China Law Blog

Alls I knows is this is China, and somebody's gonna get the death penalty for this.

Today, the press released that there are more BIG BRAND company has serious problems with the milk. It really sucks. My friend's 3 yrs son was on sanlu product for 2 months. I can see her worries.

When can those businessman really care about our society and people and so does the quality control department, who should find this ages ago, not today !

But doesn't the duty of the director to maintain secrecy stop when there are potential criminal violations of the law? I think the advice may be skewed because people are looking at this from a director duty point of view rather than a criminal or civil negligence point of view.

The specific case law in the United States is United States v. Park 421 US 658.

In situation where the director's secrecy results in a death of an individual, they would be subject to a charge of at best of being an accessory to the crime, since there as far as I can tell, no immunity given to this information.

Here is an article that I found on the relevant US law

http://www.dcba.org/brief/mayissue/1997/art50597.htm

As far as Chinese law goes. Article 148 of the Company Law requires that directors obey the law, and Chapter 8 of the Pure Food Law imposes criminal penalties for causing food poisoning. Given the state of the law, I'd much rather deal with a shareholder's lawsuit for breach of fiduciary duty then be held on charges of homicide.

Also learning something along the lines of tainted milk is not the same thing as learning about tainted milk. Both the US and China have laws specifically dealing with impure foods, and in situations where human life and safety is at risk, general principles of corporate duty do not apply.

There is the legal aspect, and fiduciary duty to shareholders. And then there is human duty. How would the directors have acted if the milk was not sold to anonymous Chinese mothers and babies, but was sold in their own home market with the risk that their wives and children could have been affected by it?

If criminal or civil negligence outweighs director duty, and foreign execs are found to have broken Chinese law, what happens then?

Given that they might argue (truthfully or not) that lower government somehow prevented the company from acting, it seems unlikely that the New Zealand govt would be comfortable (for political as much as moral reasons) with those execs being tried. And where would that lead?

TwoFish,

You have it wrong.

Steve discussed this very issue with the Chinese lawyers and looked at the various laws (in Chinese) himself. The law is very clear on this issue. In this type of setting, where there is a safety issue, criminal liability is only possible in a case where the director or other individual had direct supervision over the activity involved. Directors who act in the normal director capacity are not criminally liable.

If this were not the case, nobody would serve on a Chinese board, since these kinds of problems are all too common in China.

US law is pretty much the same. I looked at U.S. v. Park and you are misreading that case. The defendant in that case was the president of the company who was directly responsible for the violating acts. On a "knew or should of known" principle, he was held liable for sanitation violations. Note the case went all the way to the supreme court because the issue was controversial. This person was not a director or a shareholder.

Park does serve as a good lesson though for foreign participants in Chinese Joint Ventures. If they ARE in a direct supervisory capacity such as general manager or representative director, then they CAN be held liable, even if they did not directly participate in the violations. It is "knew or should have known." There is basically no real difference on this issue between Chinese and U.S. law, primarily because the Chinese have copied U.S. law on these issues.

Clearly someone in San Lu is liable. The Chairman/General Manager is in jail right now. However, the directors are not liable, nor are the shareholders, whether majority or minority, nor are the employees who were simply doing as they were told. If you widen the liability too far, no one will serve as a director and no one will act as an employee.

Dan: In this type of setting, where there is a safety issue, criminal liability is only possible in a case where the director or other individual had direct supervision over the activity involved. Directors who act in the normal director capacity are not criminally liable.

Whether someone has be in a situation where he has supervisory authority or "known or should have known" is highly situation dependent. A director could find themselves in a supervisory situation even without a formal title.

In any event, a lot of JV's do find themselves in a situation where they do have minority ownership but have appointment power over key persons, and in that situation the outcome is *very* different.

One other wrinkle in all of this is that a director in a JV is usually an agent of a parent company. If there is an issue within the JV, they have the duty not only to inform the board of the JV, but also the managers in the parent company. The managers in the parent company do not have a fiduciary duty to the JV, but rather to the parent company so if the JV declines to report the situation, it may be that the parent company disagrees. This actually seems to be what happened in the Sanlu situation.

Dan: In particular, the director has an affirmative duty to maintain the secrecy of the information, regardless of what the director thinks about the matter personally. The duty of the director is to the company, not to the general public.

