Law Abiding Foreign Executives Can Rest Easy In China

August 15, 2014 Posted by China Briefing Reading Time: 6 minutes

Directors and officers liability insurance is valid in China to cover legal costs and other expenses while under investigation

Op-Ed Commentary: Chris Devonshire-Ellis

In the wake of the prison sentence handed down to ChinaWhys Founder Peter Humphrey, much commentary has been alluded to that suggests that foreign executives in China are now “nervous” about working in the country. These reports are erroneous.

Foreign direct investment into China is booming, and increasing numbers of executives want to place a “China” position on their international CV. So how high are the risks for foreign executives in China? The answer is, for those who abide by the law, very low.

For the majority of foreign executives in China, daily operations are far removed from the smoke and mirrors of the corporate investigations industry in China. That is not to say that executives cannot find themselves in some worrying situations from time to time. I recall moving one of my practice’s then Representative Office locations in Shenzhen many years ago, and as part of that procedure returning the RO license to the local MOFCOM officer for updating. I was given a receipt, a statement that a new license would be provided inside ten days, and happily went on a business trip to Shanghai with the office having just moved into new premises.

Cue a frantic call from that same office the Monday morning, who had undergone a spot check by the local PSB asking for a copy of the RO license – now with MOFCOM for updating. The PSB frightened my staff, confiscated some computers and generally threw their weight around. I hurried back to Shenzhen to sort it out, was promptly arrested, fingerprinted and photographed as a suspected criminal for operating an illegal office.

My temporary receipt and notice of new license production was met with a dismissive rejection. “You must have this!” said the officer, jabbing a finger at a correct license. I didn’t – it was with a separate government department, and the Police were not interested, being rather more pleased at having the chance to frighten a laowai.

“Are you concerned we have confiscated your computer?” he asked me. “Maybe we can look and see what illegal business you have been doing!” I was dismissed with a summons to return at 9am on the Thursday, and told not to leave the city. On that day he kept me waiting until 2:30pm, then marched out of his office with a curt “You’re free to go” and a large box with several of my office computers in it, and that was that.

The point of the story is that many executives in China will have faced such intimidation from time to time. Executives based in China for a long period all have their war stories to tell – I call each one “getting a China medal.” It is part and parcel of operating in a country whose own government departments are not well interlinked, police education is perfunctory and the occasional worrying of foreign executives a seasonal game sport. But China isn’t really interested in harassing foreign executives who are straight, and will even tolerate naivety and the occasional mistake.

They know we are foreigners working in an unfamiliar country and that sometimes we get things wrong.

In this regard, the Chinese are pragmatic rather than vindictive, and, given that they may want to discuss a particular situation with you, are as keen as you are to get it straightened out and back on the legal track. The payment of unpaid taxes being a case in point – the tax bureau have the ability to levy fines of up to seven times the amount due as a punishment – but rarely do unless the deceit has been planned.

In any event, foreign executives at a senior level can take advantage of directors and officers (D&O) liability insurance. D&O policies cover a range of incidents – including being sued – but in Asia and China they are overwhelmingly taken out to cover the risk of regulatory investigations.

In litigious jurisdictions such as the United States, D&O policies have near 100 percent adoption rates while tellingly in China this figure is much lower – the risk is less in China than in the U.S. over being sued for malpractice or being caught up in a corporate criminal investigation. In fact, it is part of the rarity for foreign companies and executives facing criminal charges and prison sentencing in China that makes such occasion’s front page news when they happen.

Large multinational corporations operating in China will typically have D&O cover as part of their general corporate governance arrangements, but it is much rarer among local Chinese firms, where the “guanxi” system tends to offer some protection – for Chinese nationals at least. For foreign executives operating in China, the extent of policy coverage available depends on the nature of the allegations but in general operate on the basis of “innocent until proven guilty” and will pay legal costs from the moment the investigation is notified to the insurer up until the point an individual is found guilty of wrong-doing.

The policies usually stipulate that the policyholder uses legal counsel from a pre-approved list of lawyers (for a list of China registered foreign law firms licensed to practice in China please see here. Do not use foreign law firms for any China advice or work if they are not registered under their own name in China, they are purely working through local middle man firms, and will be outside any China insurance claims). Depending upon the seniority of the executive, the average D&O policy will cover costs up to US$10 million – useful if expensive legal counsel is required to defend an employee. D&O policies have become more sophisticated in recent years due to growing demand and the changing nature of regulatory investigations.

Many policies now kick into action earlier in the process, including at the pre-investigation stage when a regulator or enforcement agency makes informal inquiries – making them useful for engagement in China.

So, while it is true that foreign executives can sometimes face some unpleasant situations when doing business in China, it is still an emerging country after all and not everything runs smoothly – the fact remains that executives are less likely to be sued in China than in the United States.

Executives who play by the rule book – even with occasional mistakes – are not the target of the Chinese authorities. Those that choose to “play the game” and accept work in grey areas of Chinese law – such as corporate investigations – know the risks. And in the meantime, there is D&O liability insurance available. All said, China is a low-risk environment for foreign executives who abide by the law they work in, and the recent media headlines can be put partly at the door of shock journalism designed to attract readers rather than being an accurate commentary on the true risks most executives will face.

Experienced China hands know full well the situation is nowhere near so bad as portrayed, and can both rely on fair treatment from the authorities to sort out innocent mistakes, as well as take comfort in D&O coverage.

Chris Devonshire-Ellis is the Founding Partner of Dezan Shira & Associates – a specialist foreign direct investment practice providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam, in addition to alliances in Indonesia, Malaysia, Philippines and Thailand, as well as liaison offices in Italy, Germany and the United States. For further information, please email china@dezshira.com or visit www.dezshira.com.

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