Civil risks facing senior officers of bankrupt enterprises

By Xu Bangwei, Jingtian & Gongcheng
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In recent years, with the large increase in the number of enterprise bankruptcy cases, the instances of the legal representative or directors, supervisors and/or senior executives of a bankrupt enterprise (collectively, “senior officers”) being sued by the administrator or creditors have become common. In light of such laws as the Company Law, the Enterprise Bankruptcy Law, etc., and typical cases in judicial practice, such senior officers chiefly face the following risks:

senior officers
Xu Bangwei
Partner
Jingtian & Gongcheng

(1)Where the enterprise goes bankrupt due to a breach by senior officers of their fiduciary duty, or duty of due diligence and care, not only may they not serve as a senior officer for three years from the date of conclusion of the bankruptcy procedure, but they are also liable for damages incurred by the enterprise. For example, in a case tried by a municipal court in Zhejiang, A (the legal representative, executive director and general manager), and B (the supervisor) of Company H jointly diverted Company H funds in the amount of RMB11.25 million (US$1.58 million) to repay B’s personal debt, resulting in the bankruptcy of Company H. After commencement of the bankruptcy procedure, the administrator of Company H sued A and B, demanding that they compensate for Company H’s losses. Ultimately the court rendered a judgment ordering A and B to jointly compensate for the economic loss of Company H in the amount of RMB11.25 million, and the corresponding interest;

(2)Where a deliberate act of gross negligence is involved in the improper disposal of property of the bankrupt company, causing the bankrupt company to incur a property loss, the senior officers will also be liable for damages. Pursuant to the Enterprise Bankruptcy Law, such improper disposal of property mainly includes the following three types:

(i) Such acts as the transfer of property without consideration, the conduct of a transaction at an unreasonably low price, early repayment of a debt, waiver of a claim, etc., during the year prior to the acceptance of the bankruptcy petition. For example, in a case tried by a county court in Zhejiang, A (the legal representative), and B (the supervisor) of Company C decided to use property of Company C to repay an amount owed by another company, but failed to exercise the right of recovery against the debtor after such repayment. After the bankruptcy of Company C, the administrator sued A and B, demanding that they jointly bear the damages in respect of Company C’s losses, a demand that was supported by the court;

(ii)Individual repayment acts within six months before acceptance of the bankruptcy petition. For example, in a case tried by a municipal court in Zhejiang, Company W, despite being insolvent, proceeded to repay a certain creditor, with A (the legal representative and chairman of the board of the company), B (chairman of the supervisory board and finance manager), and C (a supervisor), participating in the approval and handling of the repayment in question. After the bankruptcy of Company W, the administrator sued A, B and C, demanding that they jointly bear the damages in respect of Company W’s losses, a demand that was supported by the court; and

(iii) Concealment or removal of the property of the bankrupt enterprise to evade a debt, or the fabrication of a debt or acknowledgement of a fabricated debt by the bankrupt enterprise.

In practice, in addition to the above-mentioned three types of acts, if such senior officers of a bankrupt enterprise engage in other acts that breach their fiduciary duty, or duty of due diligence and care, causing a loss in enterprise property, they may likewise be liable for damages. For example, in a case tried by a court in Beijing, when conducting the bankruptcy liquidation inventory, the administrator of Company B discovered that the original accounting vouchers for certain of the company’s property were missing, resulting in a discrepancy between what was recorded in the accounts and the actual inventory results. Accordingly, the administrator sued A (the chairman of the board), B (the general manager), and C (the finance manager), demanding that the three jointly bear liability for damages.

The court held that A, B and C were obliged to duly keep the financial accounts, including the original vouchers for the enterprise’s property, and transfer the same to the administrator, but they failed to perform the obligation, and also failed to give a reasonable explanation, so accordingly there was negligence. As the missing original vouchers made it impossible to ascertain the specific amount of the loss, the court referred to the penalty amount for violating the Accounting Law and determined that A and B were liable for damages to the company in an amount up to RMB20,000.

(3)The enterprise property appropriated, or the irregular income obtained by, the senior officers is recoverable by the administrator. When the enterprise is insolvent or clearly lacks the capacity for repayment, if such senior officers are still obtaining performance bonuses, or are receiving salary-type income while the enterprise is in arrears in paying its employees’ wages, such bonuses or income will also be recovered by the administrator.

(4)While the bankruptcy procedure is proceeding, the legal representative bears such statutory obligations as duly keeping the enterprise’s property, seals and documentation, attending creditors’ meetings in a non-voting capacity, truthfully responding to questions, not leaving his or her place of residence without the court’s permission, not assuming the position of director, supervisor or senior executive in another enterprise, etc., so as to co-operate with the court and administrator in their work. The court may additionally decide that other financial personnel and managers of the bankrupt enterprise are also to bear the above-mentioned obligations. If a relevant person breaches any of the foregoing obligations, the court may give him or her a reprimand, summon him or her for questioning, detain him or her, and impose a fine. If the act by him or her affects the smooth conduct of the bankruptcy procedure, the creditors may additionally demand that the relevant responsible person bear liability for damages.

From the above-mentioned it can be ascertained that once an enterprise enters a bankruptcy procedure, not only are its senior officers required to perform their obligation of co-operating with the court and the administrator, they may additionally face the risk of bearing damages toward the enterprise or its creditors for negligence or an improper act. Accordingly, the author recommends that those senior officials promptly seek the advice of a professional lawyer and take appropriate risk prevention measures, or remedial measures, so as to mitigate or preclude relevant legal risks to the greatest extent possible.

Xu Bangwei is a partner at Jingtian & Gongcheng

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