July 12, 2024

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Being a director in China has just become much tougher

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Given geopolitical tensions and slower economic momentum, it is a difficult time to be in a position of corporate responsibility in mainland China. This week, an amendment to the country’s legal code is unlikely to make it any easier.

China’s updated company law, in effect as of Monday, expands the duties of boards and “imposes additional liabilities on directors, supervisors and executive officers”, according to a briefing from law firm Squire Patton Boggs. More broadly, it also impacts capital contributions, shareholder rights and liquidations. The new law aims to further cut down on the conflicts of interest and misappropriations of capital that are sometimes associated with China’s fast-evolving and expansive business landscape.

But in an environment characterised by uncertainty over policymaking, prospective directors, roles that are often unpaid except for expenses in China, are thinking twice. “It’s always been a little challenging to get people to agree to be officers or directors of Chinese companies, particularly joint ventures,” said Daniel Roules, a partner at Squire Patton Boggs in Shanghai. “With the changes to the law, we’re seeing greater reluctance”.

The amendments are nonetheless a sign of Beijing’s appetite to move towards “international practice”, Roules adds. They are part of a longer-term shift that goes back to the private sector’s emergence from a still-relevant Communist model.

“Things have actually changed,” says Stephane Grand, president of consultancy S.J. Grand Financial and Tax Advisory and a member 20 years ago of a European Commission programme on corporate governance in Beijing. “Contracts are a lot more reliable than they were [then].”

As the system continues to evolve, however, practices that might previously have been routine or overlooked become much greater vulnerabilities. One example emerged last week, when two employees left Adidas after a probe into an anonymous whistleblower claimed senior staff in China were receiving kickbacks.

The amended law means some small companies no longer need directors. But it otherwise requires them to act in the best interests of the company, closely inspect capital contributions when a company is formed, and makes them potentially liable for a company’s losses if capital is illegally withdrawn by shareholders, according to Squire Patton Boggs. Lawyers say management should also take note. In China, the broad scope of regulatory language can make it difficult to pinpoint what has changed compared with previous legislation and how it will be implemented.

“You don’t know how things are going to be applied until six months to a year after the regulations have come into force,” says Grand. Civil servants will be wary of incorrectly applying a regulation, he adds, and may therefore apply it strictly.

The risks of top-down pushes to reach official targets are well understood in China. In the 18th century, the writer Pu Songling depicted a satirical world in which the emperor’s obsession with cricket fighting trickles down the ranks. The protagonist is to his great misfortune appointed village chief, meaning it is his responsibility to collect the insects or risk punishment.

For current corporate directors, responsibility might also be something they want to avoid. The wider political environment in China, which includes an emphasis on anti-corruption under Xi Jinping’s third term, has added to a sense of caution in the private sector.

For any foreign prospective director, these issues are compounded by the mood in the US, where a Washington select committee closely scrutinises American business. Multinationals, given geopolitical pressures on supply chains, may now be more eager to launch internal investigations to pre-emptively prevent signs of wrongdoing emerging in the mainland. Their operations there will in many ways reflect the practices of a business culture that can often clash with conventions across the Pacific.

Despite those geopolitical tensions, China’s legal amendments are a notable reminder that there is still a shift towards international standards in certain areas. But in the specific case of directors, they also highlight an environment where the risks of responsibility are often seen to be higher than the rewards.

“A lot of people who are currently financial supervisors of companies, [or] directors, are trying to get out of the jobs,” says Grand.

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