The other day, in Personal Liability For Failed China WFOEs: The Law And The Reality, we wrote how Chinese law generally does not hold WFOE (Wholly Foreign Owned Enterprise/Wholly Foreign Owned Entity) general managers, legal representatives or directors responsible for the debts of a failed WFOE, but creditors and local government officials sometimes do. A few days later, an attorney inquired about the risks of an “absentee” legal representative for a soon-to-be formed WFOE. One of my law firm’s corporate lawyers responded as follows:
You are right to be concerned about this. Too many employees sign up to be an “absentee” legal representative without fully understanding what they are getting into. We just wrote about this in Personal Liability for Failed Chinese WFOEs.
The summary is: absent fraud on your part, you owe no liability to the company, creditors or employees from your normal work as a director of the WFOE. In particular, for closely held companies, I have never seen a case in China where a director was held liable to shareholders. In this case, the liability of a director of a Chinese company is less than that of a director of a U.S. company.
The reverse is true of liability to the general public. In general, directors of Chinese companies can be held liable for “bad acts” that they committed or that they supervised. Where severe damage occurs, there is strong pressure in China to make the legal representative a scapegoat, even where legal liability under the law is unclear. Common situations include all of the following:
a. Losses to creditors due to diversion of funds/assets to the director.
b. Willful failure to pay employees when funds are available.
c. Violation of labor rules by the Chinese company. For example, most foreigners are not even aware that China has a 40 hour work week. It is routine for Chinese companies to break this rule. Your own Chinese advisers may well urge you to break all the employment rules. Later, when there is a major protest, it is the legal representative (the foreigner) who will be held responsible, not the Chinese party who gave the advice.
d. Violation by the company of environmental or safety regulations where significant damage is suffered by the public. For this, note that the directors of the milk companies that sold melamine contaminated milk in China were prosecuted and imprisoned. This risk only applies, however, in cases where the director knew or should have known of the offending activities. In the cases of which I am aware, all directors held liable were actively involved in the offending activity. However, there is a strong inclination in China to impose liability on the legal representative based on the “should have known” standard, even when the legal representative was not directly involved. As with c. above, your Chinese advisers and employees will urge you not to follow the law. This will then leave the legal representative “holding the bag” when problems arise.
Note also the concluding paragraphs of my blog post. The legal representative is often the target of pressure tactics by government officials, creditors and employees in cases where payments are not made. This can be a major problem in China.
To summarize, the risk of a director/legal representative to the shareholders of a company is very low in China. The real risk in China is for liability to third parties. As you can tell from reading current press reports, the greatest risks arise from treatment of employees and from safety/environmental violations. The risk here is real since foreign companies are held to a high standard in these areas.
The above discussion is somewhat general. If you have specific concerns, I would be pleased to discuss the matter with you in more depth.
What have you seen out there in terms of WFOE legal representatives being held liable for the acts of their China WFOE?