(By You Yunting and Wang Ting) With many foreign investors establishing enterprises in China, there are many successful examples as well as the inevitable examples of failure. Bad management may lead an enterprise to eventual failure. In the situation where an enterprise goes bankrupt due to poor management, even an individual foreigner, playing the role as a director or senior officer, may have to assume personal liability. Such liability may arise from either civil or criminal laws. Today, we will discuss what kinds of liabilities directors may assume in bankruptcy liquidation.
1. Legitimate provisions towards director’s liabilities in the Enterprise Bankruptcy Law
At present, there are no specific provisions about directors’ liabilities in the Enterprise Bankruptcy Law. In other words, this matter is referred to only generally, mainly within the Article 125 and Article 128.
Article 125 of the Enterprise Bankruptcy Law stipulates that “the directors, supervisors or officers of the bankrupt enterprise that have violated the duties of loyalty and due diligence and have led the enterprise to bankruptcy shall bear the relevant civil liability. The person involved in the above-mentioned circumstances shall not act as the director, supervisor or officer of any enterprise within three years of the date of the conclusion of the bankruptcy proceedings”. As this article states, directors, supervisors or officers of a bankruptcy enterprise directly assume liability for any breach of legal duties of loyalty and due diligence.
As Article 128 of the Enterprise Bankruptcy Law provides that “where the debtor acts as prescribed in the provisions of Articles 31, 32 and 33 of this Law, causing damages to the interests of the creditors, the legal representative and other persons directly responsible shall undertake the liability for damages legally”. During bankruptcy liquidation proceedings, legal representatives and other officers in charge may also assume liability. However, this article does not clearly stipulate that directors, supervisors or officers of a bankruptcy enterprise shall take such legal liability for damages.
2. Director’s Liabilities in bankruptcy liquidation.
Pursuant to current Company Law, a company registered in China, Chinese-invested or foreign-invested, the directors, supervisors or officers in a bankruptcy enterprise must fulfill the duties of loyalty and due diligence towards its company. The duty of loyalty requires that directors pay due attention to the companies’ management to prevent their company from damage. The duty of due diligence requires directors to put their enterprise’s interests prior to their own interests. Regarding the duties of loyalty, there are rather few provisions in the Company Law. However, the Company Law places a particular emphasis on due diligence. When entering the bankruptcy liquidation process, even although the Enterprise Bankruptcy Law does not directly stipulate how the directors may apply for bankruptcy liquidation procedures with the People’s Court, it does stipulate that directors must focus on the interests of creditors and fulfill a duty of loyalty. As far as we know, the directors’ fundamental responsibilities may include for the following:
i. Keeping the debtor’s property, seals, accounting books, documents, and other material that the directors controlled.
When an enterprise applies for bankruptcy procedure, Article 25 of the Enterprise Bankruptcy Law stipulates that the administrator shall act to take over all of the debtor’s property, seals, accounting books, documents, and other material. Responsible officers, including its legal representative and directors, as well as senior officers, must fulfill their obligations to coordinate or supervise the officers of the company to assist the administrator in performing his or her duties.
ii. Directors shall not take advantage of his power in the company and engage in cancelable acts and invalid acts as regulated in Article 31, Article 32 and Article 33 of the Enterprise Bankruptcy Law.
To initiate the bankruptcy liquidation proceeding is an action designed to protect the interests of debtors. If directors in a bankrupt enterprise perform any actions which damage their company’s interests, it will damage the interests of the debtors. Therefore, the directors are subject to obligations not to harm the debtors’ interests.
Article 31 of the Enterprise Bankruptcy Law stipulates that within one year before the People’s Court accepts an application for bankruptcy, the bankrupt enterprise must not transfer its property free of charge, or at obviously unreasonably low prices, provide property security for debts that originally had no property security, pay debts in advance, or waive credits. If an enterprise undertakes any of the aforementioned acts, an administrator is entitled to request that the People’s Court to rescind the action. This means that, refraining from such activities should be considered an obligation of the enterprise. Therefore, the directors of this company, acting in their roles as managers, must not act in any of these aforementioned ways.
As Article 32 of the Enterprise Bankruptcy Law stipulates, within six months before a People’s Court accepts an application for bankruptcy, if the bankrupt enterprise is unable to pay off its debts due, and its assets are not sufficient to pay off all of its debts in full or the said legal person is obviously insolvent, but still pays off debts to specific creditors, the administrator may be entitled to request the People’s Court rescind the payoff, unless the debtor’s property benefits from such payoff.
According to Article 33 of the Enterprise Bankruptcy Law, a bankrupt enterprise must not hide or transfer property for avoidance of debts, fabricate debts or recognize fake debts. Such actions are considered invalid.
All above activities, if they are done, will severely damage the interests of creditors. Therefore, the Enterprise Bankruptcy Law has a clear provision stating that, once the above activities cause damage to the interests of creditors, related directors and officers must assume liability for such damages.
iii. Directors must not obtain unusual income or occupy property of company by taking advantage of their authority or power of office.
Even though our Company Law has established the duties of loyalty and due diligence for directors and senior officers, there is a similar provision in the Enterprise Bankruptcy Law, stating that the administrator shall recover any unusual income that the directors, supervisors and senior executives of the debtor have obtained by taking advantage of their authority or power of their office and recover the enterprise property that they appropriated using this method.
3. Form for the bearing of directors’ liabilities
During bankruptcy liquidation proceedings, the core goal is to recover the debtor’s property to the largest possible extent and to protect the interests of creditors. If directors do not obey its duties, they may bear civil liability or criminal liability.
- Civil liability
The major provision regarding a director’s personal liability in our current Enterprise Bankruptcy Law is Article 125, stating “the directors, supervisors or officers of the bankrupt enterprise that have violated the duties of loyalty and due diligence and have led the enterprise to bankruptcy shall bear the relevant civil liability. The person involved in the above-mentioned circumstances shall not act as the director, supervisor or officer of any enterprise within three years of the date of the conclusion of the bankruptcy proceedings.”
2. Criminal liability
At the same time, as to the question whether a bankrupt enterprise shall take criminal liability, there is an ambiguous stipulation in Article 131 in the Enterprise Bankruptcy Law that provides, where the violation of the provisions of this Law constitutes a crime, the person concerned shall be prosecuted for his criminal liability according to law. In other words, despite being ambiguous and vague, if directors violate their duties and this leads to them disobeying the criminal law, such directors shall assume criminal liability to the full extent incurred.
Lawyer Contacts
You Yunting：86-21-52134918 youyunting@debund.com/yytbest@gmail.com
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