Legal Representative LIabilty for WFOE

In China WFOE Closure FAQs 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 weeks ago, an attorney inquired about the risks of becoming an “absentee” legal representative for a WFOE whose existing representative would be leaving. One of my law firm’s corporate lawyers responded as follows [modified to hide identities and to be more blog-like]:

You are right to be concerned about this. Too many employees sign up to be an “absentee” legal representative without  understanding what they are getting into. Absent fraud on your part, you legally 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, we have never seen a case in China in which 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.

But the reverse is true of liability to the general public. In general, directors of Chinese companies can be held liable for “bad acts” they committed or 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 not at all clear. Common situations where this sort of thing happens include the following:

a.  Losses to creditors due to diversion of funds/assets to the director.

b.  The company fails to pay employees when funds are available.

c.  The company violates China labor rules. Your own Chinese advisers may urge you to “fudge” on the employment rules. But later if there is a problem stemming from this, it is the WFOE’s legal representative (the foreigner) who is held responsible, not the Chinese party who gave the advice.

d.  The company violates environmental or safety regulations that damages the public. This risk usually only applies where the director knew or should have known of the offending activities. In the cases of which we are aware, the directors held liable were involved with 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, it is not uncommon for your Chinese advisers and employees to urge you not to follow the law. This will then leave the legal representative on the hook when problems arise.

To summarize, the risk of a director/legal representative to the shareholders of a company is low in China. The real risk in China is for liability to third parties. The greatest risks for legal representatives typically stem from how the company treats employees and from safety/environmental violations. Combine employee and safety and you ought to have realized that how you treat your employees with respect to COVID can be quite risky. Foreign companies are held to a high standard in these areas because the CCP feels it must act against the foreigner so as to show Chinese citizens that the CCP is their protector.

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 are you seeing out there in terms of WFOE legal representatives being held liable for the acts of their China WFOE?