However, you may have a different situation depending on how egregious the situation is.

If a director finds out that the chief executive is pouring arsenic into the milk, and lives could be saved by making that fact known to the authorities, and if the board chooses to do nothing, then there is no principle of law that I can see that would prevent the director for going to the authorities, and under many situations you could find yourself in more trouble for keeping quiet than for not keeping quiet.

To be fair, most real world cases are much more ambigious and the typical situation is one in which a director finds information that might be the cause of a problem or maybe not, and often the course of action is much more unclear. Usually the people that are actually doing this misconduct are actively hiding information from the Board, and often it's not clear whether there really is any misconduct.

Dan: If you widen the liability too far, no one will serve as a director and no one will act as an employee.

There's a tricky balance here also that if you make the penalties too severe then people will intentionally overlook a bad situation. In designing these sorts of laws there is a lot of thought given into avoiding perverse incentives.

On the other hand, if you make the penalties too lax then you end up with people overlooking a bad situation, and you certainly don't want to give a group of people on a board the power to block other people from doing morally sensible things.

This results in very complex rules, but usually these rules tend to make intuitive moral sense once you look at them. For example, if your boss asks you to put chemical A into milk, then you aren't going to be liable if chemical A is arsenic. However, if you have these big bags marked arsenic poison and your boss orders to you to dump them into milk, then you aren't going to have a defense at all.

So I'd add one more very important rule which is that rules on director duties are extremely situation dependent, and that if you get into a situation where you are doing something that is bothering your conscience or which just doesn't feel right, that you should find your own lawyer to see what the legal situation is in that specific case and not rely on general rules which may not be applicable.

Although situations in which there is a direct conflict between personal conscience and the law find themselves often in legal dramas and hypothetical situations, usually what the law tells you you should do is more or less consistent with what the conscience of a "reasonable man" tells them what they should do, so if it just *feels* wrong, then that's a sign that you should get your own lawyer to look at a situation.

As far as legal analysis of the situation in which a board of directors votes to hide information about a problem. Under the Company Law, Article 149(7) requires that directors and senior managers keep company secrets, secret. However to declare something a company secret would require a civil juristic act, and under the General Principles of Civil Law Article 55(3) and Articles 58(5), civil juristic acts that violate the law or are against public interest are void. Basically Chinese corporations do not have legal authority to force people to do things that would be against law or public interest.

In a common law jurisdiction, there would be a similar balance act between "fiduciary duty of loyalty" and "public policy."

Yet another interesting legal wrinkle....

If one of the JV partners is a publicly financed Chinese corporation.

Article 67 of the Securities Law imposes a duty on directors to make public a major event that may considerably affect the trading price of a listed company's shares and Article 67(6) includes as a major event "a major change in the external conditions for the business operation of the company." Finding out that you are part of a JV that is making tainted food products is something that I think would be considered a major event.

Also Article 69 makes directors jointly and severely liable for false records, misleading statements, or major omissions in prospectuses used for financing through issuance of corporate bonds.

There are similar provisions in US securities law.

This is a strech, but if one of the partners in the JV is a publicly traded American firm, I think that you might be able to impose personal liability on directors and senior managers of the parent corporation for non-disclosure based on Sarbanes-Oxley. (i.e. if you knew that the company had been selling tainted products, you knew that when someone found out that there would be massive lawsuits and loss of business, and you didn't inform the accountants or include that in your financial filings).

Sorry to keep posting on this, but the more I think about this, the more legally fascinating it is.

One other bit of constructive criticism that I have is that the lawyers that were thinking about the problem were doing so from the point of view of the individual director. If you think of things from the point of view of the manager within the parent company of the JV, different things come up.

In particular if a manager in a parent company can control the votes of fraction of the board of directors, I think you can argue that the manager or the parent company has supervisory powers even if none of the members of the board do. Also, normally shareholders aren't liable for criminal acts committed by the management of a company. However, this is based on the fact that shareholders normally do not have much information or control over the activities of management, and not from some general immunity that results from the corporate form.

However, a situation where a shareholder does have a lot of influence might create a new situation. If a parent company could stop an illegal action by threatening to close down the JV, but refuses to do so, we may have a very different situation from that of an "ordinary director or shareholder." Yes, this is a new, novel, and untested view of the law, but if you have a prosecutor who has reporters banging on his door wanting him to "do something" then you might have him try to invoke new, novel, and untested views of the law.

