appraisal firm to carry out the appraisal procedure, with the property rights transfer price to be determined based on the approved or filed appraisal result.

In the case of investments and acquisitions, liability will be pursued for the following acts: failing to do due diligence according to the law or failing to carry out a risk analysis in due diligence giving rise to major omissions; carrying out the financial audit or asset appraisal or valuation that violates relevant regulations; instigating or directing an intermediary firm to issue a fraudulent report; failing to include provisions on the protection of state-owned equity in the investment contract and the enterprise’s articles of association; losing control over enterprise management; failing to exercise shareholder rights after the investment or the acquisition of the equity interest; failing to promptly take stop-loss measures after the occurrence of a material change; or paying the acquisition moneys early in violation of the contract.

Violations of regulations cover the entire procedure involved in an enterprise investment or acquisition. At the initial stage, the enterprise is required to conduct legal and financial due diligence in accordance with regulations. In the past, some enterprises paid little heed to due diligence of the target enterprise that they were acquiring for consideration of 0 or 1 renminbi, resulting in their bearing serious legal consequences after the acquisition.

Second, at the contract negotiation stage, it is important to engage a professional legal advice firm to get a grip on the risks, and to include provisions for the protection of state-owned equity in the investment contract or acquisition agreement, and the articles of association, to ensure the interests of the SOE shareholder.

Finally, at the contract performance stage, it is important to perform the contract in strict accordance with its provisions and prohibit the early payment of the price in violation of the contract.

BEARING LIABILITY

The opinions expressly specify that the system for the pursuit of lifelong liability for material decisions signifies that even if the operations and management personnel of an SOE are transferred to other positions or retire, they remain subject to the pursuit of their liability and will still be required to bear liability for the losses of state-owned assets and other serious adverse consequences caused by their failure to perform, or due to their incorrectly performing, their duties.

The means of bearing liability include docking of pay, disciplinary sanctions, transfer to the judicial authority, etc., either singly or in combination. The relevant responsible persons will not only face such organizational penalties as suspension, demotion, forced resignation, etc., but also the penalty of a pay deduction, and not only deduction from the performance annual salary for the year in question, but also recovery of incentive income for the preceding three years of service, delayed payment of their performance annual salary, and termination of the unexercised portion of their medium and long-term incentive benefits. They also may not be able to participate in new medium and long-term incentives of the enterprise for a number of years.

Wang Jihong is a partner and Liu Ying is an associate at Zhong Lun Law Firm