So what a person do to when the law is so murky and complex?

*Act like a decent human being*

Most people in business are decent human beings, and if you act decently, then people will try to figure out legal theories to make sure that nothing bad will happen to you.

Conversely, if you act very badly, then there will be a lot of people that will want to nail your hide to the wall, and with lots and lots of people angry enough to try to find some legal way to get to you, they'll probably find something.

I haven't researched how one would or could use securities fraud, mail fraud, wire fraud tax evasion, the Alien Tort Claims Act, Sarbanes-Oxley Act, and the RICO Act against someone that was acting very badly, but I'm sure that given some effort, someone clever can find something.

Twofish,

Keep 'em coming. Please. Absolutely no apology necessary. These are critically important issues and damn complex. I plan to do a blog post on it, but first we (Steve and I) really need to get on top of the laws involved, of which there are many.

I ALWAYS appreciate well thought out comments -- whether I agree with them or not. Your comments always qualify and are always appreciated.

I have to side with twofish. And without intending to attack anyone personally, shall we look at what one of Fonterra's appointed director was reported to have suggested that overseas investors in China ought to get on the same wavelength with the locals in order to succeed and he talked about how old experiences do not matter and the Chinese market requires quick production line renewal because of fierce competition etc. When people go to China, learn, how should I put this, all Machiavellian ways of doing business, that person might have achieved a short term personal goal, but at what price?

I am a Chinese/Common law lawyer. I think all the talks about fiduciary duty is off the mark. None should ever be exonerated for say a charge of murder by claiming that other people decided on his behalf to carry the act of murder as a team. Same applies to a board of directors. When public interest is at stake, lift the corporate veil is appropriate and called for. If one chooses to work in the food industry, become a senior executive of a major food company that supplies food to quarter of the world that really counts and get on the same wavelengths of local people, then that person must also remind himself of a bit of sensitivity on not killing your consumers. Failing to understand that ought to at least disqualify such people willingly or negligently involved from public office or to serve as a company director. After all, we do not allow people financially broke to work as directors, why should we then allow morally questionable people?

It is trendy this week to call other people as too greedy. Maybe it is not fair to blame investment bankers at this time. But in this case for Fonterra, its management was proven too greedy and too careless. Yes, Fonterra made lots of money from China since it bought into Sanlu. Also so far nobody can prove beyond any level of doubt that Fonterra is even revealing the truth now. All the talks about they became aware of the bad milk powder in early August is not sustained by any collaborative evidence, even if, Fonterra has to admit to incompetence or negligence of its staff at Sanlu. When Fonterra bought into that group, it promised to fully integrate the JV’s supply chain management with its own. Have they?

This is the kind of event that disproves the popular theory that the earth is flat. It is not. And unless people start behaving themselves in China, it will remain a dark place to be, with gold to not. I hope people might learn from this truly tragic event from both the consumer and the investors’ perspectives.

Also, the notion that increased director’s duties would lead to a shortage of qualified people willing to become company directors is out of date. Directors in modern multinational companies get paid simply too much money; qualified people will take those posts. For smaller firms, well their directors ought to have better control of the operation and so long they do that, and do others within the law, they will do fine and plenty people will want to have their jobs...

One other thing manifest in this case, is a solid example of how the rule of law and Chinese style media controls are incompatible.
As I understand it, edicts such as the one prohibiting reporting on food problems during the Olympics do not have the status of law. And yet people are expected to obey as if they were law, to the extent that other laws might be broken by their compliance.
I'm sure Sanlu's chairwoman will be severely punished for this, but I feel that she can't possibly have a fair trial, given that the media controls that she (as section of the company's Party chapter) was privy to and expected to comply with, will never be part of that trial.

Furthermore, as Pamanush points out, Fonterra has always been keen on adapting to the Chinese environment, and their defense in this case has been that they thought it better to apply pressure within the system, rather than making unilateral media statements (during the Olympics, no less). Will this dent the confidence of the work-within-the-system approach to foreign business in China?

Wow, exellent point by JL.. Let's just say it would be a very, very interesting development if such edicts had to be adressed publicly or in court.